<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 13, 1997
REGISTRATION STATEMENT NO. 333-32873
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- --------------------------------------------------------------------------------
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 1
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
DAOU SYSTEMS, INC.
(Name of Small Business Issuer in Its Charter)
<TABLE>
<S> <C> <C>
DELAWARE 5995 330284454
(State or other jurisdiction (Primary Standard (I.R.S. Employer
of incorporation or Industrial Identification No.)
organization) Classification Code
Number)
</TABLE>
----------------
5120 SHOREHAM PLACE
SAN DIEGO, CALIFORNIA 92122
(619) 452-2221
(Address and telephone number of principal executive offices and principal place
of business)
----------------
DANIEL J. DAOU
PRESIDENT
5120 SHOREHAM PLACE
SAN DIEGO, CALIFORNIA 92122
(619) 452-2221
(Name, address and telephone number of Agent for Service)
----------------
COPIES TO:
<TABLE>
<S> <C>
JOHN J. HENTRICH, ESQ. FREDERICK T. MUTO, ESQ.
CARLOS D. HEREDIA, ESQ. JEREMY D. GLASER, ESQ.
BAKER & MCKENZIE COOLEY GODWARD LLP
101 WEST BROADWAY, TWELFTH FLOOR 4365 EXECUTIVE DRIVE, SUITE 1100
SAN DIEGO, CALIFORNIA 92101 SAN DIEGO, CALIFORNIA 92121
(619) 236-1441 (619) 550-6000
</TABLE>
----------------
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If the Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
----------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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<PAGE>
PROSPECTUS
2,365,000 SHARES
[LOGO]
COMMON STOCK
Of the 2,365,000 shares of Common Stock offered hereby, 500,000 shares are
being sold by the Company and 1,865,000 shares are being sold by the Selling
Stockholders. The Company will not receive any of the proceeds from the sale of
shares by the Selling Stockholders. See "Principal and Selling Stockholders."
The Company's Common Stock is quoted on the Nasdaq National Market under the
symbol DAOU. On August 14, 1997, the last reported sale price of the Common
Stock was $21.50 per share. See "Price Range of Common Stock."
--------------
THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 5.
-------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT (1) COMPANY (2) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per Share..................... $21.00 $1.15 $19.85 $19.85
Total (3)..................... $49,665,000 $2,719,750 $9,925,000 $37,020,250
</TABLE>
(1) See "Underwriting" for indemnification arrangements with the several
Underwriters.
(2) Before deducting expenses payable by the Company estimated at $440,000.
(3) The Selling Stockholders have granted to the Underwriters a 30-day option
to purchase up to 354,750 additional shares of Common Stock solely to cover
over-allotments, if any. If all such shares are purchased, the total Price
to Public, Underwriting Discount, Proceeds to Company and Proceeds to
Selling Stockholders will be $57,114,750, $3,127,713, $9,925,000 and
$44,062,038, respectively. See "Underwriting."
--------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, receipt and acceptance by them and subject to the right of the
Underwriters to reject any order in whole or in part and certain other
conditions. It is expected that certificates for such shares will be available
for delivery on or about August 20, 1997, at the office of the agent of
Hambrecht & Quist LLC in New York, New York.
HAMBRECHT & QUIST
ALEX. BROWN & SONS
INCORPORATED
COWEN & COMPANY
August 15, 1997
<PAGE>
[INSIDE FRONT COVER PAGE]
PHOTOGRAPH DESCRIPTIONS AND CAPTIONS
1. Top border: DAOU masthead and logo in color. Caption: Healthcare Information
Technology Solutions-- DAOU Systems designs, implements, supports and manages
computer network systems for large, complex healthcare provider organizations,
such as integrated delivery systems. Advanced computer networks enable provider
organizations to access information such as patient records, X-rays and billing
information at each location where care is provided.
2. Center left side: Color photo of DAOU engineer configuring a network of
computer servers at DAOU's on-site computer lab. Caption: Network Services --
The Company combines its knowledge of the specialized information needs of the
healthcare industry with its expertise in computer technology to design and
install advanced, reliable and cost-effective computer network solutions. The
Company uses the products and applications of various hardware and software
vendors to create advanced computer network systems.
- Network Design
- Network Implementation
3. Bottom right side corner: Color photo of individual viewing Palomar-Palmerado
Health System's website which was created by the Company. Caption: Network
Management Services -- As computer networks become increasingly complex,
provider organizations are experiencing difficulties in hiring, training and
retaining qualified personnel who can maintain the performance of their computer
network systems. DAOU's network management services are designed to continuously
monitor and enhance the efficiency and functionality of a provider
organization's computer network system. The Company offers the following
management services to its customers:
- Enterprise Network Management Services
- DAOU Employees On-Site
- Continuous Network Planning
- "Burst Mode" Implementation
- Network Support
- I/S Function Outsourcing
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE
2
<PAGE>
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ STOCK MARKET IN
ACCORDANCE WITH RULE 103 OF REGULATION M.
DAOU-SM- AND THE DAOU LOGO ARE SERVICE MARKS OF THE COMPANY. TRADEMARKS AND
SERVICE MARKS OF OTHER COMPANIES ARE ALSO REFERRED TO IN THIS PROSPECTUS.
3
<PAGE>
4
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND NOTES
THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS. EXCEPT FOR THE HISTORICAL
INFORMATION CONTAINED HEREIN, THE DISCUSSION IN THIS PROSPECTUS CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE
CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS SHOULD BE READ AS BEING APPLICABLE
TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS
PROSPECTUS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE THOSE DISCUSSED IN "RISK FACTORS," AS WELL AS THOSE DISCUSSED ELSEWHERE
HEREIN.
DAOU Systems, Inc. ("DAOU" or the "Company") designs, implements, supports
and manages advanced computer network systems primarily for hospitals,
integrated healthcare delivery networks ("IDNs"), and other healthcare provider
organizations ("provider organizations"). DAOU combines its knowledge of the
specialized information needs of the healthcare industry, including voice, video
and data requirements, with its technological expertise in computer network
systems to provide advanced, reliable and cost-effective computer network
solutions to provider organizations. The Company believes that its success is
attributable to its healthcare industry focus, depth and breadth of
technological expertise, ability to objectively evaluate its customers' computer
network systems due to its vendor independence and its history of successful
customer engagements. Since 1987, the Company has provided computer network
services to over 500 customers ranging in size from single-site organizations to
multi-state organizations with over 80 sites. The Company's customers include
Catholic Medical Center of Brooklyn and Queens, Inc., New York ("CMC"); Harris
Methodist Health, Inc., Arlington, Texas ("Harris Methodist"); Mercy Health
Services, Farmington Hills, Michigan ("Mercy"); Atlantic Health System,
Morristown, New Jersey; Lutheran Health Systems, Fargo, North Dakota; and St.
Mary's Health Network, Reno, Nevada.
Pressure to control escalating healthcare costs is causing healthcare
providers to consolidate and form multi-entity provider organizations such as
IDNs. This consolidation has resulted in the need for prompt access to
consistent and comprehensive patient information at multiple locations where
care is provided. The existing information systems in these provider
organizations are frequently inadequate because they were developed to meet the
needs of a single facility, such as a hospital or an outpatient surgery center.
In addition, the increasing variety of hardware and software applications
utilized throughout provider organizations has resulted in connectivity and
compatibility problems for many computer networks. Consequently, provider
organizations have found it increasingly difficult to internally implement and
manage their computer network systems and are looking to third parties for the
technological expertise and personnel to meet their information systems
requirements. DAOU believes that the ongoing consolidation among healthcare
provider organizations and the increasing complexity and rapid evolution of
computer network system technologies have created a significant opportunity for
companies specializing in providing computer network system solutions to
provider organizations.
DAOU offers a broad array of services to assist hospitals, IDNs and other
provider organizations in designing, implementing, supporting and managing
complex computer network systems consistent with their unique and changing
information needs. The Company's design services include an assessment of the
customer's existing computer network system and the preparation of voice, video
and data network specifications, technical design documentation and diagrams.
DAOU's implementation services include the purchase, delivery and installation
of enterprise-wide computer network systems, involving voice, video and data
applications. The Company's support and management services include remote and
on-site network management services, as well as information systems function
outsourcing ("I/S function outsourcing"), and are typically provided under
multi-year contracts. The Company provides network support services to its
customers through its regional sales and support structure and a 24-hour
technical support hotline available seven days a week. DAOU typically provides
its services on a fixed-price, fixed-time frame basis.
DAOU's strategy is to be a leading provider of advanced computer network
systems and network management services to healthcare provider organizations by
continuing to focus its sales and marketing efforts on major medical centers and
hospitals around which IDNs are forming, expanding and developing services that
complement its existing services, both internally and through acquisitions, and
continuing to develop its expertise in emerging technologies.
On July 9, 1997, the Company acquired through a pooling-of-interests merger
all of the issued and outstanding shares of Integrex Systems Corporation
("Integrex"), in exchange for 700,000 shares of Common Stock. Integrex provides
advanced network design, integration and consulting support services primarily
to healthcare organizations and also to educational and governmental
institutions. Integrex specializes in the design and integration of voice and
video networks and also designs integrated cable plants capable of supporting
voice, video and high-speed data transmission.
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company............. 500,000 shares
Common Stock offered by the Selling 1,865,000 shares
Stockholders..................................
Common Stock to be outstanding after the 11,477,499 shares (1)
offering......................................
Use of proceeds................................. Working capital and other general
corporate purposes, including possible
acquisitions.
Nasdaq National Market symbol................... DAOU
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
----------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues....................................... $ 2,728 $ 3,755 $ 9,514 $ 16,878 $ 23,767 $ 9,640 $ 14,177
Gross profit................................... 947 1,269 2,633 6,407 6,892 2,730 4,490
Income (loss) from operations.................. 1 17 182 2,197 474 1 (238)
Net income..................................... $ 5 $ 19 $ 176 $ 1,419 $ 561 $ 102 $ 60
Net income per share (2)....................... $ -- $ -- $ 0.02 $ 0.17 $ 0.06 $ 0.01 $ 0.01
Shares used in computing net income per share
(2).......................................... 7,231 7,429 7,826 8,116 9,553 9,465 11,029
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1997
-------------------------
ACTUAL AS ADJUSTED(3)
--------- --------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments.................................... $ 15,190 $ 24,675
Total assets......................................................................... 30,745 40,230
Total stockholders' equity........................................................... 25,869 35,354
</TABLE>
- ------------------------
(1) Excludes (i) 1,169,157 shares of Common Stock issuable upon exercise of
stock options outstanding under the Company's 1996 Stock Option Plan with a
weighted average exercise price of $5.93 per share at June 30, 1997, (ii)
140,300 shares of Common Stock issuable upon exercise of stock options at an
exercise price of $4.28 per share and (iii) 133,285 shares of Common Stock
issuable upon exercise of outstanding warrants at an exercise price of $4.99
per share. See "Management--1996 Stock Option Plan," "Certain Transactions,"
"Description of Capital Stock" and Note 6 of Notes to Consolidated Financial
Statements.
(2) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the calculation of net income per share.
(3) As adjusted to reflect the sale of 500,000 shares of Common Stock offered by
the Company hereby at the public offering price of $21.00 per share and the
receipt of the estimated proceeds therefrom. See "Use of Proceeds" and
"Capitalization."
------------------------
EXCEPT AS OTHERWISE SPECIFIED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO
EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION. SEE "UNDERWRITING." ALL
INFORMATION IN THIS PROSPECTUS ALSO REFLECTS THE COMBINED FINANCIAL POSITION AND
OPERATING RESULTS FOR THE COMPANY AND INTEGREX FOR ALL PERIODS PRESENTED IN THIS
PROSPECTUS.
4
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING
FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING AN INVESTMENT IN THE SHARES
OF COMMON STOCK OFFERED BY THIS PROSPECTUS. EXCEPT FOR THE HISTORICAL
INFORMATION CONTAINED HEREIN, THE DISCUSSION IN THIS PROSPECTUS CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE
CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS SHOULD BE READ AS BEING APPLICABLE
TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS
PROSPECTUS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE THOSE DISCUSSED BELOW AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS
PROSPECTUS.
MANAGEMENT OF GROWTH. The Company is currently experiencing a period of
rapid growth which has placed significant and increasing demands on the
Company's management and operational, technical, financial and other resources.
