-----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, HHRDIlTPLSjdklskexR9VNbjJIb6gZsOOADVeABjS8TloHaPAfgGsuU72ZCWw4qY D4lLuPDjpxJvxwkFnHeg0A== 0001047469-99-020983.txt : 19990518 0001047469-99-020983.hdr.sgml : 19990518 ACCESSION NUMBER: 0001047469-99-020983 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 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-Q SEC ACT: SEC FILE NUMBER: 000-22073 FILM NUMBER: 99626171 BUSINESS ADDRESS: STREET 1: 5120 SHOREHAM PL CITY: SAN DIEGO STATE: CA ZIP: 92122 BUSINESS PHONE: 6194522221 MAIL ADDRESS: STREET 1: 5120 SHOREHAM PL CITY: SAN DIEGO STATE: CA ZIP: 92122 10-Q 1 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 OR / / 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.: 000-22073 DAOU SYSTEMS, INC. (Exact name of registrant as specified in its charter) Delaware 330284454 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 5120 Shoreham Place San Diego, California 92122 (Address of principal executive offices) (Zip Code) (619) 452-2221 (Registrant's telephone number, including area code) 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 The number of shares of Registrant's Common Stock outstanding as of April 14, 1999: 17,689,728 1 DAOU SYSTEMS, INC. Index to Form 10-Q PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements Page Condensed Consolidated Balance Sheets at March 31, 1999 (unaudited) and December 31, 1998 3 Condensed Consolidated Statements of Operations (unaudited) for the Three Months Ended March 31, 1999 and 1998 4 Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 1999 and 1998 5 Notes to Condensed Consolidated Financial Statements 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-13 PART II. OTHER INFORMATION 14 Item 1. Legal Proceedings 14 Item 6. Exhibits and Reports on Form 8-K 14 SIGNATURES 15
2 PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements DAOU Systems, Inc. Condensed Consolidated Balance Sheets (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
MARCH 31, DECEMBER 31, 1999 1998 (UNAUDITED) ------------------------- ASSETS Current assets: Cash and cash equivalents $ 4,617 $ 6,756 Short-term investments, available-for-sale 1,113 1,024 Accounts receivable, net of allowance for doubtful accounts of $1,054 and $956 at March 31, 1999 and December 31, 1998, respectively 25,098 24,582 Contract work in progress 8,059 12,272 Deferred income taxes 4,520 3,362 Other current assets 1,476 1,306 ------------------------- Total current assets 44,883 49,302 Equipment, furniture and fixtures, net 4,696 4,735 Other assets 410 480 ------------------------- $ 49,989 $ 54,517 ------------------------- ------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade accounts payable and other accrued liabilities $ 6,336 $ 8,277 Accrued salaries and benefits 4,092 3,907 Current portion of long-term liabilities and lines of credit 4,158 5,453 ------------------------- Total current liabilities 14,586 17,637 Long-term liabilities 702 684 Deferred income taxes 1,421 1,421 Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value: Authorized shares - 5,000 Issued and outstanding shares - none -- -- Common stock, $.001 par value: Authorized shares - 50,000 Issued and outstanding shares - 17,689 at March 31, 1999 and at December 31, 1998 18 18 Additional paid-in capital 38,419 38,419 Deferred compensation (898) (980) Accumulated other comprehensive income 327 236 Retained deficit (4,586) (2,918) ------------------------- Total stockholders' equity 33,280 34,775 ------------------------- $ 49,989 $ 54,517 ------------------------- -------------------------
SEE ACCOMPANYING NOTES 3 DAOU Systems, Inc. Condensed Consolidated Statements of Operations (IN THOUSANDS, EXCEPT FOR PER SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999 1998 -------- ------- Revenues $ 27,323 $23,985 Cost of revenues 21,820 14,488 -------- ------- Gross profit 5,503 9,497 Operating expenses: Sales and marketing 2,905 2,733 General and administrative 5,336 3,128 Merger and related expenses -- 1,796 -------- ------- 8,241 7,657 -------- ------- Income (loss) from operations (2,738) 1,840 Interest income (expense), net (86) 142 -------- ------- Income (loss) before income taxes (2,824) 1,982 Provision (benefit) for income taxes (1,156) 914 -------- ------- Net income (loss) $ (1,668) $ 1,068 -------- ------- -------- ------- Net income (loss) per common share: Basic $ (0.09) $ 0.06 -------- ------- -------- ------- Diluted $ (0.09) $ 0.06 -------- ------- -------- ------- Shares used in computing net income (loss) per common share: Basic 17,689 17,596 -------- ------- -------- ------- Diluted 17,689 18,576 -------- ------- -------- -------
SEE ACCOMPANYING NOTES. 4 DAOU Systems, Inc. Condensed Consolidated Statements of Cash Flows (IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999 1998 ------------------------ OPERATING ACTIVITIES Net income (loss) $(1,668) $ 1,068 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 458 436 Changes in operating assets and liabilities 658 (10,512) ------------------------ Net cash used in operating activities (552) (9,008) INVESTING ACTIVITIES Purchases of equipment, furniture and fixtures (337) (947) (Purchases) maturities of short-term investments 2 3,161 Changes in other assets 70 35 ------------------------ Net cash (used in) provided by investing activities (265) 2,249 FINANCING ACTIVITIES Repayments of long-term liabilities and lines of credit (1,322) (278) Proceeds from issuance of common stock -- 820 Distributions to stockholders -- (152) Other -- (4) ------------------------ Net cash (used in) provided by financing activities (1,322) 386 ------------------------ ------------------------ Decrease in cash and cash equivalents (2,139) (6,373) Cash and cash equivalents at beginning of period 6,756 7,981 ------------------------ Cash and cash equivalents at end of period $ 4,617 $ 1,608 ------------------------ ------------------------
SEE ACCOMPANYING NOTES. 5 DAOU SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The unaudited condensed consolidated financial statements of DAOU Systems, Inc. ("DAOU" or the "Company") at March 31, 1999 and for the three-month periods ended March 31, 1999 and 1998 have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information. Accordingly, they do not include all information and footnotes required by GAAP for a complete set of financial statements. These financial statements reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary to fairly present the financial position of the Company at March 31, 1999 and the results of operations for the three month periods ended March 31, 1999 and 1998. The results of operations for the three months ended March 31, 1999 are not necessarily indicative of the results to be expected for the year ending December 31, 1999. The Company has experienced significant quarterly fluctuations in operating results and it expects that these fluctuations in revenues, expenses and net income or losses will continue. The financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financials should be read in conjunction with the audited financial statements and the related notes thereto contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on March 31, 1999 and in the Company's Annual Report on Form 10-K/A filed with the SEC on April 30, 1999. 2. Use of Estimates The preparation of financial statements in conformity with GAAP 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. 3. Lines of Credit During June 1998, the Company secured two borrowing facilities, a $2.0 million revolving line of credit and an $8.0 million line of credit under which no funds are currently available for future borrowings. As of March 31, 1999, the Company was not in compliance with one of the covenants and has been informed by the bank that the Company cannot avail itself to the unused lines of credit. Management is actively negotiating for a replacement line of credit, believes that a replacement line will be obtained before expiration of the existing lines of credit and that the Company has sufficient liquidity to fund operations until this new line is in place. In addition, the Company has an additional $700,000 line of credit, which expires May 1, 1999. The $700,000 line of credit bears interest at prime plus 0.25% (8.00% at March 31, 1999) per annum. There are no compensating balance requirements and borrowings under the line of credit are limited to 65% of qualifying receivables. At March 31, 1999 no amounts were outstanding under the line of credit. 4. Related Party Transactions The Company has an agreement with an officer that guarantees a cash bonus (approximately $650,000 at March 31, 1999) in the amount of any difference between (i) the net value at November 11, 1999 of the options granted to the officer during 1996 and (ii) $1,550,000. 6 5. Net Income (loss) Per Share The following table details the computation of basic and diluted net income (loss) per share: (In thousands, except per share information) (unaudited)
Three Months Ended March 31, 1999 1998 ------------------------ Numerator: Net income (loss) $ (1,668) $ 1,068 Denominator: Denominator for basic net income (loss) per share - weighted average common shares outstanding 17,689 17,596 Effect of dilutive securities: Warrants -- 106 Common stock options -- 874 ------------------------ -- 980 ------------------------ Denominator for diluted net income (loss) per share - adjusted weighted average common shares outstanding and assumed conversion of preferred stock 17,689 18,576 ------------------------ ------------------------ Basic net income (loss) per share $ (0.09) $ 0.06 ------------------------ ------------------------ Diluted net income (loss) per share $ (0.09) $ 0.06 ------------------------ ------------------------
6. Comprehensive Income (loss) Comprehensive income (loss) for the three months ended March 31, 1999 and 1998 totaled $(1,577,000) and $1,171,000, respectively. The difference from reported net income (loss) arises from the unrealized gains and losses on short-term investments. 7. Income Tax Expense The effective income tax rate for the three months ended March 31, 1999 and 1998 was (41)% and 46%, respectively. The effective tax rate for the three months ended March 31, 1998 differed from the expected consolidated federal statutory rate of 35% due to the non-deductibility of certain merger and related costs and adjustments made to convert the former S Corporation status of certain acquired businesses to the C Corporation status of the Company. At March 31, 1999, net deferred tax assets were approximately $3.1 million. Because the Company incurred an operating loss for 1998 and through the first quarter for 1999, management will continue to evaluate the realization of the net deferred tax assets. If realization becomes doubtful a valuation allowance will be provided. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report on Form 10-Q 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. Prospective investors are cautioned that such statements are only predictions and that actual events or results may differ materially. Forward-looking statements usually contain the words "estimate," "anticipate," "believe," "expect" or similar expressions. