-----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, JCsLxHZdFzkB7EvCpMNRhrvg15ldOLqlSg5q4P4mWW1RZAEICddk3vDICuztuPLe vsRFyddRsIf83Bit/dNl5Q== 0000950109-03-001917.txt : 20030331 0000950109-03-001917.hdr.sgml : 20030331 20030331134209 ACCESSION NUMBER: 0000950109-03-001917 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030331 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: 1934 Act SEC FILE NUMBER: 000-22073 FILM NUMBER: 03629035 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 d10k.txt FORM 10-K ================================================================================ 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, 2002 [_] 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 incorporation or organization) Identification No.) 412 Creamery Way, Suite 300, Exton, Pennsylvania 19341 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (800) 578-3268 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of share 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. [_] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES [_] NO [X] The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 28, 2002 was $16,033,700. As of March 20, 2003, the number of issued and outstanding shares of the Registrant's Common Stock was 21,782,707. Portions of the registrant's Proxy Statement for its 2003 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, 2003, the registrant intends to amend this report to include information omitted from Part III hereof. ================================================================================ PART I CAUTIONARY STATEMENT This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of Daou Systems, Inc. You should not 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," "hope", "believe," "think", "expect," "intend", "plan" or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, you should carefully review various risks and uncertainties identified in this report, including the matters set forth under the captions "Risk Factors" and in Daou's other SEC filings. These risks and uncertainties could cause Daou's actual results to differ materially from those indicated in the forward-looking statements. We do not undertake any obligation to update or publicly announce revisions to any forward-looking statements to reflect future events or developments. Item 1: Business. General Daou provides integrated information technology ("IT") solutions and services to the U.S. healthcare industry. Since 1987, we have provided IT services to approximately 1,500 customers, including many of the nation's hospitals, top 100 integrated delivery networks ("IDNs"), government healthcare organizations, health plans, insurance companies and managed care organizations. Our services include (1) management consulting, (2) traditional network services, (3) application implementation and support, (4) application development and integration, and (5) strategic outsourcing, including remote help desk and related technology support services. Daou currently has approximately 218 employees. Daou is principally focused on providing IT services and solutions to healthcare providers, payors and health plans and government healthcare organizations. We design and implement solutions to help healthcare organizations navigate the intersection of legacy systems with emerging technologies, such as web portals, wireless and other portable computing solutions. As a "trusted advisor" to leading organizations in the payor/insurer segment of the market, we provide consultative services to health maintenance organizations ("HMOs"), health insurers, blues plans and independent practice associations. Our provider customers include hospitals, IDNs, medical groups, academic medical centers, physician groups and ancillaries. In addition, we provide IT services to government healthcare organizations, third-party administrators, medical services organizations, service vendors, software vendors and hardware vendors. We believe that our key competitive advantage is our core understanding of our client's complex healthcare environment based on our extensive knowledge and experience in the healthcare industry. We remarket certain third-party applications and solutions, such as emPOWERnet (TM) portals, through our Strategic Partner Program. We sell no proprietary hardware, although our network solutions may include the resale of certain third-party products. Through extensive research and our payor and provider Advisory Boards and Chief Information Officer (CIO) Forums, we have the opportunity to fine-tune our strategic plans and service offerings with influential healthcare executives. Daou's operating philosophy is to meet or exceed the customer's objectives and to pursue excellence in every area in which our professional staff works. Daou Systems, Inc. was originally incorporated in California on July 16, 1987 and reincorporated in Delaware on November 15, 1996. Our principal executive offices are located at 412 Creamery Way, Suite 300, Exton, Pennsylvania 19341. You may contact us by telephone (800.578.3268), by facsimile (610.594.7683) or by e-mail (info@daou.com). We maintain a website where information concerning our business can be found. The address of our Internet website is http://www.daou.com. We provide a link on our website, under Investor Relations, to our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports. 1 Reorganization On January 9, 2003, we announced our decision to reorganize Daou's internal management structure, consolidate operations and eliminate non-strategic services. This reorganization, which was approved by our Board of Directors in December 2002, is part of our strategy to position Daou for continued growth in the marketplace. We recorded a one-time restructuring charge of approximately $1.6 million in the fourth quarter of 2002 related to severance costs, expenses associated with a slight workforce reduction, elimination of non-strategic services and the consolidation of office space in connection with this reorganization. As part of the reorganization, we consolidated Daou's two operating divisions--Technology Services and Application Services, and plan to operate as one business unit. For purposes of improving overall sales and operations effectiveness, and to offer our customers an integrated solutions approach through multi-disciplinary teams, we now provide our services through two primary practice groups: commercial healthcare and government healthcare. We believe the consolidation was necessary due to changing market forces in the healthcare industry. We expect that operating under our new structure will allow us to focus on our core competencies and pursue a seamless approach to applications and technology. Effective January 1, 2002, certain overhead expenses directly attributable to the business units and formerly recorded as general and administrative expenses are now recorded as cost of revenue before reimbursable expenses. The prior period amounts have been reclassified to conform to their current period presentation. Services Daou provides integrated information technology solutions and services to the U.S. healthcare industry. We principally focus on (1) healthcare providers, (2) payors and health plans and (3) government healthcare organizations. We focus exclusively on healthcare IT and have diverse technical resources. We believe that this offers our customers a combination of healthcare-familiar and practice-driven technology experts that factor in how each individual project works within the customer's IT strategic plan. Many of our technology consultants have extensive healthcare experience. In addition, our healthcare engineers and technicians are experienced with many types of technology, such as application development, networking, interfacing, database management, data security and help desk management. We work with clients to provide real-world solutions that work with their clinical and business processes. We provide services through two practice groups: commercial healthcare and government healthcare. Commercial Healthcare Daou's commercial healthcare practice serves both the health delivery and the payor/insurer segments of the industry. We believe that the healthcare industry faces a variety of challenges, including lower reimbursements, rising premiums, increased physician demand for clinical transformation and integration, and the need to improve quality of care and information management processes without harming financial performance. We seek to position Daou as a company with the know-how to help our customers out of the dilemma that faces so many healthcare organizations today--organizations that can't afford to replace their legacy systems, and can't afford not to. Many organizations are unable to afford multi-million dollar system replacements/upgrades proposed by large software application vendors. Our focus is on providing healthcare organizations with cost effective solutions to extend the useful life of legacy systems through the integration of emerging technologies and applications. By unlocking the potential of their existing systems to support the emerging technologies to stay competitive, and then implementing those technologies in a rapid, affordable way that delivers results, we are helping healthcare organizations solve their biggest IT challenge. We believe that our healthcare domain expertise, vision, applications and technology expertise, and customer service position Daou to better serve the commercial healthcare IT field in the following areas: . Management Consulting . Infrastructure--Assessment, Design and Implementation 2 . Application Implementation and Support . Application Development and Integration . Strategic Outsourcing Daou's management consulting know-how helps organizations meet the many challenges surrounding increasing competition, growing member and patient service demands, expanding regulatory requirements and the confusing horizon of emerging technologies. We provide solutions through key consulting services that include: strategic IT planning, security and privacy consulting, including readiness assessment, planning and remediation related to the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), eHealth and mHealth strategic planning, system procurement and transition management. To build teams tailored to meet unique requirements of each client engagement, our consulting practice draws upon the most experienced management personnel. HIPAA consultants offer an approach methodology--including assessment tools, educational programs, and consultative assistance--to help organizations establish a HIPAA project office, understand the regulations, plan an approach, and achieve compliance. Senior consultants offer clients the benefit of overall project management vision as well as application and technical skills appropriate for specific assignments. The unit works with its clients in a goal-directed, strategic partnership to achieve results in a timely and cost-effective manner. In the area of general consulting, our most senior consultants provide 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 management consulting services typically averages three to six months, but varies depending on the size and complexity of the project. Daou's infrastructure services are focused on two vital components of a healthcare organization's infrastructure: the information technology itself and the experts who manage it. We assist the healthcare marketplace in the assessment, design, implementation, integration and support of legacy and emerging network services and systems. We provide solutions in key areas, including servers/directories, security, wireless and desktop. The success of our infrastructure services emanates from our core understanding of the client's complex healthcare environment. Our primary focus is in helping clients extend the value of legacy systems and enabling them to work with emerging technologies, such as web portals, wireless and other portable computing devices. We support 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 data networks. Our infrastructure consultants 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, we evaluate hardware and software options, interpret research and development results, update existing network designs and research specific products and technologies of interest to customers. We provide these services subject to predetermined schedules. We provide additional technical personnel to customers 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. The engagement period for infrastructure 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 as services are performed. In the area of long-term infrastructure solutions, we offer on-site management services that are designed to maintain the effective performance of a customer's computer network system. As healthcare IT systems become more complex, organizations are experiencing difficulties in hiring, 3 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. We will work with the customer to assess the appropriate staffing needs to maintain and support its computer network system. We will place our employees on-site on a full-time basis to provide network support services and ongoing training of the customer's internal staff. We generally provide these services in multi-year engagements on a fixed-price basis, with revenue recognized over the term of the agreement. Daou's vendor-certified application implementation and support teams have helped many of the nation's largest payor and provider organizations successfully implement and support applications from The TriZetto(R) Group, Epic Systems, McKesson Corporation, QCSI, Siemens Medical Solutions Health Services, CSC and many others. We are proficient in many of the most frequently used healthcare applications for both the payor and provider markets. Daou entered the application implementation and support business with the 1998 acquisition of TMI, a company that has been the leader in implementing payor sector systems for 20 years. Together with our provider sector experts, we have assisted over 750 payor and provider organizations to implement applications solutions. We have developed a rigorous, cost-effective methodology that drives on-time, on-budget implementations. Our application implementation and support services include: . Application Procurement. We provide expert assistance in system selection, and we guide clients through the five critical stages of a successful procurement effort: 1) Planning; 2) Requirements Definition; 3) Vendor Evaluation; 4) Contract Negotiations; and 5) Pre-Implementation Planning. . Application Implementation Services. A system implementation consists of more than just converting files, installing programs and plugging in equipment. Knowledge of the process, including timelines, approach, resource selection and key project strategies, is critical to project success. Our implementation teams include project managers, configuration strategists, configuration analysts and other specialized support personnel, all with broad implementation experience and deep knowledge of the methodology necessary to make the process go smoothly. . Application and Operational Systems Support. Work doesn't stop at the end of the implementation. Changing operational environments, new business needs, additional regulatory requirements and even changes in personnel create perpetual challenges. Our operational and application support specialists help our customers leverage their initial investment to create ongoing returns. We focus our efforts in areas where technology and operations often meet, including system and personnel transition management, system evaluation and improvement, operational evaluation and improvement, application modification and support, interim business office management/model office and data consolidation and preparation. . Application Technical Support. The overlapping departmental and organizational responsibilities in healthcare require innovative technical solutions to manage and communicate data effectively. Our technical application support specialists plan and implement solutions related to system and data conversions, custom interface development, integration engine support, data extracts and e-commerce services, report writing and automated document production and distribution. . Knowledge Management/Reporting Services. From key management performance indicators to the detail data on a specific contract or business arrangement, it is critical to optimize an organization's data to meet its strategic business needs. Timely, accurate, accessible data is indeed a universal business requirement, and yet many organizations are challenged to make this a reality. Daou has assisted many clients in the last 20 years through development of strategy, system selection, implementation and deployment, and report development. . Transition Services. Migrating from one system to another is far more complex than simply turning one computer on and one off on a specified date. The process of change, or transition, to a new methodology begins with the elemental recognition that a new system or 4 process is needed. How well an organization navigates through the change of an implementation will determine the success of the project. For two decades, we have helped clients transition their organizations through the myriad changes system migration engenders. And, because transition involves nuances of organizational development and communication with stakeholders at all levels, the nuances must be managed prudently. . Project Management. Implementation project management is the initiation, continued driving and persistent follow-up of all activities and tasks throughout the continuum of the project lifecycle: Planning/Orient/Design, Load/Development, Test/Train, Go Live and Post-implementation. Three key areas of focus are: planning, people management and subject knowledge. We understand healthcare needs in all these areas, and work closely with clients to deliver projects that consistently meet management's goals. Application implementation and support services are typically provided on a time and expense basis. 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. Preserving, optimizing and extending the life cycle of existing systems is one of the key challenges facing the healthcare industry today. We help healthcare organizations maximize the value of their current and planned systems. Our application development and integration solutions are designed to enable organizations to cost-effectively access information and communicate across the enterprise despite systems running on disparate platforms in different environments. By developing interfaces, implementing existing interfaces, web-enabling a system or migrating to new, more compatible systems, we can help organizations streamline their technology to avoid information roadblock. Our custom integration skills can get clinical, lab and financial systems working in unison, while extending the value of legacy products and infrastructure. Our system integration and data extraction capabilities have helped commercial and government clients for over 20 years. Our application development and integration solutions include: custom programming, system integration engines, conversions and upgrades. The engagement period for application development and integration services generally ranges from six to nine months, but varies depending on the size and complexity of the project. Services are typically invoiced monthly on a time and expense basis. Daou's strategic outsourcing services are focused on maximizing the effectiveness of an organization's support center through our best practices methodology or by serving as an outsourcing partner in select managed services. Outsourcing service areas may include: security, network and server monitoring, help desk and desktop management. We seek to provide timely, professional resources to complement our client's existing staff and to provide proactive support for their systems. Our customer relationship and IT management team uses a proactive approach to minimize risk in these key areas: . Support Center Management. Our SCP-certified Technology Center supports the objectives of user service level agreements ("SLAs") for healthcare providers, primarily hospitals and IDNs, within a predictable financial model for world-class help desk management services. It is designed to be the first point of contact for all help desk calls. The Technology Center handles ID and password problems, printer problems, network connectivity issues, telecom requests and Microsoft Office application questions. . Desktop Management. Poorly designed or deployed desktop images frequently create an intense and unnecessary demand on a customer's support center and break/fix operation. Daou's desktop management services provide reliable and centrally managed desktop environments. From standard image content definition and creation, library management, automated distribution technologies, remote control tools, asset inventory tracking to central desktop engineering expertise, Daou works to standardize and automate desktop management. . Server/Network Management. Daou implements tools to proactively monitor server and network performance to anticipate upcoming problems, and resolve situations before they lead to costly downtime. Our remote network management services are designed to reduce the need for onsite staffing for all but emergencies or routine onsite support. 5 We provide our IT functional outsourcing services in accordance with pre-determined, detailed schedules and plans established with the customer. We typically provide help desk services and these other services in multi-year engagements on a fixed-price fee per node or fee per call basis. The engagement period for help desk and desktop computing assessments generally averages one to two months, but varies depending on the size and complexity of the project. The assessment services are normally provided to customers on a time and expense basis, with billing occurring semi-monthly or monthly. Government Healthcare Daou has extensive experience developing, implementing and/or supporting data extractions, commercial off-the-shelf (COTS) product integration, and module support for government healthcare organizations including the Military Health System, the Indian Health Services and Veterans Health Administration. Our systems integration solutions enable government healthcare organizations to cost-effectively access information and communicate across the enterprise in spite of the fact that systems run on disparate platforms in different environments. Daou entered the government healthcare market through the 1998 acquisition of Sentient. Sentient had developed an expertise in government healthcare, with a track record of implementing solutions that ultimately reduce the cost and improve the quality of healthcare. In addition to offering those services provided by our commercial healthcare practice, our government healthcare services include: . Custom Programming. We provide instrument interfaces, specialized reporting requirements, web-enabled, back-end systems allowing real-time results and support for legacy and "sunsetted" systems. . System Integration Engines. We are experienced in optimizing leading system integration engines and opening up MUMPS-based systems to current or emerging technologies through our proprietary integration engine. . Conversions and Upgrades. Fulfilling reporting requirements through data extraction, cleansing and scrubbing for warehouses and relational databases. By developing interfaces, implementing existing interfaces, Web-enabling a system, or migrating data to more compatible systems, our government healthcare practice provides federal healthcare systems 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. In addition, our capabilities include building and supporting the M/MUMPS-based systems typically used by government-run healthcare organizations. The group's consultants are experienced in healthcare information systems such as CHCS, VistA and RPMS. The engagement period for these services generally ranges from nine to twelve months, but varies depending on the size and complexity of the project. Services are typically invoiced semi-monthly or monthly on a time and expense basis. Recruiting and Training of Technical Employees We dedicate significant time and resources to recruit, train and retain qualified technical personnel. Our technical personnel include consultants, engineers and technicians providing healthcare IT consulting, managed care systems implementation, application implementation and support, application development and integration, communications infrastructure, help desk, outsourcing, Internet and emerging technology services. We use both internal and external recruiters to attract technical personnel. Our technical personnel undergo extensive training and certification attainment from leading healthcare, technology and integration vendors such as: Siemens Medical Solutions, McKesson Corporation, Eclipsys, Cerner, Epic, IDX, TriZetto, PerSe, QCSI, Microsoft, Cisco, Marconi, Nortel, Novell, Checkpoint, Citrix, Sun Microsystems, HP, Compaq and See Beyond. In addition, we are a member of leading technological forums and organizations, including HIMSS and CHIME. 6 We believe that our future success will depend in large part on our 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 payor and provider organizations that we serve. Competition for qualified technical personnel is intense and is expected to increase. Consequently, there can be no assurance that we will be successful in attracting and retaining such personnel. If we are unable to hire, train and retain a sufficient number of qualified technical personnel, our ability to adequately manage and complete our existing projects or to obtain new projects could be impaired. This could have a material adverse effect on our business, financial condition and results of operations. See "--Risk Factors--Loss of Key Personnel Could Adversely Affect Our Business;--Our executive management team is in transition;--We do not have employment agreements with most of our key business managers." Each technical employee is required to enter into a confidentiality and proprietary information agreement with Daou. This agreement is designed to protect our trade secrets and other confidential information during and subsequent to employment. Any significant loss of employees to a competitor, or our inability to enforce a confidentiality and proprietary information agreement could have a material adverse effect on our business, financial condition and results of operations. Sales and Marketing During 2002, we increased our spending in marketing and sales in an effort to re-establish Daou's position as a leading independent resource for the assessment, design, implementation, and management of the information technology infrastructure of hospitals and IDNs. We are also seeking to enhance our position as a management consultant and application implementation and support expert in the health insurer and managed care market, and application development and integration solutions provider in the government healthcare market. We seek to establish long-term relationships with our customers by providing a high level of service and by becoming an integral part of their IT operations. We focus our sales and marketing efforts on the CIOs and other technology decision-makers of hospitals, IDNs, government healthcare organizations and their prime contractors, managed care and insurance companies and other healthcare provider organizations. We rely on our reputation in the marketplace, the personal contacts and networking of our professionals, our Strategic Partner Program and the various programs of our marketing department to develop new business opportunities. We also receive sales leads directly from consultants, value added resellers, and product and service vendors. The principal objectives of our marketing department are to increase Daou's market presence, provide strategic direction and generate sales leads. We receive valuable feedback from customers, the Advisory Boards, CIO Forums, the Strategic Partner Program and other trusted advisors. Based on this feedback, our marketing program positions Daou as healthcare information technology application and infrastructure experts, with the know-how to make information technology work for healthcare organizations. We believe that Daou is well positioned to serve the growing demand for application and technology solutions that extend the useful life of legacy systems and integrate them with emerging technologies. As a supplement to our direct selling efforts, the marketing department has developed advertising campaigns, tradeshow participation, direct mail campaigns, public relations programs, marketing research and communications and sales presentation materials. Public speaking engagements and the publication of technical articles and reports directed to the healthcare information technology industry also enhance our marketing efforts. We also continue to develop our presence on the Internet as a new marketing channel. We have entered into marketing agreements with certain third party vendors to market our services to their respective customer bases. We intend to pursue additional marketing agreements, joint ventures and alliances as part of our marketing plan and business development efforts. Strategic Partner Program In 2002, we established our Strategic Partner Program as part of our evolving business and product development strategy designed to meet the clinical transformation needs of the healthcare 7 marketplace. The program provides customers with an expanded product offering from top vendors. We believe these vendors add even greater value to Daou's core consulting and management services in applications, infrastructure, systems integration and customer support. As a solutions provider, we pursue a seamless approach to applications and technology by extending the useful life of legacy systems and integrating them with emerging technology. The charter member of the program is Park City Solutions, Inc. of Midway, Utah, selected for its emPOWERnet (TM) portal solution which enables organizations to unify and extend their applications, information, and business processes to patients, clinicians, employers, payors, and their surrounding communities. We intend to pursue additional strategic partners, joint ventures and alliances as part of our marketing plan and business development efforts. Daou Advisory Boards and CIO Forums We maintain two Advisory Boards which are non-governing bodies comprised primarily of CIOs of (1) various healthcare provider organizations, and (2) organizations within the payor/insurer segment. The Advisory Boards meet bi-annually and the members confer separately with us 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 our current and future services. Members of an Advisory Board are reimbursed for travel, lodging and meal expenses incurred in connection with attendance at an Advisory Board's sessions. In 2002, we established our CIO Forums that provide an opportunity for regional healthcare IT professionals to learn from their peers. The CIO Forums are conducted in a one-day session and address issues, challenges, and opportunities within the industry. We conduct the CIO Forums several times per year in various cities throughout the United States. CIO Forum participants are reimbursed for lodging and meal expenses incurred in connection with attendance at a CIO Forum, and we may make a cash contribution to their organization's non-profit foundation or other charitable organization. Intellectual Property and Proprietary Information Our ability to compete effectively depends in part on our intellectual property and proprietary information, including our proprietary methodologies, best practices, research, tools, information systems, databases and other information and procedures. We rely on a combination of copyright laws, non-disclosure agreements and other confidentiality procedures to protect Daou's intellectual property and proprietary information. However, these protections may not be sufficient, and they do not prevent independent third-party development of competitive products or services. See "--Risk Factors--Any failure or inability to protect our technology and confidential information could adversely affect our business." Competition The healthcare IT services industry is comprised of a large number of participants and is subject to rapid change and intense competition. Further challenges, complexities and occasionally, opportunities, arise from the fact that healthcare IT vendors with specialty services may find themselves collaborating on one customer mission and competing on another. We believe that the principal competitive factors in the markets in which Daou 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. Many of our competitors have significantly greater financial, technical and marketing resources and greater name recognition than we do. Our competitors include: . consulting firms such as First Consulting Group, Inc., and Superior Consultant Holdings Corporation; . the consulting divisions or former affiliates of the major accounting firms; 8 . healthcare information technology companies such as The TriZetto Group, McKesson Corporation and Siemens Medical Solutions; . systems integrators such as Science Applications International Corporation, Electronic Data Systems Corporation and Perot Systems Corporation; . customers' internal information management departments; and . healthcare portal companies and network equipment vendors. In addition to these major companies, we also compete with smaller regional IT systems firms, which have a niche in selected geographic areas of the country. We have faced, and will continue to face, additional competition from new entrants into our 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 markets in which we compete. 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 our business, financial condition and results of operations. There can be no assurance that we will be able to compete successfully against current and future competitors. In addition, most of our 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, any decision by our customers or potential customers to perform IT services internally or choose one of our competitors could have a material adverse effect on our business, financial condition and results of operations. See "--Risk Factors--We operate in highly competitive markets." Customers Since 1987, we have provided IT services to approximately 1,500 customers, including many of the nation's hospitals, top 100 integrated delivery networks, government healthcare organizations, health plans, insurance companies and managed care organizations. In addition, selected services are provided on a business-to-business basis to other healthcare IT vendors, including emerging technology companies needing a partner to integrate these new technologies with existing, legacy systems. We derive a significant portion of our revenue from a relatively limited number of large customers. For the year ended December 31, 2002, our five largest customers accounted for approximately 32% of net revenue, with one help desk outsourcing customer accounting for 9.2% of total net revenue. Employees As of December 31, 2002, after the effects of reorganization, we employed 217 technology and support professionals involved in management consulting, infrastructure services, application installation and support, application development and integration, strategic outsourcing, sales and marketing, business development, information technology, finance and accounting, human resources, company leadership and administration. We use internal and external recruiters for the hiring of our technical and support professionals. We also have an internal referral bonus program throughout the organization to encourage employees to refer or recommend qualified professionals to join us. Referring employees are rewarded with a bonus for each candidate hired by us. Our employees are not represented by a labor union and we believe that our relationship with our employees is good. Risk Factors An investment in Daou's Common Stock involves a high degree of risk. You should carefully consider the following risk factors and warnings. The risks described below are not the only ones facing us. Additional risks that we do not yet know of or that we currently think are immaterial may 9 also impair our business operations. If any of the following risks actually occurs, our business, financial condition or results of operations could be materially and adversely affected. In such case, the trading price of our common stock could decline, and you could lose all or part of your investment. You should also refer to the other information set forth in this report, including our Consolidated Financial Statements and the related notes. Many factors cause our financial results to fluctuate. Historically, we have experienced significant quarterly fluctuations in our operating results due to shifts in demand for our services, the commencement and completion of large fixed-fee contracts, and the closure and wind down of operating units and difficulties in successfully integrating our acquired companies. Variations in our revenues and operating results are expected to 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 our current and prospective customers; . 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 or executive officers; . increased competition; . government regulations; . the reduction in size, delay in commencement, interruption or termination of one or more significant projects; . the loss or termination of preferred partnership relationships with software/hardware vendors, hospital groups, health plans or government agencies; . 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 our projects; . the development and introduction of new services; . the continued effect of acquisitions, including additional administrative staffing and other increased infrastructure requirements to integrate the newly acquired companies; and . the effect of negative publicity relating to our litigation and operations. Accordingly, we believe that quarter-to-quarter comparisons of operating results for preceding quarters are not necessarily meaningful. You should not rely on results of any one quarter as an indication of our future performance. We have a history of losses and our future profitability is uncertain. We have incurred losses in each year since 1997. As of December 31, 2002, we had an accumulated deficit of approximately $39.0 million. Our ability to achieve profitability is dependent on a number of factors, including our ability to secure new and maintain existing customers, the development and introduction of new services, industry spending patterns and market conditions and our ability to manage project risks. The markets in which we compete are highly competitive, and we may not be successful in increasing our market presence, growing our business or achieving profitability. As a result, we are unable to accurately predict the extent of any future losses or the time required to regain profitability, if at all. 10 We depend on a small number of large customers to provide a significant portion of our revenue. We receive a significant portion of our revenue from a relatively small number of large customers, some of which operate under a single contract, and we expect this pattern to continue in the future. A majority of our customers are able to reduce or cancel their use of our services before the end of the contract term, subject to certain monetary penalties. If these customers terminate or modify existing contracts or experience business difficulties, it could adversely affect our revenue and earnings. Certain of our outsourcing contracts are set to expire in the next twelve months. Failure to renew these contracts could adversely affect our revenue or earnings. As a percentage of net revenue, our five largest customers accounted for approximately 32% for the year ended December 31, 2002, 33% for the year ended December 31, 2001, and 33% for the year ended December 31, 2000. If we lose one of these large customers, or a large customer does not renew its existing contract, we will face significant challenges in finding other engagements on which to staff these employees. Delays in reassigning and the resulting under-utilization of these employees would negatively impact our operating results and financial condition. A substantial majority of our operating expenses are fixed. Though our revenue fluctuates from quarter to quarter, the substantial majority of our operating expenses, particularly personnel and related costs, depreciation and rent, are relatively fixed. We expect these costs to increase in the future as we grow our business and expand our resources. 