For the six months ended June 30, 1997, the Company's revenues increased 47% to
$14.2 million from $9.6 million for the six months ended June 30, 1996. For the
year ended December 31, 1996, the Company's revenues increased 41% to $23.8
million from $16.9 million for the year ended December 31, 1995. For the year
ended December 31, 1995, the Company's revenues increased 77% to $16.9 million
from $9.5 million for the year ended December 31, 1994. In addition, since
January 1, 1995, the Company's workforce increased from 78 to 234 full-time
employees as of July 31, 1997. Further increases in staffing levels are expected
during the remainder of 1997 and during 1998. This growth has resulted in new
and increased responsibilities for management personnel and has placed
significant demands on the Company's management and operating and financial
systems. The Company will be required to continue to develop and improve its
operational, financial and other internal systems to accommodate the increased
number of transactions and customers and the increased size of the Company's
operations, workforce and facilities. There can be no assurance, however, that
the Company's management or systems will be adequate to support the Company's
existing or future operations. Any failure to develop and improve the Company's
systems or to hire and retain appropriate personnel to manage its operations
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, any future unexpected
shortfall in revenues without a corresponding and timely reduction in staffing
and other expenses (or redeployment of employees to other customer projects), or
any staffing increase that is unaccompanied by a corresponding increase in
revenues, could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
NEED TO ATTRACT AND RETAIN KEY EMPLOYEES AND QUALIFIED NETWORK ENGINEERS.
The Company's success and execution of its business strategy will depend in
large part on the continued services of its key management and technical
personnel. The loss of the services of one or more of the Company's key
employees or the inability to hire additional key personnel as needed could have
a material adverse effect on the Company's business, financial condition and
results of operations. The Company's business involves the delivery of computer
network services and is labor-intensive. As a result, its future success will
depend in large part on its ability to hire, train and retain qualified network
engineers who together have expertise in a wide array of network and computer
systems and a broad understanding of the provider organizations that the Company
serves. Competition for qualified network engineers is intense and is expected
to increase. In particular, competition is intense for the limited number of
qualified management personnel and senior network engineers. There can be no
assurance that the Company will be successful in attracting and retaining such
personnel. While the Company is currently experiencing low rates of turnover,
there can be no assurance that these rates of turnover will not increase in the
future. Any inability of the Company to hire, train and retain a sufficient
number of qualified network engineers could impair the Company's ability to
adequately manage and complete its existing projects or to obtain new projects,
which, in turn, could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and
"Business--Recruiting and Training of Technical Employees."
5
<PAGE>
RISKS ASSOCIATED WITH ACQUISITIONS. On July 9, 1997, the Company acquired
through a pooling-of-interests merger all of the issued and outstanding shares
of Integrex. The Company currently intends as part of its business strategy to
pursue additional acquisitions of complementary businesses as it seeks to
compete in the rapidly changing industry of healthcare information technology.
Acquisitions involve numerous risks, including difficulties in the assimilation
of the operations and personnel of the acquired business, the integration of
management information and accounting systems of the acquired business, the
diversion of management's attention from other business concerns, risks of
entering markets in which the Company has no direct prior experience, and the
potential loss of key employees of the acquired business. The Company's
management will be required to devote substantial time and attention to the
integration of these businesses and to any material operational or financial
problems arising as a result of the acquisitions. There can be no assurance that
operational or financial problems will not occur as a result of any acquisition.
Failure to effectively integrate acquired businesses could have a material
adverse effect on the Company's business, results of operations and financial
condition.
The Company intends to continue to evaluate potential acquisitions of, or
investments in, companies which the Company believes will complement or enhance
its existing business. Future acquisitions by the Company may result in
potentially dilutive issuances of equity securities, the incurrence of
additional debt and amortization expenses related to goodwill and other
intangible assets which could adversely affect the Company's business, financial
condition and results of operations. The Company currently does not have any
arrangements or understandings with respect to any specific future acquisitions.
There can be no assurance that the Company will consummate any acquisition in
the future or, if consummated, that any such acquisition will ultimately be
beneficial to the Company. See "Business--Recent Acquisition."
CONTRACT CANCELLATION RIGHTS; ABSENCE OF LONG-TERM CONTRACTS. Although the
Company enters into agreements with certain of its customers which contemplate
multi-year contract terms, certain of the Company's customers are able to reduce
or cancel their use of the Company's services before the end of the contract
term. For example, Candler Health System, Savannah, Georgia ("Candler"), a large
I/S outsourcing customer of the Company, recently terminated its contract with
the Company effective November 30, 1997, which termination was influenced by
Candler's consolidation with another healthcare enterprise. The Company believes
that the number and size of its existing projects are not reliable indicators or
measures of future revenues. In addition, the Company has in the past provided,
and is likely in the future to provide, services to customers without long-term
contracts. When a customer defers, modifies or cancels a project, the Company
must be able to rapidly redeploy network engineers and other personnel to other
projects in order to minimize the under-utilization of employees and the
resulting adverse impact on operating results. In addition, the Company's
operating expenses are relatively fixed and cannot be reduced on short notice to
compensate for unanticipated variations in the number or size of projects in
progress. As a result, any termination, significant reduction or modification of
its business relationships with any of its significant customers or with a
number of smaller customers could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business--Sales and Marketing."
VARIABILITY OF QUARTERLY OPERATING RESULTS. A substantial majority of the
Company's operating expenses, particularly personnel and related costs,
depreciation and rent, are relatively fixed in advance of any particular
quarter. However, variations in the Company's revenues and operating results may
occur from time to time, as a result of various factors, including: (i) the
reduction in size, delay in commencement, interruption or termination of one or
more significant projects or contracts; (ii) the commencement or completion
during a quarter of one or more significant projects; (iii) the failure to
estimate accurately the resources required to complete new or ongoing projects;
(iv) the relatively longer sales cycle in obtaining new customers and larger
contracts; (v) the timing and extent of employee training or the loss of key
employees; (vi) competition; (vii) the development and introduction of new
services; (viii) the effect of acquisitions; and (ix) general economic
conditions which may affect the buying decisions of the Company's current and
prospective customers. In addition, the Company plans to continue to expand its
operations by hiring additional network engineers and other employees, and
6
<PAGE>
adding new offices, systems and other infrastructure. The resulting increase in
operating expenses may be incurred prior to any increase in revenues.
Consequently, the Company's business, financial condition and results of
operations would be materially and adversely affected if revenues do not
increase to support such expenses. A variation in the timing of the commencement
or completion of customer assignments, particularly at or near the end of any
quarter, may cause significant variations in operating results from quarter to
quarter and could result in losses for a particular quarter. In addition, an
unanticipated delay or termination of a major project could require the Company
to maintain or terminate under-utilized employees which could, in either case,
result in higher than expected expenses during a quarter. The Company believes
that quarterly revenues and operating results are likely to vary significantly
in the future and that period-to-period comparisons of its revenues and
operating results are not necessarily meaningful and should not be relied on as
indications of future performance. Furthermore, these variations in revenues and
operating results could cause significant variations in the price of the
Company's Common Stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
CUSTOMER CONCENTRATION. The Company has derived, and believes that it will
continue to derive, a significant portion of its revenues from a relatively
limited number of large customer contracts. During the six months ended June 30,
1997, the Company's five largest customers accounted for approximately 51% of
total revenues, with Candler, Mercy and CMC accounting for approximately 15%,
11% and 10% of such revenues, respectively. In 1996, the Company's five largest
customers accounted for approximately 58% of total revenues, with CMC, Mercy and
Candler accounting for approximately 17%, 14% and 12% of such revenues,
respectively. In 1995, the Company's five largest customers accounted for
approximately 65% of total revenues, with Mercy and Candler accounting for
approximately 41% and 9% of such revenues, respectively. The volume of work
performed for specific customers is likely to vary from year to year, and a
major customer in one year may not provide the same level of revenues in any
subsequent year. For example, Candler, a large I/S outsourcing customer of the
Company, recently terminated its contract with the Company effective November
30, 1997, which termination was influenced by Candler's consolidation with
another healthcare enterprise. The loss of any large customer could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Risk Factors--Consolidation and Uncertainty in the
Healthcare Industry" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
PROJECT RISKS. The Company's computer network systems are designed to
provide access to and accurate delivery of a wide range of information within a
provider organization, including information used by clinicians in the diagnosis
and treatment of patients. Many of the Company's projects are critical to the
operation of its customers' businesses and, therefore, the Company may expose
itself to potentially adverse risks in the event that the Company's services do
not meet the desired expectations of its customers. For example, the failure to
perform services that meet a customer's expectations may result in the Company
not being paid for services rendered and may damage the Company's reputation and
adversely affect its ability to attract new business. In addition, any failure
by the Company's computer network systems to provide accurate, reliable and
timely information could result in claims against the Company. For example,
where the unavailability of such information to a provider of healthcare
services is alleged to have resulted in any physical or emotional injury to a
patient, such provider may become subject to a medical malpractice, product
liability or other claim. The Company could then become subject to a claim
relating to its installation or management of a computer network system. The
Company is also subject to claims by its customers for actions of the Company's
employees which may have caused damages to customers' businesses or otherwise.
Although the Company maintains errors or omissions insurance, there can be no
assurance that such insurance coverage would adequately cover any claims
asserted against the Company and any such claim could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, there can be no assurance that the Company will not be subject to
claims that will result in liability in excess of its insurance coverage or that
appropriate insurance will continue to be available to the Company in the future
at commercially reasonable rates. See "Business--Information Technology
Services."
7
<PAGE>
LONG SALES AND PROJECT DELIVERY CYCLES. The Company's sales process is
often subject to delays associated with the lengthy approval process that
typically accompanies significant capital expenditures by a customer. During
this process, the Company expends substantial time, effort and resources
marketing its services, preparing contract proposals and negotiating contracts.
Any failure by the Company to procure a signed contract after expending
significant time, effort and resources could have a material adverse effect on
the Company's business, financial condition and results of operations. The
delivery of computer network services generally requires a significant
commitment of resources by the Company and by the customer. The length of time
required to complete a project may depend on many factors outside the control of
the Company, including the state of the customer's existing information systems,
budgetary constraints and the customer's ability to commit the personnel and
other resources necessary to complete elements of the project for which the
customer is responsible. In certain instances, projects have been prolonged
substantially as a result of delays attributable to customers. Consequently, the
failure of the Company to deliver its services on a timely and cost-efficient
basis could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business--Sales and Marketing" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
COMPETITION. The healthcare network services industry is comprised of a
large number of participants and is subject to rapid change and intense
competition. The Company's competitors include system integrators, value added
resellers ("VARs"), consulting companies, local and regional network services
firms, telecommunications providers and network equipment, computer systems and
healthcare software vendors, many of which have significantly greater financial,
technical and marketing resources and greater name recognition than does the
Company. In particular, the Company competes with (i) large information
technology companies such as Hewlett-Packard Company ("Hewlett-Packard"),
Electronic Data Systems Corporation ("EDS"), and Integrated Systems Solutions
Corporation, a subsidiary of International Business Machines Corporation
("IBM"); (ii) healthcare information technology companies such as HBO & Company;
and (iii) smaller regional network systems firms. In addition, the Company has
faced, and expects to continue to face, additional competition from new entrants
into its markets. Other healthcare information technology companies not
presently offering or emphasizing network systems services and large network
services companies not currently focusing on healthcare may enter the Company's
markets. Increased competition could result in price reductions, fewer customer
projects, under-utilization of employees, reduced operating margins and loss of
market share, any of which could materially and adversely affect the Company's
business, financial condition and results of operations. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors. The failure of the Company to compete successfully would
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, most of the Company's customers have
internal network support and service capabilities and could choose to satisfy
their needs through internal resources rather than through outside service
providers. As a result, the decision by the Company's customers or potential
customers to perform network services internally could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Business--Competition."