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and are subject to numerous known and unknown risks and uncertainties. The forward-looking statements included herein are based on current expectations and entail various risks and uncertainties as those set forth herein and in the Company's other SEC filings, including those more fully set forth in the "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other sections of the Company's Form 10-K for the year ended December 31, 1998 on file with the SEC. These risks and uncertainties could cause the Company's actual results to differ materially from those projected in the forward-looking statements. The Company disclaims any obligation to update or publicly announce revisions to any such statements to reflect future events or developments. Overview The Company provides integrated information technology solutions and services to the U.S. healthcare industry. DAOU's capabilities range from up-front strategic consulting to information technology ("IT") system design, implementation and long-term tactical support. DAOU's IT offerings include application implementation, communications infrastructure, management consulting and integration services. The Company's application implementation group supplies staffing resources to hospitals and other healthcare organizations. DAOU's vendor certified consultants are capable of installing nearly 90% of the most common healthcare applications. The Company's communications infrastructure group focuses on the information superstructure in healthcare enterprises, including networking, Intranet and Internet, desktop, and voice, video and data solutions. Management consulting develops business plans and solves problems for healthcare IT managers, installs and integrates applications, engineers, installs and integrates infrastructure, and manages IT systems. DAOU's integration services group analyzes, implements and supports information systems that meet a customer's business objectives and reduce the cost and improve the quality of care. The Company's gross margin with respect to implementation services varies significantly depending on the percentage of such services consisting of products (with respect to which the Company obtains a lower margin) versus professional services. Also, the Company often hires employees in anticipation of commencement of a project and if delays in contract signings occur the Company's gross margins could vary due to the associated loss of revenue to cover the fixed labor costs. Results of Operations The Company's revenues were $27.3 million and $24.0 million for the three months ended March 31, 1999 and 1998, respectively, representing an increase of 14%. Revenues increased primarily due to the increased number of professional services consulting contracts, which accounted for $3.5 million of the increase, and professional services management contracts, which accounted for $3.4 million of the increase. Growth in these two service areas was offset by a $3.5 million decrease in revenues from implementation and cabling contracts for the three months ended March 31, 1999 as compared to 1998. Services to DAOU's five largest customers accounted for $7.6 million of total revenues in for the three months ended March 31, 1999, representing 28% of total revenues. Cost of revenues was $21.8 million and $14.5 million for the three months ended March 31, 1999 and 1998, respectively, representing an increase of 51%. Gross margin was 20% and 40% for the three months ended March 31, 1999 and 1998, respectively. This decrease in gross margin during the three months ended March 31, 1999 was primarily due to the following: i) an increase in the product content of the Company's large network implementation contracts, and ii) decreases in networking labor utilization rates due to decreases in network sales within the communications infrastructure group. Sales and marketing expenses were $2.9 million and $2.7 million for the three months ended March 31, 1999 and 1998, respectively, representing an increase of 6%. This increase was primarily due to an increase in sales personnel 8 and related expenses to support the increased sales volume and activity. Sales and marketing expenses were approximately 11% of total revenues for the three months ended March 31, 1999 and 1998. Although the Company believes that it can achieve a decrease in these expenses as a percentage of revenue, the Company also expects that sales and marketing expenses will continue to increase in absolute dollars to support the anticipated growth in the Company's business. General and administrative expenses were $5.3 million and $3.1 million for the three months ended March 31, 1999 and 1998, respectively, representing an increase of 71%. The primary factors contributing to this increase were costs associated with additional administrative staffing and other increased infrastructure requirements to support growth and integration of acquired companies, increased legal fees and increased recruiting costs. General and administrative expenses were approximately 20% and 13% of total revenues for the three months ended March 31, 1999 and 1998, respectively. The Company expects that general and administrative expenses will increase in dollar terms to support the anticipated growth in the Company's business and the continued integration of acquired companies. Other income (expense), net, was $(86,000) and $143,000 for the three months ended March 31, 1999 and 1998, respectively. Other income is primarily interest income on cash and cash equivalents, and short-term investments. Interest expense consists primarily of interest associated with the Company's business lines of credit. The decrease in net other income (expense), net was primarily due to overall lower average cash reserves available for investment during the three months ended March 31, 1999 as compared to 1998. The effective income tax rate for the three months ended March 31, 1999 and 1998 was (41)% and 46%, respectively. The effective tax rate for the three months ended March 31, 1998 differed from the expected consolidated federal statutory rate of 35% due to the non-deductibility of certain merger and related costs and adjustments made to convert the former S Corporation status of certain acquired businesses to the C Corporation status of the Company. At March 31, 1999, net deferred tax assets were approximately $3.1 million. Because the Company incurred an operating loss for 1998 and through the first quarter for 1999, management will continue to evaluate the realization of the net deferred tax assets. If realization becomes doubtful a valuation allowance will be provided. Liquidity and Capital Resources On March 31, 1999, the Company had working capital of $30.3 million, a decrease of $1.4 million from $31.7 million on December 31, 1998. For the three months ended March 31, 1999, cash used in operating activities was $552,000 compared to cash used in operating activities of $9.0 million for the three months ended March 31, 1998. This decrease resulted primarily from a decrease in contract work in progress for the quarter ended March 31, 1999 as compared to 1998. Net cash used in investing activities was $265,000 in the current period, compared to net cash provided by investing activities of $2.2 million in the comparable prior period. This change was primarily from $3.2 million in 1998 of maturing marketable securities, which were not reinvested. Net cash used in financing activities was $1.3 million for the three months ended March 31,1999, compared to net cash provided by financing activities of $386,000 in the comparable prior period. This change was primarily the result of repayments of debt and lines of credit of acquired companies of $1.3 million during the three months ended March 31, 1999. During June 1998, the Company secured two borrowing facilities, a $2.0 million revolving line of credit and an $8.0 million line of credit under which no funds are currently available for future borrowings. As of March 31, 1999, the Company was not in compliance with one of the covenants and has been informed by the bank that the Company cannot avail itself to the unused lines of credit. Management is actively negotiating for a replacement line of credit, believes that a replacement line will be obtained before expiration of the existing lines of credit and that the Company has sufficient liquidity to fund operations until this new line is in place. Although the Company has an accumulated deficit and has used cash in its operating activities over the past three years, the Company believes that its available funds together with anticipated cash from operating activities will be 9 sufficient to meet its capital requirements for the foreseeable future. The Company may sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities or issuance of equity securities in future acquisitions would result in dilution to the Company's stockholders and the incurrence of additional debt could result in additional interest expense. Business Risks In addition to the factors addressed in the preceding sections, certain dynamics of the Company's markets and operations create fluctuations in the Company's quarterly results. Uncertainty and cost containment in healthcare and competitive conditions present various other risks to operating results which are more fully described in the Company's Form 10-K filed with the SEC and other SEC filings. YEAR 2000 INTRODUCTION The Company is preparing for the impact of the year 2000 issue on its business and the businesses of its customers and suppliers. The "year 2000 issue" is a term used to describe the problems created by systems that are unable to accurately interpret dates after December 31, 1999. These problems are derived predominantly from the fact that software programs, computer equipment and embedded technology historically have categorized the "year" in a two-digit format. The year 2000 issue creates potential risks that relate to, among other things, the Company's: - - Internally-used information technology ("IT") and non-IT systems; - - Third-party products and sales, service and maintenance agreements; and - - Software products of its own design. STATE OF READINESS The Company has centralized its focus on the year 2000 issue through a cross-functional project team whose task is to identify, assess, test and remediate, as applicable, the Company's internal use systems, its sales, service and maintenance agreements and the software products of its own design. Although the Company's efforts to address year 2000 issues do not fall precisely into sequential phases, these efforts generally involve an assessment and testing phase, a deployment or remediation phase and a contingency planning phase. The Audit Committee of the Board of Directors is advised periodically on the status of the Company's year 2000 compliance program. INTERNAL USE SYSTEMS. Year 2000 issues relating to the Company's internally-used IT and non-IT systems, including computer equipment, software and devices with embedded technology (collectively, "Internal Use Systems"), could result in the Company's failure or inability to process transactions, send invoices, conduct communications or engage in similar business activities, any of which could affect materially and adversely the Company's business, results of operations and financial condition. Based upon its assessment and testing efforts to date, the Company believes that its internal local area network systems are year 2000 compliant, but that certain hardware and software relating to its Internal Use Systems will require replacement or modification through, for example, ROM-BIOS upgrades to certain hardware components and year 2000 compliant software upgrades. In the ordinary course of replacing computer equipment and software, the Company also attempts to obtain replacements that it believes are year 2000 compliant. As of March 31, 1999, the Company has assembled year 2000 compliance statements from approximately 70% of its critical vendors and suppliers. Even where assurances are received from third parties, however, risks remain that the failure of the Company's Internal Use Systems could affect materially and adversely the Company's business, results of operations and financial condition. 