-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C/jnLAYw7sUu5lHu67EfMkS1uaqsFgO3aG0/HgQ5VISiYiDL9/7hGl/hbhjEcDqJ HJSqKXHPAwIu88UIDpZzYw== 0000898430-01-001202.txt : 20010409 0000898430-01-001202.hdr.sgml : 20010409 ACCESSION NUMBER: 0000898430-01-001202 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DAOU SYSTEMS INC CENTRAL INDEX KEY: 0001003989 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-RETAIL STORES, NEC [5990] IRS NUMBER: 330284454 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22073 FILM NUMBER: 1591380 BUSINESS ADDRESS: STREET 1: 5120 SHOREHAM PL CITY: SAN DIEGO STATE: CA ZIP: 92122 BUSINESS PHONE: 8584522221 MAIL ADDRESS: STREET 1: 5120 SHOREHAM PL CITY: SAN DIEGO STATE: CA ZIP: 92122 10-K 1 0001.txt FORM 10-K FOR PERIOD ENDED 12/31 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 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, 2000 [_]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 23, 2001 was $4,502,919. As of March 23, 2001, the number of issued and outstanding shares of the Registrant's Common Stock was 17,830,634. Portions of the registrant's Proxy Statement for its 2001 Annual Meeting of Stockholders are incorporated herein by reference into Part III of this Form 10-K. If the Proxy Statement is not filed with the Securities and Exchange Commission in definitive form prior to April 30, 2001, the registrant intends to amend this report to include information omitted from Part III hereof. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 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") performs applications consulting and implementation, traditional network services, remote help desk and related technology support services and integrates legacy systems with emerging technologies, such as wireless and other portable computing solutions for the U.S. healthcare industry. DAOU's IT offerings include data and voice networking, applications consulting and implementation, as well as operational and Internet solutions. DAOU has approximately 340 employees, and has provided services to more than 1,300 health care organizations, including many of the nation's top 100 integrated delivery systems and middle market payor organizations. DAOU is principally focused on providing IT services and solutions to healthcare organizations, such as managed care and insurance companies, integrated delivery networks (IDN's), hospitals, medical groups, academic medical centers and government organizations. DAOU's key competitive advantage is its extensive knowledge and experience in the healthcare industry. Through extensive research and its 15 member chief information officer (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 payor/insurer segment of the market (health maintenance organizations (HMO), health insurers, blues plans, independent practice associations, preferred provider organizations (PPO), physician/hospital organizations); in the provider arena (integrated delivery networks, hospitals, physician groups, ancillaries); as well as in the administrative/vendor segment (third-party administrators, medical services organizations, service vendors, software vendors, hardware vendors). DAOU's operating philosophy is to meet or exceed the customer's objectives and to pursue 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, until December 31, 2000, 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"). On December 31, 2000, the Company merged all of its subsidiaries with and into the Company. 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 info@daou.com; and its URL is http://www.daou.com. 1 Reorganization On February 6, 2001, DAOU Systems, Inc. announced that it had consolidated the operations of its five former subsidiaries into two divisions. DAOU has been a leading provider of IT solutions to the healthcare industry since 1987, helping over 1,300 healthcare enterprises and vendors, including many of the nation's top 100 integrated delivery systems and middle market payor organizations, identify and solve technology, process, and resource challenges. Pioneers in the assessment, design and implementation of network solutions for healthcare, the Company believes the new structure will better serve its clients in the areas of strategic consulting, applications, infrastructure and operations. The principal elements of the reorganization were the formation of an Application Services division and a Technology Services division. Application Services combines the Company's IT Consulting and Managed Care Implementation and Application Implementation groups. The Technology Services division is the combination of the Company's Communication Infrastructure, Application Development and Integration Services, Outsourcing, and Internet and Electronic Commerce (formerly known as Enosus) groups. The Company believes the consolidation was necessary due to changing market forces in the healthcare industry. The Company also believes that two operating divisions will allow DAOU to focus on its core competencies and more profitable lines of service. The Application Services division provides clients with strategic consulting (eHealth, mHealth, HIPAA, and application selection), software implementation, project management, and support services, including staff augmentation. Additionally, this division assists clients by recruiting strategic skill sets for their critical long term needs. The Technology Services division provides clients with solutions in key areas, including network infrastructure (servers, data and voice networks, and security), application and web development and integration projects, help desk solutions (remote or on-site) and network management. In addition to the two divisions, a Strategic Services Office was created to identify and develop capabilities and services responsive to emerging technologies and applications, such as wireless and other portable computing solutions. Application Services Division DAOU's Application Services division provides strategic consulting, application (software) implementation, project management and support activities. IT Consulting and Managed Care Implementation Services The IT consulting and managed care implementation services help healthcare management meet their business and IT objectives and anticipate and plan their future IT needs. Senior consultants offer clients the benefit of overall project management vision as well as application and technical skills appropriate for specific assignments. The division works with its clients in a goal-directed, strategic partnership to achieve results in a timely and cost- effective manner. Among its specific capabilities, the division installs and integrates applications, manages IT systems, and develops business plans and solves problems for healthcare IT managers. More than two-thirds of DAOU's consulting revenue derives from the implementation of managed care systems such as Erisco's(R) Facets(R), McKessonHBOC's AMISYS(R), QCSI's QMACS(R), and HSD's DIAMOND(R) 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. 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. 2 Application Implementation Services Application implementation services include supplying temporary, vendor- certified consultants to hospitals and other healthcare organizations. The primary focus is assisting customers with the installation of third-party software applications such as McKessonHBOC-STAR(R), SMS INVISION(R) and most other commonly used healthcare software applications. The application implementation group provides expertise in application implementation, project management, interim IT management, application programming, system programming, decision support and interface support. The group also supports the following service lines: . healthcare information systems; . clinical systems; . financial systems; . decision support systems; and . interface support. The engagement period for these services generally averages three to 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. Technology Services Division The Technology Services division provides clients with solutions in key areas, including network infrastructure, application and web development and integration projects, help desk solutions and network management. Communications Infrastructure Communications infrastructure services focus on IT infrastructure solutions for healthcare enterprises, including IDN's, hospitals and large academic medical centers. 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. 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. 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 on a percentage of completion basis as services are performed. DAOU's voice and data solutions services provide leading-edge voice and data solutions to IDN's, hospitals, academic medical centers, educational institutions, architects and government organizations. 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. The engagement period for voice 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 3 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. In 2000, the Company offered desktop computing services to healthcare providers, primarily IDN's, to optimize, understand and manage the cost of desktop computing. These services enabled customers to appropriately balance their end-user service levels with costs. Consultants also assisted healthcare organizations in the preparation of and transition to co-source or outsource strategies for help desk, call center and IT department/facilities functions. Communication infrastructure consultants also provided 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 included asset inventory and management, PC configuration and rollout, development of hardware/software standards and technology refresh. In 2001, the Company has limited its focus in this area. The engagement period for these services generally averages three 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. Application Development and Integration Services DAOU's application development and integration services provide 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: . MUMPS-based 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, diagnosis-related groups, materials management, patient accounting, medical billing, healthcare information systems 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. Outsourcing DAOU's outsourcing services provide remote help desk and related technology support services, support and management services that are designed to maintain the effective performance of a customer's computer network system, as well as IT function outsourcing services that are designed to manage a customer's information services functions. As healthcare IT systems become more complex, 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 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. 4 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. 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: . Remote Help Desk. DAOU provides technical information system support via its remote, Support Center Practices certified, call center using integrated telephone, web and e-mail. DAOU's customized service to healthcare related customers utilizes best-practices, service level agreements, and service level guarantees. . 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. 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 a 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 or fee per call basis. Internet and Electronic Commerce The Internet and electronic commerce services provide consulting services to healthcare organizations for Internet, web development and electronic commerce (eCommerce) services. These services were delivered under the name Enosus for the year 2000 and included customers outside of the healthcare industry. Enosus marketed these services to healthcare companies and other small to medium businesses seeking to outsource some or all of their Internet and eCommerce requirements. Enosus developed its own sales team that focused on providing services to eHealth companies and supporting venture capital firms efforts to accelerate the IT capabilities of their start-ups. In addition, Enosus utilized the Company's existing service offerings to provide data and voice 5 services to its customers. On February 6, 2001, the Company announced as part of its reorganization, the consolidation of Enosus into its Technology Services division, focused exclusively on the healthcare industry. There are three categories of services for Internet and eCommerce: . innovation services to assist healthcare organizations 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. DAOU Advisory Board In 1994, the Company established its Advisory Board (the "Advisory Board"), a non-governing body currently comprised of 15 CIOs of various healthcare provider organizations. The Advisory Board meets bi-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. Peter Strombom, Chief Information Officer of Meriter Health Systems, currently 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. In 2000, the Company maintained 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, STC, Sunquest, 3Com, McKessonHBOC, SMS, and other leading application vendors. In addition, the Company is a member of leading technological forums and organizations, including the Healthcare Research and Development Institute (HRDI), the ATM Forum, the Center for Healthcare Information Management (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 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, integration programmers 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 6 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 Effective February 6, 2001, the Company announced a reorganization of its national sales force to create separate sales teams for each of its newly created divisions: Application Services and Technology Services. In 2000, the Company's communications infrastructure, application implementation, outsourcing and eHealth sales were generated primarily from corporate-managed regional sales organizations located in the west, central, northeast and southeast regions of the United States. A vice president managed each regional organization and oversaw the development of new customers and the management of existing customers by local business development directors. The corporate- managed sales team generally sold to providers, such as IDNs, hospitals, academic medical centers and large clinics. Each of the Company's business units maintained smaller, dedicated business development teams dedicated to pursuing opportunities within specific healthcare IT technology market segments. DAOU's IT Consulting sales team marketed 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 marketed its services to clinical and governmental organizations. Enosus, the Company's eCommerce and Internet solutions provider, now known as Internet and Electronic Commerce group, maintained 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, 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 a leading provider of integrated information technolgy solutions and services to the U.S. healthcare industry. 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 continues to develop its presence on the Internet as a new marketing channel. The Company has entered into a marketing agreement with McKessonHBOC, which markets the Company's services to their customer base. The Company also has entered into a marketing alliance with SeeBeyond, whereby, as one of SeeBeyond's preferred information system integration vendors, the Company offers computer network design, implementation and support services to SeeBeyond's customers. The Company intends to pursue additional marketing agreements, joint ventures and alliances as part of its marketing plan. In addition, the Internet and Electronic Commerce group 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. 7 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; . value added resellers; . 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 McKessonHBOC and Shared Medical Systems Corporation; hardware firms such as Cisco Systems, Inc., Marconi Communications, 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 may compete against a different group of companies. For example, the integration services group of the Technology Services division competes against the information technology companies and consulting firms, but has little competition with hardware or networking telecommunication firms. The Internet offering of the Technology Services division 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. 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 application and 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, system 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. 8 Customers The Company has provided services to over 1,300 U.S. healthcare organizations, including many of the top IDNs and middle market payor organizations. The Company provides services to managed care and insurance companies, IDNs, hospitals, academic medical centers, government organizations and medical groups. In 2000, Enosus pursued selective business to business (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 years ended December 31, 2000 and 1999, the Company's five largest customers accounted for approximately 33% and 26% of total revenues, respectively, with Saint Mary's Health Network (SMHN) accounting for approximately 16% and 10% of total revenues, respectively. For the year ended December 31, 1998, the Company's five largest customers accounted for approximately 19% of total revenues, with no single customer accounting for 10% or more of total revenues. On February 27, 2001, SMHN, the Company's largest client, notified the Company of its intent to terminate the outsourcing agreement. The Company is currently negotiating the termination and transition agreement in which the Company will transition all of its on- site employees to SMHN effective March 31, 2001. The settlement includes a transition fee from SMHN to cover transition costs. In 2000, the Company's top five revenue generating customers were from the following business segments: 1. Outsourcing; 2. Outsourcing; 3. Application Development and Integration Services; 4. Outsourcing; and 5. Outsourcing. Employees As of December 31, 2000, the Company employed 406 technology and support professionals. Of these employees, 32 were involved in IT Consulting and managed care implementations, 34 in communications infrastructure, 66 in application implementation, 58 in integration services, 117 in outsourcing, 17 in Internet and electronic commerce (formerly Enosus) and 82 in sales and marketing, finance, human resources, recruiting and administrative. The Company employs full-time recruiters dedicated to the hiring of its technical and support professionals. The Company also has an internal 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. In 2001, the Company reduced its workforce in connection with its restructuring plan. As of March 23, 2001, the Company employed 343 technology and support professionals. Of these employees, 37 were involved in IT consulting and managed care implementations, 25 in communications infrastructure, 55 in application implementation, 50 in integration services, 116 in outsourcing, 5 in Internet and electronic commerce (formerly Enosus) and 55 in sales and marketing, finance, human resources, recruiting and administrative. 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 9 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. The Company may not successfully manage its business operations if it fails to hire, train and retain qualified software application consultants, computer network engineers, integration programmers and key management employees. DAOU's business strategy depends in large part on the services of its key management and technical personnel such as software application consultants, computer network engineers and programmers. These personnel are in short supply, and the competition for their services is intense. This shortage is especially acute for software application consultants, senior network engineers and programmers who have experience in and understand the payor organizations, 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 its Internet and wireless offerings. 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, increased competition for their services and recent reorganization. The Company continues to face significant challenges and risks relating to its acquisitions consumated during 1997 and 1998, including the standardization of diverse employee compensation and benefit programs, training and policies and procedures. Any inability to hire, train and retain a sufficient number of qualified applications consultants, 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. During 2000, the Company has experienced turnover in its senior management. In October 2000, after the resignation of Donald Myll, the Company appointed Neil Cassidy to serve as its Chief Financial Officer. In addition, in November 2000, after the resignation of Larry Grandia, the Company appointed James Roberto to serve as its Chief Executive Officer. Mr. Grandia, however, remains a member of the Board of Directors of the Company. This transition of management personnel may adversely affect the Company's 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 33% for the year ended December 31, 2000, 26% for the year ended December 31, 1999, and 19% for the year ended December 31, 1998. The loss of any large customer could materially and adversely affect its revenues and financial condition. On February 27, 2001, the Company's largest client, Saint Mary's Health Network ("SMHN"), notified the Company of its intent to terminate its outsourcing agreement with the Company as of March 31, 2001. The client accounted for approximately 16% of revenues for the year ended December 31, 2000. 