FIXED-PRICE, FIXED-TIME FRAME CONTRACTS. The Company offers the majority of
its computer network systems services on a fixed-price, fixed-time frame basis,
rather than on a time-and-expense basis. Consequently, the Company bears the
risk of cost over-runs in connection with these projects. The Company's failure
to estimate accurately the resources and time required for a project or its
failure to complete its contractual obligations within the fixed-time frame
committed could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
CONSOLIDATION AND UNCERTAINTY IN THE HEALTHCARE INDUSTRY. Substantially all
of the Company's revenues are derived from customers involved in the healthcare
industry. As a result, the Company's business, financial condition and results
of operations are influenced by conditions affecting this industry. Many
provider organizations are consolidating to create larger organizations with
greater regional market power and are forming affiliations for purchasing
products and services. This consolidation could reduce the Company's target
market
8
<PAGE>
and result in the termination of certain engagements of the Company. In
particular, this consolidation has resulted, and is likely to continue to
result, in the acquisition of certain of the Company's customers, and such
customers may scale back or terminate their relationship with the Company
following their acquisition. Moreover, these consolidating and affiliating
enterprises could also have greater bargaining power which could lead to
reductions in the amounts paid to the Company for its services. The reduction in
the size of the Company's target market or the failure of the Company to
maintain adequate price levels could have a material adverse effect on the
Company's business, financial condition and results of operations. The
healthcare industry is also subject to changing political, economic and
regulatory influences that may affect the procurement practices and operations
of participants in the healthcare industry. The Company cannot predict with any
certainty what impact, if any, these developments could have on its business,
financial condition and results of operations. See "Business--Industry
Overview."
RAPID TECHNOLOGICAL CHANGE. The Company has derived, and expects to
continue to derive, substantially all of its revenues from projects based on
complex computer networks. The markets for computer network products and
services are continuing to develop and are subject to rapid change. The
Company's success will depend in part on its ability to offer services that keep
pace with continuing changes in technology, evolving industry standards and
changing customer preferences and to hire, train and retain network engineers
who can fulfill the increasingly complex needs of its customers. There can be no
assurance that the Company will be successful in addressing these developments
in a timely manner. Any delay or failure by the Company to address these
developments could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, there can be no
assurance that products, systems or technologies developed by third parties will
not render certain of the Company's services noncompetitive or obsolete. See
"Business-- Information Technology Services."
DEPENDENCE ON THIRD-PARTY HARDWARE AND SOFTWARE VENDORS. The network
systems solutions delivered by the Company utilize the products of third-party
hardware and software vendors. A significant portion of the Company's
implementation service revenues are derived from the purchase and resale of
these products. Although the Company has distribution agreements with certain
product vendors, there can be no assurance that these agreements will be
renewed. Any significant adverse change in any of these relationships could have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Business--Information Technology Services."
FUTURE ADDITIONAL CAPITAL REQUIREMENTS. Since its inception, the Company
has financed its operations through cash provided by operations, the sale of
equity and through debt. In the event that the Company is unable to generate
sufficient revenues to fund its operations in the future, the Company may be
required to raise additional funds to meet its capital and operating
requirements through public or private financing, including equity financing.
Any additional equity financing may be dilutive to stockholders, and debt
financing, if available, will require payment of interest and may involve
restrictive covenants that could impose limitations on the operating flexibility
of the Company. Adequate funds for the Company's operations may not be available
when needed and, if available, may not be on terms attractive to the Company.
The failure to obtain funding on a timely basis could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
CONTROL BY EXISTING STOCKHOLDERS AND MANAGEMENT. Upon the completion of
this offering, the present executive officers, directors and their respective
family members and affiliates will beneficially own approximately 50% of the
outstanding Common Stock (approximately 47% if the Underwriters' over-allotment
option is exercised in full). As a result, these stockholders will be able to
exercise significant influence over all matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions. Such concentration of ownership may also have the effect of
delaying or preventing a change in control of the Company. See "Principal and
Selling Stockholders" and "Description of Capital Stock."
BROAD MANAGEMENT DISCRETION OVER USE OF PROCEEDS. The primary purpose of
the offering of the shares to be sold by the Company is to increase the
Company's equity capital. The anticipated net proceeds to the
9
<PAGE>
Company from this offering have not been designated for specific uses.
Accordingly, management of the Company will have broad discretion with respect
to the use of these funds. See "Use of Proceeds."
POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Common Stock
has been, and is likely to continue to be, volatile. Factors such as
announcements of new customer contracts or services by the Company or its
competitors, changes in pricing policies by the Company or its competitors,
quarterly fluctuations in the Company's operating results, announcements
relating to strategic relationships or acquisitions, changes in earnings
estimates by analysts, government regulatory actions, general conditions in the
market for computer network services, overall market conditions and other
factors may have a significant impact on the market price of the Common Stock.
In addition, in recent years the stock market in general, and the shares of
technology companies in particular, have experienced extreme price fluctuations.
This volatility has had a substantial effect on the market prices of securities
issued by many companies for reasons unrelated to the operating performance of
the specific companies. These broad market fluctuations may adversely affect the
market price of the Common Stock. See "--Variability of Quarterly Operating
Results."
SHARES ELIGIBLE FOR FUTURE SALE; RELEASE OF LOCK-UP ON EXISTING SHARES.
Sales of substantial amounts of Common Stock in the public market after this
offering, or the possibility of such sales occurring, could adversely affect
prevailing market prices for the Common Stock. Of the 11,487,320 shares to be
outstanding after this offering, 4,384,642 shares of Common Stock will be freely
tradeable without restriction in the public market, unless such shares are held
by "affiliates" of the Company, as such term is defined in Rule 144 ("Rule 144")
promulgated under the Securities Act of 1933, as amended (the "Securities Act").
The remaining 7,102,678 shares will be "restricted securities" as such term is
defined in Rule 144.
Holders of approximately 8.3 million shares of Common Stock entered into
lock-up agreements in connection with the Company's initial public offering
whereby they agreed not to offer, sell or otherwise dispose of any shares of
Common Stock, or options or warrants to acquire shares of Common Stock, owned by
them for a period of 180 days after the effective date of the registration
statement for the Company's initial public offering. Such 180-day period
expired, and such holders of Common Stock were released from such lock-up
agreements, on August 11, 1997, at which time those shares of Common Stock could
be sold in the public market if registered under the Securities Act, or if they
qualified for an exemption from registration under Rule 144. From the date of
this Prospectus, approximately 5.7 million shares of Common Stock will become
subject to new lock-up agreements as set forth below.
The Selling Stockholders and the directors and executive officers of the
Company have agreed not to offer, sell or otherwise dispose of any of their
shares of Common Stock for a period of 60 days after the date of this Prospectus
without the prior written consent of Hambrecht & Quist LLC. At the end of this
period, 50% of these shares will become eligible for sale and the remaining 50%
will become eligible for sale 90 days after the date of this Prospectus. The
Company also has entered into an agreement with the Underwriters that it will
not offer, sell or otherwise dispose of shares of Common Stock for a period of
90 days from the date of this Prospectus other than pursuant to the Company's
1996 Stock Option Plan and pursuant to currently outstanding warrants or in
connection with certain acquisition transactions. The Underwriters may, in their
sole discretion and at any time without notice, release all or any portion of
the shares subject to such lock-up agreements. Upon the completion of this
offering, the beneficial owners of approximately 1.7 million shares of Common
Stock and 133,285 shares of Common Stock issuable upon the exercise of
outstanding warrants will be entitled to certain registration rights with
respect to such shares upon the release of applicable lock-up agreements. In
addition, the Company has registered on a Form S-8 Registration Statement an
aggregate of 1,367,925 shares of Common Stock reserved for issuance under its
1996 Stock Option Plan, of which options to purchase a total of 1,169,157 shares
were outstanding as of June 30, 1997. As of such date, an additional 140,300
shares of Common Stock were subject to other outstanding stock options. See
"Principal and Selling Stockholders," "Shares Eligible for Future Sale" and
"Underwriting."
POTENTIAL ANTI-TAKEOVER EFFECTS OF DELAWARE LAW AND CERTAIN CHARTER
PROVISIONS. Certain provisions of Delaware law applicable to the Company could
delay or make more difficult a merger, tender offer or proxy
10
<PAGE>
contest involving the Company, including Section 203 of the Delaware General
Corporation Law, which prohibits a Delaware corporation from engaging in any
business combination with any interested stockholder for a period of three years
from the date the person became an interested stockholder unless certain
conditions are met. In addition, the Board of Directors of the Company may issue
shares of Preferred Stock without stockholder approval on such terms as the
Board may determine. The rights of the holders of Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. In addition, the Company's Certificate
of Incorporation and Bylaws provide for a classified board of directors,
eliminate the right of stockholders to act by written consent without a meeting,
require advanced stockholder notice to nominate directors and raise matters at
the annual stockholders meeting, eliminate cumulative voting in the election of
directors and allow for the removal of directors only for cause and with a
two-thirds vote of the Company's outstanding shares. All of the foregoing could
have the effect of delaying, deferring or preventing a change in control of the
Company and could limit the price that certain investors might be willing to pay
in the future for shares of the Company's Common Stock. See "Management" and
"Description of Capital Stock--Certain Change of Control Provisions."
ABSENCE OF DIVIDENDS. The Company has never declared nor paid cash
dividends on its capital stock. The Company currently intends to retain any
earnings for funding growth and, therefore, does not intend to pay any cash
dividends in the foreseeable future. See "Dividend Policy."
11
<PAGE>
THE COMPANY
DAOU Systems, Inc. was incorporated in California in 1987 and reincorporated
in Delaware in January 1997. DAOU-Integrex, Inc., a Delaware corporation and
wholly-owned subsidiary of the Company, is the surviving corporation of the
Company's pooling-of-interests merger with Integrex. Unless the context
otherwise requires, references in this Prospectus to "DAOU" and the "Company"
refer to DAOU Systems, Inc., a Delaware corporation, and its subsidiary. The
Company's executive offices are located at 5120 Shoreham Place, San Diego,
California 92122. Its telephone number is (619) 452-2221.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 500,000 shares of
Common Stock offered by the Company hereby at the public offering price of
$21.00 per share are approximately $9.5 million, after deducting the
underwriting discount and the estimated expenses of this offering. The Company
will not receive any proceeds from the sale of shares of Common Stock by the
Selling Stockholders.
The Company expects to use the net proceeds from this offering principally
for working capital and general corporate purposes. The Company also anticipates
using a portion of the proceeds to fund acquisitions of complementary
businesses, although there are no current arrangements or understandings with
respect to any specific acquisitions. There can be no assurance that the Company
will complete any acquisitions in the future. Pending use of the net proceeds
for the above purposes, the Company intends to invest the net proceeds of this
offering in short-term, interest bearing, investment grade securities.
PRICE RANGE OF COMMON STOCK
The Company effected its initial public offering on February 12, 1997 at a
price to the public of $9.00 per share. Since that date, the Common Stock has
traded on the Nasdaq National Market under the symbol DAOU. The following table
sets forth for the periods indicated the high and low sale prices for the Common
Stock as reported by the Nasdaq National Market:
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
1997
1st Quarter (from February 12, 1997)......................................................... 9.750 6.000
2nd Quarter.................................................................................. 19.250 5.625
3rd Quarter (through August 14, 1997)........................................................ 25.375 15.250
</TABLE>
On August 14, 1997, the last reported sale price of the Common Stock on the
Nasdaq National Market was $21.50. As of June 30, 1997, there were approximately
48 holders of record of the Common Stock.
DIVIDEND POLICY
The Company has never declared nor paid cash dividends on its capital stock.
The Company currently intends to retain any earnings for funding growth and,
therefore, does not intend to pay any cash dividends in the foreseeable future.
12
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1997 (i) on an actual basis and (ii) as adjusted to give effect to the sale
by the Company of the 500,000 shares of Common Stock offered hereby at the
public offering price of $21.00 per share and the estimated proceeds therefrom.
This table should be read in conjunction with the Company's Consolidated
Financial Statements and the Notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1997
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
Stockholders' equity (1):
Preferred stock: $.001 par value, 5,000,000 shares authorized, actual and as adjusted;
no shares issued and outstanding, actual and as adjusted.............................. $ -- $ --
Common stock: $.001 par value, 50,000,000 shares authorized, actual and as adjusted;
10,977,499 shares issued and outstanding, actual; and 11,477,499 shares issued and
outstanding, as adjusted (2).......................................................... 12 12
Additional paid-in capital.............................................................. 24,664 34,149
Deferred compensation................................................................... (1,037) (1,037)
Retained earnings....................................................................... 2,230 2,230
--------- -----------
Total stockholders' equity............................................................ 25,869 35,354
--------- -----------
Total capitalization................................................................ $ 25,869 $ 35,354
--------- -----------
--------- -----------
</TABLE>
- ------------------------
(1) The Company does not have any long-term debt.