10 The Company estimates that, as of March 31, 1999, it had completed approximately 85% of the initiatives that it believes will be necessary to fully address potential year 2000 issues relating to its Internal Use Systems. The Company currently anticipates that its year 2000 identification, assessment, testing and remediation efforts with respect to its Internal Use Systems will be completed by September 30, 1999. Notwithstanding the above assessment, both IT and non-IT systems may contain embedded technology that could delay the Company's year 2000 identification, assessment, testing and remediation efforts with respect to its Internal Use Systems. THIRD-PARTY PRODUCTS AND SALES, SERVICE AND MAINTENANCE AGREEMENTS. Third-party products ("Third-Party Products") that are re-sold, installed and/or maintained by the Company in connection with sales, service and maintenance agreements with its customers may fail to operate properly or as expected because of year 2000 issues. These system failures could disrupt customer operations through a temporary inability to, among other things, diagnose and treat patients, operate medical communications systems, access medical information and databases, process transactions, send invoices or engage in similar medical and business activities. The Company is undertaking the following initiatives with key customers regarding Third-Party Products that it has sold or installed, or currently maintains in accordance with its contractual obligations: - - compilation of vendor, manufacturer and service provider statements and assurance regarding the year 2000 issue; - - identification of year 2000 issues; and - - notification and, as appropriate, remediation of year 2000 issues. If vendors, manufacturers and service providers of Third-Party Products do not remediate successfully Third-Party Products by the year 2000 or adequately indemnify or provide pass-through warranties for products re-sold, installed and maintained by the Company, then the Company may face claims and increased obligations under its sales, service and maintenance agreements that could affect materially and adversely its business, results of operations and financial condition. The Company currently is assessing its Year 2000 related obligations under its sales, service and maintenance agreements. To date, the Company has identified one major sales, service and maintenance agreement under which it has agreed to repair, modify and replace certain Third-Party Products that are not year 2000 compliant. Accordingly, the Company's year 2000 liability under this agreement depends on the year 2000 compliance of Third-Party Products that are re-sold, installed and/or maintained under the agreement and the Company's ability to seek adequate indemnification and/or warranty coverage from the vendors, manufacturers and service providers of Third-Party Products. The Company has verified that approximately 80% of the Third-Party Products covered by this agreement are year 2000 compliant. The customer has advised the Company that the remaining 20% of these Third-Party Products will be replaced for year 2000 compliance prior to the end of this year. Because this process is still incomplete, the Company presently cannot assure, however, that it will not incur significant expenses under this agreement that could impact materially and adversely 11 the Company's business, results of operations and financial condition. The Company estimates that, as of March 31, 1999, it had completed approximately 30% of the initiatives that it believes will be necessary to fully address potential year 2000 issues relating to Third-Party Products and its contractual obligations under key sales, service and maintenance agreements. The Company currently anticipates that its year 2000 identification, assessment, testing and remediation efforts with respect to Third-Party Products and key sales, service and maintenance agreements will be completed by September 30, 1999. COMPANY SOFTWARE PRODUCTS. The Company also distributes certain software products through its subsidiary, DAOU-Sentient, inc. The Company has completed its assessment and testing of these products and believes that they are year 2000 compliant. COSTS As of March 31, 1999, the Company had incurred costs of approximately $107,000 related to its year 2000 identification, assessment, testing and remediation, of which $37,000 was incurred for Internal Use Systems and $70,000 was incurred for its assessing liability and status of the year 2000 compliance of Third-Party Products. The Company currently estimates that the cost of its year 2000 identification, assessment, remediation, and testing efforts will not exceed $200,000, of which the Company expects to incur additional costs of $63,000 for year 2000 issues relating to Internal Use Systems and additional costs of $30,000 for the identification, assessment, and notification to customers of year 2000 issues relating to Third-Party Products that are re-sold, installed or maintained in accordance with the Company's contractual obligations. These expenditures will be funded from operating cash flows. Other non-year 2000 IT efforts have not been materially delayed or impacted by year 2000 initiatives. The costs of the Company's year 2000 identification, assessment, remediation, and testing efforts and the dates on which the Company believes it will complete such efforts are based upon management's best estimates, which are derived using numerous assumptions regarding future events. There can be no assurance that these estimates will prove to be accurate and actual results could differ materially from those currently anticipated. Specific factors that could cause material differences include, among others, increased obligations and liability under the Company's contractual obligations, the availability and cost of personnel trained in year 2000 issues and the ability to identify, assess and remediate Internal Use Systems and Third Party Products as appropriate. In addition, if year 2000 issues cause customers and prospects to defer current projects or prospective purchase decisions, then the Company's financial, business and operational goals may be delayed or may not be realized at all, causing the Company's business, results of operations and financial condition to be affected materially and adversely. RISKS 12 If certain Internal Use Systems and Third-Party Products are not year 2000 compliant, then the Company could experience a negative impact on its business, results of operations and financial condition relating to factors that include, among others: - - diversion of resources by the Company to address and/or remediate year 2000 issues; - - damage to the Company's reputation; - - litigation; - - service delays to the Company's customers arising from the failure of vendors, manufacturers and service providers to adequately address year 2000 issues; and - - increased warranty and other claims by the Company's customers and/or increased product and system repair, replacement, service and maintenance obligations under its existing and future sales, service and maintenance agreements. The Company currently cannot accurately assess or estimate the possible impact of the foregoing risks and liability because: - - there is no uniform definition of "compliance with Year 2000;" - - the legal standards for year 2000 liability presently are uncertain; - - the Company's year 2000 obligations will depend on, among other things, the varying contractual terms contained in its sales, service and maintenance agreements with respect to the particular customer and the nature of such customer's year 2000 issue; and - - there can be no assurance that indemnification or pass-through arrangements relating to the Company's sales, service and maintenance agreements will cover all of the Company's liabilities and costs incurred in year 2000 related claims. Consequently, the Company cannot provide assurances that the aggregate cost of defending and resolving the foregoing issues and claims will not affect materially and adversely the Company's business, results of operations and financial condition. CONTINGENCY PLANS The Company has not yet developed a comprehensive contingency plan to address situations that may result if the Company or any of the third parties on which the Company depends is unable to achieve year 2000 readiness. However, the Company currently expects to complete its contingency planning by September 30, 1999. This contingency planning will encompass "worst case" scenarios that assume the failure of significant communications and computing infrastructures of the Company, its customers and suppliers, together with failures of governmental infrastructures affecting transportation. The Company subsequently may identify other factors that could affect materially and adversely the Company's business, results of operations and financial condition. The foregoing statements are based on management's best estimates at the present time, which were derived using numerous assumptions of future events and conditions. There can be no assurance that these assumptions will be accurate and that estimates will be achieved. The Company's evaluation and assessment is ongoing and it expects that new or different information may become available as its assessment and evaluation continue. 13 PART II OTHER INFORMATION 1. Legal Proceedings On August 24, 1998, August 31, 1998, September 14, 1998 and September 23, 1998, separate complaints were filed against the Company and certain of its officers and directors in the United States District Court for the Southern District of California. A group of shareholders has been appointed the lead plaintiffs and they filed an amended consolidated complaint on February 24, 1999. The new complaint realleges the same theory of liability previously asserted, namely the alleged improper use of the percentage-of-completion accounting method for revenue recognition. These complaints were brought on behalf of a purported class of investors in the Company's Common Stock and do not allege specific damage amounts. In addition, on October 7, 1998 and October 15, 1998, separate complaints were filed in the Superior Court of San Diego, California. These additional complaints mirror the allegations set forth in the federal complaints and assert common law fraud and the violation of certain California statutes. By stipulation of the parties, the state court litigation has been stayed pending the resolution of a motion to dismiss, which was filed on April 12, 1999 in the federal litigation. The Company believes that the allegations set forth in all of the foregoing complaints are without merit and intends to defend against these allegations vigorously. No assurance as to the outcome of this matter can be given, however, and an unfavorable resolution of this matter could have a material adverse effect on the Company's business, results of operations and financial condition. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit No. Description - ----------- ----------- 10.1 Consulting Agreement, dated as of March 15, 1999, between Larry D. Grandia and the Registrant. 27. Financial Data Schedule (b) Current Reports on Form 8-K. The Registrant filed the following Current Reports on Form 8-K with the Commission during the quarter ended March 31, 1999: 1) On January 15, 1999, the Company filed a Current Report on Form 8-K announcing that it had entered into a five-year contract to provide information technology services to Saint Mary's Health Network of Reno, Nevada. 14 SIGNATURES Pursuant to the requirements 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: May 17, 1999 DAOU SYSTEMS, INC.