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 Daou to maintain or terminate under-utilized employees, which could result in higher than expected expenses during a quarter. We operate in highly competitive markets. We operate in intensely competitive markets. We cannot assure you that we will be able to compete successfully against current and future competitors or that competitive pressures faced by us will not have a material adverse effect on our business, financial condition and operating results. See "Competition" above for a discussion of some of the risks associated with our markets. Our long sales and project delivery cycles may adversely affect financial performance. Our sales process is often subject to delays associated with the lengthy approval process that typically accompanies significant capital expenditures by a customer. During this process, we expend substantial time, effort and resources marketing our services, preparing contract proposals and negotiating contracts. Any failure to procure a signed contract after expending significant time, effort and resources could have a material adverse effect on our business, financial condition and results of operations. The implementation cycles for our network implementation, managed care implementation, Web portal and outsourcing projects generally requires a significant commitment of resources by Daou and by the customer. The length of time required to complete a project may depend on many factors outside of our control. In some instances, projects have been prolonged substantially as a result of delays attributable to customers. Any delay or failure to receive payment for our services after expending significant time, effort and resources could have a material adverse effect on our business, financial condition and results of operations. In addition, if we fail to deliver services on a timely and cost-efficient basis, our business, financial condition and results of operations could be materially and adversely affected. See "Sales and Marketing" and "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations." 11 New technologies or industry standards could render our services obsolete or unmarketable. We receive a significant portion of our revenue 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. If we fail to meet the changing demands of technology, we may not continue to be able to compete successfully with other providers of software applications and technology solutions. Our success depends on our ability to offer services and products that keep pace with continuing changes in technology, evolving industry standards and the changing preferences of our healthcare customers. We cannot make assurances that products, systems or technologies developed by third parties will not render one or more of our services noncompetitive or obsolete. We could lose customers and revenue if we fail to manage project risks or performance standards. Many of our service agreements contain performance standards or deliverables. Some of our contracts with customers permit termination in the event our performance is not consistent with service levels specified in those contracts. Our failure to perform services that meet a customer's expectations may result in not getting paid for services rendered. Further, if customers are not satisfied with our level of performance, our reputation could be damaged and our ability to attract new business may be materially and adversely affected. Our insurance coverage may not be sufficient to cover potential claims. Any failure by our computer network systems to provide accurate, reliable and timely information could result in claims against us. For example, where the unavailability of such information to a provider of healthcare services is alleged to have resulted in any physical or emotional injury to a patient, we may become subject to claims by the provider. We are also subject to claims by customers for actions of our employees which may have caused damages to customers' businesses or otherwise. Although we maintain errors and omissions insurance, there can be no assurance that such insurance coverage would adequately cover any claims asserted against us. Consequently, these potential claims could have a material adverse effect on our business, financial condition and results of operations. Customers may defer, modify or cancel a project on short notice. Many of our consulting contracts are cancelable by the customer upon 30 days written notice. When a customer defers, modifies or cancels a project, we must rapidly redeploy our technical and other personnel to other projects to minimize the under-utilization of employees and the resulting adverse impact on our operating results. Furthermore, our 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 our business relationships with any of our significant customers or with a number of smaller customers could have a material adverse effect on our business, financial condition and operating results. Loss of key personnel could adversely affect our business. Our business strategy depends in large part on the services of our key management and highly skilled healthcare technology professionals. Our business also requires that our employees learn and implement the latest technical applications and innovations for our customers. Our continued ability to compete effectively in our business depends on our ability to attract, retain and motivate these individuals. We have experienced significant turnover among our technical personnel due in part to the significant time and travel demands, increased competition for their services and recent reorganization. Any inability to hire, train and retain a sufficient number of qualified technical professionals could impair our ability to adequately manage and complete our existing projects or to obtain new customers and projects. 12 Our executive management team is in transition. In December 2002, we named Daniel J. Malcolm as our Chief Executive Officer. In January 2003, we named Vincent K. Roach as our Executive Vice President, Commercial Operations and announced the resignation of Neil R. Cassidy, Chief Financial Officer (effective the second quarter of 2003.) This transition of management personnel may adversely affect our operating performance, given the time required for new senior personnel to assimilate and manage effectively our business operations. We do not have employment agreements with most of our key business managers. We do not have employment agreements with most of our business management team. The loss of services from one or more of our management or key personnel, or the inability to hire additional management or key personnel as needed, could have a material adverse effect on our business, financial condition and operating results. In addition, we expect to further grow our operations and our needs for additional management and key personnel will increase. Our success depends on our key vendors and partners. We depend on our software application and product vendor relationships. If our software application or product vendors terminate or modify existing contracts or experience business difficulties, or if we are unable to establish new relationships with additional software application or product vendors, our business could be harmed. We depend, and will continue to depend, on our licensing and business relationships with third-party software application and product vendors. Our success depends significantly on our ability to maintain our existing relationships with our vendors and to build new relationships with other vendors in order to enhance our services and application offerings and remain competitive. Although most of our licensing agreements are perpetual or automatically renewable, they are subject to termination in the event that we materially breach such agreements. We cannot assure you that we will be able to maintain relationships with our vendors or establish relationships with new vendors. We cannot assure you that the software, products or services of our third-party vendors will achieve or maintain market acceptance or commercial success. Accordingly, we cannot assure you that our existing relationships will result in sustained business partnerships, successful product or service offerings or the generation of significant revenue for us. We do not have exclusive arrangements with our software application and product vendors. Our arrangements with third-party software application and product vendors are not exclusive. We cannot assure you that these third-party vendors regard our relationships with them as important to their own respective businesses and operations. They may reassess their commitment to us at any time and may choose to develop or enhance their own competing distribution channels and product support services. If we do not maintain our existing relationships or if the economic terms of our business relationships change, we may not be able to license and offer these services and products on commercially reasonable terms or at all. Our inability to obtain any of these licenses could delay service development or timely introduction of new services and divert our resources. Any such delays could materially adversely affect our business, financial condition and operating results. Our relationships with key vendors or partners may adversely impact our customer relationships. As we form an increasing number of relationships with software application and product vendors, our customers may perceive that we are not independent from those vendors. Our ability to obtain consulting and assessment engagements is due in part to our ability to analyze and recommend solutions while remaining independent from the software and product vendors themselves. If customers believe we are not independent from software application and product vendors, our ability to obtain consulting or assessment engagements from customers may be adversely impacted, resulting in reduced revenue and profits. 13 We may be unable to manage our restructured business units and future growth. Some of our lines of business have experienced periods of rapid growth, and we have restructured our business units in recent years. This growth and restructuring have placed, and may continue to place, significant demands on our managerial, operational and financial resources. In addition, in order to manage any future growth, we must continue to improve and expand our management, operational and financial systems and controls, including quality control and delivery and service capabilities. If we are unable to manage our growth or restructuring effectively or are unsuccessful in recruiting or retaining personnel, it could have a material adverse effect on our business, financial condition and operating results. The consolidation and changing economic environment of the healthcare industry may negatively impact revenue. We receive substantially all of our revenue from customers involved in the healthcare industry. Consequently, our 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 our target market and result in the termination of customer contracts. In particular, some of our customers have scaled back or terminated their relationship 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 us for services we perform. Any reduction in the size of our target market or failure to maintain adequate price levels could materially and adversely affect our revenue and financial condition. Increasingly complex regulatory environments may increase our risk and our costs. Increasingly complex regulatory environments affect a number of our services. As an example, changes in healthcare information privacy laws and regulations may increase our risk of liability and increase the cost of some services we offer. In addition, new regulations governing the standardization and security for healthcare information under 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 our information technology services. We cannot predict with any certainty what impact these developments could have on our business, financial condition and results of operations. Our contracts contain pricing risks that affect our revenue and profit. We offer a portion of our computer network system, consulting services and outsourcing services on a fixed-price, fixed-time frame basis, rather than on a time-and-expense basis. Consequently, we bear the risk of cost over-runs in connection with these projects. If we fail to estimate accurately the resources and time required for a project or fail to complete our contractual obligations within the committed fixed-time frame, it could have a material adverse effect on our business, financial condition and results of operations. Any failure or inability to protect our technology and confidential information could adversely affect our business. There can be no assurance that the steps we have taken to protect our intellectual property will be adequate to prevent unauthorized use or misappropriation of our proprietary information. Any significant loss or unauthorized use of our intellectual property or proprietary information by a competitor could have a material adverse effect on our business, financial condition or results of operations. We believe that our systems and procedures and other proprietary rights do not infringe upon the rights of third parties. There can be no assurance, however, that third parties will not assert infringement claims against Daou or that such claims will not require protracted and costly litigation, regardless of the merits of such claims. 14 Our officers and directors have the power to influence the election of directors and the passage of stockholder proposals. As of March 20, 2003, Daou's executive officers, directors and affiliated persons beneficially owned approximately 42.9% 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 Daou. Our common stock price is subject to wide fluctuations in value and significant volatility. Based upon the historical performance of our common stock, we anticipate that the future price of our common stock may be subject to wide fluctuations because of announcements of: . quarterly fluctuations in our operating results . changes in earnings estimates by analysts; . negative publicity relating to our litigation and operations; . strategic relationships or acquisitions; . new customer contracts or services by Daou or our competitors, or the loss of a large customer; . 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 our pricing policies or those of our 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 our common stock may be disproportionate or unrelated to our operating performance and may affect adversely the market price of our common stock. Provisions of our certificate of incorporation, bylaws, and Delaware law could deter takeover attempts. A number of provisions of Delaware law and our certificate of incorporation and bylaws could delay, defer or prevent a change in control of Daou and could limit the price that some investors might be willing to pay in the future for shares of our common stock. These provisions: . prohibit us 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 our board of directors to issue shares of preferred stock without stockholder approval on the terms as our board may determine; . provide for a classified board of directors; . eliminate the right of our 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 our outstanding shares. Future sales of our common stock could adversely affect the price of our common stock and our ability to raise additional equity capital. The sale of substantial amounts of our 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 15 price of our common stock. Of the 21,782,707 shares outstanding as of March 20, 2003, 16,783,180 shares of common stock are freely tradable without restriction in the public market. The remaining 4,999,527 shares are "restricted securities" as defined in Rule 144. In September 1999, we 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, we registered on a Form S-8 Registration Statement an aggregate of 5,000,000 shares of common stock under the Daou Systems, Inc. 1996 Stock Option Plan. An additional 1,475,000 shares of common stock were subject to options issued outside of our 1996 Stock Option Plan. In December 2000, we registered an aggregate of 1,500,000 shares of common stock under the Daou Systems, Inc. Employee Stock Purchase Plan. We have also issued warrants exercisable for 3,540,000 shares of common stock exercisable at $.01 per share and have the obligation to register the shares of common stock deliverable upon exercise of the warrants. During 2001, we sold 4,300,000 shares of restricted common stock to four of our officers and directors in return for full-recourse promissory notes. We are obligated to register such shares of common stock. Item 2: Description of Properties. Daou leases the following office space for our principal administrative, operating, support and training facilities:
Approximate Location Square Footage Expiration Principal Use -------- -------------- ------------- -------------------------------- Kensington, MD.. 21,000 February 2004 Operating and support facilities Alexandria, VA.. 21,000 May 2005 Operating and support facilities(1) Exton, PA....... 13,000 March 2009 Corporate office facility Indianapolis, IN 6,000 April 2002 Operating and support facilities Alexandria, VA.. 4,000 June 2005 Operating and support facilities Indianapolis, IN 4,000 May 2003 Operating and support facilities
- -------- (1) Portions of the property have been subleased. We continually evaluate the adequacy of our existing facilities and believe that our current and planned facilities will be adequate for the next twelve months. Item 3: Legal Proceedings. IN RE DAOU SYSTEMS SECURITIES LITIGATION On August 24, 1998, August 31, 1998, September 14, 1998 and September 23, 1998, four 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. On October 15, 2002, the Court granted the Company's Motion to Dismiss the class action complaint, with prejudice. The plaintiffs noticed appeal to the Ninth Circuit Court of Appeal on November 13, 2002. As background, a group of shareholders were appointed the lead plaintiff in this federal litigation, and they filed a second amended consolidated class action complaint on January 21, 2000. Their second amended complaint realleges that the Company improperly used the "percentage-of-completion" accounting method for revenue recognition. Claims are pleaded under both the 1933 Securities Act (relating to the Company's initial public offering) and section 10b of the 1934 Securities 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. A Motion to Dismiss the second amended consolidated class action complaint was filed on February 22, 2000. On March 27, 2002, the Court granted the Motion but extended to plaintiffs the opportunity to file a Third Amended Complaint. The plaintiffs filed their Third Amended Complaint on May 16, 2002, to which the Company responded with another Motion to Dismiss. The Motion was filed on June 24, 2002 and challenged the legal sufficiency of the allegations. On October 16, 2002, the Court granted that Motion, this time with prejudice. The plaintiffs noticed appeal to the Ninth Circuit Court of Appeal on November 13, 2002. The Company filed a Notice of Cross-Appeal on November 26, 2002 challenging the failure of the trial court to assess whether the complaints were filed in violation of Rule 11 of the Federal Rules of Civil Procedure. Plaintiffs must file their Opening Brief by April 9, 2003. The Company is currently 16 scheduled to file its Brief no later than May 19, 2003. On October 7, 1998 and October 15, 1998, two separate complaints were filed in the Superior Court of San Diego County, California. These state court complaints mirror the allegations set forth in the federal complaints. They also assert claims for common law fraud and the violation of certain California statutes. As with their federal counterparts, they do not allege specific damage amounts. On April 1, 1999, a Consolidated Amended Class Action was filed on behalf of the same state court plaintiffs, and this new complaint alleges the same factual basis as is asserted in the federal litigation. The state litigation pleads claims for fraud and violations of certain California Corporation Code provisions. By stipulation of the parties and order of the court, this state court litigation was stayed pending the outcome of the motion to dismiss the federal lawsuits. The Company believes that the allegations set forth in the federal and state complaints are without merit, and the Company intends to defend against these lawsuits vigorously. No assurance as to the outcome of this matter can be given, however, and an unfavorable resolution of this matter could have a material adverse effect on the Company's business, results of operations, and financial condition. DICKSON V DAOU SYSTEMS, INC. ET AL On February 27, 2002, a complaint was filed against certain of the Company's former officers and directors, as well as Daou On-Line, Inc., in the Superior Court of New Jersey located in Bergen County. The Court conducted a hearing on June 7, 2002 and granted the Company's Motion to Dismiss. The plaintiffs abandoned their appeal which the Appellate Court dismissed on January 3, 2003. The plaintiffs filed a Complaint against the Company, as well as certain of its former officers in San Diego County Superior Court on December 5, 2002. An answer or other responsive pleading to the Complaint must be filed on April 4, 2003 absent agreement to stay the case and proceed to arbitration. As background, a First Amended Complaint was filed on March 1, 2002, adding the Company and its former Chief Financial Officer as parties/defendant. The gravamen of the First Amended Complaint is twofold. First, it alleges Daou's financial statements were misleading and fraudulently induced the plaintiff to merge his company with Daou. Second, the First Amended Complaint alleges breach of an indemnification and severance agreement obligating the Company to defend the plaintiff in a lawsuit filed by Traci Melia, a former employee. Neither the Complaint nor the First Amended Complaint alleges specific damage amounts. The Company filed A Motion to Dismiss the First Amended Complaint on April 24, 2002. The Court conducted a hearing on June 7, 2002 and granted our motion. On July 23, 2002, plaintiffs filed a Notice of Appeal but later abandoned their appeal which the Appellate Court dismissed on January 3, 2003. The Plaintiffs filed a Complaint against the Company, as well as certain of its former officers in San Diego County Superior Court on December 5, 2002. The Summons and Complaint was served by way of Notice and Acknowledgment of Receipt. While not identical to the Complaints filed in New Jersey, the gravaman of the San Diego action is the same. The Complaint prays for compensatory damages of at least $1,450,000. An answer or other responsive pleading to the Complaint must be filed on April 4, 2003 absent agreement to stay the case and proceed to arbitration. Counsel for Mr. Dickson has advanced that proposal given a controlling arbitration provision set forth in one of the contracts giving rise to the lawsuit. The Company believes that the allegations set forth in the Complaint are without merit, and the Company intends to defend against the lawsuit or arbitration vigorously. No assurance as to the outcome of this matter can be given, however, and an unfavorable resolution of this matter could have a material adverse effect on the Company's business, results of operations and financial condition. The Company is party to other various claims and legal actions arising in the normal course of business. Although the ultimate outcome of the 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 2002. 17 PART II Item 5: Market for Common Equity and Related Stockholder Matters. Daou's shares of Common Stock have traded on the Over the Counter Bulletin Board (OTCBB) since April 25, 2001 under the symbol DAOU. Daou's shares of common stock traded on the NASDAQ National Market System under the symbol DAOU from February 12, 1997 through April 24, 2001. The following table sets forth the high and low closing bid information for the common stock. Bid quotations reflect inter-dealer prices without retail mark-up or mark-down and may not necessarily represent actual transactions.
Common Stock ------------- HIGH LOW ------ ------ 2002 1st Quarter. $1.500 $0.650 2nd Quarter. 1.560 0.910 3rd Quarter. 0.930 0.410 4th Quarter. 0.525 0.260 2001 1st Quarter. $0.789 $0.289 2nd Quarter. 0.500 0.140 3rd Quarter. 0.710 0.310 4th Quarter. 1.280 0.410
On March 20, 2003, the closing bid and ask prices of the common stock were $0.34 and $0.36, respectively. As of March 20, 2003, there were 148 holders of record of common stock. Dividend Policy Daou has never declared nor paid cash dividends on the capital stock. We currently intend to retain any earnings for future growth and, therefore, do not intend to pay any cash dividends in the foreseeable future. Daou issued Series A Preferred Stock on July 26, 1999. Holders of the Series A Preferred Stock were initially entitled to receive cumulative dividends at the rate of six percent per annum, generally payable in the form of shares of Series A Preferred Stock until July 26, 2001. The dividend rate increased to 7% on July 26, 2001, to 8% on July 26, 2002 and will continue to increase an additional 1% on July 26 of each year. As of December 31, 2002, Daou has accrued but undeclared preferred stock dividends of $3.0 million payable in shares of Series A Preferred Stock. No dividends may be paid on the common stock unless full dividends on the Series A Preferred Stock for the then current dividend period have been either paid or declared with a sum sufficient for the payment set apart. Recent Sales of Unregistered Securities On July 24, 2001, we sold 150,000 shares of restricted common stock in a private placement pursuant to Section 4(2) of the Securities Act, at the July 24, 2001 closing price of $.52 per share to one of our executive officers, in exchange for a full recourse note receivable that accrues interest at a rate of 6.75% and is due on July 24, 2006. On June 1, 2001, we sold an aggregate of 4,150,000 shares of restricted common stock in a private placement pursuant to Section 4(2) of the Securities Act, at the June 1, 2001 closing price of $.29 per share to three of our executive officers, in exchange for full recourse notes receivable that accrue interest at a rate of 6.75% and which are due on May 31, 2006. Although none of these officers has indicated a present intention to sell, Daou is contractually obligated to register these 4,300,000 shares of common stock for resale. On November 9, 2000, as a consequence of the resignation of Larry Grandia, Daou's former Chief Executive Officer, holders of the Series A Preferred Stock had the right to cause the redemption of their Series A Preferred Stock for approximately $12.9 million. We entered into an agreement with the holders of the Series A Preferred Stock under which 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 our 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. 18 Item 6: Selected Consolidated Financial Data. The following table presents selected consolidated financial data and has been derived from our consolidated financial statements, which have been audited by Ernst & Young LLP, independent auditors. 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, ---------------------------------------------- 1998 1999 2000 2001 2002 -------- -------- -------- ------- ------- Revenue before reimbursements (net revenue)................................. $104,784 $103,400 $ 63,748 $41,082 $37,935 Cost of revenue before reimbursable expenses................................. 85,834 82,030 59,923 32,424 27,668 -------- -------- -------- ------- ------- Gross profit............................... 18,950 21,370 3,825 8,658 10,267 Operating expenses: Sales and marketing..................... 12,203 10,398 5,744 3,360 5,040 General and administrative.............. 10,643 18,968 10,831 7,408 6,838 Restructuring charges................... -- -- 2,133 1,263 1,598 Merger and related expenses............. 2,825 -- -- -- -- -------- -------- -------- ------- ------- Total operating expenses............ 25,671 29,366 18,708 12,031 13,476 -------- -------- -------- ------- ------- Income (loss) from operations.............. (6,721) (7,996) (14,883) (3,373) (3,209) Other income, net.......................... 163 779 699 421 270 -------- -------- -------- ------- ------- Income (loss) before income taxes.......... (6,558) (7,217) (14,184) (2,952) (2,939) Provision (benefit) for income taxes....... (802) (1,761) -- -- -- -------- -------- -------- ------- ------- Net income (loss).......................... (5,756) (8,978) (14,184) (2,952) (2,939) Dividends on preferred stock............... -- (308) (4,837) (854) (1,054) -------- -------- -------- ------- ------- Net income (loss) available to common stockholders............................. $ (5,756) $ (9,286) $(19,021) $(3,806) $(3,993) ======== ======== ======== ======= ======= Net income (loss) available to common stockholders per common share: Basic................................... $ (0.33) $ (0.52) $ (1.07) $ (0.22) $ (0.21) ======== ======== ======== ======= ======= Diluted................................. $ (0.33) $ (0.52) $ (1.07) $ (0.22) $ (0.21) ======== ======== ======== ======= ======= Shares used in computing net income (loss) per common share: Basic................................... 17,657 17,697 17,712 17,682 19,075 ======== ======== ======== ======= ======= Diluted................................. 17,657 17,697 17,712 17,682 19,075 ======== ======== ======== ======= ======= Cash, cash equivalents, restricted cash and short-term investments................... $ 7,780 $ 15,548 $ 10,586 $15,074 $12,394 Total assets............................... 54,517 46,060 26,832 24,384 24,640 Long-term debt, less current portion....... 26 -- -- -- -- Redeemable convertible preferred stock..... -- 11,382 -- -- -- Total stockholders' equity................. $ 34,775 $ 24,974 $ 20,360 $17,308 $14,469
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations. This discussion 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. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of Daou Systems, Inc. You should not 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 word "estimate," "anticipate," 19 "hope", "believe," "think", "expect," "intend", "plan" or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, you should carefully review various risks and uncertainties identified in this report, including the matters set forth under the captions "Risk Factors" and in Daou's other SEC filings. These risks and uncertainties could cause Daou's actual results to differ materially from those indicated in the forward-looking statements. We do not undertake any obligation to update or publicly announce revisions to any forward-looking statements to reflect future events or developments. Recent Developments On January 9, 2003, we announced our decision to reorganize Daou's internal management structure, consolidate operations and eliminate non-strategic services. This reorganization, which was approved by our Board of Directors in December 2002, is part of our strategy to position Daou for continued growth in the marketplace and ultimately achieve profitability. We recorded a one-time restructuring charge of approximately $1.6 million in the fourth quarter of 2002 related to severance costs, expenses associated with a slight workforce reduction, elimination of non-strategic services and the consolidation of office space in connection with this reorganization. We have consolidated operations and incurred restructure charges in each of the last three years. As a consequence of the consolidations and elimination of non-strategic and unprofitable lines of business, our revenue has declined. In addition, competition has intensified and we have incurred operating losses. As part of the reorganization, we consolidated Daou's two operating divisions--Technology Services and Application Services, and plan to operate as one business unit. We currently have no reportable segments. (In 2001, Daou had five reportable segments: Technology Management ("TMI"), Resources in Healthcare Innovation ("RHI"), Sentient, Infrastructure Services Group ("ISG") and RTC). Today, Daou has no reportable segments and operates as one business unit. For purposes of improving overall sales and operations effectiveness, and to offer our customers an integrated solutions approach through multi-disciplinary teams, we now provide our services through two primary practice groups: commercial healthcare and government healthcare. We believe the consolidation was necessary due to changing market forces in the healthcare industry. We expect that operating under our new structure will allow us to focus on our core competencies and pursue a seamless approach to applications and technology. Effective January 1, 2002, certain overhead expenses directly attributable to the business units and formerly recorded as general and administrative expenses are now recorded as cost of revenue before reimbursable expenses. The prior period amounts have been reclassified to conform to their current period presentation. Overview Daou provides integrated IT solutions and services to the U.S. healthcare industry. Since 1987, we have provided IT services to approximately 1,500 customers, including many of the nation's hospitals, top 100 IDNs, government healthcare organizations, health plans, insurance companies and managed care organizations. Our services include (1) management consulting, (2) traditional network services, (3) application implementation and support, (4) application development and integration, and (5) strategic outsourcing, including remote help desk and related technology support services. Daou currently has approximately 218 employees. Daou is principally focused on providing IT services and solutions to healthcare providers, payors and health plans and government healthcare organizations. We design and implement solutions to help healthcare organizations navigate the intersection of legacy systems with emerging technologies such as web portals, wireless and other portable computing solutions. As a "trusted advisor" to leading organizations in the payor/insurer segment of the market, we provide consultative services to HMO, health insurers, blues plans and independent practice associations. Our provider customers include hospitals, IDNs, medical groups, academic medical centers, physician groups and ancillaries. In addition, we provide IT services to government healthcare organizations, third-party administrators, medical services organizations, service vendors, software vendors and hardware vendors. We believe that our key competitive advantage is our core understanding of our client's complex healthcare environment based on our extensive knowledge and experience in the healthcare industry. 20 We remarket certain third-party applications and solutions, such as emPOWERnet(TM) portals, through our Strategic Partner Program. We sell no proprietary hardware, although our network solutions may include the resale of certain third-party products. Through extensive research and our payor and provider Advisory Boards and CIO Forums, we have the opportunity to fine-tune our strategic plans and service offerings with influential healthcare executives. Daou's operating philosophy is to meet or exceed the customer's objectives and to pursue excellence in every area in which our professional staff works. In 2002, Daou provided integrated information technology solutions and services to the U.S. healthcare industry. We principally focused on (1) healthcare providers, (2) payors and health plans and (3) government healthcare organizations. We focus exclusively on healthcare IT and have diverse technical resources. We believe that this offers our customers a combination of healthcare-familiar and practice-driven technology experts that factor in how each individual project works within the customer's IT strategic plan. Many of our technology consultants have extensive healthcare experience. In addition, our healthcare engineers and technicians are experienced with many types of technology, such as application development, networking, interfacing, database management, data security and help desk management. We work with clients to provide real-world solutions that work with their clinical and business processes. We provide services through two practice groups: commercial healthcare and government healthcare. Our service offerings represent aggregated end-to-end healthcare IT solutions. Depending on the specific needs of our customers, our relationships may begin anywhere along the IT solution process, growing within one of the service lines or developing cohesively across the complete end-to-end IT solution process from conceptualization to operation. We generate substantially all of our revenue from professional services, primarily on a "time and expense" project basis, under which revenue is recognized as the services are performed. Billings for these services occur on a semi-monthly or monthly basis as specified by the contract with a particular customer. Our billing rates are commensurate with the healthcare-domain IT expertise, know-how and skills of our consultants. Our time and expense projects generally range from three to six months, although certain projects have been for periods in excess of a year. Our network system and payor application system implementation engagements typically average six months but may vary depending on the size and complexity of the project. We also provide support, management and help desk services, under multi-year engagements, in which revenue is recognized ratably over the period that these services are provided. Our help desk services are generally provided in multi-year engagements on a price per call or price per node basis. Prior to 1999, the majority of our contract services were generally provided on a fixed-fee basis. Revenue on fixed-fee contracts is recognized related to the level of service performed based upon the amount of labor cost incurred on the project versus the total labor costs to complete the project. Our 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 we obtain a lower margin) versus professional services. We bill our customers for out-of-pocket expenses, primarily travel and related expenses incurred with respect to services provided to customers, and have adopted the provisions of the Emerging Issues Task Force ("EITF") Topic D-103, Income Statement Characterization of Reimbursements for "Out-of-Pocket" Expenses Incurred. Payments received in advance of services performed are recorded as deferred revenue. Certain contract payment terms may result in customer billing occurring at a pace slower than revenue recognition. The resulting revenue recognized in excess of amounts billed and project costs is included in contract work in progress on our balance sheet. Cost of revenue primarily consists of all expenses that are directly attributable to our service lines and include the salaries, bonuses and related benefits of our consultants as well as non-billable managers and support staff, subcontractor expenses, training costs and unit-specific office space costs. Our consultant-related costs are relatively fixed therefore, fluctuations in our gross margin may occur due to changes in project margins and utilization rates of our professional staff. We often hire employees in anticipation of commencement of a project. If delays in contract signing occur, our gross margin could vary due to the associated loss of revenue to cover fixed labor costs. 21 Sales and marketing expenses primarily consist of the salaries, benefits, travel and other costs of our sales and marketing teams, as well as marketing initiatives and business development expenses. General and administrative expenses primarily consist of the costs attributable to the support of our consultants, such as: investments in information systems, salaries, expenses and office space costs for executive management, financial accounting, purchasing, administrative and human resources personnel, recruiting fees, legal and other professional services. Results of Operations The following table sets forth, for the years indicated, certain statement of operations data as a percentage of net revenue.