(2) Excludes (i) 1,169,157 shares of Common Stock issuable upon exercise of
stock options outstanding under the Company's 1996 Stock Option Plan with a
weighted average exercise price of $5.93 per share at June 30, 1997, (ii)
140,300 shares of Common Stock issuable upon exercise of stock options at an
exercise price of $4.28 per share and (iii) 133,285 shares of Common Stock
issuable upon exercise of outstanding warrants at an exercise price of $4.99
per share. See "Management--1996 Stock Option Plan," "Certain Transactions,"
"Description of Capital Stock" and Note 6 of Notes to Consolidated Financial
Statements.
13
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements of the
Company and Notes thereto included elsewhere in this Prospectus. The
consolidated statements of operations data for the years ended December 31,
1994, 1995 and 1996 and the consolidated balance sheet data at December 31, 1995
and 1996 are derived from the Company's consolidated financial statements that
have been audited by Ernst & Young LLP, independent auditors, included elsewhere
in this Prospectus. The consolidated statements of operations data for the six
month periods ended June 30, 1996 and 1997 and the consolidated balance sheet
data at June 30, 1997 are derived from unaudited consolidated financial
statements included elsewhere in this Prospectus. The consolidated balance sheet
data as of December 31, 1994 is derived from the Company's audited consolidated
balance sheet not included in this Prospectus. The selected financial data as of
December 31, 1992 and 1993 and for the years then ended is derived from
unaudited financial data not included in this Prospectus. The data at and for
the six months ended June 30, 1996 and June 30, 1997 include, in the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the Company's financial position at those
dates and results of operations for those periods. The results of operations for
the six months ended June 30, 1997 are not necessarily indicative of the results
to be expected for the full year or future periods.
<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------------------- ----------------
1992 1993 1994 1995 1996 1996 1997
------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues........................................ $ 2,728 $ 3,755 $ 9,514 $16,878 $23,767 $ 9,640 $14,177
Cost of revenues................................ 1,781 2,486 6,881 10,471 16,875 6,910 9,687
------- ------- ------- ------- ------- ------- -------
Gross profit.................................... 947 1,269 2,633 6,407 6,892 2,730 4,490
Operating expenses:
Sales and marketing........................... 390 658 860 1,055 2,158 831 2,344
General and administrative.................... 556 594 1,591 3,155 4,260 1,898 2,384
------- ------- ------- ------- ------- ------- -------
Total operating expenses........................ 946 1,252 2,451 4,210 6,418 2,729 4,728
------- ------- ------- ------- ------- ------- -------
Income (loss) from operations................... 1 17 182 2,197 474 1 (238)
Interest income, net............................ 4 2 13 73 208 123 329
------- ------- ------- ------- ------- ------- -------
Income before income taxes...................... 5 19 195 2,270 682 124 91
Provision for income taxes...................... -- -- 19 851 121 22 31
------- ------- ------- ------- ------- ------- -------
Net income...................................... 5 19 176 1,419 561 102 60
Accretion of redeemable preferred stock......... -- -- -- 87 485 39 --
------- ------- ------- ------- ------- ------- -------
Net income attributable to common stock......... $ 5 $ 19 $ 176 $ 1,332 $ 76 $ 63 $ 60
------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- -------
Net income per share (1)........................ $ -- $ -- $ 0.02 $ 0.17 $ 0.06 $ 0.01 $ 0.01
------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- -------
Shares used in computing net income per share
(1)........................................... 7,231 7,429 7,826 8,116 9,553 9,465 11,029
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------- JUNE 30,
1992 1993 1994 1995 1996 1997
--------- --------- --------- --------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments.................................... $ 81 $ 309 $ 293 $ 6,387 $ 2,447 $ 15,190
Total assets..................................... 557 1,699 2,122 13,588 13,524 30,745
Long-term debt, less current portion............. 8 4 -- -- -- --
Redeemable preferred stock....................... -- -- -- 7,705 8,190 --
Total stockholders' equity....................... 52 -- 299 1,654 1,837 25,869
</TABLE>
- --------------------------
(1) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the calculation of net income per share.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
"SELECTED CONSOLIDATED FINANCIAL DATA" AND THE COMPANY'S CONSOLIDATED FINANCIAL
STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS PROSPECTUS. EXCEPT FOR
THE HISTORICAL INFORMATION CONTAINED HEREIN, THE DISCUSSION IN THIS PROSPECTUS
CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES,
EXPECTATIONS AND INTENTIONS. THE CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS
SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS
WHEREVER THEY APPEAR IN THIS PROSPECTUS. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED HEREIN. FACTORS THAT
COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED IN "RISK
FACTORS," AS WELL AS THOSE DISCUSSED ELSEWHERE HEREIN.
OVERVIEW
The Company designs, implements, supports and manages advanced computer
network systems primarily for hospitals, IDNs and other provider organizations.
The Company believes that its success is attributable to its healthcare industry
focus, depth and breadth of technological expertise, ability to objectively
evaluate its customers' computer network systems due to its vendor independence
and its history of successful customer engagements. The Company's design
services include an assessment of the customer's existing computer network
system, the preparation of voice, video and data network specifications,
technical design documentation and diagrams. DAOU's implementation services
include the purchase, delivery and installation of enterprise-wide computer
network systems. Implementation service revenues consist of third-party hardware
and software products, as well as the Company's professional services. 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. The Company's support and management services include
remote and on-site network management, as well as I/S function outsourcing. The
Company typically provides these services under multi-year contracts.
In July 1997, the Company acquired through a pooling-of-interests merger all
of the issued and outstanding shares of Integrex in exchange for 700,000 shares
of Common Stock. Integrex provides advanced network design, integration and
consulting support services primarily to healthcare organizations and also to
educational and governmental institutions. Integrex specializes in the design
and integration of voice and video networks and also designs integrated cable
plants capable of supporting voice, video and high-speed data transmission. The
Company's Consolidated Financial Statements and Notes thereto reflect the
combined financial position and operating results for the Company and Integrex
for all periods presented in this Prospectus. The Company anticipates that it
will record merger related costs of approximately $400,000 (net of tax
benefits), all of which will be charged to operating results in the third
quarter of 1997.
Candler, a large I/S outsourcing customer of the Company, recently
terminated its contract with the Company effective November 30, 1997. The
Company anticipates that, in addition to revenue from specified services under
the Candler contract, it will recognize a total of approximately $500,000 during
the third and fourth quarters of 1997 as a result of the termination fee payable
by Candler under the contract.
Historically, the majority of the Company's revenues have been derived from
network design and implementation services which are generally provided on a
fixed-fee basis. These revenues are recognized using the
percentage-of-completion method with progress to completion measured by labor
costs incurred to date compared to total estimated labor costs. The Company may
also provide design and implementation services on a "time and expense" basis
for which revenues are also recognized as services are performed. A design
project typically lasts from three to five months. The time to complete
implementation projects generally ranges from three to six months, although
certain projects have required up to 13 months for completion.
Support and management service revenues are recognized ratably over the
period that these services are provided. The Company anticipates that revenues
from support and management services will increase as a
15
<PAGE>
percent of total revenues in the future. Payments received in advance of
services performed are recorded as deferred revenues. Certain contract payment
terms may result in customer billing occurring at a pace slower than revenue
recognition. The resulting revenues recognized in excess of amounts billed and
project costs are classified as contract work in progress on the Company's
balance sheet.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1997 AND 1996
The Company's revenues were $14.2 million and $9.6 million for the six
months ended June 30, 1997 and 1996, respectively, representing an increase of
approximately 47%. This increase was primarily due to increased revenues from
I/S outsourcing services which the Company began providing during the second
quarter of 1996. Services to Candler, Mercy and CMC accounted for approximately
$2.1 million, $1.6 million and $1.4 million of total revenues during the six
months ended June 30, 1997, representing approximately 15%, 11% and 10% of total
revenues, respectively.
Cost of revenues for the six months ended June 30, 1997 and 1996 were $9.7
and $6.9 million, respectively, representing an increase of approximately 40%.
Gross margin for the six months ended June 30, 1997 and 1996, was approximately
32% and 28%, respectively. This increase in gross margin was primarily due to an
increase in the professional service component of the Company's services which
had higher margins.
Sales and marketing expenses were $2.3 million and $831,000 for the six
months ended June 30, 1997 and 1996, respectively, representing an increase of
approximately 182%. This increase was primarily due to the further
implementation of a regional sales structure, an increase in sales personnel and
the expansion of the Company's marketing programs. Sales and marketing expenses
were approximately 17% and 9% of total revenues for the six months ended June
30, 1997 and 1996, respectively. The Company expects that sales and marketing
expenses will continue to increase in dollar terms to support the anticipated
growth in the Company's business.
General and administrative expenses were $2.4 million and $1.9 million for
the six months ended June 30, 1997 and 1996, respectively, representing an
increase of approximately 26%. The primary factors contributing to this increase
were costs associated with the implementation of the Company's management
information system, the addition of senior management and other infrastructure
requirements. General and administrative expenses were approximately 17% and 20%
of total revenues for the six months ended June 30, 1997 and 1996, respectively.
The Company expects general and administrative expenses to continue to increase
in dollar terms to support the anticipated growth in the Company's business.
Net interest income was $329,000 and $123,000 for the six months ended June
30, 1997 and 1996, respectively. Interest income consisted of interest on cash
and cash equivalents and short-term investments. Interest expense consisted of
interest associated with the Company's business line of credit and term
financing of insurance premiums, but was not significant during either period.
YEARS ENDED DECEMBER 31, 1996 AND 1995
The Company's revenues were $23.8 million and $16.9 million for the years
ended December 31, 1996 and 1995, respectively, representing an increase of
approximately 41%. Revenues increased primarily due to the introduction of the
Company's I/S outsourcing services under the Candler contract in April 1996.
Services to CMC, Mercy and Candler accounted for approximately $4.1 million,
$3.4 million and $2.9 million of total revenues in 1996, representing
approximately 17%, 14% and 12% of total revenues, respectively.
Cost of revenues was $16.9 million and $10.5 million for the years ended
December 31, 1996 and 1995, respectively, representing an increase of
approximately 61%. Gross margin was 29% and 38% for the years ended December 31,
1996 and 1995, respectively. This decrease in gross margin was primarily due to
the increased content of professional services in certain implementation
projects during 1995, as well as the lower gross margin related to the Company's
I/S outsourcing services initiated in 1996.
16
<PAGE>
Sales and marketing expenses were $2.2 million and $1.1 million for the
years ended December 31, 1996 and 1995, respectively, representing an increase
of approximately 105%. This increase was primarily due to the establishment of a
regional sales structure, an increase in sales and marketing personnel and the
expansion of the Company's marketing programs. Sales and marketing expenses were
approximately 9% and 6% of revenues for the years ended December 31, 1996 and
1995, respectively.
General and administrative expenses were $4.3 million and $3.2 million for
the years ended December 31, 1996 and 1995, respectively, representing an
increase of approximately 35%. The primary factors contributing to this increase
were costs associated with the Company's larger corporate facility,
implementation of a management information system and the addition of senior
management during 1996. General and administrative expenses were approximately
18% and 19% of revenues for the years ended December 31, 1996 and 1995,
respectively.
Net interest income was $208,000 and $73,000 for the years ended December
31, 1996 and 1995, respectively. Interest income consists of interest on
short-term investments, cash and cash equivalents and notes receivable from
officers and stockholders. Interest expense consists of interest associated with
the Company's business line of credit and term financing of insurance premiums,
but was not significant during either period.
YEARS ENDED DECEMBER 31, 1995 AND 1994
The Company's revenues were $16.9 million and $9.5 million for the years
ended December 31, 1995 and 1994, respectively, representing an increase of
approximately 77%. Revenues increased primarily due to growth in design and
implementation service revenues. Increases in both the number and size of
management service projects from both new and existing customers resulted in an
approximate 42% increase in management service revenues in 1995. Services to
Mercy accounted for $6.8 million, or approximately 40%, of total revenues in
1995.
Cost of revenues was $10.5 million and $6.9 million for the years ended
December 31, 1995 and 1994, respectively, representing an increase of
approximately 52%. Cost of revenues increased primarily due to greater product
costs associated with implementation projects and increased labor costs
associated with new management service contracts. Gross margin was approximately
38% and 28% of revenues for the years ended December 31, 1995 and 1994,
respectively. This increase was attributable primarily to the higher content of
professional services in implementation projects, an increase in the number of
management service contracts, a reduction in the use of third-party professional
services and increased utilization of internal engineering resources.