SIGNATURE TITLE DATE - ----------------------------------------------------------------------------------------------- /s/ Larry D. Grandia President and Director May 17, 1999 Larry D. Grandia /s/ Fred C. McGee Executive Vice President, Chief Financial May 17, 1999 Fred C. McGee Officer and Secretary
15 EX-10.1 2 EXHIBIT 10.1 CONSULTING AGREEMENT This Consulting Agreement (this "AGREEMENT") is made as of March 15, 1999 by and between DAOU Systems, Inc., a Delaware corporation (the "COMPANY"), and Larry D. Grandia, an individual resident of the State of Utah ("CONSULTANT"). RECITALS WHEREAS, the Company desires to retain the services of Consultant, and Consultant desires to render his services to the Company; and WHEREAS, the Company and Consultant desire to set forth in this Agreement the terms and conditions under which Consultant is to be engaged by the Company. NOW, THEREFORE, the Company and Consultant, in consideration of the mutual promises set forth herein, hereby agree as follows:. AGREEMENT 1. DEFINITIONS. For the purposes of this Agreement, the following terms have the meanings specified or referred to in this Section 1: "AAA" as defined in Section 7.9. "AGREEMENT" means this Consulting Agreement, including any exhibits hereto, as amended in writing from time to time. "BOARD OF DIRECTORS" means the board of directors of the Company. "CHANGE IN CONTROL" means a transaction whereby (a) substantially all of the outstanding shares of the Company's Common Stock are exchanged for cash or the securities (or combination thereof) of another Person , or (b) any Person becomes the beneficial owner (as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended), directly or indirectly, of more than fifty percent (50%) of the outstanding shares of the Company's Common Stock at such time. "COMPANY" as defined in the Preamble. "COMPENSATION" as defined in Section 3. "CONSULTANT" as defined in the Preamble. "CONSULTING PERIOD" means the term of Consultant's engagement set forth in Section 2.2. "EFFECTIVE DATE" means the date stated in the first paragraph of this Agreement. "PERSON" means any individual, corporation (including any non-profit corporation), general or limited partnership, limited liability company, joint venture, estate, trust, association, organization or governmental body. "POST-CONSULTING PERIOD" as defined in Section 6.2. "RULES" as defined in Section 7.9. "SERVICES" as defined in Section 2.1. 2. CONSULTING PERIOD AND DUTIES. 2.1 ENGAGEMENT. The Company hereby retains Consultant to provide certain management services as the Company's Interim President, and services acting as a liaison with acquisition candidates, as determined by the Company (collectively, the "SERVICES"), and Consultant hereby agrees to provide the Services to the Company upon the terms and conditions set forth in this Agreement. 2.2 TERM. The term of Consultant's engagement under this Agreement will begin on the Effective Date and, unless earlier terminated by Consultant, will terminate one (1) year after the Effective Date. 2.3 CONSULTANT'S SERVICES AND DUTIES. Consultant shall, in addition to providing the Services to the Company: (a) observe and conform to the policies and directions promulgated from time to time by the Board of Directors; (b) serve the Company faithfully, diligently and competently and to the best of his ability; and (c) devote the necessary business time, energy, ability, attention and skill in rendering the Services to the Company. 2.4 CHANGE IN CONTROL. Subject to Section 2.5 below, in the event of a Change in Control of the Company during the Consulting Period, Consultant will be entitled to receive an aggregate cash payment equal to One Million Five-Hundred Thousand Dollars ($1,500,000). 2.5 EMPLOYMENT AGREEMENT. Prior to the conclusion of the Consulting Period, Consultant may elect to execute and deliver the Employment Agreement in the form attached hereto as ATTACHMENT A (the "EMPLOYMENT AGREEMENT"). Upon such election by Consultant, the Company will be obligated to execute and deliver the Employment Agreement. Notwithstanding the above, the Company shall have no obligation to execute and deliver the Employment Agreement, if, prior to the date of such election by Consultant (i) the Company has entered into an agreement with respect to a merger involving exchange of shares or a similar transaction that would contemplate a Change in Control, or (ii) the Company is negotiating or engaging in discussions with respect to a merger involving exchange of shares resulting in a Change in Control. Upon final execution and delivery of the Employment Agreement, this Agreement shall terminate and be of no further force and effect. 3. COMPENSATION. 2 As compensation in full for the Services to be rendered by Consultant hereunder, the Company will pay to Consultant monthly consulting fees in the amount of Thirty Thousand Dollars ($30,000), or the pro-rata portion thereof (the "COMPENSATION"). Consultant will be responsible for the payment of all appropriate federal, state and local withholding taxes in connection with any and all payments made hereunder. Consultant will not be entitled to participate in any employee benefit plans of the Company; PROVIDED, HOWEVER, that during the Consulting Period, Consultant will be reimbursed by the Company for (i) insurance premiums paid by Consultant for the period of the consultancy resulting from Consultant's election of COBRA coverage relating to Consultant's previous employment and (ii) any taxes paid by Consultant relating to the Company's reimbursement of such premiums. 4. FACILITIES AND EXPENSES. 4.1 OFFICE SPACE, EQUIPMENT, ETC. The Company will furnish to Consultant office space, equipment, supplies and such other facilities and personnel as the Company deems necessary or appropriate for the performance of Consultant's duties under this Agreement, including the payment of reasonable expenses to equip Consultant's home office (e.g., personal computer and telephonic access) at Consultant's Utah residence. Subject to the Company's prior written approval, the Company will reimburse Consultant for out-of-pocket expenses (a) which are reasonable and necessary for Consultant to perform, and were incurred by Consultant in the course of the performance of, the Services, and (b) for which Consultant has submitted vouchers and completed an expense report in form and substance required by the Company. 4.2 OTHER EXPENSES. In addition, the Company will: (a) reimburse Consultant for the reasonable travel expenses of Consultant's spouse or Consultant's children for up to two (2) trips per month (in the aggregate) from Salt Lake City, Utah to San Diego, California; (b) provide Consultant with membership access to a golf club within reasonable proximity to Del Mar, California; and (c) reimburse Consultant for the amount that Consultant pays to acquire in his name the equity membership in the golf club to which Consultant's previous employer provided him with access, which reimbursement shall not exceed Twenty Thousand Dollars ($20,000). Consultant must file expense reports with respect to such expenses and reimbursements in accordance with the Company's policies. 4.3 AUTOMOBILE. During the Consulting Period, the Company will provide to Consultant a leased automobile commensurate with Consultant's role as the Interim President of the Company. 4.4 LODGING. During the Consulting Period, the Company shall provide to Consultant appropriate lodging in a condominium (available to Consultant on a full-time basis) reasonably satisfactory to Consultant. 4.5 COBRA COVERAGE. Consultant will be reimbursed by the Company for (i) insurance premiums paid by Consultant for a period of 18 months resulting from Consultant's election of COBRA coverage relating to Consultant's previous employment and (ii) any taxes paid by Consultant relating to the Company's reimbursement of such premiums. 5. CONFIDENTIALITY AND INVENTIONS AGREEMENT 3 Consultant hereby agrees to comply with the terms and conditions of Company's Employee Confidentiality and Inventions Agreement, attached hereto as ATTACHMENT B. 6. NON-COMPETITION AND NON-INTERFERENCE. 6.1 ACKNOWLEDGMENTS BY CONSULTANT. Consultant acknowledges that: (a) the Services to be performed by him under this Agreement are of a special, unique, unusual, extraordinary and intellectual character; (b) the Company's business is national in scope and its products and services are marketed throughout the United States; (c) the 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 6 are reasonable and necessary to protect the Company's business. 6.2 COVENANTS OF CONSULTANT. In consideration of the acknowledgments by Consultant, and the Compensation to be paid or provided to Consultant by the Company, and in recognition of the confidential information that Consultant will obtain related to the Company's business (including its customers and employees), Consultant covenants that he will not, directly or indirectly: (a) during the Consulting Period, except in the course of his engagement hereunder, 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 Consultant's name or any similar name to, lend Consultant's credit to or render services or advice to, any business whose products or activities compete in whole or in part with the products or activities of the Company; PROVIDED, HOWEVER, that Consultant may purchase or otherwise acquire up to (but not more than) one percent (1%) 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; (b) whether for Consultant's own account or for the account of any other Person, at any time during the Consulting Period and the Post-Consulting Period, solicit business of the same or similar type being carried on by the Company, from any Person known by Consultant to be a customer of the Company and with whom Consultant had personal contact during and by reason of Consultant's engagement with the Company; (c) whether for Consultant's own account or the account of any other Person, at any time during the Consulting Period and the Post-Consulting Period: (i) solicit, employ, or otherwise engage as an employee, independent contractor, or otherwise, any Person who is or was an employee of the Company at any time during the Consulting Period or in any manner induce or attempt to induce any employee of the Company to terminate his employment with the Company; or (ii) interfere with the Company's relationship with any Person, including any Person who at any 4 time during the Consulting Period was an employee, contractor, supplier or customer of the Company; or (d) at any time during or after the Consulting Period, disparage the Company or any of its stockholders, directors, officers, employees or agents. For purposes of this Section 6.2, the term "POST-CONSULTING PERIOD" means the one (1) year period beginning on the date of termination of Consultant's engagement with the Company. If any covenant in this Section 6.2 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 Consultant. The period of time applicable to any covenant in this Section 6.2 will be extended by the duration of any violation by Consultant of such covenant. Consultant will, while the covenant under this Section 6.2 is in effect, give notice to the Company, within ten (10) days after accepting employment or another consulting engagement, of the identity of the Person employing or retaining Consultant. The Company may notify such Person that Consultant is bound by this Agreement and, at the Company's election, furnish such Person with a copy of this Agreement or relevant portions thereof. 7. GENERAL PROVISIONS. 7.1 INJUNCTIVE RELIEF AND ADDITIONAL REMEDY. Consultant acknowledges that the injury that would be suffered by the Company as a result of a breach of the provisions of this Agreement (including any provision of Sections 5 and 6) would be irreparable and that an award of monetary damages to the Company for such a breach would be an inadequate remedy. Consequently, the Company will have the right, in addition to any other rights it may have, to obtain injunctive relief to restrain any breach or threatened breach or otherwise to specifically enforce any provision of this Agreement, and the Company will not be obligated to post bond or other security in seeking such relief. Without limiting the Company's rights under this Section 7 or any other remedies of the Company, if Consultant breaches any of the provisions of Section 5 or 6, the Company will have the right to cease making any payments otherwise due to Consultant under this Agreement. 