10 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. On February 27, 2001, the Company's largest client, SMHN notified the Company of its intent to terminate the outsourcing agreement with the Company as of March 31, 2001. The client accounted for approximately 16% of revenues for the year ended December 31, 2000. The Company may experience disruptions in its business operations and increased expenses if it does not effectively integrate its business segments. DAOU's acquisitions during the last few years have placed significant demands on its management, operational, technical, financial and other systems and resources. These acquisitions have: . 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 employee compensation and benefits programs, human resource policies and procedures, 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 implemented a new enterprise resource planning software application that is designed to coordinate accounting, utilization management, purchasing and other management functions. The Company must continue 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 continued demands caused by the integration of its acquisitions. 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 McKessonHBOC and Shared Medical Systems Corporation; 11 . system integrators such as Science Applications International Corporation, Electronic Data Systems Corporation and Perot Systems Corporation; . telecommunications providers and network equipment vendors; and . eCommerce consulting firms such as IXC, Scient, Viant and Razorfish. The Company also competes with smaller regional IT 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 applications and 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 its emerging Internet service offerings, a single provider may dominate the market. The Company's business, financial condition and operating results, could be severely harmed if its emerging Internet service offerings do not compete successfully against current or future competitors. Most of DAOU's 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. DAOU's Internet 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 the Company's 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, during and after HIPAA compliance, 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; . the effect of negative publicity relating to the Company's possible delisting from the Nasdaq National Market System; . government regulations; . the reduction in size, delay in commencement, interruption or termination of one or more significant projects; 12 . the loss or termination of preferred partnership relationships with software vendors or hospital groups; . 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 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 applications consultants, 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. Through its emerging technology service offerings, 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 its emerging technology service lines. In February 2000, the Company began to offer Internet and eCommerce services to its traditional healthcare customers and to other non-healthcare related entities under the name Enosus. However, the Company decided not to continue the Enosus' business model outside of the healthcare industry. The Company may not be able to successfully provide emerging technology services. 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 its emerging technology service offerings business plan. DAOU's emerging technology service offerings 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 DAOU intends to offer end-to-end Internet and eCommerce services to its customers, the Company does not believe that it initially will have all of the necessary employees in place to perform each of these services. Accordingly, DAOU 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 DAOU's customers with quality service, then DAOU may lose the affected customers. In addition, if DAOU loses one or more of these service providers, even for a short period of time, then DAOU may not provide its customers certain Internet and eCommerce services that it is contractually obligated to provide. 13 The success of DAOU's emerging technology service lines will depend on the increased acceptance and use of the Internet as a medium of commerce. The ability of DAOU 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 DAOU's emerging technology service lines 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 the Company 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. 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 healthcare applications and computer networks. The markets for software applications and computer network products and services are continuing to develop and are characterized by rapid change, including emerging Internet based solutions. 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. 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 17,830,634 shares outstanding as of March 23, 2000, 14,195,083 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 3,635,551 shares are "restricted securities" as defined in Rule 144. In September 1999, the Company 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 an aggregate of 5,000,000 shares of common stock under the DAOU Systems, Inc. 1996 Stock Option Plan. An additional 750,000 shares of common stock were subject to options issued outside of the Company's 1996 Stock Option Plan. In December 2000, the Company also registered an aggregate of 1,500,000 shares of common stock under the Daou Systems, Inc. Employee Stock Purchase Plan. The Company has also issued warrants exercisable for 3,540,000 shares of common stock exercisable at $.001 per share. The Company has the obligation to register for sale the shares of common stock deliverable upon exercise of the warrants. 14 The Company may be sued if its integration, Internet, computer network systems or software application implementations fail to provide accurate, reliable and timely information to healthcare providers. DAOU's integration services, computer network systems and software application implementations are designed to provide access to and accurate delivery of a wide range of information within a healthcare organization, including information used by clinicians in the diagnosis and treatment of patients. If a computer network system or software application 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. 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 and outsourcing 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 23, 2000, the Company's executive officers, directors and affiliated persons beneficially owned approximately 37% 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 services. This consolidation could reduce its target market and result in the termination of customer contracts. In particular, some of its customers 15 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 of 1996 (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: . loss of its outsourcing contract with SMHN; . quarterly fluctuations in its operating results . negative publicity relating to its possible delisting from the Nasdaq National Market System; . 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 healthcare IT applications and computer network services; . healthcare industry and general market conditions, including HIPAA developments; 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. The Company's common stock may be delisted from the Nasdaq National Market which could adversely affect the price of its common stock and its ability to raise additional equity capital. The Common Stock is currently listed for trading on the Nasdaq Stock Market's National Market. For continued listing, a company, among other things, must meet certain minimum requirements with respect to net tangible assets, market value of its securities held by non-affiliates, and minimum bid prices per share. The Common Stock, has been trading below the minimum bid price required for continued listing, and the Company cannot be sure that the bid price will rise above the required minimum bid price. The Company received notice that its Common Stock would be delisted from the Nasdaq National Market and as a result its Common Stock may be delisted from the Nasdaq National Market. Trading, if any, in the Common Stock would thereafter be 16 conducted in the over-the-counter market in the so-called "pink sheets" or the NASD's "Electronic Bulletin Board". The Electronic Bulletin Board is a less liquid market than the Nasdaq National Market. As a consequence of such delisting, an investor would likely find it more difficult to dispose of, or to obtain quotations as to, the price of the Common Stock. If the Company's Common Stock is delisted, the Company may find it more difficult to raise equity financing on terms favorable to the Company, if at all. Delisting of the Common Stock may result in lower prices for the Common Stock than would otherwise prevail. 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 . 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 September 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) Alexandria, VA.......... 4,000 June 2005 Operating and support facilities(1) Indianapolis, IN........ 6,000 April 2001 Operating and support facilities Mountainside, NJ........ 4,000 November 2003 Operating and support facilities(1) Exton, PA............... 4,000 January 2003 Operating and support facilities
- -------- (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. 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 a 17 second amended consolidated class action complaint on January 21, 2000. 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. Claims are pleaded under both the Securities Act of 1933, as amended, (relating to the Company's initial public offering) and section 10b of the Securities Exchange Act of 1934, as amended. The complaint was brought on behalf of a purported class of investors who purchased the Company's Common Stock between February 13, 1997 and October 28, 1998, but it does 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. As with their Federal court counterparts, they do not allege specific damage amounts. 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. That motion was heard on February 20, 2001 and the court took the matter under submission. 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 or financial condition. The Company is party to various claims and legal actions arising in the normal course of business. Although the ultimate outcome of these matters is not presently determinable, management believes that the resolution of all such pending matters, net of amounts accrued, will not have a material adverse affect on the Company's business, results of operations or financial condition; however, there can be no assurance that the ultimate resolution of these matters will not have a material impact on the Company's results of operations in any period. Item 4: Submission of Matters to a Vote of Security Holders. No matters were submitted to a vote of stockholders during the fourth quarter of 2000. 18 PART II Item 5: Market for Registrants 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 following table sets forth the high and low closing bid information for the Common Stock. Bid quotations reflect interdealer prices without retail mark-up or mark-down and may not necessarily represent actual transactions.
Common Stock ------------- High Low ------ ------ 2000 1st Quarter................................................ $5.250 $3.000 2nd Quarter................................................ 3.313 1.500 3rd Quarter................................................ 2.750 0.875 4th Quarter................................................ 0.875 0.344 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
On March 23, 2001, the closing bid and ask prices of the Company's Common Stock were $0.281 and $0.313, respectively. As of March 23, 2001, there were 114 holders of record of common stock. Dividend Policy DAOU has never declared nor paid cash dividends on its Common 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 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. As of December 31, 2000, the Company has accrued but undeclared preferred stock dividends of $1,057,000 payable in shares of Series A Preferred Stock. On November 9, 2000, as a consequence of the resignation of Larry Grandia as the Chief Executive Officer of the Company, holders of the Series A Preferred Stock had the right to cause the Company to redeem their Series A Preferred Stock for approximately $12.9 million. The holders of the Series A Preferred Stock and the Company entered into an agreement whereby the holders of the Series A Preferred Stock have permanently waived their redemption rights in return for $2.0 million in cash and warrants to purchase 3,540,000 shares of the Company's common stock exercisable at $0.01 per share. The total consideration of this transaction was valued at approximately $4.1 million and for financial reporting purposes was recorded as a one-time dividend in the fourth quarter of 2000. The $2.0 million cash payment was treated for financial reporting purposes as a one-time dividend in the fourth quarter of 2000. Recent Sales of Unregistered Securities 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 19 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 had the right to 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. On November 9, 2000, as a consequence of the resignation of Larry Grandia as Chief Executive Officer of the Company, holders of the Series A Preferred Stock had the right to cause the Company to redeem their Series A Preferred Stock for approximately $12.9 million. The holders of the Series A Preferred Stock and the Company entered into an agreement whereby the holders of the Series A Preferred Stock have permanently waived their redemption rights in return for $2.0 million in cash and warrants to purchase 3,540,000 shares of the Company's common stock exercisable at $0.01 per share. The Company has an obligation to register the shares of common stock deliverable upon exercise of the warrants. The total consideration of this transaction was valued at approximately $4.1 million and for financial reporting purposes was recorded as a one-time dividend in the fourth quarter of 2000. Even though the holders of the Series A Preferred Stock have waived their redemption rights, the Company still has its right to redeem the Series A Preferred Stock anytime after the fourth anniversary of the purchase date for the issue price and accrued dividends per share. 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. 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, -------------------------------------------- 1996 1997 1998 1999 2000 ------- ------- -------- -------- -------- Revenues........................ $50,327 $68,656 $104,784 $103,400 $ 63,748 Cost of revenues................ 33,110 45,154 78,021 75,927 52,781 ------- ------- -------- -------- -------- Gross profit................ 17,217 23,502 26,763 27,473 10,967 Operating expenses: Sales and marketing........... 4,166 7,780 12,203 10,398 5,744 General and administrative.... 9,945 12,425 18,456 25,071 17,973 Restructuring charges......... -- -- -- -- 2,133 Merger related expenses....... -- 718 2,825 -- -- ------- ------- -------- -------- -------- Total operating expenses.... 14,111 20,923 33,484 35,469 25,850 ------- ------- -------- -------- -------- Income (loss) from operations... 3,106 2,579 (6,721) (7,996) (14,883) Interest income, net............ 369 873 163 779 699 ------- ------- -------- -------- -------- Income (loss) before income taxes.......................... 3,475 3,452 (6,558) (7,217) (14,184) Provision (benefit) for income taxes.......................... 149 947 (802) 1,761 -- ------- ------- -------- -------- -------- Net income (loss)............... 3,326 2,505 (5,756) (8,978) (14,184) Dividends on preferred stock.... -- -- -- (308) (4,837) ------- ------- -------- -------- -------- Net income (loss) available to common stockholders............ $ 3,326 $ 2,505 $ (5,756) $ (9,286) $(19,021) ======= ======= ======== ======== ======== Net income (loss) available to common stockholders per common share: Basic......................... $ 0.26 $ 0.15 $ (0.33) $ (0.52) $ (1.07) ======= ======= ======== ======== ======== Diluted....................... $ 0.23 $ 0.15 $ (0.33) $ (0.52) $ (1.07) ======= ======= ======== ======== ======== Shares used in computing net income (loss) available to common stockholders per common share: Basic......................... 12,580 16,231 17,657 17,697 17,712 ======= ======= ======== ======== ======== Diluted....................... 14,385 17,246 17,657 17,697 17,712 ======= ======= ======== ======== ======== Cash equivalents and short-term investments.................... $ 3,962 $18,288 $ 7,780 $ 15,548 $ 10,586 Total assets.................... 21,672 54,105 54,517 46,060 26,437 Long-term debt, less current portion........................ 32 49 26 -- -- Redeemable convertible preferred stock.......................... 8,190 -- -- 11,382 -- Total stockholders' equity...... 6,304 41,837 34,775 24,974 20,360
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. Recent Developments On November 13, 2000, the Company received notification from the NASDAQ Stock Market that the Company's common stock had failed to maintain a minimum bid price of $1.00 over the prior 30 consecutive trading days as required for continued listing on the NASDAQ. The Company had an oral hearing on March 28, 2001 to demonstrate its ability to regain compliance. The Nasdaq Stock Market has requested more information from the Company before making a final determination on the proposed delisting. There can be no assurance Nasdaq will grant the Company's request for continued listing. In the event of delisting by Nasdaq, the Company's common stock may be eligible for quotation on another marketplace such as the OTC Bulletin Board. On February 27, 2001, the Company's largest client, SMHN notified the Company of its intent to terminate the outsourcing agreement with the Company. The client accounted for approximately 16% of revenues for the year ended December 31, 2000. The Company is currently negotiating the termination and transition agreement in which the Company will transition all of its on-site employees to SMHN effective March 23, 2001. The settlement includes a transition fee from SMHN to cover transition costs. On February 6, 2001, DAOU Systems, Inc. announced that it had consolidated its five former subsidiaries into two divisions: Application Services and Technology Services. The Company believes the new structure will better serve its clients in the areas of strategic consulting, applications, infrastructure and operations. Overview DAOU Systems, Inc. provides applications consulting and implementation, traditional network services, remote help desk and related technology support services, and integrates legacy systems with emerging technologies, such as wireless and other portable computing solutions for the U.S. healthcare industry. On February 6, 2001, DAOU Systems, Inc. announced that it had consolidated the operations of its five former subsidiaries into two operating divisions: Application Services and Technology Services. The Application Services division combines the Company's IT Consulting and Managed Care Implementation and Application Implementation groups. The Technology Services division is the combination of the Company's Communication Infrastructure, Integration Services, Outsourcing, and Internet and Electronic Commerce (formerly known as Enosus) groups. Prior to the consolidation in 2001, the Company operated each of the divisions as a separate segment. The Company believes the consolidation was necessary due to changing market forces in the healthcare industry. The Company also believes that two operating divisions will allow DAOU to focus on its core competencies and more profitable lines of service. The Application Services division provides clients with strategic consulting (eHealth, mHealth, HIPAA, and application selection), software implementation, project management, and support services, including staff 22 augmentation. Additionally, this division assists clients by recruiting strategic skill sets for their critical long term needs. The Technology Services division provides clients with solutions in key areas, including network infrastructure (servers, data and voice networks, and security), web development and integration projects, help desk solutions (remote or on-site) and network management. In addition to the two divisions, a Strategic Services Office was created to identify and develop capabilities and services responsive to emerging technologies and applications, such as wireless and other portable computing solutions. The Company's service offerings are segmented into the following operating divisions and service lines: Application Services . IT consulting and managed care implementation--installs and integrates managed care applications, and manages IT systems, and develops business plans and solves problems for managed care organizations. . 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. Technology Services . Communications infrastructure--focuses on the IT infrastructure in healthcare enterprises, primarily IDNs, hospitals, academic medical centers and medical groups, provides networking, voice, video and data solutions and desktop services. . Application Development and Integration services--focuses on integration of the customers information systems within government healthcare 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. . Internet and electronic commerce--provides Internet professional services and solutions to healthcare 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 provides its professional services primarily 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. Prior to 1999, 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 fixed fee contracts 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. 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 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. 23 The communications infrastructure, application implementation, integration services and Enosus groups' projects generally range from three to six months, although certain projects have been for periods in excess of a year. 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. 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, ------------------ 2000 1999 1998 ---- ---- ---- Revenues................................................ 100% 100% 100% Cost of revenues........................................ 83 73 74 --- --- --- Gross profit.......................................... 17 27 26 Operating expenses...................................... 37 34 32 Restructuring charges................................... 3 -- -- --- --- --- Loss from operations.................................. (23) (7) (6) Interest income (expense), net.......................... 1 1 0 --- --- --- Loss before income taxes................................ (22) (6) (6) Provision (benefit) for income taxes.................... -- 2 (1) --- --- --- Net loss.............................................. (22)% (8)% (5)% === === ===