Sales and marketing expenses were $1.1 million and $860,000 for the years
ended December 31, 1995 and 1994, respectively, representing an increase of
approximately 23%. This increase was due primarily to the growth in revenues and
the number of people involved in sales activities, as well as the introduction
of a new corporate marketing strategy. Sales and marketing expenses were
approximately 6% and 9% of revenues for the years ended December 31, 1995 and
1994, respectively. This decrease as a percentage of revenues was due primarily
to increased revenues and decreased commissions.
General and administrative expenses were $3.2 million and $1.6 million for
the years ended December 31, 1995 and 1994, respectively, representing an
increase of approximately 98%. This increase was due to one-time relocation
costs and expenses of approximately $205,000 associated with the Company's move
to new corporate facilities and continued growth in administrative staffing
levels in finance, purchasing and human resources. General and administrative
expenses were approximately 19% and 17% of revenues for the years ended December
31, 1995 and 1994, respectively. Excluding one-time relocation expenses, there
was no significant change on a percentage of revenue basis.
INCOME TAXES
In 1996, 1995 and 1994, the effective tax rates were approximately 18%, 37%
and 10%, respectively, and were less than the expected combined federal and
state statutory rate of 40% primarily due to the fact that
17
<PAGE>
Integrex was an S-Corporation prior to the merger with DAOU. Consequently, taxes
on the income of Integrex were the direct responsibility of its stockholders. In
1996, the benefit of Integrex's lower tax rate was partially offset by the
amortization expense related to compensatory stock options granted by the
Company during 1996.
LIQUIDITY AND CAPITAL RESOURCES
On June 30, 1997, the Company had working capital of $23.4 million, an
increase from $8.7 million on December 31, 1996. This increase was due primarily
to the successful completion of the Company's initial public offering of Common
Stock which raised $15.8 million, net of issuance costs. The Company has an
additional $1.5 million available under a revolving line of credit. Advances
under the revolving line of credit bear interest at the bank's reference rate
(currently 8.5%) plus 0.5% per annum. Through June 30, 1997, there have been no
borrowings under the revolving line of credit, which expires October 1, 1997.
This line of credit is secured by substantially all of the assets of the Company
and contains customary covenants and restrictions. As of June 30, 1997, the
Company was in compliance with all such covenants and restrictions. For the six
months ended June 30, 1997, cash used in operating activities was $1.3 million
which resulted primarily from an increase in the Company's investment in work in
process and accounts receivable due to timing on billings.
The Company believes that the net proceeds from this offering, together with
available funds, will be 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 could result in additional
dilution to the Company's stockholders, and the incurrence of additional debt
could result in additional interest expense. However, the Company currently does
not have any arrangements or understandings with respect to any specific
acquisitions.
QUARTERLY RESULTS AND SEASONALITY
The following table presents quarterly operating results for each of the
last six quarters. This information has been derived from unaudited consolidated
financial statements and has been prepared on the same basis as the Company's
audited financial statements which appear elsewhere in this Prospectus. In the
opinion of the Company's management, this information reflects all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of such information in accordance with generally accepted
accounting principles. The operating results for any quarter are not necessarily
indicative of the results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1996 1996 1996 1996 1997
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues....................................................... $ 3,383 $ 6,257 $ 6,156 $ 7,971 $ 6,590
Cost of revenues............................................... 2,459 4,451 4,291 5,674 4,641
----------- ----------- ----------- ----------- -----------
Gross profit................................................... 924 1,806 1,865 2,297 1,949
Operating expenses:
Sales and marketing.......................................... 383 448 558 769 1,132
General and administrative................................... 861 1,037 1,003 1,359 1,182
----------- ----------- ----------- ----------- -----------
Total operating expenses....................................... 1,244 1,485 1,561 2,128 2,314
----------- ----------- ----------- ----------- -----------
Income (loss) from operations.................................. (320) 321 304 169 (365)
Interest income, net........................................... 71 52 47 38 116
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes.............................. (249) 373 351 207 (249)
Provision (benefit) for income taxes........................... (44) 66 62 37 (154)
----------- ----------- ----------- ----------- -----------
Net income (loss).............................................. $ (205) $ 307 $ 289 $ 170 $ (95)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
<CAPTION>
JUNE 30,
1997
-----------
<S> <C>
Revenues....................................................... $ 7,587
Cost of revenues............................................... 5,046
-----------
Gross profit................................................... 2,541
Operating expenses:
Sales and marketing.......................................... 1,212
General and administrative................................... 1,202
-----------
Total operating expenses....................................... 2,414
-----------
Income (loss) from operations.................................. 127
Interest income, net........................................... 213
-----------
Income (loss) before income taxes.............................. 340
Provision (benefit) for income taxes........................... 185
-----------
Net income (loss).............................................. $ 155
-----------
-----------
</TABLE>
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<PAGE>
The following table sets forth, as a percentage of revenues, certain
unaudited quarterly statements of operations data:
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1996 1996 1996 1996 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
AS A PERCENT OF REVENUES:
Revenues....................................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Gross margin................................................... 27.3 28.9 30.3 28.8 29.6
Sales and marketing............................................ 11.3 7.2 9.1 9.7 17.2
General and administrative..................................... 25.5 16.6 16.3 17.0 17.9
Income (loss) from operations.................................. (9.5) 5.1 4.9 2.1 (5.5)
Net income (loss).............................................. (6.1) 4.9 4.7 2.1 (1.4)
<CAPTION>
JUNE 30,
1997
-----------
<S> <C>
AS A PERCENT OF REVENUES:
Revenues....................................................... 100.0%
Gross margin................................................... 33.5
Sales and marketing............................................ 16.0
General and administrative..................................... 15.8
Income (loss) from operations.................................. 1.7
Net income (loss).............................................. 2.0
</TABLE>
A substantial majority of the Company's operating expenses, particularly
personnel and related costs, depreciation and rent, are relatively fixed in
advance of any particular quarter. However, variations in the Company's revenues
and operating results occur from time to time, as a result of various factors,
including: (i) the reduction in size, delay in commencement, interruption or
termination of one or more significant projects or contracts; (ii) the
completion during a quarter of one or more significant projects; (iii) the
failure to estimate accurately the resources required to complete new or ongoing
projects; (iv) the relatively longer sales cycle in obtaining new customers and
larger contracts; (v) the timing and extent of employee training or the loss of
key employees; (vi) competition; (vii) the development and introduction of new
services; (viii) the effect of acquisitions; and (ix) general economic
conditions which may affect the buying decisions of the Company's current and
prospective customers. In addition, the Company plans to continue to expand its
operations by hiring additional network engineers and other employees, and
adding new offices, systems and other infrastructure. The resulting increase in
operating expenses will generally be incurred prior to any increase in revenues.
Consequently, the Company's business, financial condition and results of
operations would be materially and adversely affected if revenues do not
increase to support such expenses. A variation in the timing of the commencement
or completion of customer assignments, particularly at or near the end of any
quarter, may cause significant variations in operating results from quarter to
quarter and could result in losses for a particular quarter. In addition, an
unanticipated delay or termination of a major project could require the Company
to maintain or terminate under-utilized employees which could, in either case,
result in higher than expected expenses during a quarter. The Company believes
that quarterly revenues and operating results are likely to vary significantly
in the future and that period-to-period comparisons of its revenues and
operating results are not necessarily meaningful and should not be relied on as
indications of future performance. Furthermore, these variations in revenues and
operating results could cause significant variations in the price of the Common
Stock.
19
<PAGE>
BUSINESS
THE COMPANY
DAOU Systems, Inc. ("DAOU" or the "Company") designs, implements, supports
and manages advanced computer network systems primarily for hospitals,
integrated healthcare delivery networks ("IDNs"), and other healthcare provider
organizations ("provider organizations"). DAOU combines its knowledge of the
specialized information needs of the healthcare industry, including voice, video
and data requirements, with its technological expertise in computer network
systems to provide advanced, reliable and cost-effective computer network
solutions to provider organizations. The Company believes that its success is
attributable to its healthcare industry focus, depth and breadth of
technological expertise, ability to objectively evaluate its customers' computer
network systems due to its vendor independence and its history of successful
customer engagements. The Company's design services include an assessment of the
customer's existing computer network system and the preparation of voice, video
and data network specifications, technical design documentation and diagrams.
DAOU's implementation services include the purchase, delivery and installation
of enterprise-wide computer network systems. The Company's support and
management services are typically provided under multi-year contracts and
include remote and on-site network management services, as well as information
systems function outsourcing ("I/S function outsourcing"). The Company provides
network support services to its customers through its regional sales and support
structure and a 24-hour technical support hotline available seven days a week.
DAOU typically provides its services on a fixed-price, fixed-time frame basis.
Since 1987, the Company has provided computer network services to over 500
customers ranging in size from single-site organizations to multi-state
organizations with over 80 sites. The Company's customers include Catholic
Medical Center of Brooklyn and Queens, Inc., New York ("CMC"); Harris Methodist
Health, Inc., Arlington, Texas ("Harris Methodist"); Mercy Health Services,
Farmington Hills, Michigan ("Mercy"); Atlantic Health System, Morristown, New
Jersey; Lutheran Health Systems, Fargo, North Dakota; and St. Mary's Health
Network, Reno, Nevada.
RECENT ACQUISITION
On July 9, 1997, the Company acquired through a pooling-of-interests merger
all of the issued and outstanding shares of Integrex Systems Corporation
("Integrex") in exchange for 700,000 shares of Common Stock. Integrex provides
advanced network design, integration and consulting support services primarily
to healthcare organizations and also to educational and governmental
institutions. Integrex specializes in the design and integration of voice and
video networks and also designs integrated cable plants capable of supporting
voice, video and high-speed data transmission.
INDUSTRY OVERVIEW
Pressure by employers, health insurers and government payors to control
escalating healthcare costs is driving a movement in the healthcare industry
towards managed care and new forms of reimbursement for healthcare providers.
Payors are also demanding that providers differentiate their services by
demonstrating quality of care. These economic and competitive pressures are
causing healthcare providers to consolidate and form multi-entity provider
organizations such as IDNs. IDNs may consist of hospitals, primary care and
multi-specialty physician groups, out-patient care facilities and home
healthcare providers, and are designed to serve economically the healthcare
needs of a regional population. The consolidation of provider organizations and
the formation of IDNs have resulted in changing healthcare information needs as
these organizations increasingly require prompt access to consistent and
comprehensive patient information at each location where care is provided.
The existing information systems in many provider organizations were
developed to meet the needs of a single facility, such as a hospital or an
out-patient surgery center. The consolidation of these facilities and the
formation of IDNs create complex organizations with many disparate and
specialized information system infrastructures. The Company believes that these
infrastructures frequently are inadequate to support the flow and integration of
information necessary to efficiently manage a complex provider organization. A
typical multi-
20
<PAGE>
site IDN, for example, requires a computer network that is capable of supporting
multiple applications and processing high volumes of data across geographically
remote locations. In addition, the increasing variety of hardware and software
applications utilized throughout provider organizations has resulted in
connectivity and compatibility problems for many computer networks. These
networks must not only meet the heightened information needs of provider
organizations, but also have the capability to migrate to emerging technologies.
As a result of the competitive healthcare environment and the growing
complexity of computer network systems, provider organizations have found it
increasingly difficult to implement and manage these systems. In addition, the
Company believes that the high demand for qualified network engineers and other
technical personnel has made it increasingly difficult for provider
organizations to recruit and train qualified information technology
professionals. Consequently, many provider organizations are looking to third
parties for the technological expertise and personnel to meet their information
systems requirements. DAOU believes that the ongoing consolidation among
healthcare provider organizations and the increasing complexity and rapid
evolution of computer network system technologies have created a significant
opportunity for companies specializing in providing computer network system
solutions to provider organizations.
THE DAOU SOLUTION
DAOU provides a broad array of services to assist hospitals, IDNs and other
provider organizations in designing, implementing, supporting and managing
complex computer network systems consistent with their unique and changing
information needs. The Company believes that the delivery of a combination of
design, implementation and management services better enables the Company's
personnel to fully understand the customer's computing and operating
environments, install computer networks that meet the customer's specialized
requirements, train the customer's users and internal network management staff
prior to the full migration to a new computer network system and provide
effective, ongoing support and management of the computer network. DAOU has
extensive experience resolving the integration, implementation and management
issues faced by provider organizations. In addition, the Company has substantial
knowledge of numerous software applications developed by healthcare information
system and software vendors, as well as extensive expertise in advanced
information technologies and computer network systems, including WANs,
network/host security, high-performance LANs, Internet/Intranet and asynchronous
transfer mode ("ATM") technologies. DAOU uses the products and applications of
various hardware and software vendors to integrate the existing computing and
communication devices and equipment of legacy systems to create advanced
computer network systems. In addition, the Company does not manufacture hardware
or develop software, nor does it have exclusive arrangements with any vendors of
these products. DAOU believes that this vendor independence enables it to
objectively assess its customers' information technology requirements and select
the optimal mix of applications and products. The Company believes that its
cumulative experience, healthcare focus and technology expertise enable it to
deliver advanced computer network systems and services on a timely basis and at
fixed prices.