Years Ended December 31, ---------------------- 2002 2001 2000 ---- ---- ---- Revenue before reimbursements (net revenue). 100% 100% 100% Cost of revenue before reimbursable expenses 73 79 94 --- --- --- Gross profit................................ 27 21 6 Sales and marketing expense................. 13 8 9 General and administrative expense.......... 18 18 17 Restructuring charges....................... 4 3 3 --- --- --- Loss from operations........................ (8) (8) (23) Other income, net........................... 1 1 1 --- --- --- Loss before income taxes.................... (7) (7) (22) Provision for income taxes.................. -- -- -- --- --- --- Net loss.................................... (7)% (7)% (22)% --- --- ---
Years Ended December 31, 2002 and 2001 Our net revenue decreased 8%, or $3.2 million, to $37.9 million for the year ended December 31, 2002 from $41.1 million for the year ended December 31, 2001. This decrease is a combination of a $5.0 million increase in managed care implementation revenue, offset by a $4.0 million decrease in revenue associated with the termination of a large outsourcing contract and the elimination of unprofitable lines of business in 2001, a $2.2 million decrease in revenue due to the downsizing of our temporary staffing business, a $2.0 million decrease in revenue associated with long-term contracts expiring in 2001 that were not renewed and a reduction in infrastructure services revenue. Revenue from third-party equipment sales remained relatively flat at $1.0 million in 2002 and 2001. Services to our five largest customers accounted for $12.3 million of net revenue for the year ended December 31, 2002, representing 32% of total net revenue, with one help desk outsourcing customer accounting for 9.2% of net revenue. This compares to net revenue from the five largest customers for the year ended December 31, 2001 totaling $13.5 million, or 33% of net revenue. Cost of revenue before reimbursable expenses decreased 15%, or $4.7 million, to $27.7 million for the year ended December 31, 2002 from $32.4 million for the year ended December 31, 2001 primarily due to the 8% decrease in net revenue as well as our efforts to eliminate under-performing lines of businesses and a reduction of costs and more effective management of our workforce, offset by higher costs in our managed care implementation business associated with the higher revenue attainment in that business. Gross margin increased to 27% for the year ended December 31, 2002 as compared to 21% for the year ended December 31, 2001. This increase is attributable primarily to the above-referenced exit from certain lines of business that were not profitable or had low margins as well as disciplined management procedures and controls resulting in increased operating efficiencies and billable utilization of our workforce. 22 Sales and marketing expenses increased 50%, or $1.6 million, to $5.0 million for the year ended December 31, 2002 as compared to $3.4 million for the year ended December 31, 2001, primarily due to our efforts to re-establish market presence in 2002 following a period of limited activity as we focused internally to restructure and gain operating efficiencies. Sales and marketing expenses were 13% and 8% of net revenue for the years ended December 31, 2002 and 2001, respectively. We expect sales and marketing expenses to increase in 2003 as we continue to invest in strategic business development initiatives in an effort to increase revenue. General and administrative expenses decreased $600,000, or 8%, to $6.8 million for the year ended December 31, 2002 as compared to $7.4 million for the year ended December 31, 2001, reflecting our efforts in improving administrative operating performance and the centralization of accounting, human resources, and IT functions at the corporate level. General and administrative expenses were 18% of net revenue for each of the years ended December 31, 2002 and 2001. We recorded a restructuring charge for the year ended December 31, 2002 totaling $1.6 million primarily related to our decision to reorganize our internal management structure, consolidate operations and eliminate non-strategic services as part of our strategy to position Daou for continued growth in the marketplace. The restructuring charge includes $1.1 million in severance costs and $500,000 related to the closure and combination of certain facilities. Other income, net, decreased 36%, or $100,000 to $300,000 for the year ended December 31, 2002 as compared to $400,000 for the year ended December 31, 2001. Other income is comprised primarily of interest income on cash and cash equivalents, and investments. The effective income tax rate for the year ended December 31, 2002 and 2001 was 0%. We did not record an income tax benefit on the operating loss as realization is not certain. Years Ended December 31, 2001 and 2000 Our net revenue decreased 35%, or $22.6 million, to $41.1 million for the year ended December 31, 2001 from $63.7 million for the year ended December 31, 2000. This decrease is primarily due to our previously announced termination of large outsourcing contracts, our decision to exit certain unprofitable lines of businesses and continued softened demand for services in our core health care IT business. Revenue from third-party material sales decreased to $1.0 million in 2001 from $4.7 million in 2000. Services to our five largest customers accounted for $13.5 million of net revenue for the year ended December 31, 2001, representing 33% of total net revenue, with one customer in the Sentient business group accounting for 9.7% of total net revenue. This compares to net revenue from the five largest customers for the year ended December 31, 2000 totaling $21.0 million, or 33% of total net revenue. One customer, included in the five largest customers for each of the years, exercised its right to terminate its outsourcing contract as of March 31, 2001. This customer accounted for $3.0 million in net revenue for the year ended December 31, 2001, or 7.3% of total net revenue, and accounted for $10.1 million in net revenue, representing 16% of total net revenue, for the year ended December 31, 2000. Cost of revenue before reimbursable expenses decreased 46%, or $27.5 million, to $32.4 million for the year ended December 31, 2001 from $59.9 million for the year ended December 31, 2000 primarily due to the 35% decrease in net revenue and our efforts to reduce headcount and other costs of revenue to maximize productivity at the current revenue levels. Gross margin increased to 21% for the year ended December 31, 2001 as compared to 6% for the year ended December 31, 2000. This increase is primarily attributable to our efforts to eliminate unprofitable lines of businesses, reduce costs and more effectively manage our workforce resulting in higher utilization. Also, in February 2000, we formed the Enosus subsidiary division to provide Internet and eCommerce services. Start up investments in Enosus further reduced gross margin during 2000. We previously announced that Enosus was merged into the ISG business unit in December 2000. 23 Sales and marketing expenses decreased 41%, or $2.3 million, to $3.4 million for the year ended December 31, 2001 as compared to $5.7 million for the year ended December 31, 2000, primarily due to the reduction in sales staff and related expenditures as a result of consolidation, integration of the sales and marketing functions and our withdrawal from certain unprofitable lines of businesses. Sales and marketing expenses were 8% and 9% of net revenue for the years ended December 31, 2001 and 2000, respectively. We expect sales and marketing expenses to increase by approximately $3 million in 2002 and subsequent periods as we reinvest in marketing and sales programs to generate renewed interest in our offerings, as well as opportunities related to emerging healthcare information technologies. General and administrative expenses decreased $3.4 million, or 32%, to $7.4 million for the year ended December 31, 2001 as compared to $10.8 million for the year ended December 31, 2000, primarily due to efficiencies realized with the consolidation and integration of certain general and administrative functions of the divisions. During 2000, we completed the implementation of our ERP system and have been able to centralize certain functions into the corporate office and reduce overhead costs as a result. General and administrative expenses were 18% and 17% of net revenue for the years ended December 31, 2001 and 2000, respectively. We recorded a restructuring charge for the year ended December 31, 2001 totaling $1.3 million primarily related to the consolidation and relocation of our corporate offices with existing facilities in Exton, Pennsylvania. The restructure charge consisted of approximately $1.0 million related to the closure and combination of certain facilities and approximately $300,000 related to severance costs. We recorded a restructuring charge for the year ended December 31, 2000 totaling $2.1 million. This charge resulted primarily from severance costs related to a workforce reduction and the costs related to the closure and combination of certain facilities. We implemented the restructuring plan in order to improve our overhead cost structure and to refocus operations into areas in which we believe we have a core competency. We believe the restructuring was necessary due to the significant decline in revenue and gross margin in 2000 as compared to 1999. The restructuring charge recorded in 2000 includes the estimated costs of workforce reductions of $1.1 million and the closure and combination of certain facilities in periods subsequent to December 31, 2000 of $1.0 million. We believe these estimates reflect the anticipated costs to complete the restructuring plans. At December 31, 2001, approximately $1.9 million of the total $2.1 million restructuring charge recorded during 2000 had been paid out. As of December 31, 2001, we had incurred approximately $200,000 of the restructuring charge recorded in the fourth quarter of 2001. Other income (expense), net, decreased 40%, or $300,000 to $400,000 for the year ended December 31, 2001 as compared to $700,000 for the year ended December 31, 2000. This other income is comprised primarily of interest income on cash and cash equivalents, and investments. This decrease in other income (expense), net, was primarily due to a decrease in interest rates during 2001. The effective income tax rate for the year ended December 31, 2001 and 2000 was 0%. We did not record an income tax benefit on the operating loss as realization is not certain. Liquidity and Capital Resources On December 31, 2002, we had working capital of $12.9 million, a decrease of $3.1 million from $16.0 million on December 31, 2001. The decrease is primarily attributable to cash used to fund operations as well as to purchase equipment, furniture and fixtures. For the year ended December 31, 2002, cash used in operating activities was $1.4 million, compared to net cash provided by operating activities of $4.7 million for the year ended December 31, 2001. Cash provided by operations for the year ended December 31, 2001 resulted primarily from the net loss for 2001 and a $4.1 million decrease in trade receivables in 2001 due to our increased collection efforts. Cash used in operations for the year ended December 31, 2002 was primarily the result of our net loss for that year. 24 Net cash used in investing activities was $1.2 million for the year ended December 31, 2002, compared to $226,000 in the comparable prior period. The increase in cash used by investing activities was primarily due to increased purchases of equipment, furniture and fixtures associated with the relocation of our corporate headquarters from San Diego, California to Exton, Pennsylvania as well as investments in equipment used in our help desk service line. Net cash provided by financing activities was $84,000 for the year ended December 31, 2002, compared to cash used in financing activities of $113,000 in the comparable prior year period. This increase was primarily the result of the $198,000 cash purchase of treasury stock in 2001. On July 27, 1999 we issued 2,181,818 shares of Series A Preferred Stock. The Series A Preferred Stock agreement contained a redemption feature that was outside of our control. On November 9, 2000, the holders of the Series A Preferred Stock permanently waived their redemption rights arising from the resignation of our Chief Executive Officer, in return for $2.0 million in cash and warrants to purchase 3,540,000 shares of common stock exercisable at $0.01 per share. Even though the holders of the Series A Preferred Stock have waived their redemption rights, we still have our right to redeem the Series A Preferred Stock anytime after July 26, 2003 for the issue price plus accrued dividends. We have contractual obligations, principally under operating lease agreements, as follows: due within one year--$1,528,000; due in one to three years--$1,669,000; due in four to five years--$558,000; and due after five years--$347,000. Although we have an accumulated deficit as of December 31, 2002, we believe that our available funds will be sufficient to meet our capital requirements for the foreseeable future. We may sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities or issuance of equity securities in future acquisitions would result in dilution to our stockholders and the incurrence of additional debt could result in additional interest expense. However, there can be no assurance that we will be able to sell additional equity or debt securities, or be able to obtain additional financing on acceptable terms, if at all. See "Risk Factors--Future sales of our common stock could adversely affect the price of the common stock and our ability to raise additional equity capital." Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures. On an on-going basis, we evaluate these estimates, including those related to revenue recognition, long-lived assets, accrued liabilities, stock-based compensation, and income taxes. Estimates are based on historical experience, information received from third parties and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of our financial statements. Revenue Recognition We recognize revenue in accordance with Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements. SAB 101 requires that the following criteria be met in determining whether revenue has been earned: . persuasive evidence of an arrangement, . services have been delivered, 25 . price is fixed and determinable, and . collectibility is reasonably assured. We have the following types of revenue recognition: i) services performed on an hourly basis, ii) services performed on a fixed fee basis and iii) sales of material and maintenance contracts. In general, we enter into contracts with customers to provide services at a specified fee or rate per hour. Revenue from professional services is recognized primarily on an hourly basis. Revenue from technical support, network management and help desk services is recognized as the services are performed. Contract revenue for the development and implementation of network solutions under fixed-fee contracts is recognized related to the level of service performed based upon the amount of labor cost incurred on the project versus the total labor costs to complete the project. Provisions for estimated losses on contracts, if any, are made during the period when the loss becomes probable and can be reasonably estimated. Revenue 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. Bad Debt We are required to estimate the collectibility of our trade accounts receivable. We perform this analysis on a specific customer identification basis. A considerable amount of judgment is required in assessing the ultimate realization of these receivables, including the credit worthiness of each customer and the age of the customer balances. We estimate the amount to reserve for a specific customer by taking into account the age of the receivables and the payment history of the customer. Significant changes in required reserves have been recorded in recent periods and may occur in the future due to the current market environment and changes in client payment history. Restructuring Charges During the years ended December 2002, 2001 and 2000, we recorded reserves in connection with our restructuring program. These reserves include estimates pertaining to the reduction in employee headcount and the costs of exiting facilities and unused equipment. Although we do not anticipate significant changes, the actual costs may differ from the estimates recorded. Litigation We are currently involved in legal proceedings regarding shareholder litigation and other general legal proceedings. As discussed in Note 11 of our consolidated financial statements, we have not accrued an amount, as we believe that the lawsuits are without merit and intend to defend against them vigorously. We do not believe these proceedings will have a material adverse effect in our consolidated financial position. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in our assumptions, or the effectiveness of our strategies, related to these proceedings. Recently Issued Accounting Standards On January 1, 2002, we adopted the provisions of the Emerging Issues Task Force ("EITF") Topic D-103, Income Statement Characterization of Reimbursements for "Out-of-Pocket" Expenses Incurred. In accordance with the provisions of EITF Topic D-103, we adjusted revenue and cost of revenue for all periods reported to include out-of-pocket expenses. We have reclassified our prior period financial statements in accordance with this accounting pronouncement. Adoption of the provisions of EITF Topic D-103 had no impact on reported net loss, net loss available to common stockholders or net loss per share for the periods presented. 26 In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 provides guidance related to accounting for costs associated with disposal activities covered by SFAS No. 144 or with exit or restructuring activities previously covered by Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS No. 146 requires that costs related to exiting an activity or to a restructuring not be recognized until the liability is incurred. SFAS No. 146 will be applied prospectively to exit or disposal activities that are initiated after December 31, 2002. The adoption of this method is not expected to have a material impact on our operations or financial condition. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for Daou for the year ended December 31, 2002. Item 7A: Quantitative and Qualitative Disclosures about Market Risks. We invest excess cash primarily in U.S. government securities and marketable debt securities of financial institutions and corporations with strong credit ratings. These instruments have maturities of three months or less when acquired. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. Accordingly, we believe that, while the instruments held are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchanges rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. Item 8: Financial Statements. Index to Consolidated Financial Statements and Financial Statement Schedule
Page ---- Consolidated Financial Statements Report of Ernst & Young LLP, Independent Auditors...................................... 28 Consolidated Balance Sheets at December 31, 2002 and 2001.............................. 29 Consolidated Statements of Operations for the years ended December 31, 2002, 2001, and 2000................................................................................. 30 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2002, 2001, and 2000....................................................................... 31 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000............................................................................. 32 Notes to Consolidated Financial Statements............................................. 34 Consolidated Financial Statement Schedule Schedule II--Valuation and Qualifying Accounts............................................ 48
Other schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the consolidated financial statements or notes thereto. 27 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Daou Systems, Inc. We have audited the accompanying consolidated balance sheets of Daou Systems, Inc. as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in Item 15(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 and schedule 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, 2002 and 2001 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, 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 Philadelphia, Pennsylvania February 13, 2003 28 Daou Systems, Inc. Consolidated Balance Sheets (In thousands, except for per share data)
December 31, ------------------ 2002 2001 -------- -------- ASSETS Current assets: Cash and cash equivalents............................................... $ 12,319 $ 14,868 Restricted cash......................................................... -- 147 Investments, available-for-sale......................................... 75 59 Accounts receivable, net of allowance for doubtful accounts of $732 and $715 in 2002 and 2001, respectively................................... 7,922 7,572 Contract work in progress............................................... 2,147 310 Other current assets.................................................... 554 328 -------- -------- Total current assets....................................................... 23,017 23,284 Due from officers/stockholders............................................. 54 19 Equipment, furniture and fixtures, net..................................... 1,006 970 Other assets............................................................... 563 372 -------- -------- $ 24,640 $ 24,645 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade accounts payable.................................................. $ 705 $ 1,004 Accrued salaries and benefits........................................... 4,328 3,575 Accrued project costs................................................... 1,968 45 Other accrued liabilities............................................... 2,765 2,077 Deferred revenue........................................................ 365 585 -------- -------- Total current liabilities.................................................. 10,131 7,286 Other long-term liabilities................................................ 40 51 Commitments and contingencies Stockholders' equity: Convertible preferred stock, $ .001 par value. Authorized 3,520 shares; issued and outstanding 2,182 shares at December 31, 2002 and 2001, with a liquidation preference of $14,966 and $13,912 at December 31, 2002 and 2001, including accrued dividends............................ 2 2 Common stock, $ .001 par value. Authorized 50,000 shares; issued and outstanding 21,737 and 21,556 at December 31, 2002 and 2001, respectively and 992 shares held in treasury at December 31, 2002 and 2001.................................................................. 22 22 Additional paid-in capital.............................................. 54,806 53,668 Notes receivable from stockholders...................................... (1,281) (1,281) Accumulated other comprehensive loss.................................... (56) (72) Accumulated deficit..................................................... (39,024) (35,031) -------- -------- Total stockholders' equity................................................. 14,469 17,308 -------- -------- $ 24,640 $ 24,645 ======== ========
See accompanying notes to consolidated financial statements. 29 Daou Systems, Inc. Consolidated Statements of Operations (In thousands, except for per share data)
Years Ended December 31, --------------------------- 2002 2001 2000 ------- ------- --------- Revenue before reimbursements (net revenue)..................... $37,935 $41,082 $ 63,748 Out-of-pocket reimbursements.................................... 3,240 3,161 3,460 ------- ------- --------- Total revenue.................................................. 41,175 44,243 67,208 Cost of revenue before reimbursable expenses.................... 27,668 32,424 59,923 Out-of-pocket reimbursable expenses............................. 3,240 3,161 3,460 ------- ------- --------- Total cost of revenue.......................................... 30,908 35,585 63,383 Gross profit.................................................... 10,267 8,658 3,825 Operating expenses: Sales and marketing.......................................... 5,040 3,360 5,744 General and administrative................................... 6,838 7,408 10,831 Restructuring charges........................................ 1,598 1,263 2,133 ------- ------- --------- 13,476 12,031 18,708 ------- ------- --------- Loss from operations............................................ (3,209) (3,373) (14,883) Other income, net............................................... 270 421 699 ------- ------- --------- Loss before income taxes........................................ (2,939) (2,952) (14,184) Provision for income taxes...................................... -- -- -- ------- ------- --------- Net loss........................................................ (2,939) (2,952) (14,184) Accrued dividends on preferred stock............................ (1,054) (854) (4,837) ------- ------- --------- Net loss available to common stockholders....................... $(3,993) $(3,806) $ (19,021) ------- ------- --------- Basic and diluted net loss available to common stockholders per common share.................................................. $ (0.21) $ (0.22) $ (1.07) ------- ------- --------- Shares used in computing basic and diluted net loss available to common stockholders per common share.......................... 19,075 17,682 17,712 ======= ======= =========
See accompanying notes to consolidated financial statements. 30 Daou Systems, Inc. Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 2002, 2001, and 2000 (In thousands)
Notes Convertible receivable preferred stock Common stock Additional from --------------- -------------- paid-in stock- Deferred Shares Amount Shares Amount capital holders compensation ------ ------ ------ ------ ---------- ---------- ------------ Balance at December 31, 1999............................... -- $-- 17,712 $18 $37,395 $ -- $(192) ----- --- ------ --- ------- ------- ----- Issuance of common stock upon exercise of stock options.... -- -- 1 -- 1 -- -- Issuance of common stock under employee stock purchase plan -- -- 118 -- 54 -- -- Amortization of deferred compensation...................... -- -- -- -- -- -- 139 Reversal of deferred compensation for separated employees.. -- -- -- -- (53) -- 53 Removal of redemption feature on preferred stock........... 2,182 2 -- -- 11,380 -- -- Warrants issued to preferred stockholders.................. -- -- -- -- 2,088 -- -- Accrued dividends on preferred stock....................... -- -- -- -- 749 -- -- Comprehensive loss: Unrealized loss on investments.......................... -- -- -- -- -- -- -- Net loss................................................ -- -- -- -- -- -- -- Comprehensive loss......................................... -- -- -- -- -- -- -- ----- --- ------ --- ------- ------- ----- Balance at December 31, 2000............................... 2,182 2 17,831 18 51,614 -- -- ----- --- ------ --- ------- ------- ----- Issuance of common stock under employee stock purchase plan -- -- 318 -- 85 -- -- Accrued dividends on preferred stock....................... -- -- -- -- 854 -- -- Issuance of common stock and options for services.......... -- -- 99 -- 36 -- -- Purchase of treasury stock................................. -- -- (992) -- (198) -- -- Issuance of restricted stock in exchange for notes......... -- -- 4,300 4 1,277 (1,281) -- Comprehensive loss: Unrealized loss on investments............................. -- -- -- -- -- -- -- Net loss................................................ -- -- -- -- -- -- -- Comprehensive loss...................................... -- -- -- -- -- -- -- ----- --- ------ --- ------- ------- ----- Balance at December 31, 2001............................... 2,182 2 21,556 22 53,668 (1,281) -- ----- --- ------ --- ------- ------- ----- Issuance of common stock under employee stock purchase plan -- -- 160 -- 81 -- -- Accrued dividends on preferred stock....................... -- -- -- -- 1,054 -- -- Issuance of common stock upon exercise of stock options.... -- -- 21 -- 3 -- -- Comprehensive loss: Unrealized gain on investments............................. -- -- -- -- -- -- -- Net loss................................................ -- -- -- -- -- -- -- Comprehensive loss:..................................... -- -- -- -- -- -- -- ----- --- ------ --- ------- ------- ----- Balance at December 31, 2002............................... 2,182 $ 2 21,737 $22 $54,806 $(1,281) $ -- ----- --- ------ --- ------- ------- -----
Accumulated other Total comprehensive Accumulated stockholders' income (loss) deficit equity ------------- ----------- ------------- Balance at December 31, 1999............................... $(43) $(12,204) $ 24,974 ---- -------- -------- Issuance of common stock upon exercise of stock options.... -- -- 1 Issuance of common stock under employee stock purchase plan -- -- 54 Amortization of deferred compensation...................... -- -- 139 Reversal of deferred compensation for separated employees.. -- -- -- Removal of redemption feature on preferred stock........... -- (2,000) 9,382 Warrants issued to preferred stockholders.................. -- (2,088) -- Accrued dividends on preferred stock....................... -- (749) -- Comprehensive loss: Unrealized loss on investments.......................... (6) -- (6) Net loss................................................ -- (14,184) (14,184) -------- Comprehensive loss......................................... -- -- (14,190) ---- -------- -------- Balance at December 31, 2000............................... (49) (31,225) 20,360 ---- -------- -------- Issuance of common stock under employee stock purchase plan -- -- 85 Accrued dividends on preferred stock....................... -- (854) -- Issuance of common stock and options for services.......... -- -- 36 Purchase of treasury stock................................. -- -- (198) Issuance of restricted stock in exchange for notes......... -- -- -- Comprehensive loss: Unrealized loss on investments............................. (23) -- (23) Net loss................................................ -- (2,952) (2,952) -------- Comprehensive loss...................................... -- -- (2,975) ---- -------- -------- Balance at December 31, 2001............................... (72) (35,031) 17,308 ---- -------- -------- Issuance of common stock under employee stock purchase plan -- -- 81 Accrued dividends on preferred stock....................... -- (1,054) -- Issuance of common stock upon exercise of stock options.... -- -- 3 Comprehensive loss: Unrealized gain on investments............................. 16 -- 16 Net loss................................................ -- (2,939) (2,939) -------- Comprehensive loss:..................................... -- -- (2,923) ---- -------- -------- Balance at December 31, 2002............................... $(56) $(39,024) $ 14,469 ---- -------- --------
See accompanying notes to consolidated financial statements 31 Daou Systems, Inc. Consolidated Statements of Cash Flows (In thousands)
Years ended December 31, -------------------------- 2002 2001 2000 ------- ------- -------- Net loss........................................................... $(2,939) $(2,952) $(14,184) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation and amortization................................... 959 1,334 2,388 Amortization of deferred compensation........................... 108 60 139 Provision for uncollectible accounts............................ 186 232 402 Issuance of common stock and options for services............... -- 36 -- (Gain) loss on retirement of fixed assets....................... (10) 362 273 Changes in operating assets and liabilities: Restricted cash............................................. 147 (147) -- Accounts receivable......................................... (536) 4,096 9,610 Contract work in progress................................... 131 750 1,756 Other current assets........................................ (226) 230 490 Accounts payable and accrued liabilities.................... 259 (405) (1,443) Accrued salaries and benefits............................... 753 981 (1,975) Deferred revenue............................................ (220) 188 218 Other long-term liabilities................................. (11) 51 -- Deferred rent............................................... -- (113) (32) ------- ------- -------- Net cash (used in) provided by operating activities................ (1,399) 4,703 (2,358) Investing activities Purchase of equipment, furniture and fixtures...................... (900) (259) (907) (Increase) decrease in other assets................................ (334) 33 156 Purchases of investments........................................... -- -- (20) Payments from officers/stockholders................................ -- -- 98 ------- ------- -------- Net cash used in investing activities.............................. (1,234) (226) (673) Financing Activities Proceeds from issuance of common stock............................. 84 85 55 Payment and issuance costs to remove redemption feature of preferred stock.................................................. -- -- (2,000) Purchase of treasury stock......................................... -- (198) -- ------- ------- -------- Net cash provided by (used in) financing activities................ 84 (113) (1,945) ------- ------- -------- (Decrease) increase in cash and cash equivalents................... (2,549) 4,364 (4,976) Cash and cash equivalents at beginning of year..................... 14,868 10,504 15,480 ------- ------- -------- Cash and cash equivalents at end of year........................... $12,319 $14,868 $ 10,504 ======= ======= ======== Cash paid during the year for: Interest........................................................ -- -- $ 11 ======= ======= ========
See accompanying notes to consolidated financial statements. 32 Daou Systems, Inc. Consolidated Statements Of Cash Flows (In thousands)