7.2 COVENANTS OF SECTIONS 5 AND 6 ARE ESSENTIAL AND INDEPENDENT COVENANTS. The covenants by Consultant in Sections 5 and 6 are essential elements of this Agreement, and without Consultant's agreement to comply with such covenants, the Company would not have entered into this Agreement or engaged or continued the engagement of Consultant. The Company and Consultant have independently consulted their respective counsel and have been advised in all respects concerning the reasonableness and propriety of such covenants, with specific regard to the nature of the business conducted by the Company. 5 Consultant's covenants in Sections 5 and 6 are independent covenants and the existence of any claim by Consultant against the Company under this Agreement or otherwise will not excuse Consultant's breach of any covenant in Section 5 or 6. If Consultant's engagement hereunder expires or is terminated, this Agreement will continue in full force and effect as is necessary or appropriate to enforce the covenants and agreements of Consultant in Sections 5 and 6. 7.3 REPRESENTATIONS AND WARRANTIES BY CONSULTANT. Consultant represents and warrants to the Company that the execution and delivery by Consultant of this Agreement do not, and the performance by Consultant of his obligations hereunder will not, with or without the giving of notice or the passage of time, or both: (a) violate any judgment, writ, injunction, or order of any court, arbitrator, or governmental agency applicable to Consultant; or (b) conflict with, result in the breach of any provisions of or the termination of, or constitute a default under, any agreement to which Consultant is a party or by which Consultant is or may be bound. 7.4 WAIVER. The rights and remedies of the parties to this Agreement are cumulative and not alternative. Neither the failure nor any delay by either party in exercising any right, power, or privilege under this Agreement will operate as a waiver of such right, power, or privilege, and no single or partial exercise of any such right, power, or privilege will preclude any other or further exercise of such right, power, or privilege or the exercise of any other right, power, or privilege. To the maximum extent permitted by applicable law, (a) no claim or right arising out of this Agreement can be discharged by one party, in whole or in part, by a waiver or renunciation of the claim or right unless in writing signed by the other party; (b) no waiver that may be given by a party will be applicable except in the specific instance for which it is given; and (c) no notice to or demand on one party will be deemed to be a waiver of any obligation of such party or of the right of the party giving such notice or demand to take further action without notice or demand as provided in this Agreement. 7.5 BINDING EFFECT; DELEGATION OF DUTIES PROHIBITED. This Agreement shall inure to the benefit of, and shall be binding upon, the parties hereto and their respective successors, assigns, heirs, and legal representatives, including any entity with which the Company may merge or consolidate or to which all or substantially all of its assets may be transferred. The duties and covenants of Consultant under this Agreement, being personal, may not be delegated. 7.6 NOTICES. All notices, consents, waivers, and other communications under this Agreement must be in writing and will be deemed to have been duly given when (a) delivered by hand (with written confirmation of receipt), (b) sent by facsimile (with written confirmation of receipt), provided that a copy is mailed by registered mail, return receipt requested or (c) when received by the addressee, if sent by a nationally recognized overnight delivery service (receipt requested), in each case to the appropriate addresses and facsimile numbers set forth below (or to such other addresses and facsimile numbers as a party may designate by notice to the other parties): If to the Company: DAOU Systems, Inc. 5120 Shoreham Place San Diego, California 92122 6 ATTENTION: Chief Executive Officer and Chief Financial Officer Facsimile No.: (619) 452-2789 With a copy to: Baker & McKenzie 101 West Broadway, Twelfth Floor San Diego, California 92101-3890 ATTENTION: John J. Hentrich, Esq. Facsimile No.: (619) 236-0429 If to Consultant: Larry D. Grandia 1934 S. 850 E. Bountiful, Utah 84010 7.7 ENTIRE AGREEMENT; AMENDMENTS. This Agreement and the attachments hereto constitute 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 hereto with respect to the subject matter hereof. This Agreement may not be amended orally, but only by an agreement in writing signed by the parties hereto. 7.8 GOVERNING LAW. This Agreement will be governed by the laws of the State of California without regard to conflicts of laws principles. 7.9 BINDING ARBITRATION. Subject to the arbitration provisions set forth below, the parties hereto agree that all disputes arising out of or related to the terms and conditions of this Agreement or to the performance, breach or termination thereof, shall be submitted to binding arbitration pursuant to the Expedited Procedures of the Commercial Arbitration Rules (the "RULES") of the American Arbitration Association (the "AAA"). The arbitration will take place in San Diego, California at the offices of the AAA. The dispute will be resolved by a single arbitrator appointed by the AAA in accordance with the list procedure described in Paragraph 13 of the Rules, except that the AAA will transmit the list within ten (10) Business Days of the filing of the demand for arbitration, and the parties thereto will have five (5) Business Days to return the list to the AAA with their objections and preferences. Discovery will be limited to no more than seven (7) depositions by each side and written document requests, requesting the production of specific documents. The parties to the dispute will voluntarily produce any and all documents that they intend to use at the hearing before the close of discovery, subject to supplementation for purposes of rebuttal or good cause shown. The period for taking discovery will be sixty (60) Business Days, commencing upon the day that the answer is due under the Rules. The arbitrator will hold a pre-hearing conference within three (3) Business Days of the close of discovery and will schedule the hearing within thirty (30) Business Days of the close of discovery. After the arbitrator is selected, the arbitrator will have sole jurisdiction to hear such applications, except that any measure ordered by the arbitrator may be immediately and specifically enforced by a court otherwise having jurisdiction over the parties. All fees and costs will be allocated to the parties to the arbitration as determined by the arbitrator. Each party will pay its own fees and costs associated with the arbitration and each party will pay one-half the estimated arbitrator's fees up front and if either party fails to do so a default will be entered against such party solely with respect to such fees. Any determination of the arbitrator shall be 7 final and binding on the parties hereto. Nothing in this Agreement will prevent a party hereto from applying to a court that would otherwise have jurisdiction for provisional or interim injunctive or other equitable measures. 7.10 SECTION HEADINGS, CONSTRUCTION. The section headings in this 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 Agreement unless otherwise specified. All words used in this 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. 7.11 SEVERABILITY. If any provision of this Agreement is held invalid or unenforceable by any court of competent jurisdiction, the other provisions of this Agreement will remain in full force and effect. Any provision of this Agreement held invalid or unenforceable only in part or degree will remain in full force and effect to the extent not held invalid or unenforceable. 7.12 COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which will be deemed to be an original copy of this Agreement and all of which, when taken together, will be deemed to constitute one and the same agreement. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 8 IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement as of the date first above written. COMPANY: CONSULTANT: DAOU SYSTEMS, INC. By: /s/ Georges J. Daou By: /s/ Larry D. Grandia --------------------------------- --------------------------------- Georges J. Daou, Chief Executive Larry D. Grandia Officer 9 ATTACHMENT A EMPLOYMENT AGREEMENT 10 ATTACHMENT B EMPLOYEE CONFIDENTIALITY AND INVENTIONS AGREEMENT 11 ATTACHMENT A EMPLOYMENT AGREEMENT This Employment Agreement is made as of [__________], 1999 by DAOU Systems, Inc., a Delaware corporation ("EMPLOYER" or the "COMPANY"), and Larry D. Grandia, an individual resident of the State of Utah ("EMPLOYEE"). RECITALS WHEREAS, Employer desires to obtain the services of Employee, and Employee desires to secure employment from Employer; and WHEREAS, Employer and Employee desire to set forth in this Agreement the terms and conditions under which Employee is to be employed by Employer. NOW THEREFORE, Employer and Employee, in consideration of the mutual promises set forth herein, hereby agree as follows: AGREEMENT 1. DEFINITIONS For the purposes of this Agreement, the following terms have the meanings specified or referred to in this SECTION 1: "AAA" as defined in SECTION 10.10. "AGREEMENT" means this Employment Agreement, including any attachments hereto, as amended in writing from time to time. "BENEFITS" as defined in SECTION 3.2. "BOARD OF DIRECTORS" means the board of directors of Employer. "CAUSE" means: (a) Employee's material breach of this Agreement; (b) Employee's material failure to adhere to any written policy of Employer generally applicable to officers of the Company if Employee has been given a reasonable opportunity to comply with such policy or cure his failure to comply (which reasonable opportunity must be granted during the ten-day period preceding termination of this Agreement); (c) the appropriation (or attempted appropriation) of a material business opportunity of Employer, including attempting to secure or securing any personal profit in connection with any transaction entered into on behalf of Employer; (d) the misappropriation (or attempted misappropriation) of any of Employer's funds or property; (e) the conviction of, or the entering of a guilty plea or plea of no contest with respect to, a felony, the equivalent thereof, or any other crime with respect to which imprisonment is a possible punishment; (f) willful misconduct; (g) physical or mental disability or other inability to perform the essential functions of his position, with or without reasonable accommodation; or (h) death. "CHANGE IN CONTROL" means a transaction whereby (a) substantially all of the outstanding shares of Employer's Common Stock are exchanged for cash or the securities (or combination thereof) of another Person, or (b) any Person becomes the beneficial owner (as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended), directly or indirectly, of more than fifty percent (50%) of the outstanding shares of Employer's Common Stock at such time. "CONSULTING AGREEMENT" means the Consulting Agreement, dated as of March 1, 1999, by and between Employer and Employee. "EFFECTIVE DATE" means the date stated in the preamble of this Agreement. "EMPLOYEE" as defined in the preamble of this Agreement. "EMPLOYER" as defined in the preamble of this Agreement. "EMPLOYER'S COMMON STOCK" means Employer's common stock, $0.001 par value per share. "EMPLOYMENT" as defined in SECTION 2.1. "EMPLOYMENT PERIOD" means the term of the Employment under this Agreement. "FAIR MARKET VALUE" of one Stock Option means the amount equal to (i) the closing selling price per share of Employer's Common Stock on the date in question, as reported by the National Association of Securities Dealers on the Nasdaq National Market or any successor system, LESS (ii) the exercise price of such Stock Option. "FISCAL YEAR" means Employer's fiscal year, as it exists on the Effective Date or as changed from time to time. "INCENTIVE COMPENSATION PLAN" means Employer's Incentive Compensation Plan, attached hereto as ATTACHMENT A, as modified from time to time. "OPTION PLAN" as defined in SECTION 3.4(a). "PERFORMANCE BONUS" as defined in SECTION 3.3. "PERSON" means any individual, corporation (including any nonprofit corporation), general or limited partnership, limited liability company, joint venture, estate, trust, association, organization or governmental body. "POST-EMPLOYMENT PERIOD" as defined in SECTION 7.2. "RULES" as defined in SECTION 10.10. "SALARY" as defined in SECTION 3.1. 