STRATEGY
The Company's objective is to be a leading provider of advanced computer
network systems and network management services to healthcare provider
organizations. The principal elements of the Company's strategy are:
EXPAND AND STRENGTHEN CUSTOMER RELATIONSHIPS. The Company will continue to
focus its sales and marketing efforts on major medical centers and hospitals
around which IDNs are forming. In addition, the Company plans to focus
additional resources on serving the information technology needs of emerging
provider organizations, such as physician practice management companies,
long-term care providers and rehabilitation service providers. DAOU intends to
further develop its regional sales and support structure in order to monitor
more closely the needs of existing and prospective customers. For example, the
Company recently has placed throughout its regional structure customer-dedicated
account managers who are responsible for maintaining customer satisfaction and
developing new business opportunities.
21
<PAGE>
DEVELOP COMPLEMENTARY SERVICES. The Company intends to develop services
which complement its existing services and increase its recurring revenue
stream. Currently, DAOU is expanding its services in the areas of voice, video
and data integration, telemedicine, I/S function outsourcing, Internet/Intranet,
cabling, network outsourcing, remote network monitoring and network traffic
pattern analysis services. To obtain feedback regarding its present and future
services from a customer perspective, the Company has established an advisory
board comprised of chief information officers in the healthcare industry.
PURSUE STRATEGIC ACQUISITIONS. The Company believes that the market for
providing computer network systems and network management services to the
healthcare industry is fragmented and consists of large, diversified companies
as well as many small, niche companies. The Company believes that there is a
significant opportunity to consolidate the diverse services of these smaller
companies. Consequently, the Company intends to pursue strategic acquisitions in
order to broaden its service offerings, geographically expand its operations and
increase its customer base and market share.
MAINTAIN TECHNOLOGY EXPERTISE. The Company believes that demand for
complex, emerging technologies will grow as provider organizations seek to
employ new applications that combine voice, video and data. The Company intends
to remain at the forefront of information technology solutions for provider
organizations and to continue developing its expertise in emerging technologies.
Specific development efforts include in-house vendor presentations to educate
employees on technological advances and new products, in-house testing of new
systems, products and applications, attendance at various information technology
trade shows and participation in the ATM Forum, an industry council that
provides input regarding emerging ATM standards.
RECRUIT, TRAIN AND RETAIN QUALIFIED PERSONNEL. The Company believes that
its competitive position is enhanced by its ability to hire, train and retain
qualified technical and management personnel. DAOU believes that a key factor in
recruiting and retaining its technical personnel is its ability to provide them
with exposure to and training in a variety of leading edge technologies. The
Company intends to continue dedicating significant resources to train its
technical employees by conducting in-house workshops presented by senior network
engineers, inviting vendors to provide on-site presentations and sponsoring
employees to attend vendor certification programs.
HEIGHTEN DAOU'S HEALTHCARE INDUSTRY PRESENCE. The Company intends to
leverage its history of successful customer engagements to become a recognized
leader in providing information technology solutions to provider organizations.
The Company is expanding its marketing program to enhance the market presence
and visibility of the Company and its services among potential healthcare
customers.
INFORMATION TECHNOLOGY SERVICES
DAOU designs, implements, supports and manages computer network systems that
are capable of providing access to information such as patient records, X-rays
and billing information at each site of a provider organization. The Company
provides to its customers a broad range of computer network services, which
often follow a progression from initial network design through implementation
and computer network management. DAOU believes that the delivery of a
combination of design, implementation and management services better enables the
Company's personnel to fully understand the customer's computing and operating
environments, install computer networks that meet the customer's specialized
requirements, train the customer's users and internal network management staff
prior to the full migration to a new computer network system and provide
effective, ongoing support and management of the computer network. The Company
uses the products and applications of various hardware and software vendors to
integrate the existing computing and communication devices and equipment of
legacy systems to create advanced computer network systems. The Company focuses
on the specialized requirements of each customer project and utilizes formal
planning, monitoring and communication systems and methodologies to ensure
proper project completion and customer satisfaction.
22
<PAGE>
NETWORK SERVICES
DAOU provides network services ranging from network design to large-scale
network implementation. The Company generally provides network design services
prior to the delivery of its other network or management services in order to
determine the proper scope and delivery of these other services. DAOU generally
contracts with its customers on a fixed-price basis for defined services
delivered in accordance with scheduled milestones. The typical sales cycle for
these services begins with an engagement for network design followed by the
installation of enterprise-wide computer network systems.
NETWORK DESIGN. DAOU's network design services include a review and audit
of a customer's existing information technology infrastructure and an assessment
of the functional requirements of its computer network system. The Company
conducts detailed site visits and interviews key customer personnel in order to
identify the specific technologies to be used. The Company then determines how
new technologies will integrate into the customer's existing hardware and
software and how the entire computer network system will be managed on an
ongoing basis. Following its review, the Company prepares technical design
documentation and diagrams of the physical, logical, operational and
communication infrastructures. The Company also prepares voice, video and data
network specifications, as appropriate, and details the implementation steps
necessary to meet the customer's specific computer network requirements. As part
of this process, the Company designs integration strategies for designated
applications, fault-tolerant strategies to help ensure reliable network
operation and migration strategies for customer utilization of emerging
technologies. The Company also develops detailed recommendations for computer
network systems, including the selection of appropriate network products and the
design of multi-vendor integration plans. The typical engagement period for
network design services is three to five months.
NETWORK IMPLEMENTATION. The Company's network implementation services
involve the purchase, delivery, testing and installation of enterprise-wide
computer network systems. Networks installed by the Company provide a variety of
features and services, including switch/bridge/router configuration, PC-to-host
emulation, legacy network integration, gateway installation, universal
workstation design and installation, remote-site connectivity solutions, dial-up
remote access solutions, document management, imaging installations, video
conferencing, telecommunications and telemedicine installations. For each
implementation project, the Company assigns a project management team typically
consisting of a project manager, an account manager, a senior engineer and other
technical personnel, as well as subcontractors and third-party vendors if
required. Each project management team is carefully selected for its technical
expertise in specific areas to meet the requirements of a particular project.
The project team is responsible for creating an installation schedule, ensuring
compliance with established milestones, providing on-site coordination of the
activities of DAOU's personnel, subcontractors and third-party vendors, testing
network performance, including stress and data traffic diagnostics, and
providing regular progress reports to the project manager.
The Company installs a computer network by first conducting a detailed
review of the network design to determine the connectivity and product
requirements. DAOU typically purchases the various network components which have
been specified. After delivery to its facilities, the Company connects these
components prior to installation at the customer's site and then conducts
various tests of the computer network system, simulating the customer's actual
computing environment in accordance with the customer's software specifications.
The Company also tests the network's configuration, connectivity and
compatibility and analyzes the load and data throughput capacity of the network.
This testing process reduces downtime risk and helps ensure that the network
installation will occur with minimal disruption to the customer's ongoing
business operations.
The Company manages the installation of the computer network equipment, as
well as software and cabling, using its own personnel or selected
subcontractors. Throughout the installation process, the Company's personnel
monitor the project's progress to ensure compliance with all network
specifications. Upon completion of the equipment installation, the Company
conducts additional connectivity testing and diagnostics. The engagement period
for these services generally ranges from three to six months, but varies
depending on the size and complexity of the implementation project.
23
<PAGE>
MANAGEMENT SERVICES
As computer network systems become more complex, provider organizations are
experiencing difficulties in hiring, training and retaining information
technology professionals who can maintain the performance and functionality of
their computer network systems. Accordingly, provider organizations have begun
to outsource certain maintenance and management functions of their information
systems departments. DAOU provides support and management services that are
designed to maintain the effective performance of a customer's computer network
system, as well as I/S function outsourcing services, such as desktop
outsourcing, that are designed to manage a customer's information services
functions. The Company generally provides these services in multi-year
engagements on a fixed-price basis.
NETWORK SUPPORT. The Company provides a 24-hour technical support hotline
available seven days a week, as well as other network support resources such as
on-site seminars, on-line support and continuous network monitoring in order to
monitor remotely the performance of computer network systems on an ongoing basis
and detect and report network problems. DAOU also informs its customers of new
technological advances and network solutions that may help increase the utility
and functionality of their computer network systems. The initial engagement
period for the Company's existing support services typically is for one year,
subject to annual renewal.
ENTERPRISE NETWORK MANAGEMENT. The Company provides a range of enterprise
network management services to manage and support a customer's computer network
system. The Company uses its technical expertise and staffing experience to
package, price and deliver combinations of these services at collective rates
which are frequently lower than if provided in-house by the customer. The
customer benefits from the Company's experience in providing enterprise network
management services in a broad range of operating environments, including
client/server networks supporting both Internet and workgroup protocols
intermingled with legacy networks. The engagement period for these services
typically ranges from one to five years. The Company's enterprise network
management services include combinations of the following services, which are
selected by the customer to meet its specific needs:
- DAOU EMPLOYEES ON-SITE. DAOU works with a customer to assess the
appropriate staffing needs to maintain and support its computer network
system. The Company places its employees on-site on a full-time basis to
provide network support services and ongoing training of the customer's
internal staff. This service allows the customer to benefit continuously
from DAOU's technical expertise and to reduce its hiring and training of
internal network management personnel.
- CONTINUOUS NETWORK PLANNING. DAOU's design personnel evaluate a customer's
computer network system and provide recommendations for new network
capabilities and capacity on an ongoing basis consistent with the evolving
needs and strategy of the customer. In addition, DAOU evaluates hardware
and software options, interprets research and development results, updates
existing network designs and researches specific products and technologies
of interest to customers. The Company provides these services subject to
predetermined schedules.
- "BURST MODE" IMPLEMENTATION. DAOU provides additional technical personnel
during periods of peak network requirements to accommodate and assist in
network upgrade implementation or to accommodate the anticipated or
unanticipated need for additional technical staff. This service enables
the customer to preplan changes in its computer network without the
problems associated with recruiting and training temporary staff or hiring
excess permanent technical personnel.
- NETWORK SUPPORT. Depending on the specific needs of each customer, the
Company also provides network support services as part of its combination
of enterprise network management services.
I/S FUNCTION OUTSOURCING. The Company provides I/S function outsourcing
services for provider organizations that elect to outsource all or a portion of
their information systems functions. I/S function outsourcing services involve
long-term engagements with customers whereby the Company may staff portions of
its
24
<PAGE>
customers' information systems department and is responsible for the management
and support of those functions. DAOU provides its I/S function outsourcing
services in accordance with pre-determined, detailed schedules and plans
established with the customer. In June 1997, the Company entered into a
five-year contract to provide computer desktop support services to Harris
Methodist, pursuant to which the Company is responsible for managing all of the
repairs, installations, cabling and special projects for Harris Methodist's
approximately 5,000 personal computers. Candler, a large I/S outsourcing
customer of the Company, recently terminated its contract with the Company
effective November 30, 1997, which termination was influenced by Candler's
consolidation with another healthcare enterprise. Pursuant to the terms of such
contract, Candler is obligated to pay to the Company a termination fee in the
amount of $600,000. See "Risk Factors--Contract Cancellation Rights; Absence of
Long-Term Agreements."
OTHER SERVICES
The Company is expanding its current services and developing new services
that will assist provider organizations with the management and support of their
computer network systems. DAOU is expanding its current services in the areas of
voice, video and data integration, telemedicine, I/S function outsourcing,
Internet/Intranet, cabling network outsourcing (whereby the Company outsources
hardware as well as personnel), remote network monitoring and network traffic
pattern analysis. The Company intends to expand or develop these services either
internally or through acquisitions.