Years ended December 31, ---------------------- 2002 2001 2000 ------ ------ ------- Supplemental disclosure of noncash investing and financing activities: Issuance of common stock and options for services.................. $ -- $ 36 $ -- ====== ====== ======= Issuance of restricted common stock in exchange for notes receivable....................................................... -- 1,281 -- ====== ====== ======= Accrued preferred stock dividends to preferred stockholders........ 1,054 854 749 ====== ====== ======= Issuance of warrants to remove redemption feature of preferred stock............................................................ -- -- (2,088) ====== ====== ======= Unrealized gain (loss) on investments.............................. $ 16 $ (23) $ (6) ====== ====== =======
See accompanying notes to consolidated financial statements. 33 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 California on July 16, 1987 under the name Daou Systems, Inc., and reincorporated in Delaware on November 15, 1996. Daou is principally focused on providing IT services and solutions to the U.S. healthcare industry including providers, payors and health plans and government healthcare organizations. The Company designs and implements solutions to help healthcare organizations navigate the intersection of legacy systems with emerging technologies, such as web portals, wireless and other portable computing solutions. The Company's services include (1) management consulting, (2) traditional network services, (3) application implementation and support, (4) application development and integration, and (5) strategic outsourcing, including remote help desk and related technology support services. On December 31, 2000, the Company merged all of its subsidiaries into the parent company, Daou Systems, Inc. During December 2002, the Company reorganized its internal management structure, consolidated operations and eliminated non-strategic services. This reorganization, which was approved by the Company's Board of Directors, is part of Daou's strategy to position itself for continued growth in the marketplace. The Company recorded a one-time restructuring charge of approximately $1.6 million in the fourth quarter of 2002 related to severance costs, expenses associated with a slight workforce reduction, elimination of non-strategic services and the consolidation of office space in connection with this reorganization. As part of the reorganization, the Company consolidated its two operating divisions--Technology Services and Application Services. For purposes of improving overall sales and operations effectiveness, and to offer its customers an integrated solutions approach through multi-disciplinary teams, the Company now provides its services through two primary practice groups: commercial healthcare and government healthcare. The Company believes the consolidation was necessary due to changing market forces in the healthcare industry. Daou expects that operating as one business unit will allow the Company to focus on its core competencies and pursue a seamless approach to applications and technology. The consolidated financial statements reflect the consolidated financial position and operating results for the Company. All significant intercompany transactions and accounts have been eliminated. Revenue Recognition The Company recognizes revenue in accordance with the provisions of Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements. SAB 101 requires that the following criteria be 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 an 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. 34 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 1. Organization and Summary of Significant Accounting Policies--(Continued) Revenue from professional services is recognized primarily on an hourly basis. Revenue from technical support, network management and help desk services is recognized as the services are performed. Contract revenue for the development and implementation of network solutions under fixed-fee contracts is recognized related to the level of service performed based upon the amount of labor cost incurred on the project versus the total labor costs to complete the project. Provisions for estimated losses on contracts, if any, are made during the period when the loss becomes probable and can be reasonably estimated. Revenue recognized in excess of amounts billed and project costs is classified as contract work in progress. Payments received in advance of services performed are recorded as deferred revenue and recognized as the services are performed. Concentration of Credit Risk and Major Customers Financial instruments which subject the Company to potential concentrations of credit risk consist principally of the Company's accounts receivable. Substantially all of the Company's accounts receivable are from managed care organizations, hospitals, government healthcare organizations and other healthcare providers. The Company performs credit evaluations of its new customers and generally requires no collateral. The Company provides for losses from uncollectible accounts pursuant to a formal policy which is based on analyzing historical data and trends and such losses have historically not exceeded management's expectations. Past due or delinquency status is based on contractual terms. Past due amounts are written off against the allowance for doubtful accounts when collection is deemed unlikely and all collection efforts have ceased. Services to Daou's five largest customers accounted for approximately $12.3 million of net revenue for the year ended December 31, 2002, representing approximately 32% of total net revenue, with one customer accounting for 9.2% of net revenue. Cash, Cash Equivalents, Restricted Cash 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. At December 31, 2002, the Company has approximately $300,000 of cash related to an operating lease in an escrow account subject to certain withdrawal restrictions. This amount is classified in other assets on the balance sheet. 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 two to five years. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the remaining lease term. 35 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 1. Organization and Summary of Significant Accounting Policies--(Continued) Software development costs, consisting of internally developed software, 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 equipment, furniture and fixtures 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 $222,000, $14,000 and $145,000 for the years ended December 31, 2002, 2001 and 2000. Recent Pronouncements On January 1, 2002, the Company adopted the provisions of the Emerging Issues Task Force ("EITF") Topic D-103, Income Statement Characterization of Reimbursements for "Out-of-Pocket" Expenses Incurred. In accordance with the provisions of EITF Topic D-103, the Company adjusted revenue and cost of revenue for all periods reported to include out-of-pocket expenses. The Company has reclassified its prior period financial statements in accordance with this accounting pronouncement. Adoption of the provisions of EITF Topic D-103 had no impact on reported net loss, net loss available to common stockholders or net loss per share for the periods presented. In June 2002, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 provides guidance related to accounting for costs associated with disposal activities covered by SFAS No. 144 or with exit or restructuring activities previously covered by EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS No. 146 requires that costs related to exiting an activity or to a restructuring not be recognized until the liability is incurred. SFAS No. 146 will be applied prospectively to exit or disposal activities that are initiated after December 31, 2002. The adoption of this method is not expected to have a material impact on the Company's operations or financial condition. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for Daou for the year ended December 31, 2002. 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. 36 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 1. Organization and Summary of Significant Accounting Policies--(Continued) Reclassifications Effective January 1, 2002, certain overhead expenses directly attributable to the business units and formerly recorded as general and administrative expenses are now recorded as cost of revenue before reimbursable expenses. The prior period amounts have been reclassified to conform to their current period presentation. Certain other prior year amounts have been reclassified to conform to the current year's presentation. Stock-Based Compensation The Company has stock-based employee compensation plans, which are described more fully in Note 8. The Company applies the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for those plans. For stock options, no compensation expense is reflected in net income as all stock options granted had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. In addition, no compensation expense is recognized for common stock purchases under the Employee Stock Purchase Plan. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, "Accounting for Stock-Based Compensation," and has been determined as if the Company had accounted for its stock plans under the fair value method of SFAS No. 123. For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123:
Years Ended December 31, -------------------------- 2002 2001 2000 ------- ------- -------- Net loss as reported............................ $(3,993) $(3,806) $(19,021) Deduct total stock-based employee compensation determined under the fair value method for all awards, net of tax............................ (3,425) (5,788) (8,763) ------- ------- -------- Pro forma net loss.............................. $(7,418) $(9,594) $(27,784) ------- ------- -------- Loss per share Basic and diluted--as reported............... $ (0.21) $ (0.22) $ (1.07) ======= ======= ======== Basic and diluted--pro forma................. $ (0.39) $ (0.54) $ (1.57) ======= ======= ========
2. Net Loss Per Share Net loss per share is computed in accordance with SFAS 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. For the years ended December 31, 2002, 2001 and 2000, diluted loss per share is unchanged from basic loss per share because the effects of the assumed conversion of Series A Preferred Stock, stock options and warrants would be anti-dilutive. 37 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 2. Net Loss Per Share--(Continued) The following table details the computation of basic and diluted net loss per share: (In thousands, except per share information)
Years Ended December 31, -------------------------- 2002 2001 2000 ------- ------- -------- Numerator: Net loss available to common stockholders............................ $(3,993) $(3,806) $(19,021) Denominator: Weighted average common shares outstanding............................. 21,591 19,233 17,712 Weighted average unvested common shares subject to repurchase agreements........ (2,516) (1,551) -- ------- ------- -------- Denominator for basic and diluted calculation 19,075 17,682 17,712 ------- ------- -------- Basic and diluted net loss per share...... $ (0.21) $ (0.22) $ (1.07) ======= ======= ========
3. Restructuring Charges The Company accounts for restructuring charges in accordance with SEC SAB No. 100, Restructuring And Impairment Charges, and EITF No. 94-3, Liability Recognition For Certain Employee Termination Benefits And Other Costs To Exit An Activity (Including Certain Cost Incurred In A Restructuring). As part of its strategy to position itself for continued growth in the marketplace, the Company reorganized its management structure, consolidated operations and eliminated certain non-strategic services as of December 31, 2002. In addition, in the fourth quarter of 2002 the Company increased its estimate of costs and related sublease income related to previously announced closures of certain facilities. These combined actions resulted in a workforce reduction of approximately 16 employees and a restructuring charge in the fourth quarter of 2002 of $1.6 million. During the year ended December 31, 2001, the Company recorded restructuring charges totaling $1.3 million in connection with its decision to close and combine certain facilities. These charges included severance costs related to a reduction in workforce of approximately 28 employees and the costs estimated to be incurred in connection with the closure of certain facilities. During the year ended December 31, 2000, the Company recorded restructuring charges totaling approximately $2.1 million in connection with the various actions to reduce the cost structure of the Company. These charges included severance costs related to a reduction in workforce of approximately 50 employees and the closure of certain facilities. 38 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 3. Restructuring Charges--(Continued) The following table summarizes the restructuring and other related charges recorded, and the related activity to such charges, in the years ended December 31, 2002, 2001 and 2000 (in thousands).
Severance costs for Costs related to involuntary closure and employee combination of terminations facilities Total ------------------- ---------------- ------- Year Ended December 31, 2000: Reserve established....... $1,140 $ 993 $ 2,133 Reserve utilized.......... (747) (80) (827) ------ ------- ------- Balance at December 31, 2000. 393 913 1,306 Year Ended December 31, 2001: Reserve established....... 310 953 1,263 Reserve utilized.......... (552) (705) (1,257) ------ ------- ------- Balance at December 31, 2001. 151 1,161 1,312 Year Ended December 31, 2002: Reserve established....... 1,065 533 1,598 Reserve utilized.......... (222) (1,064) (1,286) ------ ------- ------- Balance at December 31, 2002. $ 994 $ 630 $ 1,624 ====== ======= =======
4. Investments, Available-For-Sale Short-term investments, available-for-sale, consist of the following (in thousands):
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- December 31, 2002 Government debt securities. $59 $16 $ -- $75 --- --- ---- --- December 31, 2001 Government debt securities. $82 $-- $(23) $59 === === ==== ===
The government debt securities mature in 2008. 5. Selected Balance Sheet Details Contract work in progress consists of the following (in thousands):
December 31, --------------- 2002 2001 ------- ------- Unbilled project costs....................... $ 1,726 $ -- Other........................................ 421 310 ------- ------- $ 2,147 $ 310 ======= =======
Unbilled project costs include the costs of equipment that was not billed as of December 31, 2002. 39 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 5. Selected Balance Sheet Details--(Continued) Equipment, furniture and fixtures consist of the following (in thousands):
December 31, ---------------- 2002 2001 ------- ------- Equipment and furniture.......... $ 4,492 $ 4,519 Leasehold improvements........... 178 68 ------- ------- 4,670 4,587 Less accumulated depreciation and amortization................... (3,664) (3,617) ------- ------- $ 1,006 $ 970 ======= =======
Other accrued liabilities consist of the following (in thousands):
December 31, --------------- 2002 2001 ------- ------- Restructure costs $ 1,624 $ 1,312 Other............ 1,141 765 ------- ------- $ 2,765 $ 2,077 ======= =======
6. 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 2002, 2001 and 2000 totaled $760,000, $1,312,000 and $2,144,000, respectively. Annual future minimum lease payments under non-cancelable operating leases with initial terms of one year or more at December 31, 2002, consist of the following (in thousands): 2003...... $1,528 2004...... 1,097 2005...... 572 2006...... 273 2007...... 285 Thereafter 347 ------ $4,102 ======
The Company also subleases certain of its leased facilities under non-cancelable sublease agreements through 2005. Income related to these subleases is used to primarily offset restructuring liabilities. The amount received from subleases that was not applied to restructuring liabilities totaled $0 and $133,000 for the years ended December 31, 2002 and 2001, respectively, and was recorded as rental income. Future amounts due to the Company under sublease agreements, aggregating $1,049,000, are as follows for the year ended December 31; 2003--$478,000; 2004--$492,000; and, 2005--$79,000. 7. Related Party Transactions During the years ended December 31, 2002 and 2001, the Company received certain personnel recruitment services from a Company owned by one of its Board members. The Company believes the terms of its arrangement were at least as favorable, if not more, than those offered by competing 40 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 7. Related Party Transactions--(Continued) recruitment firms. Payments for these services during the year ended December 31, 2002 consisted of cash compensation totaling $141,000. Payments for these services during the year ended December 31, 2001, consisted of cash compensation totaling $87,500 and the issuance of 88,968 shares of the Company's common stock valued at $25,000. 8. Stockholders' Equity 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 were initially entitled to receive cumulative dividends at the rate of six percent per annum, generally payable in the form of shares of Series A Preferred Stock until July 26, 2001. The dividend rate increased to 7% on July 26, 2001, to 8% on July 26, 2002 and will continue to increase an additional 1% on July 26 of each year. 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 2,720,965 shares of common stock, which includes accrued but unpaid dividends as of December 31, 2002, 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). In addition, during 1999, the Company registered 2,750,000 shares of common stock for issuance upon the conversion of the 2,181,818 outstanding shares of Series A Preferred Stock. On November 9, 2000, as a consequence of the resignation of Larry Grandia, the Company's former President and Chief Executive Officer, 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 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 warrants expire on November 9, 2005. 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. Restricted Stock Purchase Agreements and Deferred Compensation On July 24, 2001, the Company agreed to sell 150,000 shares of restricted common stock at the July 24, 2001 closing price of $.52 per share to an executive officer of the Company, in exchange for a full recourse note receivable that accrues interest at a rate of 6.75% and is due on July 24, 2006. On June 1, 2001, the Company agreed to sell an aggregate of 4,150,000 shares of restricted common stock at the June 1, 2001 closing price of $.29 per share to three executive officers of the Company, in exchange for full recourse notes receivable that accrue interest at a rate of 6.75% and which are due on May 31, 2006. As part of this agreement, 1,710,000 options to purchase common stock previously granted to these executive officers were canceled. In connection with two of the agreements, the Company agreed to reimburse the officers for the interest due in accordance with the terms of the notes receivable. Accordingly, deferred compensation totaling $321,000 was recorded in connection with these agreements. This amount is 41 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 8. Stockholders' Equity--(Continued) included in other assets and is being amortized ratably over the five year term of the notes. Amortization totaled $108,000 and $60,000 for the years ended December 31, 2002 and 2001, respectively. Common Stock Repurchase On April 25, 2001, the Company repurchased 992,111 shares of the Company's common stock from the former Chairman of the Board of the Company at a fair market value price equal to $.20 per share for a total purchase price of $198,000. 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 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, 2002 and June 30, 2002, the Company issued 105,571 shares of common stock at $.3485 per share and 54,237 shares of common stock at $.8415 per share, respectively. At December 31, 2002, 904,148 shares remained available for future issuance under the ESPP. On January 1, 2003, the Company suspended the ESPP. 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. The following summary of the Company's stock option activity and related information includes 1,550,000 non-qualified stock options at an exercise price ranging from $0.29 to $1.00 per share and 225,000 options at an exercise price ranging from $0.41 to $1.03 per share, granted outside of the plan and approved by the Company's Board of Directors in 2001 and 2002, respectively:
2002 2001 2000 -------------------- --------------------- ---------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price --------- --------- ---------- --------- ----------- --------- Outstanding--beginning of year................. 4,298,199 $1.75 3,542,731 $4.10 $ 3,363,152 $7.80 Granted................... 778,250 0.92 3,472,000 0.40 2,083,700 1.21 Exercised................. (21,669) 0.18 -- -- (400) 3.25 Forfeited................. (600,822) 2.58 (2,716,532) 3.09 (1,903,721) 7.47 --------- ----- ---------- ----- ----------- ----- Outstanding--end of year.................... 4,453,958 $1.50 4,298,199 $1.75 $ 3,542,731 $4.10 --------- ----- ---------- ----- ----------- ----- Exercisable at end of year.................... 2,144,697 $2.24 633,326 $5.95 $ 863,312 $8.03 ========= ===== ========== ===== =========== ===== Weighted-average fair value of options granted during the year......... $0.82 $0.54 $0.50 ===== ===== =====
42 DAOU SYSTEMS, INC. Notes to Consolidated Financial Statements--(Continued) 8. Stockholders' Equity--(Continued) The following table summarizes information about stock options outstanding at December 31, 2002:
Outstanding Exercisable ------------------------------------------- ---------------------------- Weighted-Average Range of Number Remaining Number Weighted-Average Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price - --------------- ----------- ---------------- -------------- ----------- ---------------- $ 0.18-$ 2.74 3,791,785 8.3 $ 0.53 1,610,576 $ 0.54 $ 2.75-$ 5.49 460,516 5.3 $ 4.71 348,284 $ 4.73 $ 5.50-$ 8.24 54,189 4.1 $ 6.00 54,189 $ 6.00 $ 8.25-$10.99 3,368 3.9 $10.69 3,368 $10.69 $11.00-$13.74 120,000 3.3 $13.63 105,600 $13.63 $13.75-$16.49 0 0 $ 0 0 $ 0 $16.50-$19.24 7,000 4.5 $16.63 7,000 $16.63 $19.25-$21.99 7,100 5.1 $21.75 5,680 $21.75 $22.00-$24.74 5,000 5.0 $24.25 5,000 $24.25 $24.75-$27.50 5,000 4.8 $25.00 5,000 $25.00 --------- --- ------ --------- ------ 4,453,958 7.8 $ 1.50 2,144,697 $ 2.24 ========= === ====== ========= ======
At December 31, 2002, options for 1,896,609 common shares were available for future grant. The fair value of options granted was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions for 2002, 2001 and 2000: risk-free interest rate of 6% for all years; dividend yield of 0% for all years; volatility factors of the expected market price of the Company's common stock of 138% for all years; and a weighted-average expected life of the options of five years for all years. Common Stock Reserved At December 31, 2002, the Company had the following shares reserved for future issuance: Redeemable convertible preferred stock 2,750,000 Warrants.............................. 3,540,000 Stock options......................... 6,350,567 Employee stock purchase plan.......... 904,148 ---------- Total.............................. 13,544,715 ==========
43 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 9. Income Taxes Deferred income taxes are provided for temporary differences in recognizing certain income and expenses items for financial and tax reporting purposes. Significant components of the Company's deferred tax assets and liabilities are shown below (in thousands):
December 31, ------------------ 2002 2001 -------- -------- Deferred tax liabilities: Depreciation and amortization................. $ -- $ 61 -------- -------- -- 61 Deferred tax assets: Reserves and allowances....................... 1,620 670 Net operating losses.......................... 10,020 9,927 -------- -------- 11,640 10,597 -------- -------- Net deferred tax asset before valuation allowance 11,640 10,536 Valuation allowance for deferred tax assets...... (11,640) (10,536) -------- -------- Net deferred tax asset........................... $ -- $ -- -------- --------
The Company has recorded a full valuation allowance against the deferred tax asset as realization of the asset is not certain. At December 31, 2002, the Company has federal and state net operating loss carryforwards of approximately $27.3 million and $8.4 million, respectively. The federal loss carryforwards will begin to expire in 2018 and the state loss carryforwards began to expire in 2002, unless previously utilized. Under section 382 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 than 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, --------------------- 2002 2001 2000 ----- ----- ----- Tax at federal statutory rate...... (35.0)% (35.0)% (35.0)% Nondeductible expenses............. 2.4 0.8 0.4 State taxes, net of federal benefit (5.5) (2.4) (2.6) Valuation allowance................ 38.1 36.6 30.0 Other.............................. -- -- 7.2 ----- ----- ----- 0.0% 0.0% 0.0% ===== ===== =====
10. Benefit Plans Effective November 1, 1999, the Company initiated a new Daou Systems, Inc. 401(k) Salary Savings Plan (New Plan) which covers employees who meet certain age and service requirements. Employees may contribute a portion of their earnings each plan year subject to certain Internal Revenue Service limitations. This New Plan replaces the former Daou Systems, Inc. 401(k) Salary Savings Plan. The Company has various other defined contribution plans related to acquisitions under which employees also participated. Contributions under these plans are made at the sole discretion of the Company and were $344,000, $426,000 and $832,000 for 2002, 2001 and 2000, respectively. The Company is currently in the process of terminating all of its other defined contribution plans and will only maintain the New Plan. 44 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 11. Contingencies On August 24, 1998, August 31, 1998, September 14, 1998 and September 23, 1998, four 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. On October 15, 2002, the Court granted the Company's Motion to Dismiss the class action complaint, with prejudice. The plaintiffs noticed appeal to the Ninth Circuit Court of Appeal on November 13, 2002. As background, a group of shareholders were appointed the lead plaintiff in this federal litigation, and they filed a second amended consolidated class action complaint on January 21, 2000. Their second amended complaint realleges that the Company improperly used the "percentage-of-completion" accounting method for revenue recognition. Claims are pleaded under both the 1933 Securities Act (relating to the Company's initial public offering) and section 10b of the 1934 Securities 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. A Motion to Dismiss the second amended consolidated class action complaint was filed on February 22, 2000. On March 27, 2002, the Court granted the Motion but extended to plaintiffs the opportunity to file a Third Amended Complaint. The plaintiffs filed their Third Amended Complaint on May 16, 2002, to which the Company responded with another Motion to Dismiss. The Motion was filed on June 24, 2002 and challenged the legal sufficiency of the allegations. On October 16, 2002, the Court granted that Motion, this time with prejudice. The plaintiffs noticed appeal to the Ninth Circuit Court of Appeal on November 13, 2002. The Company filed a Notice of Cross-Appeal on November 26, 2002 challenging the failure of the trial court to assess whether the complaints were filed in violation of Rule 11 of the Federal Rules of Civil Procedure. Plaintiffs must file their Opening Brief by April 9, 2003. The Company is currently scheduled to file its Brief no later than May 19, 2003. On October 7, 1998 and October 15, 1998, two separate complaints were filed in the Superior Court of San Diego County, California. These state court complaints mirror the allegations set forth in the federal complaints. They also assert claims for common law fraud and the violation of certain California statutes. As with their federal counterparts, they do not allege specific damage amounts. On April 1, 1999, a Consolidated Amended Class Action was filed on behalf of the same state court plaintiffs, and this new complaint alleges the same factual basis as is asserted in the federal litigation. The state litigation pleads claims for fraud and violations of certain California Corporation Code provisions. By stipulation of the parties and order of the court, this state court litigation was stayed pending the outcome of the motion to dismiss the federal lawsuits. The Company believes that the allegations set forth in the federal and state complaints are without merit, and the Company intends to defend against these lawsuits vigorously. No assurance as to the outcome of this matter can be given, however, and an unfavorable resolution of this matter could have a material adverse effect on the Company's business, results of operations, and financial condition. On February 27, 2002, a complaint was filed against certain of the Company's former officers and directors, as well as Daou On-Line, Inc, in the Superior Court of New Jersey located in Bergen County. The Court conducted a hearing on June 7, 2002 and granted the Company's Motion to Dismiss. The plaintiffs abandoned their appeal which the Appellate Court dismissed on January 3, 2003. The plaintiffs filed a Complaint against the Company, as well as certain of its former officers in San Diego County Superior Court on December 5, 2002. An answer or other responsive pleading to the Complaint must be filed on April 4, 2003 absent agreement to stay the case and proceed to arbitration. As background, a First Amended Complaint was filed on March 1, 2002, adding the Company and its former Chief Financial Officer as parties/defendant. The gravamen of the First Amended Complaint is twofold. First, it alleges Daou's financial statements were misleading and fraudulently induced the plaintiff to merge his company with Daou. Second, the First Amended Complaint alleges 45 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 11. Contingencies--(Continued) breach of an indemnification and severance agreement obligating the Company to defend the plaintiff in a lawsuit filed by Traci Melia, a former employee. Neither the Complaint nor the First Amended Complaint alleges specific damage amounts. The Company filed A Motion to Dismiss the First Amended Complaint on April 24, 2002. The Court conducted a hearing on June 7, 2002 and granted our motion. On July 23, 2002, plaintiffs filed a Notice of Appeal but later abandoned their appeal which the Appellate Court dismissed on January 3, 2003. The Plaintiffs filed a Complaint against the Company, as well as certain of its former officers in San Diego County Superior Court on December 5, 2002. The Summons and Complaint was served by way of Notice and Acknowledgment of Receipt. While not identical to the Complaints filed in New Jersey, the gravaman of the San Diego action is the same. The Complaint prays for compensatory damages of at least $1,450,000. An answer or other responsive pleading to the Complaint must be filed on April 4, 2003 absent agreement to stay the case and proceed to arbitration. Counsel for Mr. Dickson has advanced that proposal given a controlling arbitration provision set forth in one of the contracts giving rise to the lawsuit. The Company believes that the allegations set forth in the Complaint are without merit, and the Company intends to defend against the lawsuit or arbitration vigorously. No assurance as to the outcome of this matter can be given, however, and an unfavorable resolution of this matter could have a material adverse effect on the Company's business, results of operations and financial condition. The Company is party to other various claims and legal actions arising in the normal course of business. Although the ultimate outcome of the 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. 12. Disclosure of Segment Information Daou provides integrated information technology solutions and services to the U.S. healthcare industry. The Company principally focuses on healthcare providers, payors and health plans and government healthcare organizations. Daou's services include (1) management consulting, (2) traditional network services, (3) application implementation and support, (4) application development and integration, and (5) strategic outsourcing, including remote help desk and related technology support services. As part of the reorganization discussed in Note 1, the Company consolidated its two operating divisions--Technology Services and Application Services and plans to operate as one business unit. The Company currently has no reportable segments. (In 2001, Daou had five reportable segments: Technology Management ("TMI"), Resources in Healthcare Innovation ("RHI"), Sentient, Infrastructure Services Group ("ISG") and RTC). For purposes of improving overall sales and operations effectiveness, and to offer its customers an integrated solutions approach through multi- disciplinary teams, the Company now provides its services through two primary practice groups: commercial healthcare and government healthcare. The Company believes the consolidation was necessary due to changing market forces in the healthcare industry. Daou expects that operating under its new structure will allow the Company to focus on its core competencies and pursue a seamless approach to applications and technology. 46 Daou Systems, Inc. Notes to Consolidated Financial Statements--(Continued) 13. Quarterly Financial Data (Unaudited) The following is a summary of the unaudited quarterly results of operations for the year ended December 31, 2002 and 2001, respectively. The unaudited financial information reflects all normal recurring adjustments, which are in the opinion of management, necessary for the fair statement of the results of the interim periods (in thousands, except per share amounts).