Years Ended December 31, 2000 and 1999 The Company's revenues decreased 38% or $39.7 million to $63.7 million for the year ended December 31, 2000 from $103.4 million for the year ended December 31, 1999, due to a decrease in revenue primarily in the applications implementation segment and from continued weakness in the Company's core health care information technology (IT) business. Management attributes such weakness to reduced demand for such services as compared to fiscal year 1999 in which customers dedicated more resources to information technology matters in light of Year 2000 issues. Revenues from third-party material sales decreased to $4.7 million in 2000 from $18.5 million in 1999. In addition, 1999 revenues included approximately $2.8 million from its former cabling division, DAOU On-Line, Inc. and an outsourcing contract that the Company terminated in early 1999. Services to the Company's five largest customers accounted for $21.0 million of revenues for the year ended December 31, 2000, representing 33% of total revenues. One of the top five customers, which accounted for $10.1 million in revenues for the year ended December 31, 2000, representing 16% of total revenues, has given notice of its intent to terminate its outsourcing contract as of March 31, 2001. Cost of revenues decreased 30% or $23.1 million to $52.8 million for the year ended December 31, 2000, from $75.9 million for the year ended December 31, 1999, primarily due to reduced material and employee costs as a result of the decrease in revenues. The Company decreased its workforce significantly during 2000 in the Application Implementation, Communications Infrastructure and Outsourcing divisions. Gross margin decreased to 17% for the year ended December 31, 2000 as compared to 27% for the year ended December 31, 1999 as a result of the significant reduction in revenues, which caused significantly lower labor utilization rates throughout all of the Company's divisions. The Company also experienced slightly 24 increased employee costs and expenses related to staff reductions while billing rates remained fairly stable. Also, in February 2000, the Company formed its Enosus subsidiary division to provide Internet and eCommerce services. Start up investments in Enosus further reduced gross margin. Sales and marketing expenses decreased 45% or $4.7 million to $5.7 million for the year ended December 31, 2000 as compared to $10.4 million for the year ended December 31, 1999, 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. Also, in the second quarter of 2000 the Company reorganized and reduced its sales force. Sales and marketing expenses were 9% and 10% of total revenues for the years ended December 31, 2000 and 1999, respectively. General and administrative expenses decreased 28% or $7.1 million to $18.0 million for the year ended December 31, 2000 as compared to $25.1 million for the year ended December 31, 1999, primarily due to efficiencies realized with the consolidation and integration of certain general and administrative functions of the divisions. During 2000, the Company completed the implementation of its ERP system and has been able to centralize certain functions into the corporate office and reduce overhead costs as a result. Additionally, in 1999 the Company had increased costs related to 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. General and administrative expenses were 28% and 24% of total revenues for the years ended December 31, 2000 and 1999, respectively. The increase was primarily due to certain fixed administrative expenses that remained in place in 2000 while revenues were declining. The Company recorded restructuring charges for the year ended December 31, 2000 totaling $2.1 million, primarily due to severance costs related to a workforce reduction and the costs related to the closure and combination of certain facilities. The Company implemented the restructuring plan in order to improve its overhead cost structure and to refocus operations into areas in which the Company believes it has a core competency. The Company believes the restructuring was necessary due to the significant decline in revenue and gross margin in 2000 as compared to 1999. The restructuring charges recorded in 2000, includes the estimated costs of workforce reductions of $1.1 million and the closure of certain facilities in periods subsequent to December 31, 2000 of $1.0 million. The Company believes these estimates reflect the anticipated costs to complete the restructuring plan. However, the loss of the Company's SMHN outsourcing agreement and other unanticipated events may result in additional restructuring expenses in the future. Other income (expense), net, decreased 10% or $80,000 to $699,000 for the year ended December 31, 2000 as compared to $779,000 for the year ended December 31, 1999,. 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 slight decrease in other income (expense), net, was primarily due to a $546,000 gain from the sale of investments recorded in 1999 offset by increased interest income due to higher average cash reserves available for investment and reduced interest expense due to the payoff of outstanding debt in 1999. Due to the Company's current operating loss and the loss carryforwards, no provision for taxes was recorded in 2000. The effective income tax rate for the year ended December 31, 1999 was 56%. Although the Company had a pre-tax loss for 1999, the Company recorded a provision for taxes to reserve the Company's net deferred tax assets, resulting from previously recorded tax benefits, when the realization of the tax benefits became uncertain. 25 Years Ended December 31, 1999 and 1998 The Company's revenues decreased 1% or $1.4 million to $103.4 million for the fiscal year ended December 31, 1999 as compared to $104.8 million for the year ended December 31, 1998, 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, accounted for $10.8 million in revenues for the year ended December 31, 1999, representing 10% of total revenues. Cost of revenues decreased 3% or $2.1 million to $75.9 million for the fiscal year ended December 31, 1999 as compared to $78.0 million for the year ended December 31, 1998, primarily the result of a decrease in revenues from the communications infrastructure group resulting from the closure of the Company's cabling division. Gross margin increased to 27% for the fiscal year ended December 31, 1999 as compared to 26% for the year ended December 31, 1998, 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 decreased 15% or $1.8 million to $10.4 million for the fiscal year ended December 31, 1999 as compared to $12.2 million for the year ended December 31, 1998, 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 increased 36% or $6.6 million to $25.1 million for the fiscal year ended December 31, 1999 as compared to $18.5 million for the year ended December 31, 1998, primarily due to costs 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, increased to $779,000 for the fiscal year ended December 31, 1999 as compared to $163,000 for the year ended December 31, 1998. 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 related costs and adjustments made to convert the former S corporation status of certain acquired businesses to the C corporation status of the Company. 26 Income Taxes In 2000, 1999 and 1998, the effective tax rates were 0%, 56% and (12)%, respectively. In 2000, the effective rate was different from the expected federal statutory rate of 35% due to the Company's current operating loss and the loss carryforwards, no provision for taxes was recorded. In 1999 the effective rate was different from the expected federal statutory rate 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, the effective rate was 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 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, the benefit of Integrex, 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, 2000, the Company had working capital of $17.9 million, a decrease of $14.3 million from $32.2 million on December 31, 1999. The decrease is primarily from a decrease in the accounts receivable balance as a result of lower revenues and increased collection efforts. Cash used in operating activities was $2.4 million, for the year ended December 31, 2000, compared to cash provided by operating activities of $3.3 million for the year ended December 31, 1999. The decrease in cash from operations resulted primarily from the Company's net loss, decreases in trade accounts payable and other accrued liabilities, and in accrued salaries and benefits offset by decreases in trade accounts receivable as compared to 1999. Net cash used in investing activities was $673,000 for the year ended December 31, 2000, compared to $164,000 in the comparable prior period. The increase in cash used by investing activities was primarily due to the maturing of investments of $1.2 million that were not reinvested in 1999, offset by decreased purchases of equipment, furniture and fixtures. Net cash used in financing activities was $1.9 million for the year ended December 31, 2000, compared to cash provided by of $5.6 million in the comparable prior period. This decrease was primarily the result of the net proceeds from the issuance of Series A Preferred Stock in 1999, which raised $11.1 million, after expenses, partially offset by the repayments of debt and lines of credit of $5.2 million in 1999 offset by the $2.0 million cash portion of the one-time dividend paid to the holders of the Series A Preferred Stock in 2000. 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 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, 2000. On July 27, 1999 the Company issued 2,181,818 shares of Series A Preferred Stock. The Series A Preferred Stock agreement contained a redemption feature which was outside of the control of the Company. On November 9, 2000, the holders of the Series A Preferred Stock permanently waived their redemption rights in return for $2.0 million in cash and warrants to purchase 3,540,000 shares of the Company's common stock exercisable at $0.01 per share. Even though the holders of the Series A Preferred Stock have waived their redemption rights, the Company still has its right to redeem the Series A Preferred Stock anytime after the fourth anniversary of the purchase date for the issue price and accrued dividends per share. Although the Company has an accumulated deficit as of December 31, 2000, the Company believes that its available funds together with anticipated cash from operating activities will be sufficient to meet its capital requirements for the foreseeable future. The Company may sell additional equity or debt securities or obtain 27 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. The Company may not be able to raise additional capital on terms favorable to the Company, if at all. See "Risk Factors--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." Item 7A. Quantitative and Qualitative Disclosures about Market Risks The Company invests 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. The Company does not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. Accordingly, the Company believes that, while the instruments held are subject to changes in the financial standing of the issuer of such securities, the Company is not subject to any material risks arising from changes in interest rates, foreign currency exchanges rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. 28 Item 8: Financial Statements. Index to Consolidated Financial Statements DAOU SYSTEMS, INC. Report of Ernst & Young LLP, Independent Auditors......................... F-1 Consolidated Balance Sheets at December 31, 2000 and 1999................. F-2 Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998...................................................... F-3 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998......................................... F-4 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998...................................................... F-5 Notes to Consolidated Financial Statements................................ F-7
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, 2000 and 1999 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. Our audits also included financial statement Schedule II listed in Item 14(a). These financial statements and schedule 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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of DAOU Systems, Inc. at December 31, 2000 and 1999 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000 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, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP San Diego, California February 15, 2000 F-1 DAOU SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (In thousands)
December 31, ------------------ 2000 1999 -------- -------- ASSETS ------ Current assets: Cash and cash equivalents................................ $ 10,504 $ 15,480 Investments, available-for-sale.......................... 82 68 Accounts receivable, net of allowance for doubtful accounts of $1,138 and $1,868 in 2000 and 1999, respectively............................................ 11,900 21,912 Contract work in progress................................ 665 2,816 Income tax receivable.................................... -- 378 Other current assets..................................... 558 670 -------- -------- Total current assets................................... 23,709 41,324 Due from officers/stockholders............................. -- 98 Equipment, furniture and fixtures, net..................... 2,565 4,319 Other assets............................................... 163 319 -------- -------- $ 26,437 $ 46,060 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Trade accounts payable................................... $ 342 $ 849 Accrued salaries and benefits............................ 2,273 4,248 Other accrued liabilities................................ 2,944 3,220 Income taxes payable..................................... -- 450 Deferred revenue......................................... 2 179 Current portion of severance payable..................... 210 210 -------- -------- Total current liabilities.............................. 5,771 9,156 Deferred rent.............................................. 113 145 Severance payable.......................................... 193 403 Commitments and contingencies Redeemable convertible preferred stock, $.001 par value. Authorized 3,520 shares; issued and outstanding 2,182 shares at December 31, 1999, with a liquidation preference of $12,308 at December 31, 1999, including accrued dividends................................................. -- 11,382 Stockholders' equity: Convertible preferred stock, $.001 par value. Authorized 3,520 shares; issued and outstanding 2,182 shares at December 31, 2000, with a liquidation preference of $13,057 at December 31, 2000, including accrued dividends............................................... 2 -- Common stock, $.001 par value. Authorized 50,000 shares; issued and outstanding 17,831 and 17,712 at December 31, 2000 and 1999, respectively............................. 18 18 Additional paid-in capital............................... 51,614 37,395 Deferred compensation.................................... -- (192) Accumulated other comprehensive income................... (49) (43) Retained deficit......................................... (31,225) (12,204) -------- -------- Total stockholders' equity............................. 20,360 24,974 -------- -------- $ 26,437 $ 46,060 ======== ========
See accompanying notes to consolidated financial statements. F-2 DAOU SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except for per share data)
Years Ended December 31, ---------------------------- 2000 1999 1998 -------- -------- -------- Revenues........................................ $ 63,748 $103,400 $104,784 Cost of revenues................................ 52,781 75,927 78,021 -------- -------- -------- Gross profit.................................... 10,967 27,473 26,763 Operating expenses: Sales and marketing........................... 5,744 10,398 12,203 General and administrative.................... 17,973 25,071 18,456 Restructuring charges......................... 2,133 -- -- Merger related expenses....................... -- -- 2,825 -------- -------- -------- 25,850 35,469 33,484 -------- -------- -------- Loss from operations............................ (14,883) (7,996) (6,721) Interest income, net............................ 699 779 163 -------- -------- -------- Loss before income taxes........................ (14,184) (7,217) (6,558) Provision (benefit) for income taxes............ -- 1,761 (802) -------- -------- -------- Net loss.................................... (14,184) (8,978) (5,756) Accrued dividends on preferred stock............ (4,837) (308) -- -------- -------- -------- Net loss available to common stockholders... $(19,021) $ (9,286) $ (5,756) ======== ======== ======== Basic and diluted net loss available to common stockholders per common share.................. $ (1.07) $ (0.52) $ (0.33) ======== ======== ======== Shares used in computing basic and diluted net loss available to common stockholders per common share................................... 17,712 17,697 17,657 ======== ======== ========
See accompanying notes to consolidated financial statements. F-3 DAOU SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 2000, 1999 and 1998 (In thousands)