2 "STOCK OPTIONS" as defined in SECTION 3.4(a). 2. EMPLOYMENT TERMS AND DUTIES 2.1 EMPLOYMENT. Employer hereby employs Employee, and Employee hereby accepts employment by Employer (the "EMPLOYMENT"), upon the terms and conditions set forth in this Agreement. 2.2 AT-WILL EMPLOYMENT. Employee's Employment relationship with Employer is at-will, terminable at any time and for any reason, with or without Cause, by either Employer or Employee. While certain paragraphs of this Agreement describe events which could occur at a particular time in the future, nothing in this Agreement may be construed as a guarantee of Employment of any length. 2.3 DUTIES. Employee will serve as the [______________] of Employer and have such other duties as are assigned or delegated to Employee by the Board of Directors. Employee will (i) devote his entire business time, attention, skill and energy exclusively to the business of Employer (except for Employee's reasonable, outside board or professional activities), (ii) use his best efforts to promote the success of Employer's business and (iii) cooperate fully with the Board of Directors in the advancement of the best interests of Employer. If Employee continues to serve or is elected as a director of Employer or as a director or officer of any of its affiliates, then Employee will fulfill his duties as such director or officer without additional compensation, except as set forth in SECTION 3.4(a). 2.4 COMPLIANCE WITH EMPLOYER'S POLICIES. Employee acknowledges and agrees that compliance with Employer's policies, practices and procedures is a term and condition of the Employment under this Agreement. 3. COMPENSATION 3.1 SALARY. Employee will be paid an annual salary (the "SALARY") of Two Hundred Thirty Thousand Dollars ($230,000), which will be payable in equal periodic installments according to Employer's customary payroll practices. The Board of Directors (or a committee thereof) will review the Salary no less frequently than annually. 3.2 BENEFITS. Employee will, during the Employment Period, be permitted to participate in such pension, profit sharing, bonus, life insurance, hospitalization, major medical and other employee benefit plans of Employer that may be in effect from time to time, to the extent Employee is eligible under the terms of those plans (collectively, the "BENEFITS"). In addition, during the Employment Period, Employer will provide Employee with a life insurance policy, providing for payment of One Million Dollars ($1,000,000) to the named beneficiaries to be specified by Employee. Employee hereby represents and warrants that he is in good physical health and has not been denied medical or life insurance in the past. 3.3 ADDITIONAL COMPENSATION. As additional compensation for the services to be rendered by Employee pursuant to this Agreement, Employer will pay to Employee an annual performance bonus (the "PERFORMANCE BONUS") in an amount up to One Hundred Fifty-Thousand Dollars ($150,000) in accordance with the Incentive Compensation Plan. Upon commencement 3 of employment, Employer will pay to Employee a signing bonus in the amount of Fifty Thousand Dollars ($50,000), which signing bonus shall constitute a non-refundable advance against the Performance Bonus for Fiscal Year 1999. Subject to SECTION 8, in order to be eligible to receive the Performance Bonus, Employee must be employed by Employer on the date that the Performance Bonus is distributed by the Employer. 3.4 STOCK OPTIONS. (a) GRANT OF OPTIONS. Effective on the Effective Date, Employer will grant to Employee options representing the right to purchase up to Four Hundred Thousand (400,000) shares of Employer's Common Stock (collectively, the "STOCK OPTIONS"). Two Hundred Fifty Thousand (250,000) of the Stock Options shall be outside of the Company's 1996 Stock Option Plan (the "OPTION PLAN"). One Hundred and Fifty Thousand (150,000) of the Stock Options shall be pursuant to the Option Plan. The Stock Options granted pursuant to the Option Plan will consist of incentive stock options as defined in Internal Revenue Code Section 422(b) to the extent permitted by applicable law (generally limited to options with no more than One Hundred Thousand Dollars ($100,000) in exercise price in a given year) and the balance will be non-qualified options (non-statutory options). All of the Stock Options granted outside of the Option Plan will be non-qualified/non-statutory stock options. The exercise price for the Stock Options will be the closing price per share of Employer's Common Stock on the Effective Date. Employee will be entitled to retain and continue to vest his existing director stock options as long as he remains a director (the "DIRECTOR OPTIONS"). The Company agrees that, if permitted by law, the exercise price of the Director Options will be adjusted in the event that the exercise price of employee stock options granted under the Option Plan is adjusted. (b) VESTING SCHEDULE. The Stock Options will vest in accordance with the following schedule: (i) 50,000 of the Stock Options on the Effective Date, (ii)100,000 of the Stock Options on December 15, 1999, (iii) 100,000 of the Stock Options on December 15, 2000, and (iv) 150,000 of the Stock Options on December 15, 2001. However, in the event of a Change in Control of the Company, 70% of the then unvested Stock Options will vest immediately upon the consummation of such Change in Control, except if such Change in Control is initiated within six (6) months of the Effective Date and intended to be consummated as a merger through an exchange of equity securities. Furthermore, in the event that Employee is terminated without Cause: (i) prior to December 15, 1999, 100,000 of the Stock Options will vest immediately upon such termination; (ii) on or after December 15, 1999 but prior to December 15, 2000, an additional 100,000 of the Stock Options will vest immediately upon such termination; or (iii) on or after December 15, 2000 but prior to December 15, 2001, all of the remaining unvested Stock Options will vest immediately upon such termination. (c) OTHER TERMS. The Stock Options granted outside of the Option Plan shall contain and be subject to such other terms and conditions as are generally included in the Option Plan and the related stock option agreement except as set forth herein. In addition, Employer shall register the shares of Employer's Common Stock underlying the Stock Options by filing a Registration Statement on Form S-8 (or other available registration statement) with the Securities and Exchange Commission. 4 3.5 LOAN. Upon Employee's written request to Employer, Employer will, within thirty (30) days after receipt of such written request, loan to Employee, at the minimum interest rate permitted under applicable tax regulations, Two Hundred Thousand Dollars ($200,000) (the "LOAN"). The Loan shall be due and payable by Employee to Employer in the event and on the date of a Change in Control which occurs on or before the second anniversary of the effective date of the Loan, unless such Change in Control occurs within the first six (6) months after the Effective Date. In the event that a Change in Control occurs (i) within the first six (6) months after the Effective Date or (ii) does not occur before the second anniversary of the effective date of the Loan, the Loan will be forgiven by the Company. In the event that Employee is entitled to receive any payment pursuant to SECTION 8.2 or SECTION 8.5, Employer shall have the right to deduct from any such payment any outstanding balance with respect to the Loan made pursuant to this SECTION 3.5. Employee hereby acknowledges that the Loan and any forgiveness thereof will result in imputed income to Employee and Employee shall be responsible for payment of all applicable federal and state taxes. 3.6 MERGER AND ACQUISITION SUCCESS FEE. In the event that there is a Change in Control transaction, Employee will be afforded the opportunity to assist in the negotiations related thereto if he is still employed by the Company; and Employee will be entitled to a success fee of (i) $750,000 if such Change in Control occurs within the first six (6) months after the Effective Date or (ii) $500,000 if such Change in Control occurs after the date that is six (6) months after the Effective Date. 4. FACILITIES AND EXPENSES Employer will furnish to Employee office space, equipment, supplies and such other facilities and personnel as Employer deems necessary or appropriate for the performance of Employee's duties under this Agreement, including the payment of reasonable expenses to equip Employee's home office (e.g., personal computer and telephonic access) at Employee's Utah residence. Employer will pay on behalf of Employee (or reimburse Employee for) reasonable expenses incurred by Employee at the request of, or on behalf of, Employer in the performance of Employee's duties pursuant to this Agreement, and in accordance with Employer's employment policies, including reasonable expenses incurred by Employee in attending conventions, seminars, and other business meetings, in appropriate business entertainment activities, and for promotional expenses. Employee must file expense reports with respect to such expenses in accordance with Employer's policies. In addition, Employer will: (a) reimburse Employee for the reasonable travel expenses of Employee's spouse or Employee's children for up to two (2) trips per month (in the aggregate) from Salt Lake City, Utah to San Diego, California; (b) provide Employee with membership access to a golf club within reasonable proximity to Del Mar, California; and (c) to the extent not previously covered under the Consulting Agreement, reimburse Employee for the amount that Employee pays to acquire in his name the equity membership in the golf club to which Employee's previous employer provided him with access, which reimbursement shall not exceed Twenty Thousand Dollars ($20,000). Employee must file expense reports with respect to such expenses and reimbursements in accordance with Employer's policies. 5. VACATIONS AND HOLIDAYS 5 Employee will be entitled to four (4) weeks of paid vacation per year and holidays in accordance with Employer's policies. Employee will accrue vacation to a maximum of six (6) weeks. After Employee reaches this maximum accrual amount, he will cease to accrue additional vacation until his accrued vacation falls below this maximum accrual amount. 6. CONFIDENTIALITY; EMPLOYEE INVENTIONS Employee hereby agrees to comply with the terms and conditions of Employer's Employee Confidentiality and Inventions Agreement, attached hereto as ATTACHMENT B. 7. NON-COMPETITION AND NON-INTERFERENCE 7.1 ACKNOWLEDGMENTS BY EMPLOYEE. Employee acknowledges that: (a) the services to be performed by him under this Agreement are of a special, unique, unusual, extraordinary and intellectual character; (b) Employer's business is national in scope and its products and services are marketed throughout the United States; (c) Employer competes with other businesses that are or could be located in any part of the United States; and (d) the provisions of this SECTION 7 are reasonable and necessary to protect Employer's business. 