Quarter Ended -------------------------------------------- March 31, June 30, September 30, December 31, --------- -------- ------------- ------------ 2002 Net revenue..................................... $ 9,104 $ 9,734 $9,493 $ 9,604 Gross profit.................................... 2,575 2,398 2,364 2,930 Net loss available to common stockholders....... (709) (858) (871) (1,555) Basic and diluted net loss available to common stockholders per common share..................................... (0.04) (0.05) (0.05) (0.07) 2001 Net revenue..................................... $12,760 $10,121 $9,129 $ 9,072 Gross profit.................................... 2,428 1,690 1,727 2,813 Net loss available to common stockholders....... (622) (1,062) (965) (1,157) Basic and diluted net loss available to common stockholders per common share..................................... (0.03) (0.06) (0.06) (0.07)
47 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
COL. A COL. B COL. C COL. D COL. E - ----------------------------- ------------ ------------------------- ---------- ---------- Additions ------------------------- Balance at Charged to Balance at Beginning of Costs and Charged to Other End of Description Period Expenses Accounts--Describe Write-offs Period ----------- ------------ ---------- ------------------ ---------- ---------- Year Ended December 31, 2002: Allowance for doubtful accounts................ $ 715 $186 $ -- $ 169 $ 732 Year Ended December 31, 2001: Allowance for doubtful accounts................ $1,138 $232 $(381)(A) $ 274 $ 715 Year Ended December 31, 2000: Allowance for doubtful accounts................ $1,868 $402 $ -- $1,132 $1,138
- -------- (A) Amounts reclassified to Contract work in progress. 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 and Related Stockholders Matters. The information required by this item will be included under the captions entitled "Security Ownership of Certain Beneficial Owners and Management" and "Equity Compensation Plan Information" 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. Item 14: Controls and Procedures. (a) Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), within 90 days of the filing date of this report. Based on their evaluation, our principal executive officer and principal accounting officer concluded that Daou's disclosure controls and procedures are effective. (b) There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above. 48 PART IV Item 15: Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) The following are filed as part of, or included in, this Annual Report on Form 10-K: (1) The financial statements listed in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule, filed as a part of this Annual Report on Form 10-K. (2) The financial statement schedule listed in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule, filed as a part of this Annual Report on Form 10-K. (3) The exhibits listed in the Index to Exhibits hereof are attached hereto or incorporated herein by reference and filed as part of this Report. (b) Reports on Form 8-K: (1) No reports on Form 8-K were filed by the Company during the fourth quarter of the year ended December 31, 2002. 49 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 31, 2003 DAOU SYSTEMS, INC. By: /s/ Daniel J. Malcolm ----------------------------- Daniel J. Malcolm Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Daniel J. Malcolm and Neil R. Cassidy, jointly and severally, as his attorney-in-fact, each with the power of substitution, for him 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/ DANIEL J. MALCOLM March 31, 2003 - --------------------------- Director, President and Chief Daniel J. Malcolm Executive Officer /s/ NEIL R. CASSIDY Executive Vice President, March 31, 2003 - --------------------------- Chief Financial Officer and Neil R. Cassidy Secretary (Principal Financial and Accounting Officer) /s/ JAMES T. ROBERTO Chairman of the Board March 31, 2003 - --------------------------- James T. Roberto /s/ DAVID W. JAHNS Director March 31, 2003 - --------------------------- David W. Jahns /s/ LARRY R. FERGUSON Director March 31, 2003 - --------------------------- Larry R. Ferguson /s/ H. LAWRENCE ROSS Director March 31, 2003 - --------------------------- H. Lawrence Ross /s/ VINCENT K. ROACH Director and Executive Vice President, Commercial Operations March 31, 2003 - --------------------------- Vincent K. Roach
50 CERTIFICATION I, Daniel J. Malcolm, certify that: 1. I have reviewed this annual report on Form 10-K of Daou Systems, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 /s/ DANIEL J. MALCOLM By: ----------------------------- Daniel J. Malcolm Principal Executive Officer 51 CERTIFICATION I, Neil R. Cassidy, certify that: 1. I have reviewed this annual report on Form 10-K of Daou Systems, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 31, 2003 /s/ NEIL R. CASSIDY By: ----------------------------- Neil R. Cassidy Principal Financial Officer 52 EXHIBIT INDEX
Exhibit Number Description ------- ----------------------------------------------------------------------------------------------------- 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(2) --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) --Amended and Restated 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"). 4.5(6) --Restricted Stock Purchase Agreement, dated June 1, 2001, by and between the Registrant and Vincent K. Roach. 4.6(6) --Registration Rights Agreement, dated June 1, 2001, by and between the Registrant and Vincent K. Roach. 4.7(6) --Stock Purchase Agreement, dated April 25, 2001, by and between the Registrant and Georges J. Daou. 4.8(7) --Restricted Stock Purchase Agreement, dated June 1, 2001, by and between the Registrant and Neil R. Cassidy. 4.9(7) --Registration Rights Agreement, dated June 1, 2001, by and between the Registrant and Neil R. Cassidy. 4.10(7) --Restricted Stock Purchase Agreement, dated June 1, 2001, by and between the Registrant and James T. Roberto. 4.11(7) --Registration Rights Agreement, dated June 1, 2001, by and between the Registrant and James T. Roberto. 4.12(8) --Restricted Stock Purchase Agreement, dated November 6, 2001, by and between the Registrant and Daniel J. Malcolm. 4.13(8) --Registration Rights Agreement, dated November 6, 2001, by and between the Registrant and Daniel J. Malcolm. 10.1(1) --Form of Indemnification Agreement. 10.2(8) --DAOU Systems, Inc. 1996 Stock Option Plan, as amended. 10.3(1) --Form of Incentive Stock Option Agreement under the 1996 Stock Option Plan. 10.4(1) --Form of Nonstatutory Stock Option Agreement under the 1996 Stock Option Plan. 10.5(+ )(1) --Principal Agreement, dated as of June 18, 1996, by and between the Registrant and Catholic Medical Center of Brooklyn & Queens, Inc. 10.6(+ )(1) --Master Agreement, dated as of June 4, 1996, by and between the Registrant and Atlantic Health System. 10.7(1) --Form of Master Services Agreement. 10.8(3) --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. 10.9(3) --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.
1
Exhibit Number Description - ------- ------------------------------------------------------------------------------------------------- 10.10(5) --Employment Agreement, dated October 2, 2000, by and between the Registrant and Neil R. Cassidy. 10.11(6) --Employment Agreement, dated June 1, 2001, by and between the Registrant and Vincent K. Roach. 10.12(6) --Secured Promissory Note, dated June 1, 2001, by and between the Registrant and Vincent K. Roach. 10.13(6) --Stock Pledge Agreement, dated June 1, 2001, by and between the Registrant and Vincent K. Roach. 10.14(7) --Amendment No. 1 to Employment Agreement, dated June 1, 2001, by and between the Registrant and Neil R. Cassidy. 10.15(7) --Secured Promissory Note, dated June 1, 2001, by and between the Registrant and Neil R. Cassidy. 10.16(7) --Stock Pledge Agreement, dated June 1, 2001, by and between the Registrant and Neil R. Cassidy. 10.17(7) --Amendment to Employment Agreement, dated June 1, 2001, by and between the Registrant and James T. Roberto. 10.18(7) --Secured Promissory Note, dated June 1, 2001, by and between the Registrant and James T. Roberto. 10.19(7) --Stock Pledge Agreement, dated June 1, 2001, by and between the Registrant and James T. Roberto. 10.20(8) --Employment Agreement, dated November 6, 2001, by and between the Registrant and Daniel J. Malcolm. 10.21(8) --Secured Promissory Note, dated November 6, 2001, by and between the Registrant and Daniel J. Malcolm. 10.22(8) --Stock Pledge Agreement, dated November 6, 2001, by and between the Registrant and Daniel J. Malcolm. 10.23(8) --Executive Stock Option Agreement, dated December 13, 2001, between the Registrant and Neil R. Cassidy. 10.24(8) --Executive Stock Option Agreement, dated December 13, 2001, between the Registrant and James T. Roberto. 10.25(8) --Executive Stock Option Agreement, dated November 6, 2001, between the Registrant and Daniel J. Malcolm. 10.26(*) --Executive Stock Option Agreement, dated May 17, 2002, by and between Registrant and Neil R. Cassidy. 10.27(*) --Amendment No. 2 to Employment Agreement, dated July 1, 2002, by and between the Registrant and Neil R. Cassidy. 10.28(*) --Form of Board of Director Stock Option Agreement, dated November 5, 2002, by and between Registrant and Kevin. M. Fickenscher, David W. Jahns, and H. Lawrence Ross (25,000 options each), and November 6, 2002, by and between Registrant and Larry R. Ferguson (100,000 options). 10.29(*) --Separation Agreement and General Release, dated December 31, 2002, between the Registrant and Neil R. Cassidy. 10.30(*) --Separation Agreement and General Release, dated December 31, 2002, between the Registrant and James T. Roberto. 10.31(*) --Form of Indemnification Agreement.
2
Exhibit Number Description - ------- ----------------------------------------------------------------------------------------------------- 23.1 --Consent of Ernst & Young LLP, independent auditors. 24 --Power of Attorney (included on the signature page to this report). 99.1(*) --Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2(*) --Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- -------- (*) Filed herewith. (+) Confidential treatment has been granted with respect to certain portions of this exhibit. (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 April 14, 1998. (3) Incorporated by reference to the similarly described exhibit included with the Registrant's Current Report on Form 8-K, filed with the Commission on July 29, 1999. (4) 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 14, 2000. (5) Incorporated by reference to the similarly described exhibit included with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001, filed with the Commission on May 14, 2001. (6) 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, 2001, filed with the Commission on August 14, 2001. (7) 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, 2001, filed with the Commission on November 14, 2001. (8) Incorporated by reference to the similarly described exhibit included with the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the Commission on April 1, 2002. 3 EX-10.26 3 dex1026.txt INCENTIVE STOCK PLAN AGREEMENT - EXCUTIVE Exhibit 10.26 Daou Systems, Inc. INCENTIVE STOCK OPTION AGREEMENT -Executive- This Stock Option Agreement is made and entered into this 10th Day of December 2002, pursuant to the DAOU SYSTEMS, INC. 1996 Stock Option Plan (the "Plan"). Any terms not defined in this Agreement will have the meanings ascribed to such terms in the Plan. The Committee administering the Plan has selected Neil R. Cassidy (the "Optionee") to receive the following grant of an incentive stock option ("Stock Option") to purchase shares of the common stock of DAOU SYSTEMS, INC., a Delaware corporation (the "Corporation"), on the terms and conditions set forth below to which Optionee accepts and agrees: 1. Stock Options Granted: Number of Shares Subject to Option 50,000 Date of Grant May 17, 2002 Vesting Commencement Date May 17, 2002 Exercise Price Per Shares $1.15 Expiration Date May 17, 2012 2. The Stock Option is granted pursuant to the Plan to purchase the number of shares of authorized but unissued common stock of the Corporation specified in Section 1 (the "Shares"). The Stock Option will expire, and all rights to exercise it will terminate on the earliest of: (a) the date provided below in Sections 4, 5 and 6, (b) the Expiration Date, and (c) such earlier date as provided in the Plan. The number of shares subject to the Stock Option granted pursuant to this Agreement will be adjusted as provided in the Plan. 3. The Stock Option will be exercisable in all respects in accordance with the terms of the Plan which are incorporated herein by this reference. Optionee acknowledges having received and read a copy of the Plan. 4. Optionee will have the right to exercise the Stock Option in accordance with the following schedule: a) the Stock Option will vest in thirty-six equal increments on the monthly anniversary of the Date of Grant through May 17, 2005. b) Any of these 50,000 Stock Options that are unvested at the time of a Change in Control immediately will vest and become exercisable in the event of a Change in Control. For purposes of this Section, "Change in Control" is defined to have occurred if, and only if: (1) 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; (2) 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 (3) all or substantially all of the assets of the Company are sold, liquidated or distributed. c) In the event that Optionee's employment with the Corporation is terminated without "Cause" or Optionee terminates his employment for Good Reason pursuant to the terms of Optionee's Employment Agreement with the Corporation, dated as of October 2, 2000 (the "Employment Agreement") (which terms are incorporated by this reference), all unvested Stock Options will immediately vest and become exercisable and the Stock Option will not expire until the Expiration Date defined in Section 1 of this Agreement. d) Continued Employment. Except as described in this Section and Section 7 of the Employment Agreement, 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 under this Agreement). 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. e) The right to exercise the Stock Option will be cumulative. Optionee may buy all, or from time to time any part, of the maximum number of shares which are exercisable under the Stock Option, but in no case may Optionee exercise the Stock Option with regard to a fraction of a share, or for any share for which the Stock Option is not exercisable. 5. The Stock Option will lapse and becomes unexercisable in full on the earliest of the following events: a) the first anniversary of the Optionee's death, as provided below in Section 6; b) the first anniversary of the date the Optionee ceases to be an Employee due to total and permanent disability, as provided below in Section 6; c) the date otherwise provided below in Section 6, unless the Committee otherwise extends such period before the applicable expiration date (if permissible pursuant to applicable tax regulation) d) the date provided in Section 9 of the Plan for a transaction described in such Section; or 2 e) the date the Optionee files or has filed against him or her, a petition in bankruptcy. 6. Except as described in Section 4 of this Stock Option Agreement, if Optionee ceases to be an Employee for any reason other than his or her death or disability, the Optionee will have the right, subject to the other provisions of this Agreement, to exercise the Stock Option for 30 days after his or her termination of employment, but not beyond the otherwise applicable term of the Option and only to the extent that on such date of termination of employment the Optionee's right to exercise such Option had vested, and at the end of such 30-day period the Stock Option will expire, and all rights to exercise it will terminate. a) For purposes of this Section 6, employment will be deemed to terminate on the date the Optionee ceases active employment with the Corporation or any Affiliate, unless the Optionee's reemployment rights are guaranteed by statute or contract. b) If Optionee dies while an Employee, or after ceasing to be an Employee but during the period while he or she could have exercised an Option under the preceding sub-Sections (a) or (b), the Option granted to the Optionee may be exercised, to the extent it has vested at the time of death and subject to the Plan, at any time within 12 months after the Optionee's death, by the executors or administrators of his or her estate or by any person or persons who acquire the Option by will or the laws of descent and distribution, but not beyond the otherwise applicable term of the Option. c) If Optionee ceases to be an Employee due to becoming totally and permanently disabled within the meaning of Section 22(e)(3) of the Code, the Stock Option may be exercised to the extent it has vested at the time of cessation and, subject to the Plan, at any time within 12 months after the Optionee's termination of employment, but not beyond the otherwise applicable term of the Stock Option. 7. The Optionee agrees to comply with all laws, rules, and regulations applicable to the grant and exercise of the Stock Option and the sale or other disposition of the common stock of the Corporation received pursuant to the exercise of such Stock Option. 8. The Corporation will not be under any obligation to issue any Shares upon the exercise of this Stock Option unless and until the Corporation has determined that: (i) it and Optionee have taken all actions required to register such Shares under the Securities Act, or to perfect an exemption from the registration requirements thereof; (ii) any applicable listing requirement of any stock exchange on which such Shares are listed has been satisfied; and (iii) all other applicable provisions of state and federal law have been satisfied. [REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] 3 IN WITNESS WHEREOF, each of the parties hereto has executed this Stock Option Agreement, in the case of the Corporation by its duly authorized officer, as of the date and year written above. OPTIONEE DAOU SYSTEMS, INC., a Delaware corporation /s/ Neil R. Cassidy By: /s/ James T. Roberto - ---------------------------------- ------------------------------ (signature) James T. Roberto Its: Chief Executive Officer & President Neil R. Cassidy - ---------------------------------- (Type or Print Name) Address: 412 Creamery Way ------------------------- Suite 300 ------------------------- Exton, PA 19341 ------------------------- [SIGNATURE PAGE TO DAOU SYSTEMS, INC. INCENTIVE STOCK OPTION AGREEMENT] 4 EX-10.27 4 dex1027.txt AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT Exhibit 10.27 AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT This Amendment No. 2 to Employment Agreement (this "Second Amended Agreement") is made as of July 1, 2002 by and between Daou Systems, Inc., a Delaware corporation ("Employer"), and Neil Cassidy ("Employee"). RECITALS A. Pursuant to Section 3 of the Employment Agreement dated October 2, 2000, between Employer and Employee ( the "Employment Agreement"), Employee is entitled to certain "Compensation"; B. Pursuant to Section 7.2 of the Employment Agreement, Employee is entitled to certain severance benefits in the event of a Change in Control Termination as that term is defined in the Employment Agreement. C. By this Second Amended Agreement and according to its terms, Employer and Employee agree to amend and revise the provisions of Section 3 and Section 7.2 of the Employment Agreement. In all other respects, the Employment Agreement, along with any prior amendments, remains in full force and effect. AGREEMENT 1. Section 3 Amendment. Section 3 of the Employment Agreement is amended and revised to include the following: 3.1 Salary. Employee will be paid an annual salary of Two Hundred Thousand Dollars ($200,000) (the "Salary"), less any applicable taxes or other payroll deductions. The Salary will be payable in equal periodic installments according to Employer's customary payroll practices. Any adjustment to the Salary is at the sole discretion of Employer. 3.3 Additional Compensation. As additional compensation for the services rendered by Employee pursuant to this Agreement, Employee is eligible for an annual bonus in accordance with Employer's Incentive Compensation Plan (the "Additional Compensation") that will be created on behalf of the Company's executive officers no later than December 31, 2002. The parties currently anticipate that the Additional Compensation plan will provide for payment as bonus a percentage of Salary upon achievement of stated Employee and Company goals. In order to be eligible for the Additional Compensation, Employee shall be employed by Employer on the date that the Additional Compensation, if any, is customarily distributed by Employer. Signature Page to Amendment No. 2 to Employment Agreement, Executed as of December 16, 2002, to be Effective as of the Date First Written Above 1 2. Section 7.2 Amendment. Section 7.2 of the Agreement is clarified as follows: 7.2 Termination of Employee without Cause or Resignation by Employee for Good Reason following a Change in Control. In the event of a Change in Control Termination (as defined below), Employee will receive any earned portion of Salary and accrued but unused vacation through the Termination Date and severance payments 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 the Termination Date. All payments will be less applicable state and federal taxes and/or other payroll deductions. Any severance payments will be paid in a lump sum within 45 days of termination. Further, if Employee elects to continue insurance coverage as afforded to Employee according to COBRA, Employer (or its successor) will reimburse Employee the amount of the premiums incurred by Employee during the period beginning on the Termination Date and for twelve (12) months following the Termination Date. Nothing in this Agreement will extend Employee's COBRA period beyond the period allowed under COBRA, nor is the Company assuming any responsibility that Employee has for formally electing to continue coverage. 7.2 (d) Resignation by Employee for Good Reason. Employee shall have the right to terminate his employment with Employer, and such termination shall, for purposes of this Agreement, be considered a resignation by Employee for "Good Reason" if Employer: (i) changes Employee's position and title from Executive Vice President and Chief Financial Officer to a title and position of decreased responsibility or salary; or (ii) Employee's place of employment is located more than 50 miles from the current corporate location in Exton, Pennsylvania; or (iii) any failure by Employer to pay Employee's Compensation in a timely manner; and (iv) Employer does not remedy the circumstances giving rise to Good Reason in a manner which is reasonably satisfactory to Employee within thirty (30) day's of Employer's receipt of such written notice. Employee's resignation will not be for Good Reason unless Employee communicates to Employer in writing his intent to resign for Good Reason. 3. Miscellaneous. 3.1 Entire Agreement; Amendments. This Second Amended Agreement and the Employment Agreement, along with any prior amendments, by and between Employer and Employee, contain the entire agreement between the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, between the parties to this Second Amended Agreement with respect to the subject matter of this Second Amended Agreement. This Second Amended Agreement may not be amended orally, but only by an agreement in writing signed by the parties. Signature Page to Amendment No. 2 to Employment Agreement, Executed as of December 16, 2002, to be Effective as of the Date First Written Above 2 3.2 Governing Law. This Amended Agreement will be governed by the laws of the Commonwealth of Pennsylvania without regard to conflicts of laws principles. 3.3 Drafting Ambiguities. Each party to this Second Amended Agreement has had an opportunity to consult with counsel regarding this Second Amended Agreement and its covenants. The rule of construction that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Second Amended Agreement or any of the amendments to this Second Amended Agreement. 3.4 Section Headings, Construction. The section headings in this Second Amended Agreement are provided for convenience only and will not affect its construction or interpretation. All references to "section" or "sections" refer to the corresponding section or sections of this Second Amended Agreement unless otherwise specified. All words used in this Second Amended Agreement will be construed to be of such gender or number as the circumstances require. Unless otherwise expressly provided, the word "including" does not limit the preceding words or terms. 3.5 Severability. If any provision of this Second Amended Agreement is held invalid or unenforceable by any court of competent jurisdiction, the other provisions of this Second Amended Agreement will remain in full force and effect. Any provision of this Second Amended 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. 3.6 Counterparts. This Second Amended Agreement may be executed in one or more counterparts, each of which will be deemed to be an original copy of this Second Amended Agreement and all of which, when taken together, will be deemed to constitute one and the same agreement. EMPLOYER: EMPLOYEE: Daou Systems, Inc. /s/ Daniel J. Malcolm By: /s/ Neil Cassidy - -------------------------------- --------------------------- By: Daniel J. Malcolm Neil Cassidy Its: President, Chief Executive Officer Signature Page to Amendment No. 2 to Employment Agreement, Executed as of December 16, 2002, to be Effective as of the Date First Written Above 3 EX-10.28 5 dex1028.txt NON-STATUTORY STOCK OPTION AGREEMENT Exhibit 10.28 THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD, PLEDGED, OR OTHERWISE TRANSFERRED WITHOUT AN EFFECTIVE REGISTRATION THEREOF UNDER SUCH ACT OR AN OPINION OF COUNSEL, SATISFACTORY TO THE CORPORATION AND ITS COUNSEL, THAT SUCH REGISTRATION IS NOT REQUIRED. Daou Systems, Inc. NON-STATUTORY STOCK OPTION AGREEMENT (Director) This Non-Statutory Stock Option Agreement is made and entered as of ____________, 2002. This option is being issued outside of the 1996 Stock Option Plan (the "Plan") of Daou Systems, Inc., a Delaware corporation (the "Corporation"), however, any terms not defined in this Agreement will have the meanings ascribed to such terms in the Plan. The Committee administering the Plan has selected _______________ (the "Optionee") to receive the following grant of a non-statutory stock option ("Stock Option") to purchase shares of the common stock of the Corporation on the terms and conditions set forth below to which Optionee accepts and agrees: 1. Stock Options Granted: Number of Shares Subject to Option ______ Date of Grant November __, 2002 Vesting Commencement Date November __, 2002 Exercise Price Per Share $___ Expiration Date November __, 2009 2. The Stock Option is granted to purchase up to the number of shares of authorized but unissued common stock of the Corporation specified in Section 1 (the "Shares"). The Stock Option will expire, and all rights to exercise it will terminate on the earliest of: (a) the date provided below in Sections 5 and 6, and (b) the Expiration Date. The number of shares subject to the Stock Option granted pursuant to this Agreement will be adjusted as provided in the Plan. This Stock Option is intended by the Corporation and the Optionee to be a Non-statutory Stock Option and does not qualify for any special tax benefits to the Optionee. 3. Except as otherwise set forth herein, the Stock Option will be exercisable in all respects in accordance with the terms of the Plan as they relate to Non-Statutory Stock Options that are incorporated by this reference. Optionee acknowledges having received and read a copy of the Plan. 4. Optionee will have the right to exercise the Stock Option in accordance with the following schedule: (a) Optionee may exercise the Stock Option as to 1/36 of the Shares on each monthly anniversary of the Vesting Commencement Date. (b) The right to exercise the Stock Option will be cumulative. Optionee may buy all, or from time to time any part, of the maximum number of shares which are exercisable under the Stock Option, but in no case may Optionee exercise the Stock Option with regard to a fraction of a share, or for any share for which the Stock Option is not exercisable. (c) If at any time on or after the end of the first full year following the Vesting Commencement Date a change in control (as defined in the following sentence) occurs, then Optionee may exercise the Stock Option as to one hundred percent (100%) of the Shares which are not otherwise vested on the date of the change in control. For purposes of this Section 4, "change in control" means that: (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 Corporation representing fifty percent (50%) or more of the combined voting power of the Corporation's then outstanding securities entitled to vote in the election of directors of the Corporation; or (ii) there occurs a reorganization, merger, consolidation or other corporate transaction involving the Corporation ("Transaction"), in each case, with respect to which the stockholders of the Corporation immediately prior to such Transaction do not, immediately after the Transaction, own more than fifty percent (50%) of the combined voting power of the Corporation or other corporation resulting from such Transaction; or (iii) all or substantially all of the assets of the Corporation are sold, liquidated or distributed. 