Convertible Preferred Accumulated Stock Common Stock Additional other Retained Total ------------- ------------- paid-in Deferred comprehensive earnings stockholders' Shares Amount Shares Amount capital compensation income (deficit) equity ------ ------ ------ ------ ---------- ------------ ------------- --------- ------------- Balance at December 31, 1997.................... -- $ -- 16,945 $17 $36,040 $(907) $146 $ 6,541 $ 41,837 Shares issued in connection with formation of S corporations............ -- -- 506 1 506 -- -- -- 507 Deferred compensation... -- -- -- -- 385 (385) -- -- -- Tax benefit from exercise of noncompensatory stock options................. -- -- -- -- 630 -- -- -- 630 Amortization of deferred compensation............ -- -- -- -- -- 312 -- -- 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................. -- -- 236 -- 844 -- -- -- 844 Issuance of common stock upon exercise of warrants................ -- -- 2 -- 14 -- -- -- 14 Comprehensive loss: Unrealized gain on short-term investments............ -- -- -- -- -- -- 90 -- 90 Net loss............... -- -- -- -- -- -- -- (5,756) (5,756) -------- Comprehensive loss...... (5,666) ----- ---- ------ --- ------- ----- ---- -------- -------- Balance at December 31, 1998.................... -- -- 17,689 18 38,419 (980) 236 (2,918) 34,775 ----- ---- ------ --- ------- ----- ---- -------- -------- Issuance of common stock upon exercise of stock options................. -- -- 23 -- 95 -- -- -- 95 Amortization of deferred compensation............ -- -- -- -- -- 299 -- -- 299 Reversal of deferred compensation for separated employees..... -- -- -- -- (489) 489 -- -- -- Accrued dividends on preferred stock......... -- -- -- -- -- -- -- (308) (308) Reversal of tax benefit from exercise of noncompensatory stock options................. -- -- -- -- (630) -- -- -- (630) Comprehensive loss: Net realized gain on investments............ -- -- -- -- -- -- (279) -- (279) Net loss............... -- -- -- -- -- -- -- (8,978) (8,978) -------- Comprehensive loss...... (9,257) ----- ---- ------ --- ------- ----- ---- -------- -------- Balance at December 31, 1999.................... -- -- 17,712 18 37,395 (192) (43) (12,204) 24,974 ===== ==== ====== === ======= ===== ==== ======== ======== Issuance of common stock upon exercise of stock options................. -- -- 1 -- 1 -- -- -- 1 Issuance of common stock under employee stock purchase plan........... -- -- 118 -- 54 -- -- -- 54 Amortization of deferred compensation............ -- -- -- -- -- 139 -- -- 139 Reversal of deferred compensation for separated employees..... -- -- -- -- (53) 53 -- -- -- Removal of redemption feature on preferred stock................... 2,182 2 -- -- 11,380 -- -- (2,000) 9,382 Warrants issued to preferred stockholders.. -- -- -- -- 2,088 -- -- (2,088) -- Accrued dividends on preferred stock......... -- -- -- -- 749 -- -- (749) -- Comprehensive loss: Unrealized loss on investments............ -- -- -- -- -- -- (6) -- (6) Net loss............... -- -- -- -- -- -- -- (14,184) (14,184) -------- Comprehensive loss...... (14,190) ----- ---- ------ --- ------- ----- ---- -------- -------- Balance at December 31, 2000.................... 2,182 $ 2 17,831 $18 $51,614 $ -- $(49) $(31,225) $ 20,360 ===== ==== ====== === ======= ===== ==== ======== ========
See accompanying notes to consolidated financial statements. F-4 DAOU SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended December 31, -------------------------- 2000 1999 1998 -------- ------- ------- Operating activities Net loss........................................... $(14,184) $(8,978) $(5,756) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization.................... 2,388 2,077 1,715 Amortization of deferred compensation............ 139 299 312 Provision for uncollectible accounts............. 402 1,643 644 Deferred income taxes............................ -- 1,311 (1,378) Gain on sale of investment....................... -- (546) -- Loss on retirement of fixed assets............... 273 88 -- Changes in operating assets and liabilities: Accounts receivable............................ 9,610 1,027 (9,482) Contract work in progress...................... 2,151 9,456 1,019 Other current assets and income taxes receivable.................................... 490 258 458 Accounts payable, accrued liabilities and income taxes payable.......................... (1,233) (3,397) 2,773 Accrued salaries and benefits.................. (1,975) 341 1,232 Deferred revenue............................... (177) (182) (8) Severance payable.............................. (210) (210) (210) Deferred rent.................................. (32) 100 (10) -------- ------- ------- Net cash (used in) provided by operating activities.................................. (2,358) 3,287 (8,691) Investing activities Purchase of equipment, furniture and fixtures...... (907) (1,450) (2,279) Decrease (increase) in other assets................ 156 (10) 156 Purchases of investments........................... (20) -- (8) Proceeds from sale and maturities of investments... -- 1,223 9,381 Payments from (advances to) officers/stockholders.. 98 73 200 -------- ------- ------- Net cash (used in) provided by investing activities.................................. (673) (164) 7,450 Financing Activities Proceeds from long-term debt and line of credit.... -- 358 5,483 Repayments of long-term debt and line of credit.... -- (5,926) (3,129) Distributions to stockholders of acquired companies......................................... -- -- (3,703) Proceeds from issuance of common stock............. 55 95 1,365 Proceeds of redeemable convertible preferred stock............................................. -- 11,074 -- Payment and issuance costs to remove redemption feature of preferred stock........................ (2,000) -- -- -------- ------- ------- Net cash (used in) provided by financing activities.................................. (1,945) 5,601 16 -------- ------- ------- (Decrease) increase in cash and cash equivalents... (4,976) 8,724 (1,225) Cash and cash equivalents at beginning of year..... 15,480 6,756 7,981 -------- ------- ------- Cash and cash equivalents at end of year..... $ 10,504 $15,480 $ 6,756 ======== ======= ======= Cash paid during the year for: Income taxes..................................... $ -- $ 213 $ 144 ======== ======= ======= Interest......................................... $ 11 $ 262 $ 290 ======== ======= =======
F-5 DAOU SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended December 31, --------------------- 2000 1999 1998 ------- ----- ----- Supplemental disclosure of noncash investing and financing activities: Deferred tax benefit from exercise of noncompensatory options............................................... $ -- $(630) $ 630 ======= ===== ===== Accrued preferred stock dividends to redeemable preferred stockholders................................ $ 749 $ 308 $ -- ======= ===== ===== Issuance of warrants to remove redemption feature of preferred stock....................................... $(2,088) $ -- $ -- ======= ===== ===== Unrealized (loss) gain on investments.................. $ (6) $ 7 $ (42) ======= ===== =====
See accompanying notes to consolidated financial statements. F-6 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 applications consulting and implementation, traditional network services, remote help desk and related technology support services, and integrates legacy systems with emerging technologies, such as wireless and other portable computing solutions for the U.S. healthcare industry. On February 6, 2001, DAOU Systems, Inc. announced that it had consolidated its five subsidiary operating companies into two operating divisions: Application Services and Technology Services. The Application Services division combines the Company's IT Consulting and Managed Care Implementation and Application Implementation groups. The Technology Services division is the combination of the Company's Communication Infrastructure, Integration Services, Outsourcing, and Internet and Electronic Commerce (formerly known as Enosus). In the year 2000, 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 and managed care implementation services 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 IT 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. Enosus provides Internet consulting services and solutions to organizations executing an eBusiness strategy. The consolidated financial statements reflect the combined financial position and operating results for the Company. All intercompany accounts have been eliminated. On December 31, 2000, the Company merged all of its subsidiaries into the parent company, Daou Systems, Inc. Revenue Recognition The Company recognizes revenue in accordance with Staff Accounting Bulletin ("SAB") No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS. SAB 101 requires that the following criteria are met in determining whether revenue has been earned: . Persuasive evidence of an arrangement, . Services have been delivered, . Price is fixed and determinable, and . Collectibility is reasonably assured. The Company has the following types of revenue recognition: 1) services performed on a hourly basis, 2) services performed on a fixed fee basis and 3) sales of material and maintenance contracts. In general, the Company enters into contracts with customers to provide services at a specified fee or rate per hour. Revenue from professional services is recognized primarily on a hourly basis. Revenue from technical support and network management services is recognized as the services are performed. Contract revenue for the development and implementation of network solutions under fixed-fee contracts is recognized using the percentage-of- F-7 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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. 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 Customers Substantially all of the Company's accounts receivable are from managed care organizations, hospitals and other healthcare providers. Generally, the Company obtains a significant deposit from its customers upon signing a fixed fee 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 $21.0 million of revenues for the year ended December 31, 2000, representing approximately 33% of total revenues. One of the top five customers accounted for $10.1 million and $10.8 million of revenues for the years ended December 31, 2000 and 1999, respectively, representing approximately 16% and 10% of total revenues, respectively. This customer has notified the Company of its intent to terminate the outsourcing agreement. The Company is currently negotiating an extended transition period. 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. 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. 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. Advertising Expense Advertising expenditures are charged to expense as incurred. The Company expensed $145,000, $64,000 and $61,000 for the years ended December 31, 2000, 1999 and 1998, respectively. F-8 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) New Accounting Standards In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("FAS 133"), ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. In May 1999, the FASB delayed the effective date of FAS 133 by one year. The Company will be required to adopt FAS 133 for fiscal year 2001. This statement establishes a new model for accounting for derivatives and hedging activities. Under FAS 133, certain derivatives must be recognized as assets and liabilities and measured at fair value. The Company is not currently engaged in derivative or hedging activities. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 101 , REVENUE RECOGNITION IN FINANCIAL STATEMENTS. In June 2000, the SEC staff amended SAB 101 to provide registrants with additional time to implement SAB 101. The Company adopted SAB 101 in the fourth quarter of fiscal 2000. The adoption of SAB 101 did not have a material effect on its consolidated financial position or results of operations. 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 Loss Per Share Net loss per share is computed in accordance with FASB Statement No. 128, EARNINGS PER SHARE. Basic net loss per share is computed using the weighted average number of common shares outstanding during each period. Diluted net loss per share includes the dilutive effect of common shares potentially issuable upon the exercise of stock options and warrants. In 2000, 1999 and 1998 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 loss per share and calculation thereof (in thousands, except per share information):
2000 1999 1998 -------- ------- ------- Numerator: Net loss available to common shareholders.... $(19,021) $(9,286) $(5,756) Denominator: Shares used in basic net loss per share-- weighted average common shares outstanding.. 17,712 17,697 17,657 Net effect of dilutive common share equivalents based on treasury stock method.. -- -- -- -------- ------- ------- Denominator for diluted net loss per share-- adjusted weighted average common shares outstanding................................. 17,712 17,697 17,657 ======== ======= ======= Basic loss per share....................... $ (1.07) $ (.52) $ (.33) ======== ======= ======= Diluted loss per share..................... $ (1.07) $ (.52) $ (.33) ======== ======= =======
F-9 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. Compensation charges for options granted to non-employees have been determined in accordance with SFAS No. 123 and EITF 96-18 as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured. Charges for options granted to non- employees are periodically remeasured as the underlying options vest. In March 2000, the Financial Accounting Standards Board ("FASB"), released FASB Interpretation No. 44 ("FIN 44"), ACCOUNTING FOR CERTAIN TRANSACTIONS INVOLVING STOCK COMPENSATION AND INTERPRETATION OF APB OPINION NO. 25. FIN 44 provides clarification of APB Opinion 25 for certain issues such as the determination of who is an employee, the criteria for determining whether a plan qualifies as a non-compensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and the accounting for an exchange of stock compensation awards in a business combination. The Company believes that its practices are in conformity with this guidance, and therefore, FIN 44 had no impact on its financial statements. 2. RESTRUCTURING CHARGES AND FOURTH QUARTER ADJUSTMENTS In connections with the Restructuring Plan, the Company has undertaken various actions to reduce the cost structure of the Company. As a result, the Company has recorded restructuring charges in the second and the fourth quarters of 2000 totaling approximately $2.1 million. Such charges were determined in accordance with SEC SAB No. 100, RESTRUCTURING AND IMPAIRMENT CHARGES, and Emerging Issues Task Force No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COST INCURRED IN A RESTRUCTURING). These charges include severance costs related to a reduction in workforce of approximately 50 employees and the closure of certain facilities. The following table summarizes the restructuring and other related charges recorded in 2000, of which $1,306,000 are included in accrued liabilities at December 31, 2000. Severance costs for involuntary employee terminations.......... $1,140,000 Costs related to closure and combination of facilities......... 993,000 ---------- $2,133,000 ==========
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 restructured its organization. During 1999, the Company's net loss resulted in the Company being in a cumulative loss position over the previous three 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 1999 a revaluation allowance of $3.5 million was also recorded to fully reserve cumulative deferred tax assets recorded. F-10 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 3. INVESTMENTS, AVAILABLE-FOR-SALE Short-term investments, available-for-sale, consist of the following (in thousands):
Gross Gross Amortized Unrealized Unrealized Estimated Fair Cost Gains Losses Value --------- ---------- ---------- -------------- DECEMBER 31, 2000 Government debt securities............... $131 $ -- $(49) $ 82 ==== ===== ==== ====== DECEMBER 31, 1999 Government debt securities............... $111 $ -- $(43) $ 68 ==== ===== ==== ====== DECEMBER 31, 1998 Mutual Funds.............. $788 $ 286 $(50) $1,024 ==== ===== ==== ======
The government debt securities mature in 2008. 4. SELECTED BALANCE SHEET DETAILS Contract work in progress consists of the following (in thousands):
December 31, ----------- 2000 1999 ---- ------ Unbilled accounts receivable.................................. $354 $2,474 Other......................................................... 311 342 ---- ------ $665 $2,816 ==== ======
Equipment, furniture and fixtures consist of the following (in thousands):
December 31, ---------------- 2000 1999 ------- ------- Equipment and furniture.................................. $ 6,108 $ 9,575 Leasehold improvements................................... 578 664 ------- ------- 6,686 10,239 Less accumulated depreciation and amortization........... (4,121) (5,920) ------- ------- $ 2,565 $ 4,319 ======= =======
Other accrued liabilities consist of the following (in thousands):
December 31, ------------- 2000 1999 ------ ------ Accrued contract costs...................................... $ 778 $ 740 Other accrued liabilities................................... 2,166 2,480 ------ ------ $2,944 $3,220 ====== ======
F-11 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 5. LINES OF CREDIT On June 29, 1999, the Company secured an $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, 2000 and 1999. Interest expense for the years ended December 31, 2000, 1999 and 1998 was approximately $0, $253,000 and $216,000, respectively. 6. 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 2000, 1999 and 1998 totaled $2,144,000, $2,213,000 and $1,665,000, respectively. Annual future minimum lease payments under noncancelable operating leases with initial terms of one year or more at December 31, 2000, consist of the following (in thousands): 2001.............................................................. $2,248 2002.............................................................. 2,149 2003.............................................................. 2,074 2004.............................................................. 1,524 2005.............................................................. 853 Thereafter........................................................ -- ------ $8,848 ======
Severance Payable In connection with the retirement of a founder of one of the Company's acquired businesses, the founder received a severance agreement whereby the retiring founder will receive 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, 2000 and 1999, the Company had an outstanding payable of $402,500 and $612,500, respectively. The aggregate minimum future payments under the severance agreements as of December 31, 2000 are $210,000 and $192,500 for the years ending December 31, 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, who is no longer an employee, $827,000 in November of 1999. In 2000 and 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 were not material in 2000. In 1999, revenues, costs and gross profit totaled $1,567,000, $1,377,000 and $190,000, respectively. The company has $0 and $840,000 in accounts receivable outstanding at December 31, 2000 and 1999, respectively, related to the implementation services provided. F-12 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 7. STOCKHOLDERS' EQUITY Redeemable Convertible Preferred Stock 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. At December 31, 2000, the Company had accumulated but unpaid dividends of $1,057,000. 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 Series A Preferred Stock is redeemable at the option of the Company four years after the date of issuance. 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). On November 9, 2000, as a consequence of the resignation of Larry Grandia, holders of the Series A Preferred Stock had the right to cause the Company to redeem their Series A Preferred Stock for approximately $12.9 million. The holders of the Series A Preferred Stock and the Company entered into an agreement whereby the holders of the Series A Preferred Stock have permanently waived their redemption rights in return for $2.0 million in cash and warrants to purchase 3,540,000 shares of the Company's common stock exercisable at $0.01 per share. The total consideration of this transaction was valued at approximately $4.1 million and for financial reporting purposes was recorded as a one-time dividend in the fourth quarter of 2000. Even though the holders of the Series A Preferred Stock have waived their redemption rights, the Company still has its right to redeem the Series A Preferred Stock anytime after the fourth anniversary of the purchase date for the issue price and accrued dividends per share. 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. Employee Stock Purchase Plan In May 2000, the Company adopted the Daou Systems, Inc. Employee Stock Purchase Plan ("ESPP"), under which 1,500,000 shares of the Company's common stock are reserved for issuance. Under the ESPP, eligible employees are allowed to purchase common stock at six-month intervals at the lower of 85% of the fair market value at the beginning of the measurement period or 85% of the fair market value at the end of the measurement period. On December 31, 2000, the Company recorded the issuance of 118,266 shares of common stock under the ESPP at $0.45 per share. Stock Option Plans During 1996, the Company adopted the 1996 Stock Option Plan (the "Plan"), under which 5,000,000, as amended, shares of the Company's common stock are reserved for issuance upon exercise of options granted by the Company. 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. F-13 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(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, 550,000 stock options at an exercise price ranging from $4.31 to $5.50 per share, and 750,000 stock options at an exercise price of $0.50 granted outside the plan in 1996, 1999 and 2000, respectively:
2000 1999 1998 --------------------- -------------------- -------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ---------- --------- --------- --------- --------- --------- Outstanding--beginning of year................ 3,366,186 $7.94 3,226,794 $10.44 1,540,399 $ 7.49 Granted............... 2,083,700 1.21 1,091,500 4.94 2,699,045 13.22 Exercised............. (400) 3.25 (22,240) 4.28 (235,637) 6.16 Forfeited............. (1,608,373) 7.21 (929,868) 13.21 (777,013) 16.29 ---------- ----- --------- ------ --------- ------ Outstanding--end of year............... 3,841,113 $4.59 3,366,186 $ 7.94 3,226,794 $10.44 ========== ===== ========= ====== ========= ====== Exercisable at end of year................... 1,148,033 $8.70 985,534 $ 8.58 266,526 $13.35 ========== ===== ========= ====== ========= ====== Weighted-average fair value of options granted during the year................... $0.50 $ 3.30 $ 6.79 ===== ====== ======