DAOU ADVISORY BOARD
In 1994, the Company established its Advisory Board (the "Advisory Board"),
a non-governing body currently comprised of 13 chief information officers
("CIOs") of various provider organizations. The Advisory Board meets as a group
annually and the members confer separately with the Company periodically to
provide advice on issues and trends in the healthcare industry and emerging
technologies, as well as to provide strategic direction and feedback regarding
the Company's present and future services. Members of the Advisory Board are
reimbursed for travel, lodging and meal expenses incurred in connection with
attendance at the Advisory Board's sessions and may also receive options to
purchase shares of the Company's Common Stock. Larry Grandia, the CIO of
Intermountain Health Care Inc., serves as the Chairman of the Advisory Board.
RECRUITING AND TRAINING OF TECHNICAL EMPLOYEES
The Company dedicates significant time and resources to recruit, train and
retain qualified technical personnel. The technical staff of the Company
consists of senior network engineers, network engineers and network systems
technicians. The Company hires many of its technical staff as entry-level
network systems technicians and provides these individuals with the necessary
training and experience to become network engineers who are responsible for
network configuration, testing, burn-in analysis, installation and
documentation. Further training and experience is provided to enable these
engineers to become senior network engineers who are responsible for project and
resource management. The Company's technical staff undergoes extensive training
and maintains certifications from leading network technology vendors such as
Cisco Systems, Inc., Bay Networks, Inc., Microsoft Corporation and 3Com
Corporation. In addition, the Company is a member of leading technological
forums and organizations, including the ATM Forum, the CHIM Telecommunications
Committee, the HL7 Committee and the BICSI Organization.
The Company believes that its future success will depend in large part on
its ability to hire, train and retain qualified network engineers who together
have expertise in a wide array of network and computer systems and a broad
understanding of the provider organizations that the Company serves. Competition
for qualified network engineers is intense and is expected to increase. In
particular, competition is intense for the limited number of qualified senior
network engineers. Consequently, there can be no assurance that the Company will
be successful in attracting and retaining such personnel. While the Company is
currently experiencing low rates of turnover, there can be no assurance that
these rates of turnover will not increase in the future. Any inability of the
Company to hire, train and retain a sufficient number of qualified network
engineers could impair the
25
<PAGE>
Company's ability to adequately manage and complete its existing projects or to
obtain new projects, which, in turn, could have a material adverse effect on the
Company's business, financial condition and results of operations.
Each technical employee is required to enter into a confidentiality
agreement with the Company designed to protect the Company's trade secrets and
other confidential information during and subsequent to employment with the
Company. Any significant loss of employees to a competitor could have a material
adverse effect on the Company's business, financial condition and results of
operations.
SALES AND MARKETING
The Company's sales and support operations are divided into five regional
organizations located in the west, midwest, east, southeast and southwest
regions of the United States. A vice president heads each regional organization
and oversees the management of existing customers by the account managers and
the development of new customers by the account executives. In particular,
account managers are responsible for maintaining customer satisfaction and
developing new business opportunities as customer needs for computer network
services evolve or increase.
The Company seeks to establish long-term relationships with its customers by
providing high levels of service and by becoming an integral part of their
computer network systems operations. The Company focuses its sales and marketing
efforts on the CIOs and other technology decision makers of IDNs, hospitals and
other provider organizations. The Company relies upon its reputation in the
marketplace, the personal contacts and networking of its professionals and the
various programs of its marketing department to develop new business
opportunities. The Company also receives sales leads directly from consultants,
VARs and product and service vendors.
The principal objectives of the Company's marketing department are to
increase the Company's market presence, provide strategic direction and generate
sales leads. As a supplement to the direct selling efforts of the Company, the
marketing department has developed various programs that include advertising
campaigns, trade show participation, direct mail campaigns, public relations
programs, marketing research and communications and the development of sales
presentation materials. The Company's marketing efforts are enhanced by speaking
engagements and the publication of technical articles and reports directed to
the healthcare information technology industry. The Company's marketing
department is also responsible for the continued development of the Company's
presence on the Internet as a new marketing channel.
The Company has recently entered into marketing agreements with LAN Vision
Systems, Inc., IDX Systems Corporation and Health Systems Technologies whereby
these companies market the Company's services to their respective customer
bases. The Company has also entered into a marketing alliance with VHA, Inc.
("VHA"), whereby, as one of VHA's preferred information system integration
vendors, the Company offers computer network design, implementation and support
services to VHA members. The Company intends to pursue additional marketing
agreements, joint ventures and alliances as part of its marketing plan.
COMPETITION
The healthcare network services industry is comprised of a large number of
participants and is subject to rapid change and intense competition. The
Company's competitors include system integrators, VARs, consulting companies,
local and regional network services firms, telecommunications providers and
network equipment, computer systems and healthcare software vendors, many of
which have significantly greater financial, technical and marketing resources
and greater name recognition than does the Company. In particular, the Company
competes with (i) large information technology companies such as
Hewlett-Packard, EDS and Integrated Systems Solutions Corporation, a subsidiary
of IBM; (ii) healthcare information technology companies such as HBO & Company;
and (iii) smaller regional network systems firms. In addition, the Company has
faced, and expects to continue to face, additional competition from new entrants
into its markets. Other healthcare information technology companies not
presently offering or emphasizing network systems services and large network
services companies not currently focusing on healthcare may enter the Company's
markets.
26
<PAGE>
Increased competition could result in price reductions, fewer customer projects,
under-utilization of employees, reduced operating margins and loss of market
share, any of which could materially and adversely affect the Company's
business, financial condition and results of operations. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors. The failure of the Company to compete successfully would
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, most of the Company's customers have
internal network support and service capabilities and could choose to satisfy
their needs through internal resources rather than through outside service
providers. As a result, the decision by the Company's customers or potential
customers to perform network services internally could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company believes that the principal competitive factors in the markets
in which it competes include: reputation, healthcare industry expertise, network
performance and reliability, timely delivery of services, quality of service,
responsiveness to customers, product knowledge and technological expertise,
marketing, customer relationships and price. The Company believes that it is
competitive with respect to the above mentioned factors.
CUSTOMERS
Since 1987, DAOU has provided computer network services to over 500
customers ranging in size from single-site organizations to multi-state
organizations with over 80 sites. The Company's customers include CMC, New York,
New York; Harris Methodist, Arlington, Texas; Mercy, Farmington Hills, Michigan;
Atlantic, Morristown, New Jersey; Lutheran Health Systems, Fargo, North Dakota;
and St. Mary's Health Network, Reno, Nevada. The Company has derived, and
believes that it will continue to derive, a significant portion of its revenues
from a relatively limited number of large customer contracts. During the six
months ended June 30, 1997, the Company's five largest customers accounted for
approximately 51% of total revenues, with Candler, Mercy and CMC accounting for
approximately 15%, 11% and 10% of total revenues, respectively. For the year
ended December 31, 1996, CMC, Mercy and Candler accounted for approximately 17%,
14% and 12% of total revenues, respectively. For the year ended December 31,
1995, Mercy and Candler accounted for approximately 41% and 9% of total
revenues, respectively. No other customer accounted for more than 10% of the
Company's revenues during such periods.
EMPLOYEES
As of July 31, 1997, the Company employed 234 persons. Of these employees,
173 were involved in providing computer network services, 30 in sales and
marketing and 31 in general administration, finance and clerical. The Company's
employees are not represented by a labor union and the Company's management
believes that its relationship with its employees is good.
FACILITIES
The Company leases approximately 32,000 square feet of office space in San
Diego, California for its principal administrative, support and training
facilities. This lease expires in September 1998. The Company also leases 10,000
of square feet in Alexandria, Virginia which expires in April 1998 and 1,400
square feet in Des Moines, Iowa which expires in February 1999. In addition, the
Company has executive offices in Chicago, Atlanta and Philadelphia to provide
regional sales and support activities to its customers and plans to establish
executive offices in Dallas and Los Angeles during the second half of 1997. The
Company continually evaluates the adequacy of its existing facilities and
believes that its current and planned facilities will be adequate for the next
twelve months.
27
<PAGE>
LEGAL PROCEEDINGS
Gary Colvin, an ex-employee of the Company, filed a lawsuit on February 25,
1997 against the Company and certain of its officers and directors in the U.S.
District Court of the Southern District of California (Gary L. Colvin v. DAOU
Systems, et al.). In the complaint, the ex-employee alleges various claims
related to his former employment with the Company, including, among other
claims, wrongful termination, breach of contract, certain civil rights
violations and claims of unpaid minimum wages and unpaid overtime, and seeks
damages in the aggregate amount of approximately $30 million. The Company
believes that the lawsuit is without merit and intends to defend the lawsuit
vigorously.
28
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company and their ages as of the
date of this Prospectus are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------------- --- --------------------------------------------------
<S> <C> <C>
Georges J. Daou................... 36 Chairman of the Board and Chief Executive Officer
Daniel J. Daou.................... 32 President and Director
Robert J. McNeill................. 58 Executive Vice President and Chief Operating
Officer
Fred C. McGee..................... 50 Senior Vice President, Chief Financial Officer and
Secretary
Dan L. Porter..................... 58 Senior Vice President, Human Resources
David W. Jahns (1)(2)............. 31 Director
Bernard F. McDonagh (1)(2)........ 53 Director
John H. Moragne (1)(2)............ 40 Director
</TABLE>
- ------------------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
MR. GEORGES DAOU, a founder of the Company, has served as Chairman of the
Board and Chief Executive Officer since the Company's inception in 1987. Mr.
Daou sits on the boards of various healthcare and community organizations,
including the College of Healthcare Management Executives and the Healthcare
Information Managers Association. He holds a B.S. in Electrical Engineering and
an M.S. in Information and Communication Theory from the University of
California, San Diego.
MR. DANIEL DAOU, a founder of the Company, has served as President since
December 1994 and as a director since the Company's inception in 1987. From
November 1992 to December 1994, he was the President of Complex Network
Solutions, Inc., an engineering services company. From July 1987 to November
1992, he served as Vice President of the Company. He holds a B.S. in Computer
Engineering from the University of California, San Diego.
MR. MCNEILL joined the Company as Executive Vice President and Chief
Operating Officer in November 1996. From September 1981 through November 1996,
he served in various executive capacities with Shared Medical Systems
Corporation ("SMS"), a healthcare information services company. In his most
recent position with SMS as Senior Vice President of Marketing, Mr. McNeill was
responsible for marketing and professional services and managed several business
units, including networking and imaging systems integration. He holds a B.S. in
Accounting from St. Joseph's University.
MR. MCGEE joined the Company as Senior Vice President and Chief Financial
Officer in August 1996. From October 1988 through July 1996, Mr. McGee was Vice
President of Finance and Chief Financial Officer of Infrasonics, Inc., a
publicly-traded manufacturer of medical devices used in respiratory care. Prior
thereto, Mr. McGee held various financial and management positions with Sears
Roebuck & Co. and other retail, wholesale and manufacturing companies. He holds
a B.S. in Finance from San Diego State University.
MR. PORTER has served as Senior Vice President, Human Resources, of the
Company since June 1994. From October 1993 to June 1994, he was the Director,
Human Resources, of the San Diego Convention Center. From October 1979 to
October 1993, Mr. Porter was the Corporate Vice President, Human Resources, of
Scripps Memorial Hospitals, where he was responsible for all human resources
activities at five acute-care facilities, two extended-care facilities and all
affiliated businesses. He holds a B.A. in Psychology from the University of
Tulsa.
29
<PAGE>
MR. JAHNS has been a director of the Company since October 1995. Mr. Jahns
joined Galen Associates, a venture capital investment firm, in January 1993, and
has served as Vice President since January 1994. Prior thereto, he earned an
M.B.A. from the J.L. Kellogg Graduate School of Business. Mr. Jahns currently
serves on the board of directors of various private healthcare services and
technology companies. He holds a B.A. in Political Science and Economics from
Colgate University.
MR. MCDONAGH has been a director of the Company since March 1996. Since
February 1995, he has been Vice President, Investor Relations and Business
Research, for United Healthcare Corporation, a managed care services provider,
where he is responsible for the venture investments of that company. From August
1989 to February 1995, Mr. McDonagh was a Senior Healthcare Services Analyst and
managing director for Piper Jaffray, Inc., an investment banking firm. He holds
a B.A. from Manhattan College, a Ph.D. in Statistics from The Catholic
University of America and an M.B.A. from the University of Minnesota.
MR. MORAGNE has been a director of the Company since October 1995. Mr.
Moragne has been a managing director of Trident Capital, Inc., a private
investment firm, since May 1993 and a member of Trident Capital Management, LLC,
an affiliated entity, since October 1995. From August 1989 to May 1993, Mr.