5. The Stock Option will lapse and becomes unexercisable in full on the earliest of the following events: (a) the first anniversary of the Optionee's death, as provided below in Section 6; (b) the first anniversary of the date on which Optionee ceases to be a director of the Corporation (a "Director") due to total and permanent disability, as provided in Section 6 below; (c) the date otherwise provided below in Section 6, unless the Committee otherwise extends such period before the applicable expiration date; (d) the date provided in Section 9 of the Plan for a transaction described in such Section; or 2 (e) the date the Optionee files or has filed against him a petition in bankruptcy. 6. Exercise of Stock Options (a) If Optionee ceases to be a Director for any reason other than his death or disability, the Optionee will have the right, subject to the other provisions of this Agreement, to exercise the Stock Option for the term of the Option but only to the extent that on the date Optionee ceases to be a Director the Optionee's right to exercise such Option had vested, and at the end of such period the Stock Option will expire, and all rights to exercise it will terminate. (b) If Optionee dies while a Director, or after ceasing to be an Director but during the period while he could have exercised a Stock Option under the preceding sub-Sections (a), the Option granted to the Optionee may be exercised, to the extent it has vested at the time of death and subject to the Plan, at any time within twelve (12) months after the Optionee's death, by the executors or administrators of his estate or by any person or persons who acquire the Option by will or the laws of descent and distribution, but not beyond the otherwise applicable term of the Stock Option. (c) If Optionee ceases to be a Director due to becoming totally and permanently disabled within the meaning of Section 22(e)(3) of the Internal Revenue Code of 1986, the Stock Option may be exercised to the extent it has vested at the time of cessation and, subject to the Plan, at any time within twelve (12) months after Optionee ceases to be a Director, but not beyond the otherwise applicable term of the Stock Option. 7. The Optionee agrees to comply with all laws, rules, and regulations applicable to the grant and exercise of the Stock Option and the sale or other disposition of the common stock of the Corporation received pursuant to the exercise of such Stock Option. 8. The Corporation will not be under any obligation to issue any Shares upon the exercise of this Stock Option unless and until the Corporation has determined that: (a) it and Optionee have taken all actions required to register such Shares under the Securities Act, or to perfect an exemption from the registration requirements thereof; (b) any applicable listing requirement of any stock exchange on which such Shares are listed has been satisfied; and (c) all other applicable provisions of state and federal law have been satisfied. 9. Optionee acknowledges that the tax effect of the exercise of this Stock Option and the sale of the underlying Shares is complicated, that Optionee has consulted with his own professional advisor which respect to all tax matters relating to this Stock Option and the exercise and sale of the Shares and has not relied on any assurances or representations of the Corporation as to such matters. 3 IN WITNESS WHEREOF, each of the parties hereto has executed this Stock Option Agreement, in the case of the Corporation by its duly authorized officer, as of the date and year written above. OPTIONEE DAOU SYSTEMS, INC., a Delaware corporation - -------------------------- ------------------------------------------ By: Its: 4 EX-10.29 6 dex1029.txt SEPARATION AGREEMENT AND GENERAL RELEASE Exhibit 10.29 SEPARATION AGREEMENT AND GENERAL RELEASE The parties to this Separation Agreement and General Release ("Agreement") are Neil R. Cassidy ("Cassidy") and Daou Systems, Inc. ("DAOU" or the "Company"), (collectively, the "Settling Parties"). RECITALS This Agreement is made with reference to the following facts: A. Cassidy resign his position as Chief Financial Officer of the Company effective March 31, 2003 (the "Separation Date"). As of the Separation Date, Cassidy's rights and obligations as an employee will cease, except as set forth in this Agreement. B. The Company and Cassidy desire to resolve and dispose of, fully and completely, all claims, demands, and causes of action, known or unknown, which Cassidy may have against the Company or its subsidiaries or affiliates, including, those rights, claims, demands and causes of action arising out of the employment relationship, the July 1, 2002 amended and restated employment agreement (the "Employment Agreement") between Cassidy and DAOU and the termination of the employment relationship between Cassidy and DAOU. AGREEMENT 1. Effect of Separation on Salary and Benefits and Stock Options. 1.1. On the Separation Date, DAOU shall provide Cassidy with a final paycheck which includes accrued and unused vacation pay, less all applicable federal, state and local income, social security and other payroll taxes. 1.2. Severance Payment. After execution of this Agreement, the execution of the release referenced in Section 2.1 and the passage of the seven-day revocation period referenced in Section 3.1 below, the Company will pay to Cassidy an amount equal to Two Hundred Sixty Thousand Dollars ($260,000.00), which will be paid in a lump sum payment within 15 days following the Separation Date. Cassidy acknowledges that he is not entitled to any other consideration or monies from the Company and would not be entitled to the consideration described above but for his execution of this Agreement. Further, Cassidy hereby waives any right, claim or interest that he may have to any severance, compensation or other benefit(s) payable to him by the Company under the Employment Agreement and acknowledges that the benefits under this Separation Agreement and General Release are being received in lieu of any such Employment Agreement benefits. 1.3. Within 14 days of the Separation Date, DAOU will provide Cassidy with election forms for health insurance continuation as provided by the Consolidated Omnibus Budget Reconciliation Act of 1986 (" COBRA "). In the event Cassidy elects to continue coverage as provided by COBRA, for a period of up to twelve (12) months, the Company will pay, on behalf of Cassidy, the monthly premium for continuation of Cassidy's health insurance. Nothing in this Agreement may be construed to continue Cassidy's insurance coverage beyond the period allowed by COBRA, nor may it be construed to create any obligation on the part of the Company with respect to Cassidy's responsibilities for formally electing to continue coverage under COBRA. 1.4. The Company will pay Cassidy's reasonable and customary business expenses, if any, through March 31, 2003 in accordance with Company policy. 1.5. Stock Options. On the Separation Date, all unexercised stock options previously granted to Cassidy which have not vested as of the Separation Date and which are set forth on Exhibit A, will not expire but shall continue in effect and shall expire on the date set forth in the related stock option agreement; and any unvested stock options among the Options granted to Cassidy on May 17, 2002 immediately will vest and become exercisable on the Separation Date. 1.6. Transfer in Ownership of DAOU Property. On the Separation Date, DAOU agrees to transfer ownership to Cassidy of the DAOU personal computer and home office equipment that he utilized during his employment with DAOU for the sum of $____________. 1.7. No Other Obligations. Except as specified above, the Company shall have no payment or other obligation to Cassidy. 1.8. Tax Consequences. The Company has made no representations to Cassidy as to his tax liability with respect to any of the above consideration. Cassidy acknowledges that he has consulted with his own professional advisors with respect to all tax matters, and is not relying on any representation by the Company on any tax matter. Cassidy will be solely responsible for any and all tax responsibility for the payment by the Company, and for any additional tax responsibility which may be assessed either against him or against the Company, including any penalties assessed by any agency against any party, which may arise as a result of his characterization of any payment. The Company may withhold any payroll and related taxes required by applicable law. 2. Consideration from Cassidy. 2.1. General Release. In exchange for the consideration set forth in Article 1 above, Cassidy agrees that he will sign the Release ("Exhibit B"). Cassidy acknowledges that with this document he has been given a twenty-one (21) day period in which to consider entering into the release of the ADEA claims set forth in Exhibit B, if any. In addition, Cassidy acknowledges that he has been informed that he may revoke a signed waiver of those ADEA claims for up to seven days after executing this Agreement and his release of ADEA claims will not be enforceable until the seven-day revocation period expires. 3. Indemnification. Nothing in this Agreement may be construed as a waiver by Cassidy of any rights he may have for indemnification under any DAOU insurance policy or written indemnification agreement for acts by Cassidy in his capacity as an officer of DAOU. 4. Acknowledgments. Cassidy acknowledges that with this document he has been advised in writing of his right to consult with an attorney prior to executing this Agreement and -2- release. Cassidy expressly waives any rights and benefits he otherwise might have under California Civil Code Section 1542, which provides: A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR. Cassidy acknowledges that he may discover facts different from or in addition to those which he now believes to be true with respect to this Agreement. Cassidy agrees that this Agreement shall remain effective notwithstanding the discovery of any different or additional facts. 5. Settlement. Nothing in this Agreement shall be construed as an admission by the Company of any liability of any kind to Cassidy, except to the extent that such liability is expressly provided for in this Agreement. 6. Confidentiality and Other Agreements. 6.1. Cassidy acknowledges and agrees that he has a continuing obligation to protect the Company's Confidential Information according to the terms and conditions of Exhibit A of the Employment Agreement which he signed on October 10, 2000. 6.2. The Settling Parties agree to keep confidential the terms of this Agreement and agree to refrain from disclosing any information regarding this Agreement to any third party unless required to do so (a) by a regulatory body (e.g. filings with the Securities Exchange Commission ("SEC"); (b) in financial disclosures to auditors or in audited financial statements; (c) under oath, if properly ordered, in a court of competent jurisdiction; (d) to his wife; or (e) previously disclosed publicly by the Company to the extent so disclosed. Each of the Settling Parties agrees to notify the other Settling Parties in writing upon first notification that he or it may be required by law to disclose any information deemed confidential by this Agreement. Notice must be provided in sufficient time for the party receiving notice to oppose or otherwise respond to the request. 6.3. Cassidy agrees that he will not interfere with or otherwise act adverse to the business affairs of the Company, including, without limitation, making disparaging remarks, either orally or in writing, to any person concerning the Company or the Company's business. The Company agrees to not make disparaging remarks, either orally or in writing, to any person or party concerning Cassidy or Cassidy's employment. 7. Representations and Warranties. The parties represent and warrant as follows: 7.1. Each party has read this Agreement, understands its contents, and understands its legal effect and binding nature. Each party further acknowledges that he or it is acting voluntarily and of his own free will in executing this Agreement. 7.2. Cassidy is not relying upon any statement, representation or promise of the Company, or any of its officers, directors, agents, partners, employees, consultants, -3- representatives or attorneys in executing this Agreement or in making this settlement except as expressly stated in this Agreement. 8. Claims Arising out of this Agreement. 8.1. To the extent there is any controversy or dispute concerning the interpretation or enforcement of any provisions of this Agreement, including the arbitrability of such dispute, the Settling Parties shall submit such dispute to arbitration in Exton, Pennsylvania by one or more experienced labor and employment law arbitrators licensed to practice law in Pennsylvania and selected in accordance with the Employment Arbitration Rules of the American Arbitration Association. The arbitrator(s) shall not have the power to modify any of the provisions of this Agreement. The arbitrator(s)' decision shall be final and binding upon the parties and judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction. The arbitrator will decide how the costs of arbitration should be shared. 8.2. In the event of any arbitration arising out of or relating to this Agreement, its breach or enforcement, including an action for declaratory relief, the prevailing party in such action or proceedings shall be entitled to receive his or its damages, court costs, and reasonable out-of-pocket expenses including reasonable attorneys' fees. Such recovery shall include court costs, reasonable out-of-pocket expenses, and attorneys' fees on appeal, if any. The arbitrator(s) or court shall determine who is the prevailing party, whether or not the dispute or controversy proceeds to final judgment. Both Cassidy and the Company expressly acknowledge this paragraph is not intended to in any way alter the parties' agreement that arbitration shall be the exclusive method of resolving any dispute related to this Agreement or Cassidy's employment with the Company. 8.3. Cassidy acknowledges that from the date hereof and during the period which Cassidy remains an employee of the Company pursuant to the terms of this Agreement, Cassidy shall be the Company's principal financial officer and in such capacity, Cassidy shall be responsible for all materials filed by the Company with the Securities and Exchange Commission which require the signature of the Company's Chief Financial Officer, principal financial officer or chief accounting officer, including but not limited to the Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and any certifications required by Section 302 or Section 906 of the Sarbanes Oxley Act of 2002 (the "Act") or any rules promulgated pursuant to the Act. 9. Miscellaneous. 9.1. This Agreement shall be deemed to have been executed and delivered within the Commonwealth of Pennsylvania, and its rights and obligations shall be construed and enforced in accordance with and governed by, the laws of Pennsylvania. 9.2. Cassidy and the Company understand and agree that this Agreement shall bind and benefit their heirs, employees, parent corporation, subsidiaries, affiliates, controlled corporations, sister corporations, agents, representatives, predecessors, successors and assigns. The Company's successors shall include (without limitation) any person, corporation or other entity who or which enters into a Corporate Transaction with the Company (hereinafter "Company Successor"). For purposes of this Agreement, a "Corporate Transaction" is defined to -4- mean a transaction in which any person, corporation or other entity acquires, directly or indirectly, all or substantially all of the stock, business or assets of the Company, whether by way of merger, consolidation, sale, transfer or otherwise. 9.3. This Agreement may be amended only by an agreement in writing designated as an amendment to this Agreement and signed by the parties. 9.4. This Agreement may be executed in counterparts, and when each party has signed and delivered at least one such counterpart, each counterpart shall be deemed an original, and, when taken together with the other executed counterparts, shall constitute one Agreement, which shall be binding upon and effective as to all parties. Dated: December 31, 2002 /s/ Neil R. Cassidy ------------------------------ Neil R. Cassidy Dated: December 31, 2002 By: /s/ Daniel J. Malcolm ------------------------------ Daniel J. Malcolm Chief Executive Officer on behalf of Daou Systems, Inc. -5- EXHIBIT A Prior Stock Option Grants 1. 25,000 Options, issued on December 13, 2001: (i) 12,500 will vest on the sooner of (a) the first date following ten (10) consecutive trading days during which the Common Stock trades at a value of at least $2.50 per Share as adjusted for any stock combination, stock dividend, stock split or other recapitalization event occurring with respect to the Company's Common Stock (a Recapitalization"); or (b) five (5) years from the date of grant. (ii) 12,500 will vest on the sooner of (a) the first date following ten (10) consecutive trading days during which the Common Stock trades at a value of at least $5.00 per Share as adjusted for any Recapitalization; or (b) five (5) years from the date of grant. 2. 50,000 Options, issued on May 17, 2002: On the Separation Date, all unvested stock options among the 50,000 Options previously granted to Cassidy on May 17, 2002 which have not vested as of the Separation Date immediately will vest and become exercisable and will not expire but shall continue in effect and shall expire on the date set forth in the related stock option agreement. -6- EXHIBIT B RELEASE THIS RELEASE is entered into by and between Neil R. Cassidy ("Employee") and Daou Systems, Inc. ("Daou"). WHEREAS, the Employee has reviewed the terms of the foregoing Separation Agreement and General Release and agrees to abide by the terms of the Separation Agreement and General Release; WHEREAS, the Employee agrees to execute this Release upon the request of Daou as it relates to the Separation Agreement and General Release; and WHEREAS, the parties desire to separate on amicable terms. NOW, THEREFORE, the parties agree as follows, in consideration of the mutual covenants and obligations contained herein, and intending to be legally held bound: 1. Consideration. To resolve and settle all disputes, and to avoid the costs and uncertainty of litigation, in consideration for the releases and other covenants set forth in the foregoing Separation Agreement and General Release, Employee acknowledges he has received the consideration referred to in Section 1.2 of the Separation Agreement and General Release. This payment will not be made until after the expiration of the seven-day revocation period referenced in paragraph 7. 2. Employee further acknowledges that these payments and promises include consideration to which the Employee would not otherwise be entitled. 3. Employee's Release of Daou. Employee hereby generally releases and discharges Daou, together with each and every of its predecessors, successors (by merger or otherwise), parents, subsidiaries, affiliates, divisions and related entities directors, officers, employees and agents, whether present or former (collectively the "Releasees") from any and all suits, causes of action, complaints, obligations, demands, or claims of any kind, whether in law or in equity, direct or indirect, known or unknown, suspected or unsuspected (hereinafter "claims"), which the Employee ever had or now has arising out of or relating to any matter, thing or event occurring up to and including the date of this Release, except for future obligations expressly arising under the Separation Agreement and General Release. 4. Employee's release specifically includes, but is not limited to: (a) any and all claims for wages and benefits including, without limitation, salary, stock, options, commissions, royalties, license fees, health and welfare benefits, severance pay, vacation pay, and bonuses, excluding the COBRA health insurance compensation described in paragraph 1.3 of the Separation Agreement and General Release. -7- (b) any and all claims for wrongful discharge, breach of contract (whether express or implied), or for breach of the implied covenant of good faith and fair dealing; (c) any and all claims for alleged employment discrimination on the basis of age, race, color, religion, sex, national origin, veteran status, disability and/or handicap and any and all other claims in violation of any federal, state or local statute, ordinance, judicial precedent or executive order, including but not limited to claims under the following statutes: Title VII of the Civil Rights Act of 1964, 42 U.S.C. (S)2000e et seq., the Civil Rights Act of 1866, 42 U.S.C. (S)1981, the Age Discrimination in Employment Act, 29 U.S.C. (S)621 et seq., the Older Workers Benefit Protection Act, 29 U.S.C. (S)626(f), the Americans with Disabilities Act, 42 U.S.C. (S)12101 et seq., the Family and Medical Leave Act of 1993, the Fair Labor Standards Act, the Employee Retirement Income Security Act of 1974, or any comparable statute of any other state, country, or locality except as required by law, but excluding any claim for vested benefits under Daou's retirement benefit plans; (d) any and all claims under any federal, state or local statute or law; (e) any and all claims in tort (including but not limited to any claims for misrepresentation, defamation, interference with contract or prospective economic advantage, intentional or negligent infliction of emotional distress, duress, loss of consortium, invasion of privacy and negligence); (f) any and all claims for attorneys' fees and costs; and (g) any and all other claims for damages of any kind. Nothing in this Release is intended to affect Employee's rights to indemnification under the Pennsylvania Business Corporation Law of the 1998, Sections 1741-1743, or under Daou's Articles of Incorporation or Bylaws. 5. Acknowledgment. Employee understands that his release extends to all of the aforementioned claims and potential claims which arose on or before the date of the execution of this Release, whether now known or unknown, suspected or unsuspected, and that this constitutes an essential term of this Release. Employee further understands and acknowledges the significance and consequence of this Release and of each specific release and waiver, and expressly consents that this Release shall be given full force and effect according to each and all of its express terms and provisions, including those relating to unknown and unsuspected claims, demands, obligations, and causes of action, if any, as well as those relating to any other claims, demands, obligations or causes of action herein above-specified. 6. Reinstatement. Employee hereby waives any right or claim the Employee may have to employment, re-instatement, or re-employment with the Releasees, and agrees not to apply for employment with the Releasees. 7. Advice of Counsel; Revocation Period. Employee is hereby advised to seek the advice of counsel. Employee acknowledges that he has, in fact, sought the advice of counsel, and is acting of his own free will, that the Employee has been afforded a reasonable time to read and review the terms of Release, and that the Employee is voluntarily entering into -8- this Release with full knowledge of its provisions and effects. Employee intends that this Release shall not be subject to any claim for duress. Employee further acknowledges that the Employee has been given at least twenty-one (21) days within which to consider this Release and that if the Employee decides to execute this Release before the twenty-one day period has expired, the Employee does so voluntarily and waives the opportunity to use the full review period. The Employee also acknowledges that the Employee has seven (7) days following his execution of this Release to revoke acceptance of the Release of age discrimination claims, with the Release of age discrimination claims not becoming effective until the revocation period has expired. If the Employee chooses to revoke his acceptance of this Release, he should provide written notice to: Jeffrey P. Libson, Esquire Pepper Hamilton, LLP 400 Berwyn Park 899 Cassatt Road Berwyn, PA 19312-1183 IN WITNESS WHEREOF, the parties, acknowledging that they are acting of their own free will, have caused the execution of this Release as of this day and year written below. _____________________________ Witness: ______________________ Neil R. Cassidy Date: ________________________ DAOU SYSTEMS, INC. By:_________________________ Title:________________________ Date:________________________ -9- EX-10.30 7 dex1030.txt SEPRATION AGREEMENT AND GENERAL RELEASE - ROBERTO Exhibit 10.30 SEPARATION AGREEMENT AND GENERAL RELEASE This Separation Agreement and General Release (the "Agreement"), dated as of December 31, 2002, is made and entered into by and between James T. Roberto ("Roberto") and Daou Systems, Inc., a Delaware corporation ("DAOU" or the "Company"), (collectively, the "Settling Parties"). RECITALS This Agreement is made with reference to the following facts: A. Roberto intends to resign from his position as President and Chief Executive Officer and as an employee of the Company effective December 31, 2002 (the "Separation Date"). For the period from January 1, 2003 through March 31, 2003, Roberto agrees to act as a non-employee consultant to the Chief Executive Officer of DAOU to assist in the transition of his responsibilities (the "Consultant Period"). During the Consultant Period, Roberto agrees to provide consulting services on an as-needed basis. As of the Separation Date, Roberto's rights and obligations as an employee will cease, except as set forth in this Agreement. Roberto shall continue to serve as a Class I director of the Company for his designated term, expiring at the 2004 annual meeting of stockholders and until his respective successor is duly elected and qualified, unless he resigns or his seat on the Board becomes vacant due to his death, removal or other cause. B. The Company and Roberto desire to settle and dispose of, fully and completely, all claims, demands, and causes of action, known or unknown, which Roberto may have against the Company or its subsidiaries or affiliates, including, those rights, claims, demands and causes of action arising out of the employment relationship, the employment agreement dated as of November 9, 2000 (the "Employment Agreement") and Amendment No. 1 to Employment Agreement dated as of June 1, 2001 (the "Amended Agreement") between Roberto and DAOU and the termination of the employment relationship between Roberto and DAOU. AGREEMENT 1. Effect of Separation on Salary and Benefits and Restricted Stock and Secured Promissory Note and Stock Options. 1.1. On the Separation Date, DAOU shall provide Roberto with a final paycheck which includes accrued and unused vacation pay, less all applicable federal, state and local income, social security and other payroll taxes. 1.2. Severance Payment. After execution of this Agreement, the execution of the release referenced in Section 3.1 and the passage of the seven-day revocation period referenced in Section 4.1 below, the Company will pay to Roberto an amount equal to Four Hundred Ten Thousand Dollars ($410,000.00), which will be paid within 45 days following Roberto's execution of this Agreement. Roberto acknowledges that he is not entitled to any other consideration or monies from the Company and would not be entitled to the consideration described above but for his execution of this Agreement. Further, Roberto hereby waives any right, claim or interest that he may have to any severance, compensation or other benefit(s) payable to him by the Company under the Employment Agreement or the Retention Agreement and acknowledges that the benefits under this Separation Agreement and General Release are being received in lieu of any such Employment Agreement and the Retention Agreement benefits. 1.3. The Company will pay Roberto's reasonable and customary business expenses, if any, through December 31, 2002. 1.4. In connection with the Amended Agreement, Roberto purchased 1.5 million restricted shares of Employer's common stock, par value $.001 per share (the "Shares ") in accordance with the terms of the Restricted Stock Agreement (the "Purchase Agreement"). Upon execution of this Agreement, Roberto shall acquire a vested interest in and the Company's Right of Repurchase shall lapse with respect to all of the Shares. In all other respects, the Purchase Agreement remains in full force and effect 1.5. Upon the date of this Agreement, all unexercised stock options previously granted to Roberto which have not vested as of the Effective Date of this Agreement and which are set forth on Exhibit E, will not expire but shall continue in effect and shall expire on the date set forth in the related stock option agreement. 2. Consideration to Roberto. 2.1. Consulting Fee. During the Consultant Period, the Company shall pay Roberto the sum of Fifteen Thousand Dollars ($15,000.00) per month for consulting services provided to DAOU, and shall reimburse him for reasonable travel expenses. The Consultant Period may be terminated with thirty days notice by either party. The Consultant Period may be extended by mutual written agreement of the parties. 2.2. No Other Obligations. Except as specified above, Roberto and the Company agree that the Company shall have no other payment obligations to Roberto pursuant to the Employment Agreement or otherwise. 2.3. Tax Consequences. The Company has made no representations to Roberto as to his tax liability on any payment or other Consideration described in this Section 1. Roberto acknowledges that he has consulted with his own professional advisors with respect to all tax matters, and is not relying on any representation by the Company on any tax matter. Roberto will be solely responsible for any and all tax responsibility for the payment by the Company, and for any additional tax responsibility which may be assessed either against him or against the Company, including any penalties assessed by any agency against any party, which may arise as a result of his characterization of any payment. The Company may withhold any payroll and related taxes required by applicable law. 2 3. Non-competition and Non-interference. 