The following table summarizes information about stock options outstanding at December 31, 2000:
Outstanding Exercisable --------------------------------- --------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Number Contractual Exercise Number Exercise Range of Exercise Prices Outstanding Life Price Exercisable Price - ------------------------ ----------- ----------- --------- ----------- --------- $ 0.00-$ 2.74.......... 1,727,700 9.9 $ 0.56 -- $ 0.00 $ 2.75-$ 5.49.......... 1,407,747 7.1 $ 4.72 674,710 $ 4.69 $ 5.50-$ 8.24.......... 156,442 4.0 $ 6.02 115,639 $ 6.01 $ 8.25-$10.99.......... 72,602 5.9 $10.16 58,344 $10.12 $11.00-$13.74.......... 260,200 6.5 $13.61 133,333 $13.61 $13.75-$16.49.......... 24,400 5.5 $16.02 13,600 $16.01 $16.50-$19.24.......... 26,600 1.7 $16.95 23,800 $16.99 $19.25-$21.99.......... 50,155 5.1 $21.75 28,540 $21.75 $22.00-$24.74.......... 24,400 2.3 $24.25 21,200 $24.25 $24.75-$27.50.......... 90,867 4.9 $25.01 78,867 $25.00 --------- --- ------ --------- ------ 3,841,113 8.0 $ 4.59 1,148,033 $ 8.70 ========= === ====== ========= ======
At December 31, 2000, options for 1,306,875 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 2000, 1999 and 1998: risk- F-14 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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 138% 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 Company's adjusted pro forma information is as follows (in thousands, except for per share information):
Years Ended December 31, ---------------------------- 2000 1999 1998 -------- -------- -------- Adjusted pro forma net income (loss)....... $(18,476) $(19,294) $(16,380) ======== ======== ======== Adjusted pro forma net income (loss) per share: Basic.................................... $ (1.04) $ (1.09) $ (0.93) ======== ======== ======== Diluted.................................. $ (1.04) $ (1.09) $ (0.93) ======== ======== ========
Common Stock Reserved At December 31, 2000, the Company had the following shares reserved for future issuance: Redeemable convertible preferred stock.......................... 2,750,000 Warrants........................................................ 3,540,000 Stock option plan............................................... 5,144,696 Employee stock purchase plan.................................... 1,381,734 ---------- Total......................................................... 12,816,430 ==========
8.INCOME TAXES The provision for income taxes consists of the following (in thousands):
Years Ended December 31, ------------------- Current: Federal............................................. $ -- $ -- $ -- State............................................... -- 450 576 ---- ------ ------- -- 450 576 Deferred: Federal............................................. -- 1,119 (1,205) State............................................... -- 192 (173) ---- ------ ------- -- 1,311 (1,378) ---- ------ ------- $ -- $1,761 $ (802) ==== ====== =======
Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. F-15 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Significant components of the Company's deferred tax assets and liabilities are shown below (in thousands):
2000 1999 ------- ------- Deferred tax liabilities: Accounting method change for tax purposes.............. $ 575 $ 1,322 Depreciation and amortization.......................... -- 229 ------- ------- 575 1,551 Deferred tax assets: Reserves and allowances................................ 1,451 945 Depreciation........................................... 270 -- Net operating losses................................... 6,091 3,594 ------- ------- 7,812 4,539 Net deferred tax asset before valuation allowance........ 7,237 (2,988) ------- ------- Valuation allowance for deferred tax assets.............. (7,237) 2,988 ------- ------- Net deferred tax asset................................... $ -- $ -- ======= =======
At December 31, 2000, the Company has federal and state net operating loss carryforwards of approximately $16.1 million and $7.6 million, respectively. The federal and state loss carryforwards will begin to expire in 2019 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, --------------------- 2000 1999 1998 ----- ----- ----- Tax at federal statutory rate.................... (35.0)% (35.0)% (35.0)% S corporation income not subject to corporate income taxes.................................... -- -- (18.1) Nondeductible expenses........................... 0.4 -- 10.6 Adjustment on conversion of S corporation to C corporation..................................... -- -- 27.6 State taxes, net of federal benefit.............. (2.6) 9.3 1.9 Valuation allowance.............................. 30.0 81.9 -- Other............................................ 7.2 -- 1.0 ----- ----- ----- 0.0 % 56.2 % (12.0)% ===== ===== =====
9.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 $832,000, $428,000 and $471,000 for 2000, 1999 and 1998, respectively. F-16 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 10. CONTINGENCIES 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 a second amended consolidated class action complaint on January 21, 2000. 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. Claims are pleaded under both the Securities Act of 1933, as amended, (relating to the Company's initial public offering) and section 10b of the 1934 Securities Exchange Act. The complaint was brought on behalf of a purported class of investors who purchased the Company's Common Stock between February 13, 1997 and October 28, 1998, but it does 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. As with their Federal court counterparts, they do not allege specific damage amounts. 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. That motion was heard on February 20, 2001 and the court took the matter under submission. 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 or financial condition. The Company is party to various claims and legal actions arising in the normal course of business. Although the ultimate outcome of these matters is not presently determinable, management believes that the resolution of all such pending matters, net of amounts accrued, will not have a material adverse affect on the Company's business, results of operations or financial condition; however, there can be no assurance that the ultimate resolution of these matters will not have a material impact on the Company's results of operations in any period. 11. DISCLOSURE OF SEGMENT INFORMATION DAOU Systems, Inc. provides applications consulting and implementation, traditional network services, remote help desk and related technology support services, and integrates legacy systems with emerging technologies, such as wireless and other portable computing solutions for the U.S. healthcare industry. On February 6, 2001, DAOU Systems, Inc. announced that it had consolidated its five subsidiary operating companies into two operating divisions: Application Services and Technology Services. The Application Services division combines the Company's IT Consulting and Managed Care Implementation and Application Implementation groups. The Technology Services division is the combination of the Company's Communication Infrastructure, Integration Services, Outsourcing, and Internet and Electronic Commerce (formerly known as Enosus formed in February 2000). Prior to the consolidation in 2001, the Company operated each of the divisions as a separate segment. The Application Services division provides clients with strategic consulting (eHealth, mHealth, HIPAA, and application selection), software implementation, project management, and support services, including staff augmentation. Additionally, this division assists clients by recruiting strategic skill sets for their critical long term needs. The Technology Services division provides clients with solutions in key areas, including network infrastructure (servers, data and voice networks, and security), web development and integration projects, help desk solutions (remote or on-site) and network management. F-17 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Company's service offerings are segmented into the following operating divisions and service lines: Application Services . IT consulting and managed care implementation--installs and integrates managed care applications, and manages IT systems, and develops business plans and solves problems for managed care organizations. . 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. Technology Services . Communications infrastructure--focuses on the IT infrastructure in healthcare enterprises, primarily IDNs, hospitals, academic medical centers and medical groups, provides networking, voice, video and data solutions and desktop services. . Integration services--focuses on integration of the customers information systems within government healthcare 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. . Internet and electronic commerce--provides Internet professional services and solutions to healthcare organizations executing an eBusiness strategy. 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. F-18 DAOU SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Application Services Division Technology Service Division ----------------------------- ------------------------------------------------- IT Consulting Application Internet and Managed Development and Care Application and Communication Electronic Implementation Implementation Integration Infrastructure Outsourcing Commerce Total -------------- -------------- ----------- -------------- ----------- ---------- -------- 2000 Total revenues.......... $ 8,318 $13,851 $10,074 $10,397 $20,438 $ 670 $ 63,748 Cost of services........ 6,446 11,189 6,999 9,382 17,377 1,388 52,781 ------- ------- ------- ------- ------- ----- -------- Gross profit........... $ 1,872 $ 2,662 $ 3,075 $ 1,015 $ 3,061 $(718) 10,967 ======= ======= ======= ======= ======= ===== Gross profit percent.... 23% 19% 31% 10 % 15% (107)% Sales and marketing..... 5,744 General and administrative......... 17,973 Restructuring charges... 2,133 -------- Loss from operations.... $(14,883) -------- 1999 Total revenues.......... $11,353 $30,938 $14,166 $23,493 $23,450 $ -- $103,400 Cost of services........ 6,713 17,135 8,831 24,854 18,394 -- 75,927 ------- ------- ------- ------- ------- ----- -------- Gross profit........... $ 4,640 $13,803 $ 5,335 $(1,361) $ 5,056 $ -- 27,473 ======= ======= ======= ======= ======= ===== ======== Gross profit percent.... 41% 45% 38% (6)% 22% 0 % Sales and marketing..... 10,398 General and administrative......... 25,071 -------- Loss from operations.... $ (7,996) -------- 1998 Total revenues.......... $11,161 $20,612 $12,897 $44,248 $15,866 $ -- $104,784 Cost of services........ 6,880 11,500 7,328 39,415 12,898 -- 78,021 ------- ------- ------- ------- ------- ----- -------- Gross profit........... $ 4,281 $ 9,112 $ 5,569 $ 4,833 $ 2,968 $ -- 26,763 ======= ======= ======= ======= ======= ===== Gross profit percent.... 38% 44% 43% 11 % 19% 0 % Sales and marketing..... 12,203 General and administrative......... 18,456 Merger related expenses............... 2,825 -------- Income from operations.. $ (6,721) ========
12. QUARTERLY FINANCIAL DATA (Unaudited)
Quarter Ended ---------------------------------------------- March 31, June 30, September 30, December 31, --------- -------- ------------- ------------ 2000 Net revenue.................... $17,575 $16,127 $15,341 $14,705 Gross margin................... 1,619 3,082 2,082 4,184 Net loss available to common stockholders.................. (4,650) (3,595) (4,104) (6,672) Basic and diluted net loss available to common stockholders per common share....................... $ (0.26) $ (0.20) $ (0.23) $ (0.38) 1999 Net revenue.................... $27,323 $27,051 $25,382 $23,644 Gross margin................... 5,503 7,934 7,681 6,355 Net income (loss) available to common stockholders........... (1,668) 60 625 (8,303) Basic and diluted net income (loss) available to common stock-holders per common share....................... $ (0.09) $ 0.00 $ 0.04 $ (0.47)
F-19 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Col. A Col. B Col. C Col. D Col. E ------ ---------- --------------------- ---------- ---------- Additions --------------------- Charged to Balance at Charged to Other Balance at Beginning Costs and Accounts-- End of Description of Period Expenses Describe Write-offs Period ----------- ---------- ---------- ---------- ---------- ---------- Year Ended December 31, 2000: Allowance for doubtful accounts............. $1,868 $ 402 $ -- $1,132 $1,138 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
29 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 will be 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 will be 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 will be 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 will be included under the caption entitled "Certain Relationships and Related Transactions " in the Company's Proxy Statement and is incorporated herein by reference. 30 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) Consolidated balance sheets of the Registrant as of December 31, 2000 and 1999 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. (2) Schedule II--Valuation and Qualifying Accounts. (b) Reports on Form 8-K. (1) Current reports on Form 8-K, filed on October 2, 2000, reporting press release of new Chief Financial Officer and retention of strategic consulting firm. (c) Exhibits.
Exhibit Number Description ------- ----------- 2.1 Agreement and Plan of Merger by and between the Registrant and each of its former subsidiaries, dated December 31, 2000 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(4) Certificate of Designations of the Registrant, as filed with the Secretary of State of the State of Delaware on July 23, 1999. 4.4(4) 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"). 4.5(5) Registration Rights Agreement, dated as of November 9, 2000, 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"). 4.7(5) Form of Warrant 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. 10.6(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.
31
Exhibit Number Description ------- ----------- 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(*)(2) Information Management Agreement, dated as of January 1, 1999, by and between the Registrant and Saint Mary's Health Network. 10.15(3) 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(3) 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(4) 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(4) 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(5) Investment Agreement, dated November 9, 2000, by and among the Registrant, Galen III, Galen International and Galen Employee Fund. 10.20(5) Separation and General Release, dated November 11, 2000 by and between the Registrant and Larry D. Grandia. 10.21(6) Daou Systems, Inc., Employee Stock Purchase Plan. 10.22 Employment Agreement dated November 9, 2000, by and between the Registrant and James T. Roberto. 23.1 Consent of Ernst & Young LLP, independent auditors. 24 Power of Attorney (included on the signature page to this report).
- -------- (+) 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 January 15, 1999. (3) 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. (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 July 29, 1999. (5) 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, 2000, filed with the Commission on November 15, 2000. (6) Incorporated by reference to the similarly described exhibit included with the Registrant's Registration Statement on Form S-8, File No. 333-52704. 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, 2001 DAOU SYSTEMS, INC. /s/ James T. Roberto By: _________________________________ James T. Roberto Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James T. Roberto and Neil R. Cassidy, 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, 2001 ____________________________________ Georges J. Daou /s/ James T. Roberto President and Chief March 28, 2001 ____________________________________ Executive Officer and James T. Roberto Director (Principal Executive Officer) /s/ Neil R. Cassidy Executive Vice President, March 28, 2001 ____________________________________ Chief Financial Officer and Neil R. Cassidy Secretary (Principal Financial and Accounting Officer) /s/ David W. Jahns Director March 28, 2001 ____________________________________ David W. Jahns /s/ Kevin M. Fickenscher, M.D. Director March 28, 2001 ____________________________________ Kevin M. Fickenscher, M.D. /s/ Larry D. Grandia Director March 28, 2001 ____________________________________ Larry D. Grandia
33 EX-2.1 2 0002.txt AGREEMENT AND PLAN OF MERGER EXHIBIT 2.1 The Registrant entered into a separate Agreement and Plan of Merger with each of its former subsidiaries: DAOU Sentient, Inc., a Delaware corporation; DAOU Synexus, Inc., a Delaware corporation; DAOU TMI, Inc., a Delaware corporation; DAOU RHI, Inc., a Delaware corporation; and Enosus, Inc., a Delaware corporation. The Agreement and Plan of Merger, dated December 28, 2000, by and between the Registrant and DAOU RHI, Inc., which is attached, is substantially identical in all material respects to each other Agreement and Plan of Merger by and between the Registrant and each other subsidiary. As provided in Item 601 of Regulation S-K, only one copy of the Agreement and Plan of Merger is attached. Each Agreement and Plan of Merger is identical except that each was entered into with a different subsidiary. ================================================================================ AGREEMENT AND PLAN OF MERGER between DAOU Systems, Inc. and DAOU - RHI, Inc. Dated as of December 28, 2000 ================================================================================ TABLE OF CONTENTS
Page 1. DEFINITIONS AND USE OF TERMS. 1 1.1 Construction........................................................................... 1 1.2 Definitions............................................................................ 2 2. THE MERGER; CLOSING......................................................................... 4 2.1 Basic Transaction...................................................................... 4 2.2 Effective Time; Closing................................................................ 4 2.3 Effect of the Merger................................................................... 5 2.4 Certificate of Incorporation; Bylaws................................................... 5 2.5 Directors and Officers................................................................. 5 2.6 Succession, Liabilities and Further Assurances......................................... 5 2.7 Cancellation of Securities............................................................. 6 2.8 Stock Transfer Books................................................................... 6 3. REPRESENTATIONS AND WARRANTIES OF SUBSIDIARY................................................ 6 3.1 Organization and Good Standing........................................................ 6 3.2 Enforceability; No Conflict........................................................... 7 3.3 Capitalization........................................................................ 7 3.4 Intellectual Property................................................................. 8 3.5 Contracts; No Defaults................................................................ 8 3.6 Compliance with Legal Requirements; Governmental Authorizations....................... 8 3.7 Legal Proceedings; Orders............................................................. 9 3.8 Board Recommendation.................................................................. 10 4. REPRESENTATIONS AND WARRANTIES OF THE PARENT............................................... 10 4.1 Organization.......................................................................... 10 4.2 Enforceability; No Conflict........................................................... 10 4.3 Certain Proceedings................................................................... 11 5. ADDITIONAL AGREEMENTS...................................................................... 11 5.1 Required Approvals.................................................................... 11 5.2 Notification.......................................................................... 11 6. CONDITIONS PRECEDENT TO THE SUBSIDIARY'S OBLIGATION TO CLOSE............................... 12
-i-