7.2 COVENANTS OF EMPLOYEE. In consideration of the acknowledgments by Employee and the Compensation and the Benefits to be paid or provided to Employee by Employer, and in recognition of the confidential information that Employee will obtain related to Employer's business (including its customers and employees), Employee covenants that he will not, directly or indirectly: (a) during the Employment Period, except in the course of the Employment hereunder, 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 Employee's name or any similar name to, lend Employee's credit to or render services or advice to, any business whose products or activities compete in whole or in part with the products or activities of Employer; PROVIDED, HOWEVER, that Employee may purchase or otherwise acquire up to (but not more than) one percent (1%) 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; (b) whether for Employee's own account or for the account of any other Person, at any time during the Employment Period and the Post-Employment Period, solicit business of the same or similar type being carried on by Employer, from any Person known by Employee to be a customer of Employer and with whom Employee had personal contact during and by reason of the Employment with Employer; (c) whether for Employee's own account or the account of any other Person (i) at any time during the Employment Period and the Post-Employment Period, solicit, employ, or otherwise engage as an employee, independent contractor, or otherwise, any Person who is or was an employee of Employer at any time during the Employment Period or in any manner induce or attempt to induce any employee of Employer to terminate his employment 6 with Employer; or (ii) at any time during the Employment Period and the Post-Employment Period, interfere with Employer's relationship with any Person, including any Person who at any time during the Employment Period was an employee, contractor, supplier, or customer of Employer; or (d) at any time during or after the Employment Period, disparage Employer or any of its shareholders, directors, officers, employees or agents. For purposes of this SECTION 7.2, the term "POST-EMPLOYMENT PERIOD" means the one (1) year period beginning on the date of termination of the Employment with Employer. If any covenant in this SECTION 7.2 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 Employee. The period of time applicable to any covenant in this SECTION 7.2 will be extended by the duration of any violation by Employee of such covenant. Employee will, while the covenant under this SECTION 7.2 is in effect, give notice to Employer, within ten (10) days after accepting any other employment, of the identity of Employee's employer. Employer may notify such employer that Employee is bound by this Agreement and, at Employer's election, furnish such employer with a copy of this Agreement or relevant portions thereof. 8. TERMINATION PAY Effective upon the termination of this Agreement, Employer will be obligated to pay to Employee (or, in the event of his death, his designated beneficiary as defined below) only such compensation as is provided in this SECTION 8. 8.1 TERMINATION WITH CAUSE. In the event that Employer terminates Employee with Cause, Employee only will be entitled to receive the portion of the Salary and the Performance Bonus accrued and owing to Employee only through the date that such termination is effective, but will not be entitled to any compensation during any subsequent Fiscal Year. 8.2 TERMINATION WITHOUT CAUSE. In the event that Employer terminates Employee without Cause, Employee will be entitled to receive a severance payment of One Million Five Hundred Thousand Dollars ($1,500,000). Payment of this severance amount will be conditional upon Employee signing a standard form general release of claims against the Company and its directors, officers, affiliates and agents. Upon payment of such amount, Employee will not be entitled to receive any other payment under this SECTION 8. 8.3 [RESERVED.] 7 8.4 RESIGNATION. In the event that Employee resigns from Employer, Employee shall not be entitled to any termination pay, other than the portion of the Salary and the Performance Bonus accrued and owing to Employee only through the date that such resignation is effective. 8.5 NON-RENEWAL PAYMENT. In the event that, on or before August 15, 2001, the Company does not offer an employment agreement to Employee which is acceptable to Employee (after reasonable negotiations between Employer and Employee lasting for at least thirty (30) days), then Employee will be entitled to payment of One Million Five Hundred Thousand Dollars ($1,500,000); PROVIDED, HOWEVER, that payment of such amount will be conditional upon Employee signing a standard form general release of claims against the Company and its directors, officers, affiliates and agents. Upon payment of such amount, Employee will not be entitled to receive any other payment under this SECTION 8. 8.6 BENEFITS. Employee's accrual of, or participation in plans providing for, the Benefits will cease at the effective date of Employee's termination, and Employee will be entitled to accrued Benefits pursuant to such plans only as provided in such plans. 8.7 DESIGNATED BENEFICIARY. For purposes of this SECTION 8, Employee's designated beneficiary will be such individual beneficiary or trust, located at such address, as Employee may designate by notice to Employer from time to time or, if Employee fails to give notice to Employer of such a beneficiary, Employee's estate. Notwithstanding the preceding sentence, Employer will have no duty, in any circumstances, to attempt to open an estate on behalf of Employee, to determine whether any beneficiary designated by Employee is alive or to ascertain the address of any such beneficiary, to determine the existence of any trust, to determine whether any person or entity purporting to act as Employee's personal representative (or the trustee of a trust established by Employee) is duly authorized to act in that capacity, or to locate or attempt to locate any beneficiary, personal representative or trustee. 8.8 CHANGE IN CONTROL. In the event that (i) there is a Change in Control of the Company and (ii) the acquiring party in such Change in Control does not offer to Employee a position acceptable to Employee, such acquiring party will pay to Employee an amount equal to one and one-half (1 1/2) times the aggregate of the Salary and the Performance Bonus. The acquiring party will pay to Employee such amount upon the consummation of such Change in Control. 9. RELOCATION AND OTHER BENEFITS 9.1 AUTOMOBILE. During the Employment Period, Employer will provide to Employee a leased automobile commensurate with Employee's role as the [____________] of Employer. 9.2 LODGING. During the Employment Period, Employer shall provide to Employee appropriate lodging in a condominium (available to Employee on a full-time basis) reasonably satisfactory to Employee, until June 30, 2000, or longer if Employee is requested by Employer to spend a substantial portion of his time in San Diego, California. 9.3 HOUSING RELOCATION BENEFITS. Employee will be entitled to the housing relocation benefits, including reasonable moving expenses and realtor fees and the current house sales price guarantee described in ATTACHMENT C to this Agreement. 8 9.4 COBRA COVERAGE. Employee will be reimbursed by the Company for (i) insurance premiums paid by Employee for a period of 18 months resulting from Employee's election of COBRA coverage relating to Employee's previous employment and (ii) any taxes paid by Employee relating to the Company's reimbursement of such premiums. 9.5 CERTAIN ADDITIONAL PAYMENTS. (a) Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be determined that any payment or distribution by Employer or for the benefit of Employee (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 9.5) (a "PAYMENT") would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "CODE"), or any interest or penalties are incurred by Employee with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "EXCISE TAX"), then Employee shall be entitled to receive an additional payment (a "GROSS-UP PAYMENT") in an amount such that, after payment by Employee of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, Employee retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (b) Subject to the provisions of Section 9.5(c), all determinations required to be made under this Section 9.5, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by Ernst & Young LLP (the "ACCOUNTING FIRM"), which shall provide detailed supporting calculations to Employer and Employee within fifteen (15) business days of the receipt of notice from Employee that there has been a Payment, or such earlier time as is requested by Employer. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting Change in Control, Employee shall appoint another nationally recognized accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by Employer. Any Gross-Up Payment, as determined pursuant to this Section 9.5, shall be paid by Employer to Employee within five (5) days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by Employee, it shall furnish Employee with a written opinion that failure to report the Excise Tax on the Executive's applicable federal income tax return should not result in the imposition of a negligence or similar penalty. Any determination by the Accounting Firm shall be binding upon Employer and Employee. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by Employer should have been made ("UNDERPAYMENT"), consistent with the calculations required to be made hereunder. In the event that Employer exhausts its remedies pursuant to Section 9.5(c) and Employee thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by Employer to or for the benefit of Employee. 9 (c) Employee shall notify Employer in writing of any claim by the Internal Revenue Service that, if successful, would require the payment of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after Employee is informed in writing of such claim and shall apprise Employer of the nature of such claim and the date on which such claim is requested to be paid. Employee shall not pay such claim prior to the expiration of the 30-day period following the date on which it gives such notice to Employer (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If Employer notifies Employee in writing prior to the expiration of such period that it desires to contest such claim, Employee shall: (i) give Employer any information reasonably requested by Employer relating to such claim; (ii) take such action in connection with contesting such claim as Employer shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by Employer; (iii) cooperate with Employer in good faith in order effectively to contest such claim; and (iv) permit Employer to participate in any proceedings relating to such claim; PROVIDED, HOWEVER, that Employer shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold Employee harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 9.5(c), Employer shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct Employee to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and Employee agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as Employer shall determine; PROVIDED, HOWEVER, that if Employer directs Employee to pay such claim and sue for a refund, Employer shall advance the amount of such payment to Employee, on an interest-free basis and shall indemnify and hold Employee harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and FURTHER, PROVIDED, that any extension of the statute of limitations relating to payment of taxes for the taxable year of Employee with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, Employer's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and Employee shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. 