3.1. Acknowledgments by Roberto. Roberto acknowledges that: (a) the services he performed for the Company and those to be performed by him under this Agreement are of a special, unique, unusual, extraordinary and intellectual character; (b) Company's business is national in scope and its products and services are marketed throughout the United States; (c) Company competes with other businesses that are or could be located in any part of the United States; and (d) the provisions of this Section 3 are reasonable and necessary to protect Company's business. 3.2. Covenants of Roberto. In consideration of the acknowledgments by Roberto, and in consideration of the severance and consulting payments to be paid to Roberto by Company, Roberto covenants that he will not knowingly, directly or indirectly: 3.2.1. during the term of his employment and subsequent Consultant Period, except in the course of his employment and consulting, and for a period of one (1) year after the Consultant Period, engage or invest in, own, manage, operate, finance, control, or participate in the ownership, management, operation, financing, or control of, be employed by, associated with, or in any manner connected with, lend Roberto's name or any similar name to, lend Roberto's credit to or render services or advice to, any business that has products or activities which compete in whole or in part with any of Company's products or activities which existed during his employment or consulting period, anywhere within the United States where Company, at the time Roberto's employment or consulting terminates, is doing business or marketing the services of Company in the areas of healthcare information technology services that are related to planning, selecting, implementing, integrating or managing healthcare information processing systems and associated software and Internet portals for healthcare providers and payers in the healthcare and government healthcare industries; provided, however, that Roberto may purchase or otherwise acquire up to (but not more than) five percent (5%) of any class of securities of any enterprise (but without otherwise participating in the activities of such enterprise) if such securities are listed on any national or regional securities exchange or have been registered under Section 12(g) of the Securities Exchange Act of 1934, as amended. For any other exceptions to this non-compete Roberto must seek and obtain express permission from Company's Board of Directors, which permission will not be unreasonably refused. 3.2.2. Roberto acknowledges and agrees that Company is currently performing and marketing the above described services through Roberto in a majority of states throughout the United States, but particularly in the states of California, Connecticut, Florida, Illinois, Indiana, Maryland, Massachusetts, Michigan, New York, Pennsylvania, and Wisconsin. Roberto acknowledges and agrees that this list of states may expand during Employment and Consultant Period such that this Section may, at the time his employment and consulting is terminated, apply to states not listed at the time this Agreement is executed. Roberto agrees that this covenant is reasonable with respect to its duration, geographical area and scope. Notwithstanding the foregoing, following his Employment and Consultant Period, Roberto shall not be prohibited from engaging or investing in, owning, managing, operating, financing, controlling, or participating in the ownership, management, operation, financing, or control of, being employed by, associated with, or in any manner connected with, lending Roberto's name or any similar name to, lending Roberto's credit to or rendering services or advice to, any 3 business whose products or activities do not compete with the above described services of Company; 3.2.3. whether for Roberto's own account or for the account of any other person, at any time during his employment and the Consultant Period and for a period of one (1) year after the Consultant Period, accept, divert or solicit business of the same or similar type being carried on by Company, from any individual or entity known to be a customer of Company where Roberto had personal contact or relationship with such individual or entity during and by reason of his employment or consulting; 3.2.4. whether for Roberto's own account or the account of any other Person (i) at any time during his employment and Consultant Period and for a period of one(1) year after the Consultant Period, solicit, employ, or otherwise engage as an employee, independent contractor, or otherwise, any Person who is or was an employee of Company at any time during the employment or Consultant Period or in any manner induce or attempt to induce any employee of Company to terminate his employment with Company; or (ii) at any time during the employment and Consultant Period and for a period of one(1) year after the Consultant Period, interfere with Company's relationship with any Person, including any Person who at any time during the Employment or Consultant Period was an employee, contractor, supplier, or customer of Company; or 3.2.5. at any time during or after the employment and Consultant Period, disparage Company or any of its shareholders, directors, officers, employees or agents. 3.3. Roberto is not bound by the non-compete provisions of Section 3.2.1 in the event Roberto's employment is terminated without "Cause" prior to December 31, 2002 as defined in Section 7 of the Employment Agreement. 3.4. If any covenant in this Section 3 is held to be unreasonable, arbitrary or against public policy, such covenant will be considered to be divisible with respect to scope, time and geographic area, and such lesser scope, time or geographic area, or all of them, as a court of competent jurisdiction may determine to be reasonable, not arbitrary and not against public policy, will be effective, binding and enforceable against Roberto. 3.5. The period of time applicable to any covenant in this Section 3 will be extended by the duration of any violation by Roberto of such covenant. 3.6. Roberto will, while the covenant under this Section 3 is in effect, give notice to Company, within ten (10) days after accepting any other employment, of the identity of Roberto's employer. Company may notify such employer that Roberto is bound by this non-competition and non-interference provision and, at Company's election, furnish such employer with a copy of this Section 3 or relevant portions thereof. 3.7. Disputes or Controversies. Roberto recognizes that should a dispute or controversy arising from or relating to this non-compete be submitted for adjudication to any court, arbitration panel or other third party, the preservation of the secrecy of Confidential Information may be jeopardized. All pleadings, documents, testimony, and records relating to any such adjudication will be maintained in secrecy and, subject to the order of such court, 4 arbitration panel or other third party, will be available for inspection by Company, Roberto, and their respective attorneys and experts, who will agree, in advance and in writing, to receive and maintain all such information in secrecy, except as may be limited by them in writing. 3.8. Injunctive Relief. Roberto acknowledges that any breach of the terms and conditions of this non-compete may result in irreparable and continuing damage to Company for which there can be no adequate remedy at law, and in the event of any such breach, Company shall be entitled to seek immediate injunctive relief and other equitable remedies in addition to such other and further relief as may be proper. Company's obligation to post an undertaking in support of a petition for injunction under this Section will be determined under the applicable law and in an amount to be determined by the court. 4. General Release. 4.1. General Release. In exchange for the consideration set forth in Section 1 above, Roberto agrees that he will sign the first Release ("Exhibit A"). Roberto acknowledges that with this document he has been given a twenty-one (21) day period in which to consider entering into the release of the ADEA claims set forth in Exhibit A, if any. In addition, Roberto acknowledges that he has been informed that he may revoke a signed waiver of those ADEA claims for up to seven days after executing this Agreement. 4.2. Transition Services. In exchange for the consideration set forth in Article 2 above, and specifically in Sections 2.1-2.2 above, after the Separation Date and through March 31, 2003 Roberto agrees (i) to provide the Company with transition services as shall be reasonably requested by the Chief Executive Officer (the "Transition Services") and (ii) to sign the second Release ("Exhibit B") within ten (10) days after March 31, 2002. Roberto acknowledges that with this document he has been given a twenty-one (21) day period in which to consider entering into the release of the ADEA claims set forth in Exhibit B, if any. In addition, Roberto acknowledges that he has been informed that he may revoke a signed waiver of those ADEA claims for up to seven days after executing the record Release. 5. Acknowledgments. Roberto acknowledges that with this document he has been advised in writing of his right to consult with an attorney prior to executing this Agreement and release. Roberto expressly waives any rights and benefits he otherwise might have under California Civil Code Section 1542, which provides: A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR. 6. Settlement. Nothing in this Agreement shall be construed as an admission by the Company of liability of any kind to Roberto. 5 7. Confidentiality and Other Agreements. 7.1. Roberto acknowledges and agrees that he has a continuing obligation to protect the Company's Confidential Information according to the terms and conditions of the Employment Agreement and continues to be bound by Exhibit A of the Employment Agreement. 7.2. Roberto agrees to keep confidential the terms of this Agreement and agrees to refrain from disclosing any information regarding this Agreement to any third party, unless required to do so (a) by a regulatory body (e.g. filings with the Securities Exchange Commission ("SEC"); (b) in financial disclosures to auditors or in audited financial statements; (c) under oath, if properly ordered, in a court of competent jurisdiction; (d) to his wife; or (e) previously disclosed publicly by the Company to the extent so disclosed. Employee agrees to notify the Company in writing upon first notification that he may be required by law to disclose any information deemed confidential by this Agreement. Notice must be provided in sufficient time for the party receiving notice to oppose or otherwise respond to the request. 7.3. Roberto agrees that he will not interfere with or otherwise act adverse to the business affairs of the Company, including, without limitation, making disparaging remarks, either orally or in writing, to any person concerning the Company or the Company's business. 8. Representations and Warranties. The parties represent and warrant as follows: 8.1. Roberto has read this Agreement, understands its contents, and understands its legal effect and binding nature. Roberto further acknowledges that he is acting voluntarily and of his own free will in executing this Agreement. 8.2. Roberto is not relying upon any statement, representation or promise of the Company, or any of its officers, directors, agents, partners, employees, consultants, representatives or attorneys in executing this Agreement or in making this settlement except as expressly stated in this Agreement. 9. Claims Arising out of this Agreement. 9.1. Roberto agrees that, should he allege a violation of the terms of this Agreement, any such dispute and the arbitrability of such dispute shall be settled exclusively by arbitration in Exton, Pennsylvania by one or more experienced labor and employment law arbitrators licensed to practice law in Pennsylvania and selected in accordance with the Employment Arbitration Rules of the American Arbitration Association. The arbitrator(s) shall not have the power to modify any of the provisions of this Agreement. The arbitrator(s)' decision shall be final and binding upon the parties and judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction. The arbitrator will decide how the costs of arbitration should be split. 9.2. In the event of any arbitration arising out of or relating to this Agreement, its breach or enforcement, including an action for declaratory relief, the prevailing party in such action or proceedings shall be entitled to receive his or its damages, court costs, and reasonable out-of-pocket expenses including reasonable attorneys' fees. Such recovery shall include court costs, reasonable out-of-pocket expenses, and attorneys' fees on appeal, if any. The arbitrator(s) 6 or court shall determine who is the prevailing party, whether or not the dispute or controversy proceeds to final judgment. Both Roberto and the Company expressly acknowledge this paragraph is not intended to in any way alter the parties' agreement that arbitration shall be the exclusive method of resolving any dispute related to this Agreement or Roberto's employment with the Company. 10. Miscellaneous. 10.1. This Agreement shall be deemed to have been executed and delivered within the Commonwealth of Pennsylvania, and its rights and obligations shall be construed and enforced in accordance with and governed by, the laws of the Commonwealth of Pennsylvania. 10.2. Roberto and the Company understand and agree that this Agreement shall bind and benefit their heirs, employees, parent corporation, subsidiaries, affiliates, controlled corporations, sister corporations, agents, representatives, predecessors, successors and assigns. The Company's successors shall include (without limitation) any person, corporation or other entity who or which enters into a Corporate Transaction with the Company (hereinafter "Company Successor"). For purposes of this Agreement, a "Corporate Transaction" is defined to mean a transaction in which any person, corporation or other entity acquires, directly or indirectly, all or substantially all of the stock, business or assets of the Company, whether by way of merger, consolidation, sale, transfer or otherwise. 10.3. This Agreement may be amended only by an agreement in writing designated as an amendment to this Agreement and signed by the parties. 10.4. This Agreement may be executed in counterparts, and when each party has signed and delivered at least one such counterpart, each counterpart shall be deemed an original, and, when taken together with the other executed counterparts, shall constitute one Agreement, which shall be binding upon and effective as to all parties. IN WITNESS WHEREOF, the parties to this Agreement have executed and delivered this Agreement as of the date first above written. /s/ James T. Roberto ----------------------------------- James T. Roberto By: /s/ Neil R. Cassidy ----------------------------------- Neil R. Cassidy Its: Chief Financial Officer ----------------------------------- Daou Systems, Inc. 7 EXHIBIT E Prior Stock Option Grants 400,000 Options, issued on December 13, 2001: (i) 200,000 will vest on the sooner of (a) the first date following ten (10) consecutive trading days during which the Common Stock trades at a value of at least $2.50 per Share as adjusted for any stock combination, stock dividend, stock split or other recapitalization event occurring with respect to the Company's Common Stock (a Recapitalization"); or (b) five (5) years from the date of grant. (ii) 200,000 will vest on the sooner of (a) the first date following ten (10) consecutive trading days during which the Common Stock trades at a value of at least $5.00 per Share as adjusted for any Recapitalization; or (b) five (5) years from the date of grant. 8 EXHIBIT A RELEASE THIS RELEASE is entered into as of this 31st day of December, 2002, by and between James T. Roberto ("Employee") and Daou Systems, Inc. ("Daou"). WHEREAS, the Employee has reviewed the terms of the foregoing Separation Agreement and General Release and agrees to abide by the terms of the Separation Agreement and General Release; WHEREAS, the Employee agrees to execute this Release upon the request of Daou as it relates to the Separation Agreement and General Release; and WHEREAS, the Employee agrees to continue his employment with Daou through December 31, 2002; and WHEREAS, the Employee agrees to continue to devote his entire business skill, time and effort diligently to the affairs of Daou and will perform all such duties, and otherwise conduct himself, to promote the best interests of Daou through the date of his resignation effective December 31, 2002; and WHEREAS, the parties desire to separate on amicable terms. NOW, THEREFORE, the parties agree as follows, in consideration of the mutual covenants and obligations contained herein, and intending to be legally held bound: 1. Consideration. To resolve and settle all disputes and to avoid the costs and uncertainties of litigation, in consideration for this Release and other covenants set forth in the foregoing Separation Agreement and General, Employee acknowledges he will receive the consideration referred to in Section 3.1 of the Separation Agreement and General Release. 2. Employee further acknowledges that these payments and promises include consideration to which the Employee would not otherwise be entitled. 3. Employee's Release. In exchange for the payment referenced in paragraph 1, Employee hereby generally releases and discharges Daou, with each and every of Daou's predecessors, successors (by merger or otherwise), parents, subsidiaries, affiliates, divisions and related entities, directors, officers, employees and agents, whether present or former (collectively the "Releasees"), from any and all suits, causes of action, complaints, obligations, demands, or claims of any kind, whether in law or in equity, direct or indirect, known or unknown, suspected or unsuspected (hereinafter "claims"), which the Employee ever had or now has arising out of or relating to any matter, thing or event occurring up to and including the date of this Release. Employee's release specifically includes, but is not limited to: 9 (a) any and all claims for wages and benefits including, without limitation, salary, stock, options,commissions, royalties, license fees, health and welfare benefits, severance pay, vacation pay, and bonuses, excluding the compensation described in paragraph 2 of the Separation Agreement and General Release; (b) any and all claims for wrongful discharge, breach of contract (whether express or implied), or for breach of the implied covenant of good faith and fair dealing; (c) any and all claims for alleged employment discrimination on the basis of age, race, color, religion,sex, national origin, veteran status, disability and/or handicap and any and all other claims in violation of any federal, state or local statute, ordinance, judicial precedent or executive order, including but not limited to claims under the following statutes: Title VII of the Civil Rights Act of 1964, 42 U.S.C. (S)2000e et seq., the Civil Rights Act of 1866, 42 U.S.C. (S)1981, the Age Discrimination in Employment Act, (S)29 U.S.C. 621 et seq., the Older Workers Benefit Protection Act, 29 U.S.C. (S)626(f), the Americans with Disabilities Act, 42 U.S.C. (S)12101 et seq., the Family and Medical Leave Act of 1993, the Fair Labor Standards Act, the Employee Retirement Income Security Act of 1974, or any comparable statute of any other state, country, or locality except as required by law, but excluding claims for vested benefits under Daou's retirement plans; (d) any and all claims under any federal, state or local statute or law; (e) any and all claims in tort (including but not limited to any claims for misrepresentation, defamation, interference with contract or prospective economic advantage, intentional or negligent infliction of emotional distress, duress, loss of consortium, invasion of privacy and negligence); (f) any and all claims for attorneys' fees and costs; and (g) any and all other claims for damages of any kind. Nothing in this Release is intended to affect Employee's rights to indemnification under the Pennsylvania Business Corporation Law of 1998, Sections 1741-1743, or under Daou's Articles of Incorporation or Bylaws. 4. Acknowledgment. Employee understands that his release extends to all of the aforementioned claims and potential claims which arose on or before the date of execution of this Release, whether now known or unknown, suspected or unsuspected, and that this constitutes an essential term of this Release. Employee further understands and acknowledges the significance and consequence of this Release and of each specific release and waiver, and expressly consents that this Release shall be given full force and effect according to each and all of its express terms and provisions, including those relating to unknown and unsuspected claims, demands, obligations, and causes of action, if any, as well as those relating to any other claims, demands, obligations or causes of action herein above-specified. 5. Reinstatement. Employee hereby waives any right or claim the Employee may have to employment, re-instatement, or re-employment with the Releasees, and agrees not to apply for employment with the Releasees. 10 6. Advice of Counsel; Revocation Period. Employee is hereby advised to seek the advice of counsel. Employee acknowledges that he has, in fact, sought the advice of counsel, and is acting of his own free will, that the Employee has been afforded a reasonable time to read and review the terms of the Release, and that the Employee is voluntarily entering into this Release with full knowledge of its provisions and effects. Employee intends that this Release shall not be subject to any claim for duress. Employee further acknowledges that the Employee has been given at least twenty-one (21) days within which to consider this Release and that if the Employee decides to execute this Release before the twenty-one day period has expired, the Employee does so voluntarily and waives the opportunity to use the full review period. The Employee also acknowledges that the Employee has seven (7) days following his execution of this Release to revoke acceptance of the Release of age discrimination claims, with the Release of age discrimination claims not becoming effective until the revocation period has expired. If the Employee chooses to revoke his acceptance of this Release, he should provide written notice to: Jeffrey P. Libson, Esquire Pepper Hamilton, LLP 400 Berwyn Park 899 Cassatt Road Berwyn, PA 19312-1183 IN WITNESS WHEREOF, the parties, acknowledging that they are acting of their own free will, have caused the execution of this Release as of this day and year written below. /s/ James T. Roberto Witness: /s/ Neil R. Cassidy - ------------------------------------ -------------------------- James T. Roberto Date: December 31, 2002 ------------------------------ DAOU SYSTEMS, INC. By: /s/ Neil R. Cassidy --------------------------------- Title: Chief Financial Officer ----------------------------- Date: December 31, 2002 ------------------------------ 11 EXHIBIT B RELEASE THIS RELEASE is entered into by and between James T. Roberto ("Employee") and Daou Systems, Inc. ("Daou"). WHEREAS, the Employee has reviewed the terms of the foregoing Separation Agreement and General Release and agrees to abide by the terms of the Separation Agreement and General Release; WHEREAS, the Employee agrees to execute this Release upon the request of Daou as it relates to the Separation Agreement and General Release; and WHEREAS, the parties desire to separate on amicable terms. NOW, THEREFORE, the parties agree as follows, in consideration of the mutual covenants and obligations contained herein, and intending to be legally held bound: 1. Consideration. To resolve and settle all disputes, and to avoid the costs and uncertainty of litigation, in consideration for the releases and other covenants set forth in the foregoing Separation Agreement and General Release, Employee acknowledges he has received the consideration referred to in Section 3.2 of the Separation Agreement and General Release. This payment will not be made until after the expiration of the seven-day revocation period referenced in paragraph 7. 2. Employee further acknowledges that these payments and promises include consideration to which the Employee would not otherwise be entitled. 3. Employee's Release of Daou. Employee hereby generally releases and discharges Daou, together with each and every of its predecessors, successors (by merger or otherwise), parents, subsidiaries, affiliates, divisions and related entities directors, officers, employees and agents, whether present or former (collectively the "Releasees") from any and all suits, causes of action, complaints, obligations, demands, or claims of any kind, whether in law or in equity, direct or indirect, known or unknown, suspected or unsuspected (hereinafter "claims"), which the Employee ever had or now has arising out of or relating to any matter, thing or event occurring up to and including the date of this Release. 4. Employee's release specifically includes, but is not limited to: (a) any and all claims for wages and benefits including, without limitation, salary, stock, options,commissions, royalties, license fees, health and welfare benefits, severance pay, vacation pay, and bonuses, excluding the compensation described in paragraph 2 of the Separation Agreement and General Release. -12- (b) any and all claims for wrongful discharge, breach of contract (whether express or implied), or for breach of the implied covenant of good faith and fair dealing; (c) any and all claims for alleged employment discrimination on the basis of age, race, color, religion, sex, national origin, veteran status, disability and/or handicap and any and all other claims in violation of any federal, state or local statute, ordinance, judicial precedent or executive order, including but not limited to claims under the following statutes: Title VII of the Civil Rights Act of 1964, 42 U.S.C. (S)2000e et seq., the Civil Rights Act of 1866, 42 U.S.C. (S)1981, the Age Discrimination in Employment Act, 29 U.S.C. (S)621 et seq., the Older Workers Benefit Protection Act, 29 U.S.C. (S)626(f), the Americans with Disabilities Act, 42 U.S.C. (S)12101 et seq., the Family and Medical Leave Act of 1993, the Fair Labor Standards Act, the Employee Retirement Income Security Act of 1974, or any comparable statute of any other state, country, or locality except as required by law, but excluding any claim for vested benefits under Daou's retirement benefit plans; (d) any and all claims under any federal, state or local statute or law; (e) any and all claims in tort (including but not limited to any claims for misrepresentation, defamation, interference with contract or prospective economic advantage, intentional or negligent infliction of emotional distress, duress, loss of consortium, invasion of privacy and negligence); (f) any and all claims for attorneys' fees and costs; and (g) any and all other claims for damages of any kind. Nothing in this Release is intended to affect Employee's rights to indemnification under the Pennsylvania Business Corporation Law of the 1998, Sections 1741-1743, or under Daou's Articles of Incorporation or Bylaws. 5. Acknowledgment. Employee understands that his release extends to all of the aforementioned claims and potential claims which arose on or before the date of the execution of this Release, whether now known or unknown, suspected or unsuspected, and that this constitutes an essential term of this Release. Employee further understands and acknowledges the significance and consequence of this Release and of each specific release and waiver, and expressly consents that this Release shall be given full force and effect according to each and all of its express terms and provisions, including those relating to unknown and unsuspected claims, demands, obligations, and causes of action, if any, as well as those relating to any other claims, demands, obligations or causes of action herein above-specified. 6. Reinstatement. Employee hereby waives any right or claim the Employee may have to employment, re-instatement, or re-employment with the Releasees, and agrees not to apply for employment with the Releasees. 