Page 6.1 Accuracy of Representations........................................................... 12 6.2 Subsidiary's Performance.............................................................. 12 6.3 Additional Documents.................................................................. 12 6.4 No Proceedings........................................................................ 13 6.5 No Prohibition........................................................................ 13 7. CONDITIONS PRECEDENT TO SUBSIDIARY'S OBLIGATION TO CLOSE................................... 13 7.1 Accuracy of Representations........................................................... 13 7.2 The Parent's Performance.............................................................. 13 7.3 Additional Documents.................................................................. 14 7.4 No Prohibition........................................................................ 14 8. TERMINATION................................................................................ 14 8.1 Termination Events.................................................................... 14 8.2 Effect of Termination................................................................. 14 9. GENERAL PROVISIONS......................................................................... 15 9.1 Further Assurances.................................................................... 15 9.2 Entire Agreement and Modification..................................................... 15 9.3 Severability.......................................................................... 15 9.4 No Third-Party Rights................................................................. 15 9.5 Governing Law......................................................................... 15 9.6 Counterparts.......................................................................... 15
-ii- AGREEMENT AND PLAN OF MERGER This Agreement and Plan of Merger (this "Agreement") is entered into as of --------- December 28, 2000, by and between DAOU Systems, Inc., a Delaware corporation (the "Parent"), and DAOU - RHI, Inc., a Delaware corporation and a wholly-owned ------ subsidiary of the Parent (the "Subsidiary"). The Parent and the Subsidiary are ---------- referred to herein individually as a "Party" collectively as the "Parties." ----- ------- PRELIMINARY STATEMENTS A. The Parent is a corporation duly organized and validly existing under the laws of the State of Delaware, and is authorized to issue (i) fifty million (50,000,000) shares of common stock, $.001 par value per share, of which seventeen million seven hundred twelve thousand seven hundred sixty-eight (17,712,768) shares are issued and outstanding as of the date of this Agreement and (ii) six million six hundred three thousand four hundred thirty (6,603,430) shares of preferred stock, $.001 par value per share, of which two million one hundred eighty-two thousand (2,182,000) shares are issued and outstanding as of the date of this Agreement. B. The Subsidiary is a corporation duly organized and validly existing under the laws of the State of Delaware and is authorized to issue common stock. The issued and outstanding shares of common tock are referred to herein as the "Subsidiary Shares". ----------------- C. The Parent is the sole stockholder of the Subsidiary Shares. D. The respective Boards of Directors of the Parent and the Subsidiary, deeming it advisable and in the best interests of each such corporation and its respective stockholders, have approved and adopted this Agreement providing for the merger of the Subsidiary with and into the Parent (the "Merger") as ------ authorized by Section 253 of the Delaware General Corporation Law ("DGCL"), upon ---- the terms and conditions set forth in this Agreement. AGREEMENT The Parties, intending to be legally bound, agree as follows: 1. Definitions and Use of Terms. 1.1 Construction. ------------ All references in this Agreement to "Articles," "Sections" or refer to the -------- -------- corresponding Articles and Sections of this Agreement, respectively, unless the context indicates otherwise. The headings of Articles and Sections are provided for convenience only and should not affect the construction or interpretation of this Agreement. All words used in this Agreement should be construed to be of such gender or number as the circumstances require. The terms "include" or ------- "including" indicate examples of a foregoing general statement and not a - ---------- limitation on that general statement. Any reference to a statute refers to the statute, any amendments or successor legislation, and all regulations promulgated under or implementing the statute, as in effect at the relevant time. Any reference to a Contract (as defined below) or other document as of a given date means the Contract or other document as amended, supplemented, and modified from time to time through such date. 1.2 Definitions. ----------- For the purposes of this Agreement, the following terms and variations on them have the meanings specified in this Section: "Business Day" means a day of the year in which banks are not required or ------------ authorized to be closed in the City of San Diego, California. "Certificate of Ownership and Merger" is defined in Section 2.2. ----------------------------------- "Closing" means the consummation and completion of the Merger and the ------- transactions contemplated hereby. "Closing Date" is defined in Section 2.2. ------------ "Consent" means any approval, consent, ratification, waiver, or other ------- authorization. "Contract" means any contract, agreement, commitment, understanding, lease, -------- license, franchise, warranty, guaranty, mortgage, note, bond, or other instrument or consensual obligation (whether written or oral and whether express or implied) that is legally binding. "Contravene" -- an act or omission would "Contravene" something if, as the ---------- context requires: (a) the act or omission would conflict with it, violate it, result in a breach or violation of or failure to comply with it, or constitute a default under it; (b) the act or omission would give any Governmental Body or other Person the right to challenge, revoke, withdraw, suspend, cancel, terminate, or modify it, to exercise any remedy or obtain any relief under it, or to declare a default or accelerate the maturity of any obligation under it; or (c) the act or omission would result in the creation of an Encumbrance on the stock or assets of the Subsidiary or the Parent, as appropriate. "DGCL" is defined in the Preliminary Statements. ---- "Effective Time" is defined in Section 2.2. -------------- "Encumbrance" means any charge, claim, mortgage, servitude, easement, right ----------- of way, community or other marital property interest, covenant, equitable interest, lien, option, pledge, security interest, preference, priority, right of first refusal, or similar restriction. "GAAP" means generally accepted accounting principles for financial ---- reporting in the United States. 2 "Governmental Authorization" means any franchise, grant, approval, Consent, -------------------------- license, permit, easement, variance, exception, certificate, order, waiver, registration or other authorization issued, granted, given, or otherwise made available by or under the authority of any Governmental Body or pursuant to any Legal Requirement. "Governmental Body" means any: ----------------- (a) nation, region, state, county, city, town, village, district, or other jurisdiction; (b) federal, state, local, municipal, foreign, or other government; (c) governmental or quasi-governmental authority of any nature (including any governmental agency, branch, department, or other entity and any court or other tribunal); (d) multinational organization; (e) body exercising, or entitled to exercise, any administrative, executive, judicial, legislative, policy, regulatory, or taxing authority or power of any nature; and (f) official of any of the foregoing. "Intellectual Property" is defined in Section 3.4. --------------------- "Legal Requirement" means any constitution, law, statute, treaty, rule, ----------------- regulation, ordinance, binding case law or principle of common law, notice, approval or Order of any Governmental Body, and any Contract with any Governmental Body relating to compliance with any of the foregoing. "Liabilities" includes liabilities or obligations of any nature, whether ----------- known or unknown, whether absolute, accrued, contingent, choate, inchoate, or otherwise, whether due or to become due, and whether or not required to be reflected on a balance sheet prepared in accordance with GAAP. "Merger" is defined in the Preliminary Statements. ------ "Order" means any order, injunction, judgment, decree, ruling, assessment, ----- or arbitration award of any Governmental Body or arbitrator. "Ordinary Course of Business" means the ordinary course of business --------------------------- consistent with past custom and practice (including with respect to quantity and frequency). "Organizational Document" means any charter, articles, bylaws, certificate, ----------------------- statement, statutes, or similar document adopted, filed, or registered in connection with the creation, formation, or organization of an entity, and any Contract among all equityholders, partners, or members of an entity. 3 "Parent" is defined in the first paragraph of this Agreement. ------ "Parties" and "Party" are defined in the first paragraph of this Agreement. ------- ----- "Person" refers to an individual or an entity, including a corporation, ------ share company, limited liability company, partnership, trust, association, joint venture, joint stock company, unincorporated organization, Governmental Body, or any other body with legal personality separate from its equityholders or members. "Proceeding" means any action, arbitration, audit, examination, ---------- investigation, hearing, litigation, or suit (whether civil, criminal, administrative, judicial, or investigative, whether formal or informal, and whether public or private) commenced, brought, conducted, or heard by or before, or otherwise involving, any Governmental Body or arbitrator. "Securities Exchange Act" means the Securities Exchange Act of 1934, as ----------------------- amended. "Subsidiary" is defined in the first paragraph of this Agreement. ---------- "Subsidiary Contract" means any Contract (a) under which Subsidiary has or ------------------- may acquire rights, (b) under which Subsidiary is or may become subject to Liability, or (c) by which Subsidiary or any of its assets is or may become bound. "Subsidiary Shares" is defined in the Preliminary Statements. ----------------- "Surviving Corporation" is defined in Section 2.1. --------------------- "Threatened" -- an action or matter would be considered to have been ---------- "Threatened" if a demand or statement has been made or a notice has been given, or any other event has occurred or any other circumstances exist, that would lead a prudent Person to conclude that such action or matter is likely to be asserted, commenced, taken or otherwise pursued in the future. 2. The Merger; Closing. 2.1 Basic Transaction. ----------------- Upon the terms and subject to the conditions set forth in this Agreement and in accordance with the DGCL, at the Effective Time, the Subsidiary shall be merged with and into the Parent. The Parent shall be the surviving corporation in the Merger (the "Surviving Corporation") and continue to exist under and be --------------------- governed by the laws of the State of Delaware. The separate corporate existence of the Subsidiary shall cease, and the outstanding shares of capital stock of the Subsidiary shall be canceled in the manner provided in Section 2.7 of this Agreement. The name of the Surviving Corporation shall be "DAOU Systems, Inc." 2.2 Effective Time; Closing. ----------------------- As promptly as practicable after Closing, and in no event later than the first Business Day following the satisfaction or, if permissible, waiver of the conditions set forth in Articles 6 and 7 (or such other date as may be agreed in writing by each of the Parties), the Parties shall cause the 4 Merger to be consummated by filing a certificate of ownership and merger, substantially in the form attached hereto as Annex A (the "Certificate of ------- -------------- Ownership and Merger"), with the Secretary of State of Delaware in such form as - --------------------- is required by, and executed in accordance with the relevant provisions, of the DGCL. The Merger shall become effective on the date and time of the filing of the Certificate of Ownership and Merger with the Secretary of State of Delaware (or such later time as may be agreed in writing by each of the Parties and specified in the Certificate of Ownership and Merger) (the "Effective Time"). -------------- Immediately prior to the filing of the Certificate of Ownership and Merger, the Closing will be held at the offices of the Parent, San Diego, California (or such other place as the Parties may agree) on the first Business Day after the date on which the last of the conditions to Closing set forth in Articles 6 and 7 hereof (other than conditions to be satisfied at the Closing) are fulfilled or waived by the appropriate Party, as the case may be (or such other time, date or place as the Parties may agree) (the "Closing Date"). ------------ 2.3 Effect of the Merger. -------------------- At the Effective Time, the effect of the Merger shall be as provided in the applicable provisions of the DGCL. 2.4 Certificate of Incorporation; Bylaws. ------------------------------------ (a) The certificate of incorporation of the Parent, as in effect immediately prior to the Effective Time, shall be the certificate of incorporation of the Surviving Corporation, until thereafter amended as provided therein or by applicable law. (b) The bylaws of the Parent, as in effect immediately prior to the Effective Time, shall be the bylaws of the Surviving Corporation until thereafter amended as provided therein or by applicable law. 2.5 Directors and Officers. ---------------------- The persons who are directors and officers of the Parent immediately prior to the Effective Time shall, after the Effective Time, be the directors and officers of the Surviving Corporation until their successors have been duly elected or appointed and qualified or until their earlier death, resignation, removal or disqualification in accordance with the articles of incorporation and bylaws of the Surviving Corporation and applicable law. 2.6 Succession, Liabilities and Further Assurances. ---------------------------------------------- (a) All corporate acts, plans, policies, applications, agreements, orders, registrations, licenses, approvals, and authorizations of the Parties, their respective shareholders, Boards of Directors, committees elected or appointed by their Boards of Directors, officers, and agents, which were valid and effective immediately prior to the Effective Time, shall be taken for all purposes on and after the Effective Time as acts, plans, policies, applications, agreements, orders, registrations, licenses, approvals, and authorizations of the Surviving Corporation and shall be as effective and binding thereon as the same were with respect to the Parties immediately prior to the Effective Time. 5 (b) At the Effective Time, all rights, title, and interests to all property owned by each of the Parties shall be allocated to and vested in the Surviving Corporation without reversion or impairment, without further act or deed, and without any transfer or assignment having occurred, but subject to any existing liens thereon. (c) The Surviving Corporation shall, at the Effective Time and thereafter, be responsible and liable for all Liabilities of each of the Parties, and a Proceeding pending against any Party may be continued as if the Merger did not occur, or the Surviving Corporation may be substituted in the Proceeding in place of any Party. (d) If at any time the Surviving Corporation shall deem or be advised that additional grants, assignments, confirmations or assurances are necessary or desirable to vest or to perfect or confirm of record or otherwise in the Surviving Corporation the title to any property of any Party, the officers, or any of them, or the directors of such Party may execute and deliver any and all such deeds, assignments, confirmation and assurances and do all things necessary or proper so as best to prove, confirm and ratify to such property in the Surviving Corporation or otherwise to carry out the purposes of the Merger and the terms of this Agreement. The Surviving Corporation shall have the same power and authority to act in respect to any debt, liabilities and duties of the Parties as the Parties would have had, had they continued in existence. 2.7 Cancellation of Securities. -------------------------- At the Effective Time, each issued and outstanding Subsidiary Share that was held by the Parent immediately before the Effective Time, shall, by virtue of the Merger and without any action on the part of the holders thereof, be canceled and retired and shall cease to exist, and all certificates representing such Shares shall be canceled, and no cash or securities or other property shall be issued in the Merger in respect to such Shares. 2.8 Stock Transfer Books. -------------------- From and after the Effective Time, the stock transfer books of the Subsidiary shall be closed, and no transfer of the capital stock of the Subsidiary shall be made or consummated thereafter. 3. Representations and Warranties of SUBsidiary. The Subsidiary represents and warrants to the Parent that the statements contained in this Article 3 are correct and complete in all material respects as of the date of this Agreement and will be correct and complete in all material respects as of the Closing Date (as though made then and as though the Closing Date were substituted for the date of this Agreement throughout this Article 3). 3.1 Organization and Good Standing. ------------------------------ (a) The Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, with full corporate power and authority to 6 conduct its business as it is now being conducted, to own or use the properties and assets that it purports to own or use, and to perform all its obligations under all Subsidiary Contracts. (b) The Subsidiary does not, directly or indirectly, have any equity, voting or ownership interests in any corporation, partnership, joint venture, limited liability company or other legal entity. 3.2 Enforceability; No Conflict. --------------------------- (a) Assuming due authorization, execution and delivery of this Agreement by the Parent, this Agreement constitutes the legal, valid, and binding obligation of the Subsidiary, enforceable against the Subsidiary in accordance with its terms, except as enforceability may be limited by bankruptcy, insolvency, moratorium or other similar laws of general application affecting the enforceability of creditor's rights generally or by general principles of equity whether applied by a court of law or equity. The Subsidiary has the absolute and unrestricted right, power, authority, and capacity to execute and deliver this Agreement and to perform its obligations under this Agreement. (b) The Subsidiary is not and will not be required to give any notice to any Person or obtain any Consent or Governmental Authorization in connection with the execution and delivery of this Agreement or the consummation or performance of any of the transactions contemplated hereby, except the filing and recordation of an appropriate Certificate of Ownership and Merger with the Secretary of State of Delaware as required by the DGCL. (c) Neither the execution and delivery of this Agreement nor the consummation or performance of any of the transactions contemplated hereby will directly or indirectly (with or without notice or lapse of time): (i) Contravene any provision of the Organizational Documents of the Subsidiary, or any resolution adopted by the Board of Directors or stockholder of the Subsidiary; (ii) Contravene any Subsidiary Contract, Governmental Authorization, Legal Requirement or Order to which the Subsidiary, or any of the assets owned or used by the Subsidiary, may be subject; or (iii) result in the imposition or creation of any Encumbrance upon or with respect to any of the assets owned or used by the Subsidiary. 3.3 Capitalization. -------------- As of the date of this Agreement, only the Subsidiary Shares are issued and outstanding, all of which are validly issued, fully paid and nonassessable and not subject to preemptive rights. Immediately prior to the Effective Time, the authorized capital stock of the Subsidiary will be the same as set forth in the first sentence of this Section 3.3. No shares of capital stock of the Subsidiary have been acquired by the Subsidiary that are subject to outstanding pledges by the Subsidiary to secure the future payment of some or all of the purchase price for such shares. As of the date of this Agreement, there are no options, warrants or other rights, agreements, arrangements or commitments of any character relating to the issued or unissued capital stock of 7 the Subsidiary obligating the Subsidiary to issue or sell any shares of capital stock of, or other equity interests in, the Subsidiary. There are no outstanding contractual obligations of the Subsidiary to repurchase, redeem or otherwise acquire any shares of capital stock of the Subsidiary. 3.4 Intellectual Property. --------------------- (a) "Intellectual Property" means all intellectual property owned, used or licensed (as licensor or licensee) by the Subsidiary. (b) There are no outstanding and, to the Subsidiary's knowledge, no Threatened disputes or disagreements with respect to any Subsidiary Contracts relating to the Intellectual Property. (c) (i) The Subsidiary is the owner or licensee of all right, title, and interest in and to the Intellectual Property, free and clear of all Encumbrances, and has the absolute right to use all of the Intellectual Property without payment to a third party. (ii) All former and current employees of the Subsidiary have executed written Contracts with the Subsidiary that assign to the Subsidiary all rights to any inventions, improvements, discoveries, or information relating to the business of the Subsidiary. 