10 (d) If, after the receipt by Employee of an amount advanced by Employer pursuant to Section 9.5(c), Employee becomes entitled to receive any refund with respect to such claim, Employee shall promptly pay to Employer the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by Employee of an amount advanced by Employer pursuant to Section 9.5(c), a determination is made that Employee shall not be entitled to any refund with respect to such claim and Employer does not notify Employee in writing of its intent to contest such denial of refund prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. 10. GENERAL PROVISIONS 10.1 INJUNCTIVE RELIEF AND ADDITIONAL REMEDY. Employee acknowledges that the injury that would be suffered by Employer as a result of a breach of the provisions of this Agreement (including any provision of SECTIONS 6 and 7) would be irreparable and that an award of monetary damages to Employer for such a breach would be an inadequate remedy. Consequently, Employer will have the right, in addition to any other rights it may have, to obtain injunctive relief to restrain any breach or threatened breach or otherwise to specifically enforce any provision of this Agreement, and Employer will not be obligated to post bond or other security in seeking such relief. Without limiting Employer's rights under this SECTION 10 or any other remedies of Employer, if Employee breaches any of the provisions of SECTION 6 or 7, Employer will have the right to cease making any payments otherwise due to Employee under this Agreement. 10.2 COVENANTS OF SECTIONS 6 AND 7 ARE ESSENTIAL AND INDEPENDENT COVENANTS; ADVICE OF COUNSEL. The covenants by Employee in SECTIONS 6 and 7 are essential elements of this Agreement, and without Employee's agreement to comply with such covenants, Employer would not have entered into this Agreement or employed or continued the Employment of Employee. Employer and Employee have independently consulted their respective counsel and have been advised in all respects concerning the terms of this Agreement, including the reasonableness and propriety of the above referenced covenants, with specific regard to the nature of the business conducted by Employer. Employee further confirms that he has been advised by counsel and/or tax professionals with respect to the income tax effects of the terms of his employment, including, but not limited to, potential "golden parachute" tax lability. Subject to the final execution and delivery of this Agreement, Employer will reimburse Employee for all reasonable legal and tax consulting fees (not to exceed Five Thousand Dollars ($5,000)) associated with Employee's review and negotiation of this Agreement. Employee's covenants in SECTIONS 6 and 7 are independent covenants and the existence of any claim by Employee against Employer under this Agreement or otherwise will not excuse Employee's breach of any covenant in SECTION 6 or 7. If Employee's Employment hereunder expires or is terminated, this Agreement will continue in full force and effect as is necessary or appropriate to enforce the covenants and agreements of Employee in SECTIONS 6 and 7. 11 10.3 REPRESENTATIONS AND WARRANTIES BY EMPLOYEE. Employee represents and warrants to Employer that the execution and delivery by Employee of this Agreement do not, and the performance by Employee of his obligations hereunder will not, with or without the giving of notice or the passage of time, or both: (a) violate any judgment, writ, injunction, or order of any court, arbitrator, or governmental agency applicable to Employee; or (b) conflict with, result in the breach of any provisions of or the termination of, or constitute a default under, any agreement to which Employee is a party or by which Employee is or may be bound. 10.4 OBLIGATIONS CONTINGENT ON PERFORMANCE. The obligations of Employer hereunder, including its obligation to pay the compensation provided for herein, are contingent upon Employee's performance of Employee's obligations hereunder. 10.5 WAIVER. The rights and remedies of the parties to this Agreement are cumulative and not alternative. Neither the failure nor any delay by either party in exercising any right, power, or privilege under this Agreement will operate as a waiver of such right, power, or privilege, and no single or partial exercise of any such right, power, or privilege will preclude any other or further exercise of such right, power, or privilege or the exercise of any other right, power, or privilege. To the maximum extent permitted by applicable law, (a) no claim or right arising out of this Agreement can be discharged by one party, in whole or in part, by a waiver or renunciation of the claim or right unless in writing signed by the other party; (b) no waiver that may be given by a party will be applicable except in the specific instance for which it is given; and (c) no notice to or demand on one party will be deemed to be a waiver of any obligation of such party or of the right of the party giving such notice or demand to take further action without notice or demand as provided in this Agreement. 10.6 BINDING EFFECT; DELEGATION OF DUTIES PROHIBITED. This Agreement shall inure to the benefit of, and shall be binding upon, the parties hereto and their respective successors, assigns, heirs, and legal representatives, including any entity with which Employer may merge or consolidate or to which all or substantially all of its assets may be transferred. The duties and covenants of Employee under this Agreement, being personal, may not be delegated. 10.7 NOTICES. All notices, consents, waivers, and other communications under this Agreement must be in writing and will be deemed to have been duly given when (a) delivered by hand (with written confirmation of receipt), (b) sent by facsimile (with written confirmation of receipt), provided that a copy is mailed by registered mail, return receipt requested or (c) when received by the addressee, if sent by a nationally recognized overnight delivery service (receipt requested), in each case to the appropriate addresses and facsimile numbers set forth below (or to such other addresses and facsimile numbers as a party may designate by notice to the other parties): If to Employer: DAOU Systems, Inc. 5120 Shoreham Place San Diego, CA 92122 Attention: Chairman of the Board and Chief Financial Officer Facsimile No.: (619) 452-2789 12 With a copy to: Baker & McKenzie 101 West Broadway, Twelfth Floor San Diego, California 92101-3890 ATTENTION: John J. Hentrich, Esq. Facsimile No.: (619) 236-0429 If to Employee: Larry D. Grandia 1934 S. 850 E. Bountiful, UT 84010 10.8 ENTIRE AGREEMENT; AMENDMENTS. This Agreement contains the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements and understandings, oral or written, between the parties hereto with respect to the subject matter hereof, including the Consulting Agreement. This Agreement may not be amended orally, but only by an agreement in writing signed by the parties hereto. 10.9 GOVERNING LAW. This Agreement will be governed by the laws of the State of California without regard to conflicts of laws principles. 10.10 BINDING ARBITRATION. Subject to the arbitration provisions set forth below, the parties hereto agree that all disputes arising out of or related to the terms and conditions of this Agreement or to the performance, breach or termination thereof, shall be submitted to binding arbitration pursuant to the Expedited Procedures of the Commercial Arbitration Rules (the "RULES") of the American Arbitration Association (the "AAA"). The arbitration will take place in San Diego, California, at the offices of the AAA. The dispute will be resolved by a single arbitrator appointed by the AAA in accordance with the list procedure described in Paragraph 13 of the Rules, except that the AAA will transmit the list within ten (10) Business Days of the filing of the demand for arbitration, and the parties thereto will have five (5) Business Days to return the list to the AAA with their objections and preferences. Discovery will be limited to no more than seven (7) depositions by each side and written document requests, requesting the production of specific documents. The parties to the dispute will voluntarily produce any and all documents that they intend to use at the hearing before the close of discovery, subject to supplementation for purposes of rebuttal or good cause shown. The period for taking discovery will be sixty (60) Business Days, commencing upon the day that the answer is due under the Rules. The arbitrator will hold a pre-hearing conference within three (3) Business Days of the close of discovery and will schedule the hearing within thirty (30) Business Days of the close of discovery. After the arbitrator is selected, the arbitrator will have sole jurisdiction to hear such applications, except that any measure ordered by the arbitrator may be immediately and specifically enforced by a court otherwise having jurisdiction over the parties. All fees and costs will be allocated to the parties to the arbitration as determined by the arbitrator. Each party will pay its own fees and costs associated with the arbitration and each party will pay one-half the estimated arbitrator's fees up front and if either party fails to do so a default will be entered against such party solely with respect to such fees. Any determination of the arbitrator shall be final and binding on the parties hereto. Nothing in this Agreement will prevent a party hereto from applying to a court that would otherwise have jurisdiction for provisional or interim injunctive or other equitable measures. 13 10.11 SECTION HEADINGS, CONSTRUCTION. The section headings in this 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 Agreement unless otherwise specified. All words used in this 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. 10.12 SEVERABILITY. If any provision of this Agreement is held invalid or unenforceable by any court of competent jurisdiction, the other provisions of this Agreement will remain in full force and effect. Any provision of this Agreement held invalid or unenforceable only in part or degree will remain in full force and effect to the extent not held invalid or unenforceable. 10.13 COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which will be deemed to be an original copy of this Agreement and all of which, when taken together, will be deemed to constitute one and the same agreement. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 14 IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement as of the date first above written. DAOU SYSTEMS, INC. EMPLOYEE: By: By: ------------------------------- ------------------------------ Georges J. Daou, Larry D. Grandia Chief Executive Officer 15 ATTACHMENT A INCENTIVE COMPENSATION PLAN 16 ATTACHMENT B EMPLOYEE CONFIDENTIALITY AND INVENTIONS AGREEMENT 17 ATTACHMENT C HOUSING AND RELOCATION BENEFITS Employee will be entitled to the following housing and relocation benefits: 1. In the event that, during the Employment Period, Employee elects to relocate his personal residence in Salt Lake City, Utah (the "UTAH RESIDENCE") to San Diego, California, Employee shall provide written notice of such election to Employer. Within 15 days of the date of such written notice, Employee shall obtain from three (3) licensed real estate appraisers in the Salt lake City area three (3) separate appraisals of the fair market value of the Utah Residence (collectively, the "APPRAISALS"). To the extent that (i) Employee is unable to sell the Utah Residence within 90 days after the conclusion of such 15-day period and (ii) Employee subsequently sells the Utah Residence during the Employment Period and relocates to San Diego, California to continue his employment with Employer, Employer agrees to pay to Employee the amount, if any, by which the average value of the Appraisals exceeds the actual sales price of the Utah Residence. 2. Employer will reimburse Employee for standard closing costs relating to Employee's sale of the Utah Residence as set forth above in item 1. 18 EX-27 3 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE REGISTRANTS FINANCIAL STATEMENTS AS OF MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 4,617 1,113 26,152 1,054 8,059 44,883 9,418 4,722 49,989 14,586 0 0 0 18 33,115 49,989 27,323 27,323 21,820 21,820 8,240 98 106 (2,824) (1,156) (1,668) 0 0 0 (1,668) (0.09) (0.09)
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