7. Advice of Counsel; Revocation Period. Employee is hereby advised to seek the advice of counsel. Employee acknowledges that he has, in fact, sought the advice of counsel, and is acting of his own free will, that the Employee has been afforded a reasonable time to read and review the terms of Release, and that the Employee is voluntarily entering into this Release -13- with full knowledge of its provisions and effects. Employee intends that this Release shall not be subject to any claim for duress. Employee further acknowledges that the Employee has been given at least twenty-one (21) days within which to consider this Release and that if the Employee decides to execute this Release before the twenty-one day period has expired, the Employee does so voluntarily and waives the opportunity to use the full review period. The Employee also acknowledges that the Employee has seven (7) days following his execution of this Release to revoke acceptance of the Release of age discrimination claims, with the Release of age discrimination claims not becoming effective until the revocation period has expired. If the Employee chooses to revoke his acceptance of this Release, he should provide written notice to: Jeffrey P. Libson, Esquire Pepper Hamilton, LLP 400 Berwyn Park 899 Cassatt Road Berwyn, PA 19312-1183 IN WITNESS WHEREOF, the parties, acknowledging that they are acting of their own free will, have caused the execution of this Release as of this day and year written below. _____________________________ Witness: ______________________ James T. Roberto Date: ________________________ DAOU SYSTEMS, INC. By:_________________________ Title:________________________ Date:________________________ -14- EX-10.31 8 dex1031.txt INDEMNIFICATION AGREEMENT Exhibit 10.31 INDEMNIFICATION AGREEMENT THIS AGREEMENT (the "Agreement") is made and entered into this ___ day of ______, 2003, between DAOU Systems, Inc., a Delaware corporation (the "Company") and [insert name of director/officer of DAOU Systems, Inc.] ("Indemnitee"). BACKGROUND Indemnitee performs a valuable service for the Company. To induce Indemnitee to continue to serve as a director and/or officer of the Company, the Company has determined and agreed to enter into this Agreement with Indemnitee. AGREEMENT NOW, THEREFORE, in consideration of the promises contained in this Agreement and Indemnitees's agreement to continue service as a director and/or officer of the Company, the parties hereto, intending to be legally bound, agree as follows: 1. Certain Definitions. Capitalized terms used in this Agreement shall have the meanings set forth on Appendix A to this Agreement. Other terms are defined where appropriate in this Agreement. 2. Scope of Indemnity. The Company shall hold harmless and indemnify Indemnitee from any action described in Sections 3 and 4 of this Agreement to the fullest extent permitted by Delaware law, now in effect or as may hereafter be in effect, including any changes after the date of the Agreement in any applicable law, statute, or rule which expand the ability of a Delaware corporation to indemnify its directors or officers or the permissible scope of such indemnification. All such changes shall be, ipso facto, within the purview of Indemnitee's rights and the Company's obligations under this Agreement. In the event of any change in any applicable law, statute, or rule which narrows the right of a Delaware corporation to indemnify its directors or officers, such changes, to the extent not otherwise required by such law, statute or rule to be applied to the Agreement, shall have no effect on this Agreement or the parties' rights and obligations hereunder or to any matter that arose from circumstances that occurred before the effective date of such change. 3. Indemnity. Subject only to the limitations contained in Section 5 of this Agreement, the Company shall hold harmless and indemnify Indemnitee to the fullest extent permitted by applicable law if Indemnitee was or is or becomes a party to or witness or other participant in, or is threatened to be made a party to or witness or other participant in any Proceeding, other than an action by or in the right of the Company, by reason of (or arising in part or in while out of) any event or occurrence related to the fact that Indemnitee is or was a director, officer, employee or agent of the Company, or any subsidiary of the Company, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or is or was serving in a fiduciary capacity with respect to any profit sharing, pension, or other type of benefit plan or trust for the benefit of employees of the Company, or any subsidiary of the Company, against all Expenses and Liabilities actually and reasonably incurred by Indemnitee in connection with the Proceeding -1- if Indemnitee acted in good faith and in a manner which Indemnitee reasonably believed to be in or not opposed to the best interests of the Company and, with respect to any criminal law Proceeding, Indemnitee had no reasonable cause to believe Indemnitee's conduct was unlawful. 4. Proceeding by or in the Right of the Company. Subject only to the limitations contained in Section 5 of this Agreement, the Company shall hold harmless and indemnify Indemnitee to the fullest extent permitted by Delaware law if Indemnitee was or is or becomes a party to or witness or other participant in, or is threatened to be made a party to or witness or other participant in any Proceeding by or in the right of the Company or by or in the right of any employee benefit plan or trust to procure a judgment in its favor, by reason of (or arising in part or in while out of) any event or occurrence related to the fact that Indemnitee is or was a director, officer, stockholder, employee or agent of the Company, or any subsidiary of the Company, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or is or was serving in a fiduciary capacity with respect to any profit sharing, pension, or other type of benefit plan or trust for the benefit of employees of the Company, or any subsidiary of the Company, against all Expenses actually and reasonably incurred by Indemnitee in connection with the Proceeding, so long as Indemnitee acted in good faith and in a manner which Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, provided that, no indemnification shall be made in respect of any claim, issue or matter as to which Indemnitee is adjudged to be liable to the Company unless and only to the extent that the court or forum in which such Proceeding was brought determines upon application that despite the adjudication of liability, but in view of all the circumstances of the case, Indemnitee is fairly and reasonably entitled to indemnity for such expenses which such court or forum shall deem proper. 5. Limitations on Indemnity. (a) No indemnity pursuant to Sections 3 or 4 of this Agreement shall be paid by the Company for any of the following: (i) in respect of remuneration paid to Indemnitee if it shall be determined by a final judgment or other final adjudication that such remuneration was in violation of law; (ii) on account of any Proceeding in which judgment is rendered against Indemnitee for an accounting of profits made from the purchase or sale by Indemnitee of securities of the Company pursuant to the provisions of Section 16 of the Securities Exchange Act of 1934 and amendments thereto or similar provisions of any federal, state or local statutory law; (iii) provided there has been no Change of Control, on account of or arising in response to any Proceeding (other than a Proceeding referred to in Section 12(b) hereof) initiated by Indemnitee or any of Indemnitee's affiliates against the Company or against any officer, director or stockholder of the Company unless such Proceeding was authorized by the Board of Directors of the Company; -2- (iv) on account of any Proceeding to the extent that Indemnitee is a plaintiff, a counter-complainant or a cross-complainant therein (other than an action, suit or proceeding permitted by Section 5(a)(iii) or Section 12(b) of this Agreement); or. (v) if a final decision by a court having jurisdiction in the matter shall determine that such indemnification is not lawful. (b) In addition to those limitations set forth above in paragraph (a) of this Section 5, no indemnity pursuant to Section 4 of this Agreement in an action by or in the right of the Company shall be paid by the Company for any of the following: (i) with respect to any transaction from which Indemnitee derived an improper personal benefit, if so established by an Adverse Judgment; (ii) on account of acts or omissions that show a reckless disregard for Indemnitee's duty to the Company or its stockholders in circumstances in which Indemnitee was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the Company or its stockholders, if so established by an Adverse Judgment; and (iii) Liabilities and Expenses paid or incurred in settlement of a pending Proceeding without the approval of the Company, which approval shall not be unreasonably withheld. 6. Procedure for Determination of Entitlement to Indemnification. (a) Whenever Indemnitee believes that he is entitled to indemnification pursuant to this Agreement, Indemnitee shall submit a written request for indemnification to the Company. A request for indemnification shall include sufficient documentation or information reasonably available to Indemnitee to support his claim for indemnification. Indemnitee shall submit his claim for indemnification within a reasonable time not to exceed three years after any judgment, order, settlement, dismissal, arbitration award, conviction, acceptance of a plea of nolo contendere or its equivalent, final termination or other disposition or partial disposition of any Proceeding (or, if no such event occurs, after incurring any Expenses for which indemnification is sought), whichever is the later date for which Indemnitee requests indemnification. The president or the secretary or other appropriate officer of the Company shall, promptly upon receipt of Indemnitee's request for indemnification, advise the Board of Directors in writing that Indemnitee has made such a request. Determination of Indemnitee's entitlement to indemnification shall be made not later than 90 days after the Company's receipt of his written request for such indemnification. (b) Upon written request by Indemnitee for indemnification as provided in Section 6(a), a determination, if required by applicable law, with respect to Indemnitees entitlement thereto shall be made in the specific case by: (i) A majority of the Board of Directors consisting of Disinterested Directors, even though less than a quorum; or -3- (ii) A committee of such Disinterested Directors designated by a majority vote of such Disinterested Directors, even though less than a quorum; or (iii) If there are no Disinterested Directors or if the Disinterested Directors so direct, Independent Legal Counsel, who shall make the determination in a written opinion; or (iv) The stockholders of the Company. 7. Presumptions and Effect of Certain Proceedings. (a) Upon making a request for indemnification, Indemnitee shall be presumed to be entitled to indemnification under this Agreement and the Company shall have the burden of proof to overcome that presumption in reaching any contrary determination. The termination of any Proceeding by judgment, order, settlement, arbitration award or conviction, or upon a plea of nolo contendere or its equivalent shall not affect this presumption or establish a presumption with regard to any factual matter relevant to determining Indemnitee's rights to indemnification under this Agreement. If the person or group so empowered to make a determination pursuant to Section 6(b) hereof fails to make the requested determination within 90 days after receipt of the written request required by Section 6(a) hereof, the determination that Indemnitee is entitled to indemnification shall be deemed to have been made. (b) Indemnitee shall be deemed to have acted in good faith if Indemnitee's action is based on the records or books of account of the Company, including financial statements, or on information supplied to Indemnitee by the officers of the Company in the course of their duties, or on the advice of legal counsel for the Company or on information or records given or reports made to the Company by an independent certified public accountant or by an appraiser or other expert selected with reasonable care by the Company. In addition, the knowledge and/or actions, or failure to act, of any director, officer, agent or employee of the Company shall not be imputed to Indemnitee for purposes of determining the right to indemnification under this Agreement. Whether or not the foregoing provisions of this Section 7(b) are satisfied, it shall in any event be presumed that Indemnitee has at all times acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company. Anyone seeking to overcome this presumption shall have the burden of proof and the burden of persuasion by clear and convincing evidence. 8. Contribution. If the indemnification provided in Sections 2, 3 and 4 is unavailable and may not be paid to Indemnitee for any reason other than those set forth in Section 5 (excluding subsection 5(b)(iii)), then in respect of any Proceeding in which the Company is or is alleged to be jointly liable with Indemnitee, the Company shall contribute to the amount of Expenses and Liabilities actually incurred and paid or payable by Indemnitee in such proportion as is appropriate to reflect: (i) the relative benefits received by the Company on the one hand and Indemnitee on the other hand from the transaction or events that form the basis of the Proceeding giving rise to Indemnitee's Expenses and Liabilities, and -4- (ii) the relative fault of the Company on the one hand and of Indemnitee on the other in connection with the events that resulted in such Expenses and Liabilities, as well as any other relevant equitable considerations. The relative fault of the Company on the one hand and of Indemnitee on the other shall be determined by reference to, among other things, the parties' relative intent, knowledge, access to information and opportunity to correct or prevent the circumstances resulting in such Expenses and Liabilities. The Company agrees that it would not be just and equitable if contribution pursuant to this Section 8 were determined by pro rata allocation or any other method of allocation which does not take account of the foregoing equitable considerations. 9. Continuation of Obligations. All obligations of the Company contained herein shall continue during the period Indemnitee is a director, officer, employee or agent of the Company (or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise) and shall continue thereafter so long as Indemnitee shall be subject to any possible claim or threatened, pending or completed Proceeding, by reason of the fact that Indemnitee was serving the Company or any such other entity in any capacity referred to herein. 10. Notification and Defense of Claim. (a) After receipt by Indemnitee of notice of the commencement of any Proceeding, Indemnitee shall, promptly after concluding that a claim in respect thereof may be made against the Company under this Agreement, notify the Company of the commencement thereof; but the failure so to notify the Company will not relieve the Company from any liability which it may have to Indemnitee under this Agreement, unless and only to the extent that the failure to provide notice results in prejudice to the Company. (b) With respect to any such Proceeding as to which Indemnitee notifies the Company of the commencement thereof, the Company shall be entitled to participate in the Proceeding at its own expense and except as otherwise provided below, to the extent that it may wish, the Company jointly with any other indemnifying party similarly notified will be entitled to assume the defense thereof, with counsel reasonably satisfactory to Indemnitee. After notice from the Company to Indemnitee of its election to assume the defense of any Proceeding, the Company shall not be liable to Indemnitee under this Agreement or otherwise for any Expenses subsequently incurred by Indemnitee in connection with the defense of such Proceeding other than reasonable costs of investigation or as otherwise provided below. Indemnitee shall have the right to employ his or her own counsel in such Proceeding, but all Expenses related thereto incurred after notice from the Company of its assumption of the defense shall be at Indemnitee's expense unless: (i) the employment of counsel by Indemnitee has been authorized by the Company, (ii) counsel to the Company reasonably concludes and notifies Indemnitee that there may be a conflict of interest between the Company and Indemnitee in the conduct of the defense of such action, and Indemnitee notifies the Company after receiving such notice from the Company that he or she is engaging counsel, or -5- (iii) the Company shall not in fact have employed counsel to assume the defense of such action. In each of the foregoing three cases, the Company shall reimburse Indemnitee for all Expenses incurred by him or her. The Company shall not be entitled to assume the defense of any Proceeding brought by or on behalf of the Company or as to which Indemnitee shall have made the conclusion referred to in (ii) above. (c) The Company shall not be liable to indemnify Indemnitee under this Agreement or otherwise for any amounts paid in settlement of any Proceeding effected without the Company's written consent, provided, however, that if a Change of Control has occurred, the Company shall be liable for indemnification of Indemnitee for amounts paid in settlement if the Independent Counsel has approved the settlement. The Company shall not settle any Proceeding in any manner which would impose any penalty or limitation on Indemnitee without Indemnitee's prior written consent. 11. Advancement and Repayment of Expenses. (a) If Indemnitee employs his own counsel pursuant to Section 10(b)(i) through (iii) above, the Company shall advance to Indemnitee, prior to any final disposition of any Proceeding, all Expenses incurred in investigating or defending any Proceeding within 30 days after receiving copies of invoices presented to Indemnitee for such Expenses. (b) Indemnitee shall reimburse the Company for all Expenses advanced by the Company in defending any Proceeding against Indemnitee if, and only to the extent that, it is ultimately determined by a final judicial decision (from which there is no right of appeal) that Indemnitee is not entitled, under applicable law, the Company's certificate of incorporation or bylaws, this Agreement or otherwise, to be indemnified by the Company for such Expenses, provided, that any obligation of the Indemnitee to reimburse the Company shall be null and void if the existence of such obligation would cause the advancement of such expenses to be deemed a loan in violation of any applicable securities laws. 12. Remedies of Indemnitee. (a) If (i) a determination pursuant to Section 6 hereof is made that Indemnitee is not entitled to indemnification, (ii) advances of Expenses are not made pursuant to this Agreement, (iii) payment has not been timely made following a determination of entitlement to indemnification pursuant to this Agreement, or (iv) Indemnitee otherwise seeks enforcement of this Agreement, Indemnitee shall be entitled to a final adjudication of his rights in an appropriate court. The Company shall not oppose Indemnitee's right to seek any such adjudication. (b) If a determination that Indemnitee is not entitled to indemnification, in whole or in part, has been made pursuant to Section 6 hereof, the decision in the judicial proceeding provided in paragraph (a) of this Section 12 shall be made de novo and Indemnitee shall not be prejudiced by reason of a determination that he is not entitled to indemnification. -6- (c) If a determination that Indemnitee is entitled to indemnification has been made pursuant to Section 6 hereof or otherwise pursuant to the terms of this Agreement, the Company shall be bound by such determination in the absence of (i) a misrepresentation of a material fact by Indemnitee or (ii) a specific finding (which has become final) by a court that all or any part of such indemnification is prohibited by law. (d) In any Proceeding brought by Indemnitee under this Section 12, the Company shall be precluded from asserting that the procedures and presumptions of this Agreement are not valid, binding and enforceable. The Company shall stipulate in any such court that the Company is bound by all the provisions of this Agreement and is precluded from making any assertion to the contrary. (e) The Company acknowledges that a monetary remedy for breach of this Agreement, at some later date, will be inadequate, impracticable and difficult to prove, and further acknowledges that such breach would cause Indemnitee irreparable harm. Accordingly, Indemnitee shall be entitled to temporary and permanent injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bond or other undertaking in connection therewith. Any such requirement of bond or undertaking is hereby waived by the Company, and the Company acknowledges that in the absence of such a waiver, a bond or undertaking may be required by the court. 13. Enforcement. (a) The Company acknowledges that it has entered into this Agreement and assumed the obligations imposed on the Company hereby in order to induce Indemnitee to continue as a director and/or officer of the Company, and acknowledges that Indemnitee is relying upon this Agreement in continuing in such capacity. (b) If Indemnitee is required to bring any action to enforce rights or to collect moneys due under this Agreement and is successful in such action, the Company shall reimburse Indemnitee for all of Indemnitee's Expenses incurred in bringing and pursuing such action. 14. Mutual Acknowledgement. Both the Company and Indemnitee acknowledge that in certain instances, federal law or applicable public policy may prohibit the Company from indemnifying Indemnitee under this Agreement or otherwise. For example, the Company and Indemnitee acknowledge that the Securities and Exchange Commission (the "SEC") has taken the position that indemnification is not permissible for liabilities arising under certain federal securities laws, and federal legislation prohibits indemnification for certain ERISA violations. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the SEC to submit the question of indemnification to a court in certain circumstances for a determination of the Company's ability under public policy to indemnify Indemnitee. 15. Separability. Each of the provisions of this Agreement is a separate and distinct agreement and independent of the others, so that if any provision hereof shall be held to be invalid or unenforceable to any extent for any reason, such invalidity or unenforceability shall -7- not affect the validity or enforceability of the other provisions hereof, and the affected provision shall be construed and enforced so as to provide the Indemnitee with the benefits contemplated by this Agreement to the maximum extent possible. 16. Governing Law. This Agreement shall be governed by and interpreted and enforced in accordance with the laws of the State of Delaware. 17. Consent To Jurisdiction. The Company and Indemnitee each irrevocably consent to jurisdiction of the courts of the State of Delaware for all purposes in connection with any Proceeding which arises out of or relates to this Agreement and agree that any action instituted under this Agreement shall be brought only in the state courts of the State of Delaware. 18. Binding Effect. This Agreement shall be binding upon Indemnitee and upon the Company, its successors and assigns, and shall inure to the benefit of Indemnitee, his heirs, personal representatives and assigns and to the benefit of the Company, its successors and assigns. 19. Entire Agreement. This Agreement represents the entire agreement between the parties hereto and there are no other agreements, contracts or understandings between the parties hereto with respect to the subject matter of this Agreement. Notwithstanding the foregoing, the rights conferred on Indemnitee by this Agreement shall not be exclusive of any other right which Indemnitee may have or hereafter acquire under any statute, provision of the Company's certificate of incorporation or bylaws, vote of stockholders or directors, or otherwise, both as to action in his official capacity and as to action in another capacity while holding office or under any insurance policy maintained by the Company. 20. Amendment and Termination. No amendment, modification, waiver, termination or cancellation of this Agreement shall be effective for any purpose unless set forth in writing signed by both parties hereto. 21. Subrogation. If the Company makes any payment under this Agreement, it shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Company effectively to bring suit to enforce such rights. 22. Survival Of Rights. The rights conferred on Indemnitee by this Agreement shall continue after Indemnitee has ceased to be a director, officer, employee or other agent of the Company and shall inure to the benefit of Indemnitee's heirs, executors and administrators. 23. Notices. All notices, requests, demands and other communications hereunder shall be in writing and shall be addressed to Indemnitee or to the Company, as the case may be, at the address indicated on the signature page below, or to such other address as may have been furnished by either party to the other, and shall be deemed to have been duly given if (a) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed, (b) delivered by a nationally recognized overnight delivery service, on the first business after the date on which it is delivered to or deposited with such service for overnight delivery, or (c) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed. -8- IN WITNESS WHEREOF, the parties hereto have executed this Agreement on and as of the day and year first above written. INDEMNITEE: CORPORATION: DAOU SYSTEMS, INC. ___________________________________ By:_____________________________________ Signature Signature ___________________________________ ________________________________________ Print Name Print Name ________________________________________ Title Address for Notices: Address for Notices: ___________________________________ DAOU Systems, Inc. 412 Creamery Way, Suite 300 ___________________________________ Exton, PA 19341 ___________________________________ Appendix A Certain Defined Terms 1. "Adverse Judgment" means a final, non-appealable judgment or final adjudication of a court that contains findings of fact or conclusions of law adverse to Indemnitee's interest. 2. "Change of Control" means a change in control of the Company occurring after the effective date of this Agreement of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Company is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if after the effective date of this Agreement: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing fifty percent (50%) or more of the combined voting power of the Company's then outstanding securities without the prior approval of at least two-thirds of the members of the Board in office immediately prior to such person attaining such percentage interest; (ii) there occurs a proxy contest, or the Company is a party to a merger, consolidation, sale of assets, plan of liquidation or other reorganization not approved by at least two-thirds of the members of the Board then in office, as a consequence of which members of the Board in office immediately prior to such transaction or event constitute less than a majority of the Board thereafter; or (iii) during any period of two consecutive years, other than as a result of an event described in clause (ii) of this definition, individuals who at the beginning of such period constituted the Board (including for this purpose any new director whose election or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of such period) cease for any reason to constitute at least a majority of the Board. 3. "Disinterested Director" means a director of the Company who is not or was not a party to the Proceeding in respect of which indemnification is being sought by Indemnitee. 4. "Expenses" means all direct and indirect costs (including, without limitation, reasonable attorneys' fees and costs, retainers, court costs, transcripts, fees and costs of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, all other disbursements or out-of-pocket expenses) actually and reasonably incurred in connection with a Proceeding or establishing or enforcing a right to indemnification under this Agreement, applicable law or otherwise. "Expenses" shall not include any Liabilities. 5. "Independent Legal Counsel" means a law firm or member of a law firm selected by the Company and approved by Indemnitee (which approval shall not be unreasonably withheld) and that neither is presently nor in the past five years has been retained to represent: A-1 (a) the Company, in any material matter, or (b) any other party to the Proceeding giving rise to a claim for indemnification hereunder. Notwithstanding the foregoing, the term "Independent Legal Counsel" shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing Indemnitee in an action to determine Indemnitee's right to indemnification under this Agreement. 6. "Liabilities" means liabilities of any type whatsoever including, but not limited to, any judgments, fines, penalties and amounts paid in settlement (including all interest assessments and other charges paid or payable in connection with or in respect of such judgments, fines, penalties or amounts paid in settlement) of any Proceeding. 7. "Proceeding" means any threatened, pending or completed action, claim, suit, arbitration, alternative dispute resolution mechanism, investigation, administrative hearing or any other proceeding whether civil, criminal, administrative or investigative, including any appeal therefrom. A-2 EX-23.1 9 dex231.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-8 (No.'s 333-52704, 333-52716, 333-59795 and 333-29745) and Form S-3 (No.'s 333-87103, 333-68197, 333-52971, and 333-47777) of Daou Systems, Inc. of our report dated February 13, 2003, 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, 2002. /s/ Ernst & Young LLP Philadelphia, Pennsylvania March 31, 2003 EX-99.1 10 dex991.txt CEO CERTIFICATION Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Daou Systems, Inc. (the "Company") on Form 10-K for the period ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Daniel J. Malcolm, the Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ DANIEL J. MALCOLM - ------------------------------ Daniel J. Malcolm Chief Executive Officer EX-99.2 11 dex992.txt CFO CERTIFICATION Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Daou Systems, Inc. (the "Company") on Form 10-K for the period ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Neil R. Cassidy, the Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ NEIL R. CASSIDY - -------------------------------- Neil R. Cassidy Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----