3.5 Contracts; No Defaults. ---------------------- (a) The Subsidiary has not Contravened any of the applicable terms and requirements of any Subsidiary Contract, and the Subsidiary has no knowledge of any Contravention of any Subsidiary Contract by the other party or parties to it. (b) There are no renegotiations of, attempts to renegotiate, or outstanding rights to renegotiate any Subsidiary Contract, and no one has made written demand for such renegotiations. The Subsidiary has no knowledge that any party to a Subsidiary Contract does not intend to renew it. 3.6 Compliance with Legal Requirements; Governmental Authorizations. --------------------------------------------------------------- (a) The Subsidiary is, and at all times since its incorporation, has been in all material respects, in full compliance with each Legal Requirement that is or was applicable to it or to the conduct or operation of its business or the ownership or use of any of its assets. (b) No event has occurred or circumstance exists that (with or without notice or lapse of time) may cause the Subsidiary to Contravene any Legal Requirement or may give rise to any obligation on the part of the Subsidiary to undertake, or to bear all or any portion of the cost of, any remedial action of any nature. (c) The Subsidiary has not received, at any time since its incorporation, any notice or other communication (whether oral or written) from any Governmental Body or any other Person regarding any actual, alleged, possible, or potential Contravention of any Legal Requirement or any actual, alleged, possible, or potential obligation on the part of any of the 8 Subsidiary to undertake, or to bear all or any portion of the cost of, any remedial action of any nature. (d) The Subsidiary is, and at all times since its incorporation, has been, in full compliance with all of the terms and requirements of each such Governmental Authorization. (e) No event has occurred or circumstance exists that may (with or without notice or lapse of time) constitute or result directly or indirectly in Contravention of any Governmental Authorization. (f) The Subsidiary has not received, at any time since its incorporation, any notice or other communication (whether oral or written) from any Governmental Body or any other Person regarding any actual, alleged, possible, or potential Contravention of any Governmental Authorization. (g) All applications required to have been filed for the renewal of such Governmental Authorizations have been duly filed on a timely basis with the appropriate Governmental Bodies, and all other filings required to have been made with respect to such Governmental Authorizations have been duly made on a timely basis with the appropriate Governmental Bodies. (h) All such Governmental Authorizations are renewable by their terms or in the Ordinary Course of Business without the need to comply with any special qualification procedures or to pay any amounts other than routine fees or similar charges. 3.7 Legal Proceedings; Orders. ------------------------- (a) There is no pending Proceeding: (i) by or against the Subsidiary or that otherwise relates to or may affect the business of, or any of the assets owned or used by, the Subsidiary; or (ii) that challenges, or that may have the effect of preventing, delaying, making illegal, or otherwise interfering with, any of the transactions contemplated hereby. To the knowledge of the Subsidiary, no such Proceeding has been Threatened. (b) There is no Order to which the Subsidiary, its business or any of its assets is subject. (c) To the knowledge of the Subsidiary, no officer, director, agent, or employee of the Subsidiary is subject to any Order that prohibits such officer, director, agent, or employee from engaging in or continuing any conduct, activity, or practice relating to the business of the Subsidiary. (d) The Subsidiary is, and at all times since its incorporation, has been, in full compliance with all of the terms and requirements of each Order to which it, or any of the assets owned or used by it, is or has been subject. 9 (e) No event has occurred or circumstance exists that may constitute or result in (with or without notice or lapse of time) a violation of or failure to comply with any term or requirement of any Order to which the Subsidiary or any of the assets owned or used by the Subsidiary, is subject. (f) The Subsidiary has not received, at any time since its incorporation, any notice or other communication (whether oral or written) from any Governmental Body or any other Person regarding any actual, alleged, possible, or potential violation of, or failure to comply with, any term or requirement of any Order to which the Subsidiary, or any of the assets owned or used by it, is or has been subject. 3.8 Board Recommendation. -------------------- The Board of Directors of the Subsidiary has adopted a resolution (a) approving the Merger, based on a determination that the Merger is fair to, and in the best interests of, the stockholder of the Subsidiary and (b) approving this Agreement and the transactions contemplated hereby and unanimously recommending approval of this Agreement and the transactions contemplated hereby by the stockholder of the Subsidiary. 4. Representations and Warranties of the parent. The Parent represents and warrants to the Subsidiary as follows: 4.1 Organization. ------------ The Parent is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. 4.2 Enforceability; No Conflict. --------------------------- (a) The Parent has the absolute and unrestricted right, power, and authority to execute and deliver this Agreement and to perform its obligations under this Agreement, which action has been duly authorized and approved by all necessary corporate action of the Parent. Assuming the execution and delivery of this Agreement by the Subsidiary, this Agreement constitutes the legal, valid, and binding obligation of the Parent, enforceable against the Parent in accordance with the terms of this Agreement, except as enforceability may be limited by bankruptcy, insolvency, moratorium or other similar laws of general application affecting the enforceability of creditor's rights generally or by general principles of equity whether applied by a court of law or equity. (b) The Parent will not be required to obtain any Governmental Authorization or Consent in connection with the execution and delivery of this Agreement or the consummation or performance of any of the transactions contemplated hereby, except the filing and recordation of an appropriate Certificate of Ownership and Merger with the Secretary of State of Delaware as required by the DGCL. (c) Neither the execution and delivery of this Agreement by the Parent nor the consummation or performance of any of the transactions contemplated hereby by the Parent will 10 give any Person the right to prevent, delay, or otherwise interfere with any of the transactions contemplated hereby pursuant to: (i) any provision of the Parent's Organizational Documents; (ii) any resolution adopted by the board of directors or the Parent; (iii) any Legal Requirement or Order to which the Parent may be subject; or (iv) any Contract to which the Parent is a party or by which the Parent may be bound. 4.3 Certain Proceedings. ------------------- There is no pending Proceeding that has been commenced against the Parent and that challenges, or may have the effect of preventing, delaying, making illegal, or otherwise interfering with, any of the transactions contemplated hereby. To the Parent's knowledge, no such Proceeding has been Threatened. 5. ADDITIONAL AGREEMENTS. 5.1 Required Approvals. ------------------ As promptly as practicable after the date of this Agreement, the Parties will make all filings that Legal Requirements require them to make to consummate the transactions contemplated hereby. Between the date of this Agreement and the Closing Date, each Party will cooperate with the other Party with respect to all filings that the other Party elects to make or that Legal Requirements require such Party to make in connection with the transactions contemplated hereby. 5.2 Notification. ------------ Between the date of this Agreement and the Closing Date, the Subsidiary will promptly notify the Parent in writing of: (a) any fact or condition that causes or constitutes a breach of any of the Subsidiary's representations and warranties as of the date of this Agreement, or (b) the occurrence after the date of this Agreement of any fact or condition that would (except as expressly contemplated by this Agreement) cause or constitute a breach of any such representation or warranty had that representation or warranty been made as of the time of the occurrence or discovery of such fact or condition. Such delivery will not affect any rights of the Parent under Section 8.2 and will not prevent or cure any misrepresentation, breach of warranty, or breach of contract. During the same period, the Subsidiary will promptly notify the Parent of the occurrence of any breach of any covenant of the Subsidiary in this Article or of the occurrence of any event that may make the satisfaction of the conditions in Article 6 impossible or unlikely. 11 6. Conditions Precedent to the subsidiary's Obligation to Close. The Subsidiary's obligation to consummate the Merger and to take the other actions required to be taken by the Subsidiary at the Closing is subject to the satisfaction, on or before the Closing Date, of each of the following conditions (any of which may be waived by the Parent in writing, in whole or in part): 6.1 Accuracy of Representations. --------------------------- (a) Except as set forth in Section 6.1(b), all of the Subsidiary's representations and warranties in this Agreement (considered both individually and collectively) must have been accurate in all material respects as of the date of this Agreement, and must be accurate in all material respects for those representations and warranties as of the Closing Date as if then made. (b) Each of the Subsidiary's representations and warranties in Section 3.2(a) must have been accurate in all respects as of the date of this Agreement, and must be accurate in all respects as of the Closing Date as if then made. (c) The Parent shall have received an officer's certificate of the Subsidiary to the effect that each of the conditions specified in Sections 6.1, 6.2, 6.4 and 6.5 is satisfied in all respects. 6.2 Subsidiary's Performance. ------------------------ (a) All of the covenants and obligations that the Subsidiary is required to perform or to comply with pursuant to this Agreement on or before the Closing Date (considered both collectively and individually) must have been duly performed and complied with in all material respects. (b) The Subsidiary must have (i) delivered each document, agreement and certificate that is required to be delivered pursuant to this Article 6; and (ii) performed and complied with, in all respects, each of the covenants and obligations in Section 5.1 and each of the covenants and obligations in this Agreement that the Subsidiary is required to perform or comply with on or before the Closing Date that contains an express materiality qualification. 6.3 Additional Documents. -------------------- The Subsidiary must have caused to be delivered to the Parent such documents as the Parent may reasonably request for the purpose of (i) evidencing the accuracy of any of the Subsidiary's representations and warranties, (ii) evidencing the performance by the Subsidiary of, or the compliance by the Subsidiary with, any covenant or obligation required to be performed or complied with by the Subsidiary, (iii) evidencing the satisfaction of any condition referred to in this Article, or (iv) otherwise facilitating the consummation or performance of any of the transactions contemplated hereby. 12 6.4 No Proceedings. -------------- Since the date of this Agreement, there must not have been commenced or Threatened any action, suit, or proceeding before any court or quasi-judicial or administrative agency of any federal, state, local, or foreign jurisdiction or before any arbitrator wherein an unfavorable injunction, judgment, order, decree, ruling, or charge would (a) prevent consummation of any of the transactions contemplated by this Agreement, (b) cause any of the transactions contemplated by this Agreement to be rescinded following consummation, (c) affect adversely the right of the Parent to own the Subsidiary Shares and to control the Subsidiary, or (d) affect adversely the right of any of the Subsidiary to own its assets and to operate its businesses (and no such injunction, judgment, order, decree, ruling, or charge shall be in effect). 6.5 No Prohibition. -------------- Neither the consummation nor the performance of any of the transactions contemplated hereby will, directly or indirectly (with or without notice or lapse of time), Contravene, or cause the Parent to suffer any adverse consequence under, (a) any applicable Legal Requirement or Order, or (b) any Legal Requirement or Order that has been published, introduced, or otherwise proposed by or before any Governmental Body. 7. Conditions Precedent to subsidiary's Obligation to Close. The Subsidiary's obligation to consummate the Merger and to take the other actions required to be taken by the Subsidiary at the Closing is subject to the satisfaction, on or before the Closing Date, of each of the following conditions (any of which may be waived by the Subsidiary in writing, in whole or in part): 7.1 Accuracy of Representations. --------------------------- All of the Parent's representations and warranties in this Agreement (considered collectively and individually) must have been accurate in all material respects as of the date of this Agreement and must be accurate in all material respects as of the Closing Date as if then made. 7.2 The Parent's Performance. ------------------------ All of the covenants and obligations that the Parent are required to perform or to comply with pursuant to this Agreement on or before the Closing Date (considered both collectively and individually) must have been performed and complied with in all material respects. (a) The Parent must have executed and delivered each of the documents required to be delivered by the Parent pursuant to this Article 7. (b) The Subsidiary must have received an officer's certificate of the Parent to the effect that the condition specified in Section 7.1 is satisfied in all respects. 13 7.3 Additional Documents. -------------------- The Parent must have caused to be delivered to the Subsidiary such documents as the Subsidiary may reasonably request for the purpose of (a) evidencing the accuracy of any representation or warranty of the Parent, (b) evidencing the performance by the Parent of, or the compliance by the Parent with, any covenant or obligation required to be performed or complied with by the Parent, (c) evidencing the satisfaction of any condition referred to in this Article, or (d) otherwise facilitating the consummation of any of the transactions contemplated hereby. 7.4 No Prohibition. -------------- There must not be in effect any Legal Requirement or Order that (a) prohibits the consummation of the transactions contemplated hereby, and (b) has been adopted or issued, or has otherwise become effective, since the date of this Agreement. 8. Termination. 8.1 Termination Events. ------------------ This Agreement may, by notice given before or at the Closing and subject to Section 8.2, be terminated: (a) by the Parent, on the one hand, or the Subsidiary, on the other hand, if a material breach of any provision of this Agreement has been committed by the other Party and such breach has not been waived; (b) (i) by the Parent, if any condition in Article 6 has not been satisfied as of the date specified for Closing in Section 2.2 or if satisfaction of such a condition by such date is or becomes impossible (other than through the failure of the Parent to comply with its obligations under this Agreement) and the Parent has not waived such condition on or before such date; or (ii) by the Subsidiary, if any condition in Article 7 has not been satisfied as of the date specified for Closing in Section 2.2 or if satisfaction of such a condition by such date is or becomes impossible (other than through the failure of the Subsidiary to comply with their obligations under this Agreement) and the Subsidiary has not waived such condition on or before such date; or (c) by mutual consent duly authorized by the Board of Directors of each of the Parent and the Subsidiary. 8.2 Effect of Termination. --------------------- Each Party's right of termination under Section 8.1 is in addition to any other rights it may have under this Agreement or otherwise, and the exercise of such right of termination will not be an election of remedies. If this Agreement is terminated pursuant to Section 8.1, all obligations of the Parties will terminate. 14 9. General Provisions. 9.1 Further Assurances. ------------------ The Parties agree (a) to furnish upon request to each other such further information, (b) to execute and deliver to each other such other documents, and (c) to do such other acts and things, all as the other Party may reasonably request for the purpose of carrying out the intent of this Agreement, the Merger and the transactions contemplated hereby. 9.2 Entire Agreement and Modification. --------------------------------- This Agreement supersedes all prior agreements among the Parties with respect to its subject matter and constitutes (along with the documents delivered pursuant to this Agreement) a complete and exclusive statement of the terms of the agreement between the Parties with respect to its subject matter. This Agreement may not be amended except by a written agreement executed by the Party to be charged with the amendment. 9.3 Severability. ------------ If any provision of this Agreement is held invalid or unenforceable by any court of competent jurisdiction, the other provisions of this Agreement will remain in full force and effect. Any provision of this Agreement held invalid or unenforceable only in part or degree will remain in full force and effect to the extent not held invalid or unenforceable. 9.4 No Third-Party Rights. --------------------- Nothing expressed or referred to in this Agreement will be construed to give any Person, other than the Parties to this Agreement, any legal or equitable right, remedy, or claim under or with respect to this Agreement or any provision of this Agreement. 9.5 Governing Law. ------------- This Agreement will be governed by and construed under the laws of the State of Delaware without regard to conflicts of laws principles that would require the application of any other law. 9.6 Counterparts. ------------ This Agreement may be executed in one or more counterparts, each of which will be deemed to be an original copy of this Agreement and all of which, when taken together, will be deemed to constitute one and the same agreement. 15 The Parties have executed and delivered this Agreement as of the date indicated in the first sentence of this Agreement. DAOU SYSTEMS, INC. By: _____________________________ Name: ___________________________ Title: __________________________ DAOU - RHI, INC. By: _____________________________ Name: ___________________________ Title: __________________________ 16 EX-10.22 3 0003.txt EMPLOYMENT AGREEMENT EXHIBIT 10.22 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is made as of November 9, 2000 by --------- and between DAOU Systems, Inc., a Delaware corporation ("Company"), and James T. ------- Roberto, an individual resident of California ("Employee"). -------- AGREEMENT The parties to this Agreement, intending to be legally bound, agree as follows: 1. Effective Date. Employee's employment with the Company will commence -------------- November 9, 2000 (the "Effective Date"). -------------- 2. Employment Terms and Duties. --------------------------- 2.1 Employment. The Company employs Employee, and Employee accepts ---------- employment by the Company (the "Employment"), upon the terms and ---------- conditions set forth in this Agreement. 2.2 At-Will Employment. Employee's employment relationship with the ------------------ Company is at-will, terminable by either the Company or Employee at any time and for or no reason, and with or without "Cause" as defined in Section 7.2 of this Agreement. Although certain provisions of this Agreement describe events that could occur at a particular time in the future, nothing in this Agreement may be construed as a guarantee of Employee's employment for any length of time. 2.3 Duties. Effective upon his appointment by the Company's Board of ------ Directors ("Board"), Employee will serve as President and Chief Executive ----- Officer of the Company and will have such reasonable duties as are assigned or delegated to Employee by the Board. Employee will: (i) devote his entire business time, attention, skill, and energy exclusively to the business of the Company; (ii) use his best efforts to promote the success of the Company's business; and (iii) cooperate fully with the Board in the advancement of the best interests of the Company. 2.4 Election to the Board. The Board agrees to appoint Employee as a --------------------- member of the Board on November 9, 2000. 2.5 Consulting Services to Sterltech and the VanKoevering Company and ----------------------------------------------------------------- Participation on Outside Boards of Directors. - -------------------------------------------- (a) Notwithstanding the provisions of Section 2.3, for a period not to exceed 120 days from the Effective Date, Employee will be permitted to provide services as a consultant to Sterltech Corporation and the VanKoevering Company, provided that performance of this consulting does not interfere with or diminish the performance by Employee of his duties set forth in Section 2.3. Employee agrees that he will not provide consulting services to any company beyond the period described in this Section without the express written permission of the Board. If the Company terminates Employee's employment because he continues service in a consultant capacity to any company beyond the period defined in this Section without the Board's prior written approval in violation of this Section 2.5, his termination will be for "Cause" as defined in Section 7.2 of this Agreement. (b) Notwithstanding the provisions of this Section 2.5, Employee shall be permitted to participate as a member of the board of directors of other corporations provided that (i) such participation does not interfere with or diminish the performance by Employee of his duties set forth in Section 2.3, and (ii) Employee obtains the prior written consent of the Board (which consent will not unreasonably be withheld). Employee agrees to resign from any such boards of directors at the request of the Board if the Board concludes, in its discretion, that the participation of Employee on such board of directors is not in the best interest of the Company. 2.6 Compliance with the Company's Policies. Employee acknowledges and -------------------------------------- agrees that compliance with the Company's policies, practices and procedures is a term and condition of the Employment. Employee agrees to execute and comply with the terms and conditions of the Company's Employee Confidentiality and Inventions Agreement, a copy of which is attached as Exhibit A and is --------- incorporated by this reference. 3. Compensation. ------------ 3.1 Salary. From the Effective Date through either March 10, 2001 or the ------ date on which Employee terminates his consulting relationship with Sterltech Corporation and tveyes.com, whichever is sooner, Employee will be paid salary in the amount of Twenty Four Thousand Dollars ($24,000) per month, less any applicable state and federal taxes or other payroll deductions (the "Initial ------- Salary"). From March 11, 2001 or the date on which Employee terminates his - ------ consulting relationship with Sterltech Corporation and tveyes.com , Employee's salary will increase to Thirty Thousand Dollars ($30,000) per month, less any applicable state and federal taxes or other payroll deductions (the "Salary"). ------ Any adjustment to the Salary is at the sole discretion of the Company. 3.2 Benefits. Employee will be permitted to participate in such sick -------- leave, pension, profit sharing, life insurance, hospitalization, long term disability, major medical and other employee benefit plans of the Company (collectively, the "Benefits"), that may be in effect from time to time for -------- management level employees, to the extent that Employee is eligible under the terms of those plans. 3.3 Additional Compensation. Employee may be eligible, as additional ----------------------- compensation for the services rendered by Employee pursuant to this Agreement, for a quarterly bonus at the discretion of the Board and in an amount to be determined by the Board, in accordance with the Company's Incentive Compensation Plan (the "Additional Compensation"). In order to be eligible for the Additional ----------------------- Compensation, Employee shall be employed by the Company on the date that the Additional Compensation, if any, is customarily distributed by the Company. 2 3.4 Compensation upon Change of Control. ----------------------------------- (a) In the event of a "Change of Control," as defined in this ------------------ Agreement, on or before February 8, 2001, Employee will receive three percent (3%) of the net purchase price for the Company. (b) "Change in Control" is defined to have occurred if, and only if: ----------------- (i) any individual, partnership, firm, corporation, association, trust, unincorporated organization or other entity or person, or any syndicate or group deemed to be a person under Section 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is or becomes the ------------ "beneficial owner" (as defined in Rule 13d-3 of the General Rules and Regulations under the Exchange Act), directly or indirectly, of securities of the Company representing 50% or more of the combined voting power of the Company's then outstanding securities entitled to vote in the election of directors of the Company; (ii) there occurs a reorganization, merger, consolidation or other corporate transaction involving the Company ("Transaction"), in each ----------- case, with respect to which the stockholders of the Company immediately prior to such Transaction do not, immediately after the Transaction, own more than fifty percent (50%) of the combined voting power of the Company or other corporation resulting from such Transaction; or (iii) all or substantially all of the assets of the Company are sold, liquidated or distributed. 4. Growth Incentive. ---------------- 4.1 Grant of Options. On, or as soon as practicable after, the Effective ---------------- Date, the Company will grant to Employee options to purchase One Million, Five Hundred Thousand (1,500,000) shares of the Company's Common Stock (the "Options"), of which 1,000,000 Options shall be issuable under the Company's ------- 1996 Stock Option Plan (the "Plan"), and 500,000 Options shall be issuable ---- outside of the Plan. The Options granted pursuant to the Plan will consist of incentive stock options as defined in Internal Revenue Code Section 422(b) to the extent permitted by applicable law and the balance will be non-qualified options (non-statutory options). All of the Options granted outside of the Plan will be non-qualified/non-statutory options. The exercise price for the Options will be the closing price per share of the Company's Common Stock on the date of grant. In addition to the terms set forth in this Section 4, all of the Options (whether or not issued pursuant to the Plan) will be subject to such other terms, conditions and limitations as generally are included in the Plan and in any related stock option agreement, as well as applicable state and federal laws including, but not limited to, tax and securities laws. The Options will vest as set forth below in Section 4.2 and shall terminate under such conditions as generally are included in the Plan and any related stock option agreement. 4.2 Vesting of the Options. ---------------------- (a) From the Effective Date through February 9, 2001, no Options will vest. On February 9, 2001, 3/36 of the Options will vest. Thereafter, the unvested Options will 3 vest in thirty-three equal increments on the monthly anniversary of the Effective Date through November 9, 2003. (b) all unvested Options immediately will vest and become exercisable in the event of a Change of Control after February 8, 2001; (c) in the event the Employment is terminated after February 8, 2001 without "Cause" as that term is defined in Section 7.2 of this Agreement, in ------ addition to any already vested Options, up to 500,000 non-statutory Options immediately will vest and become exercisable on the date of termination. 4.3 Continued Employment. Except as described in this Section, vesting -------------------- of the Options pursuant to this Agreement is earned only by continuing as an employee of the Company at the will of the Company (not through the act of being granted the Option or acquiring shares hereunder). This Agreement, the transactions contemplated under it and the vesting schedule set forth in this Agreement do not constitute an express or implied promise of continued engagement for the vesting period, for any period, or at all. 5. Expenses. The Company will pay on behalf of Employee (or reimburse -------- Employee) reasonable expenses incurred by Employee at the request of, or on behalf of, the Company in the performance of Employee's duties pursuant to this Agreement, and in accordance with the Company's employment policies, including reasonable expenses incurred by Employee (a) while attending conventions, seminars and other business meetings, (b) for appropriate business entertainment activities and (c) for appropriate promotional expenses. The Company also will reimburse Employee for the legal expenses incurred by Employee in the initial review and execution of this Agreement in an amount up to Three Thousand Dollars ($3,000). In addition, the Company will reimburse Employee for the reasonable costs of equipping a home office (e.g. computer, phone line, printer and facsimile). Employee shall file expense reports with respect to such expenses in accordance with the Company's policies. 6. Vacations and Holidays. Employee will be entitled to paid vacation in an ---------------------- amount of four weeks per year. Employee may carry-over from one year to the next any accrued but unused vacation up to a maximum of six weeks of vacation. Once Employee accrues the maximum vacation, he will not accrue additional vacation until he takes enough vacation to bring his accrual below the maximum. Employee may take vacation at such time or times as approved by the Board. Employee is entitled to holidays in accordance with the holiday policies of the Company in effect for its employees from time to time. 7. Payment upon Termination of Employment. Upon termination of Employee's -------------------------------------- Employment, the Company will be obligated to pay to Employee only such compensation as is provided in this Section 7. 7.1 Termination of Employee For Any Reason on or Before February 8, 2001. -------------------------------------------------------------------- In the event Employee's Employment terminates for any reason on or before February 8, 2001, Employee will be eligible for payment of the Salary and accrued but unused vacation through the date of such termination. 4 7.2 Termination of Employee without Cause After February 8, 2001. In ------------------------------------------------------------ the event the Company terminates Employee's Employment without "Cause" after ----- February 8, 2001, Employee will be eligible for payment of the Salary and accrued but unused vacation through the date of such termination and severance payments (the "Severance Payment") in an aggregate amount equal to (a) the Salary plus (b) an amount equal to the Additional Compensation, if any, paid to Employee during the twelve (12) month period preceding termination. The Severance Payment, if any, will be paid in a lump sum within 45 days of termination. Employee's receipt of the Severance Payment is conditioned upon his execution of a release of all claims effective as of the termination date, in substantially the form attached to this Agreement as Exhibit B. Termination for "Cause" occurs if Employee is terminated for any one of the following reasons: ----- (i) Employee's material breach of this Agreement; (ii) Employee's material failure to adhere to any written policy of the Company that is legal and generally applicable to officers of the Company; (iii) the appropriation (or attempted appropriation) of a material business opportunity of the Company, including attempting to secure or securing any personal profit in connection with any transaction entered into on behalf of the Company; (iv) the misappropriation (or attempted misappropriation) of any of the Company's funds or property; (v) the conviction of, or the entering of a guilty plea or plea of no contest with respect to, a felony, the equivalent thereof, or any other crime with respect to which imprisonment is a possible punishment; or (vi) willful misconduct. 7.3 Termination of Employee for Cause after February 8, 2001. In the -------------------------------------------------------- event that the Company terminates Employee for Cause after February 8, 2001, Employee will be entitled to receive the portion of the Salary accrued and owing to Employee only through the date of such termination. In addition, at the option of the Company in its sole discretion, Employee may be eligible for the Severance Payments as described in Section 7.2 in exchange for his execution of a release of all claims effective as of the termination date, in substantially the form attached to this Agreement as Exhibit B. --------- 7.4 Termination of Employment following Death or Disability. Where the ------------------------------------------------------- Employment is terminated following Employee's death or where the Employment is terminated as a result of Employee suffering a disability which cannot be reasonably accommodated and which renders him unable to perform the essential functions of his position for 120 days, Employee is eligible for payment of the Salary and accrued but unused vacation through the date of such termination. 7.5 Termination for Any Other Reason. If Employee terminates his -------------------------------- employment for any reason, then Employee only will be entitled to receive the portion of the Salary accrued and owing to Employee through the date of such termination. 7.6 Benefits. Employee's accrual of, or participation in plans providing -------- for, the Benefits will cease at the effective date of Employee's termination, and Employee will be entitled to accrued Benefits pursuant to such plans only as provided in such plans. 5 8. General Provisions. ------------------ 8.1 Representations and Warranties by Employee. Employee represents and ------------------------------------------ warrants to the Company that the execution of this Agreement and the performance by Employee of his obligations under this Agreement will not: (a) violate any judgment, writ, injunction, or order of any court, arbitrator, or governmental agency applicable to Employee; or (b) conflict with, result in the breach of any provisions of or the termination of, or constitute a default under, any agreement to which Employee is a party or by which Employee is or may be bound. 8.2 Obligations Contingent on Performance. The obligations of the Company ------------------------------------- under this Agreement, including its obligation to pay the compensation provided for in this Agreement, are contingent upon Employee's performance of Employee's obligations under this Agreement. 8.3 Waiver. No waiver of any provision or consent to any exception to the ------ terms of this Agreement or any agreement contemplated by this Agreement will be effective unless in writing and signed by the party to be bound and then only to the specific purpose, extent, and instance so provided. 8.4 Binding Effect; Delegation of Duties Prohibited. This Agreement shall ----------------------------------------------- inure to the benefit of, and shall be binding upon, the parties to this Agreement and their respective successors, assigns, heirs, and legal representatives, including any entity with which the Company may merge or consolidate or to which all or substantially all of its assets may be transferred. The duties and covenants of Employee under this Agreement, being personal, may not be delegated. 8.5 Notices. All notices, amendments, consents, waivers, and other ------- communications under this Agreement must be in writing and will be deemed to have been duly given when (a) delivered by hand (with written confirmation of receipt), (b) sent by facsimile (with written confirmation of receipt), provided that a copy is mailed by registered mail, return receipt requested or (c) when received by the addressee, if sent by a nationally recognized overnight delivery service (receipt requested), in each case to the appropriate addresses and facsimile numbers set forth below (or to such other addresses and facsimile numbers as a party may designate by notice to the other parties): If to the Company: DAOU Systems, Inc. 5120 Shoreham Place San Diego, CA 92122 Attention: Chairman of the Board Facsimile No.: (619) 452-2789 With a copy to: Baker & McKenzie Two Allen Center, Suite 1200 1200 Smith Street Houston, Texas 77002 Attention: Alan Harvey, Esq. --------- Facsimile No.: (713) 427-5099 6 If to Employee: James T. Roberto Facsimile No.: 8.6 Entire Agreement; Amendments. This Agreement, including its exhibits, ---------------------------- contains the entire agreement between the parties with respect to the subject matter of this Agreement and supersedes all prior agreements and understandings, oral or written, between the parties with respect to the subject matter of this Agreement. This Agreement may not be amended orally, but only by an agreement in writing signed by the parties to this Agreement. 8.7 Governing Law. This Agreement will be governed by the laws of ------------- California without regard to conflicts of law principles. 8.8 Jurisdiction. Any proceeding seeking to enforce any provision of, or ------------ based on any right arising out of, this Agreement will be brought against any of the parties in the United States District Court for California, and each of the parties consents to the jurisdiction of such courts (and of the appropriate appellate courts) in any such action or proceeding and waives any objection to that venue. Process in any action or proceeding referred to in the preceding sentence may be served on any party anywhere in the world. 8.9 No Undue Influence. This Agreement is executed voluntarily and ------------------ without any duress or undue influence. Employee acknowledges that he has read this Agreement and executed it with his full and free consent. No provision of this Agreement shall be construed against any party by virtue of the fact that such party or its counsel drafted such provision or the entirety of this Agreement. 8.10 Arbitration. The parties agree that any controversy between the ----------- Company and Employee arising from the Employment or termination of the Employment, including, without limitation, any controversy related to the construction or application of any of the terms of this Agreement, arbitrability of this Agreement, claims for statutory violations, including claims for violation of the Civil Rights Act of 1991 (Title VII), the Age Discrimination in Employment Act, the Americans with Disabilities Act, the Fair Employment and Housing Act, or any amendments to those statutes, claims for wages or other compensation, or other claims arising out of the Employment, shall, on the written request of Employee or the Company, be submitted to final and binding arbitration. Arbitration shall be pursuant to the Employment Arbitration Rules ----- (the "Rules") of the American Arbitration Association (the "AAA"). The --- arbitration will take place in San Diego, California at the offices of the AAA. All fees and costs will be allocated to the parties to the arbitration as determined by the arbitrator; provided, however, that each party will pay one- -------- ------- half of the estimated arbitrator's fees up front and, if either party fails to do so, then a default will be entered against such party solely with respect to such fees. Any determination of the arbitrator shall be final and binding on the parties. Nothing in this Agreement will prevent a party hereto from applying to a court that would otherwise have jurisdiction for provisional or interim injunctive or other equitable measures. 8.11 Section Headings, Construction. The section headings in this ------------------------------ Agreement are provided for convenience only and will not affect its construction or interpretation. 7 8.12 Severability. If any provision of this Agreement is held invalid or ------------ unenforceable by any court of competent jurisdiction, the other provisions of this Agreement will remain in full force and effect. Any provision of this Agreement held invalid or unenforceable only in part or degree will remain in full force and effect to the extent not held invalid or unenforceable. 8.13 Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which will be deemed to be an original copy of this Agreement and all of which, when taken together, will be deemed to constitute one and the same agreement. DAOU SYSTEMS, INC. EMPLOYEE: By: /s/Georges Daou By: /s/ James T. Roberto ------------------------------ ----------------------------------- Georges Daou James T. Roberto Chairman of the Board of Directors 8 EX-23.1 4 0004.txt CONSENT OF ERNST & YOUNG LLP Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements on Form S-3 No.'s 333-47777, 333-52791, 333-68197, and 333-87103 and Form S-8 No.'s 333-40393, 333-52704 and 333-52716 of Daou Systems, Inc., of our report dated February 15, 2001, with respect to the consolidated financial statements and schedule of Daou Systems, Inc. included in the Annual Report on Form 10-K for the year ended December 31, 2000. /s/ ERNST & YOUNG LLP San Diego, California March 29, 2001 -----END PRIVACY-ENHANCED MESSAGE-----