Moragne was a principal of Bain Capital, a private investment firm, as well as a
principal of Information Partners, a private equity firm associated with Dun &
Bradstreet Enterprises and Bain Capital. He currently serves on the board of
directors of various private information technology companies. He holds a B.A.
from Dartmouth College, an M.S. from the Stanford Graduate School of Applied
Engineering and an M.B.A. from the Stanford Graduate School of Business.
The Company's Bylaws provide for a range of one to 11 directors, with the
current authorized number set at five. The Board of Directors will be classified
into three classes at the Company's annual meeting of stockholders in 1998, with
each class consisting of approximately the same number of directors, who will
serve for a one, two or three-year period or until their successors are duly
elected and qualified. At each annual meeting of stockholders thereafter, the
successors to the class of directors whose term then expires will be elected to
hold office for a term expiring at the annual meeting of stockholders held
subsequently in three years. The Board of Directors has a Compensation Committee
and an Audit Committee, each composed of Messrs. Jahns, McDonagh and Moragne.
The Compensation Committee makes recommendations to the Board of Directors
concerning salaries and incentive compensation for the Company's officers and
employees and administers the Company's 1996 Stock Option Plan. The Audit
Committee aids management in the establishment and supervision of the Company's
financial controls, evaluates the scope of the annual audit, reviews audit
results, consults with management and the Company's independent auditors prior
to the presentation of financial statements to the stockholders and, if
appropriate, initiates inquiries into aspects of the Company's financial
affairs. Officers are elected by and serve at the discretion of the Board of
Directors. Georges Daou and Daniel Daou are brothers, and Joseph Daou, a former
officer and director of the Company, is their father.
30
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth certain information for the year ended
December 31, 1996, regarding the compensation of the Company's Chief Executive
Officer and each of the four most highly compensated executive officers of the
Company whose salary and bonus for such year were in excess of $100,000 on an
annualized basis (the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL
COMPENSATION
---------------------- ALL OTHER
NAME AND PRINCIPAL POSITION SALARY BONUS COMPENSATION
- --------------------------------------------------------------------------- ---------- ---------- -------------
<S> <C> <C> <C>
Georges Daou
Chairman of the Board and
Chief Executive Officer.................................................. $ 201,923 $ 35,409 $ 4,774(1)
Daniel Daou
President................................................................ 201,923 41,129 8,244(2)
Joseph Daou
Former Treasurer......................................................... 105,769 -- 6,264(3)
Robert J. McNeill
Executive Vice President and
Chief Operating Officer.................................................. 16,827(4) -- 105,000(5)
Fred C. McGee
Senior Vice President,
Chief Financial Officer and Secretary.................................... 44,269(6) -- --
</TABLE>
- ------------------------
(1) Includes $3,056 of automobile expenses and $1,718 of health insurance
benefits.
(2) Includes $2,480 of automobile expenses, $3,536 of health insurance benefits
and $2,228 of contributions made by the Company under its 401(k) plan.
(3) Includes $2,728 of automobile expenses and $3,536 of health insurance
benefits.
(4) The Company hired Mr. McNeill in November 1996 at an annual salary of
$175,000.
(5) Reflects a one-time signing bonus. See "--Employment Agreement."
(6) The Company hired Mr. McGee in August 1996 at an annual salary of $130,000.
31
<PAGE>
OPTION GRANTS. The following table sets forth certain information for the
year ended December 31, 1996, with respect to grants of stock options to the
Named Executive Officers. The Company has not granted any stock appreciation
rights to the Named Executive Officers.
OPTION GRANTS IN THE LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
------------------------------------------------------------------------ VALUE AT ASSUMED
NUMBER OF PERCENT OF ANNUAL RATES OF
SECURITIES TOTAL OPTIONS STOCK PRICE
UNDERLYING GRANTED TO FAIR MARKET APPRECIATION FOR
OPTIONS EMPLOYEES IN EXERCISE VALUE ON OPTION TERM(2)
GRANTED FISCAL YEAR PRICE DATE OF GRANT EXPIRATION --------------------
NAME (#) 1996 ($/SH)(1) ($/SH) DATE 0%($) 5%($)
- ---------------------------- ----------- ---------------- ----------- --------------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Robert J. McNeill (3)....... 140,300 14.9% $4.28 $ 10.69 11/10/06 $ 899,323 $1,842,139
Fred C. McGee (4)........... 63,135 6.7% 4.28 4.28 01/01/06 -- 169,833
<CAPTION>
NAME 10%($)
- ---------------------------- ---------
<S> <C>
Robert J. McNeill (3)....... $3,290,035
Fred C. McGee (4)........... 430,581
</TABLE>
- ------------------------
(1) The exercise price is to be paid in cash, by surrendering shares of Common
Stock held by optionee for more than 12 months, or in any combination of
such consideration or such other consideration and method of payment
permitted under applicable law.
(2) The 0%, 5% and 10% assumed annual rates of compounded stock price
appreciation are mandated by rules of the Securities and Exchange
Commission. There can be no assurance that the actual stock price
appreciation over the ten-year option term will be at the assumed 0%, 5% or
10% levels or at any other defined level.
(3) In November 1996, the Company granted to Mr. McNeill an option to purchase
140,300 shares of Common Stock at an exercise price of $4.28 per share. This
option vests over five years on each anniversary of November 1, 1996. The
Company has agreed to pay to Mr. McNeill a cash bonus in the amount of the
difference, if any, between (i) the net value of the options at the end of
the third anniversary of their date of issuance and (ii) $1,550,000. See
"--Employment Agreement."
(4) In August 1996, the Company granted to Mr. McGee an option to purchase
63,135 shares of Common Stock at an exercise price of $4.28 per share under
the Company's 1996 Stock Option Plan. This option vests over five years on
each anniversary of January 2, 1996.
The following table sets forth information for the Named Executive Officers
regarding the value of unexercised options held as of December 31, 1996. No
options were exercised by the Named Executive Officers during the year ended
December 31, 1996.
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED OPTIONS IN-THE-MONEY
AT OPTIONS AT
DECEMBER 31, 1996(#) DECEMBER 31, 1996($)(1)
NAME (EXERCISABLE/UNEXERCISABLE) (EXERCISABLE/UNEXERCISABLE)
- ------------------------------------------------------ ------------------------------- ------------------------
<S> <C> <C>
Robert J. McNeill (2)................................. --/140,300 $ --/$899,323
Fred C. McGee......................................... --/ 63,135(3) --/ 404,695
</TABLE>
- ------------------------
(1) Calculated by determining the difference between the fair market value of
the securities underlying the option at December 23, 1996 ($10.69 per share
as determined by the Board of Directors) and the exercise price of the
option.
(2) The Company has agreed to pay to Mr. McNeill a cash bonus in the amount of
the difference, if any, between (i) the net value of the options at the end
of the third anniversary of their date of issuance and (ii) $1,550,000. See
"--Employment Agreement."
(3) Includes options to purchase 12,627 shares which vested on January 2, 1997.
32
<PAGE>
EMPLOYMENT AGREEMENT
The Company entered into an employment agreement effective as of November
11, 1996 with Robert McNeill, its Executive Vice President and Chief Operating
Officer. The agreement provides for (i) a base salary of $175,000 per year, (ii)
a one-time signing bonus not to exceed $105,000 and (iii) up to $120,000 in
annual bonus compensation, subject to achievement by the Company of specified
performance goals. In addition, the Company granted to Mr. McNeill non-qualified
stock options to purchase 140,300 shares of Common Stock at an exercise price of
$4.28 per share, and has agreed to pay to Mr. McNeill a cash bonus in the amount
of the difference, if any, between (i) the net value of the options at the end
of the third anniversary of their date of issuance and (ii) $1,550,000. The
agreement also contains provisions designed to ensure that the after-tax effect
of the options issued to Mr. McNeill will be equivalent to the result that would
pertain had they been issued as incentive stock options ("ISOs") rather than
non-qualified stock options. To accomplish this, the agreement provides that (i)
the Company loan to Mr. McNeill on an interest free basis an amount of money
equal to the tax liability that he incurs upon exercise of the options in excess
of the amount that would have been incurred had the options been originally
issued as ISOs, and (ii) the aforementioned loan will become due and payable at
the earlier of (a) the time of sale or disposition of the shares subject to the
options, (b) the termination date of Mr. McNeill's employment with the Company
or (c) January 17, 2002. The loan amount subject to repayment will be reduced by
the amount, if any, by which the cumulative tax liability on exercise of the
options and on disposition of the underlying shares by Mr. McNeill exceeds the
tax that would have been incurred had the options originally been issued as
ISOs. In the event that Mr. McNeill is terminated without cause, he will be
entitled to severance payments in an aggregate amount not to exceed 18 months of
compensation. See "Certain Transactions."
DIRECTOR COMPENSATION
Directors of the Company do not receive cash for services that they provide
as directors or as committee members. The Company has granted to each
non-employee director an option to purchase 21,045 shares of Common Stock at an
exercise price of $4.28 per share. These options vest over three years. The
Company anticipates that it will compensate its independent directors in the
future. See "Management--1996 Stock Option Plan" and "Certain Transactions."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
In 1996, the Compensation Committee of the Board of Directors consisted of
Messrs. Daniel Daou and Moragne and currently consists of Messrs. Jahns,
McDonagh and Moragne. Upon the completion of this offering, entities affiliated
with Messrs. Jahns, McDonagh and Moragne will own 692,208, 135,720 and 485,226
shares of Common Stock, respectively. No executive officer of the Company served
on the compensation committee of another entity or on any other committee of the
board of directors of another entity performing similar functions during the
last fiscal year.
1996 STOCK OPTION PLAN
The Company's 1996 Stock Option Plan (the "1996 Stock Option Plan") provides
for the grant of incentive stock options to employees and nonstatutory stock
options to employees, directors and consultants. A total of 1,367,925 shares of
Common Stock have been reserved for issuance under the 1996 Stock Option Plan,
under which options to purchase 1,169,157 shares of Common Stock have been
granted as of June 30, 1997. Options granted under the 1996 Stock Option Plan
typically vest over five years. The Compensation Committee of the Board of
Directors administers the 1996 Stock Option Plan and determines the exercise
price of options granted thereunder. The exercise price of incentive stock
options must be at least equal to the fair market value of the Common Stock on
the date of grant. In addition, the exercise price of any stock option granted
to an optionee who owns stock representing more than 10% of the voting power of
all classes of stock of the Company must equal at least 110% of the fair market
value of the Common Stock on the date of grant. The exercise price may be paid
in such consideration as determined by the Board of Directors. With respect to
any participant who owns stock representing more than 10% of the voting power of
all classes of stock of the Company, the term of the option is limited to five
years or less. The term for all other options may not exceed ten years.
The Board of Directors may amend or modify the 1996 Stock Option Plan at any
time without the consent of the optionees, so long as such action does not
adversely affect their outstanding options. The 1996 Stock
33
<PAGE>
Option Plan will terminate in 2006, unless terminated earlier by the Board of
Directors. Each outstanding option provides that, in the event of a "change in
control," including the dissolution or liquidation of the Company or a merger of
the Company with or into another corporation, each optionee will be entitled to
exercise up to 70% of the shares of Common Stock underlying his unvested options
immediately prior to the consummation of such "change in control" event.
SECTION 401(K) PLAN
In August 1994, the Company adopted a 401(k) Salary Savings Plan (the
"401(k) Plan") covering the Company's full-time employees located in the United
States. The 401(k) Plan is intended to qualify under Section 401(k) of the
Internal Revenue Code, so that contributions to the 401(k) Plan by employees or
by the Company, and the investment earnings thereon, are not taxable to
employees until withdrawn from the 401(k) Plan, and so that contributions by the
Company, if any, will be deductible by the Company when made. Pursuant to the
401(k) Plan, employees may elect to reduce their current compensation by up to
the statutorily prescribed annual limit ($9,500 in 1996) and to have the amount
of such reduction contributed to the 401(k) Plan. The 401(k) Plan permits, but
does not require, additional matching contributions to the 401(k) Plan by the
Company on behalf of all participants in the 401(k) Plan.
In October 1994, Integrex adopted a retirement benefit plan effective
January 1, 1995. The plan is intended to qualify under Internal Revenue Code
Section 401(a) and provides for employee salary deferrals under Internal Revenue
Code Section 401(k), company matching payments and company profit sharing
payments.
LIMITATIONS ON DIRECTORS' LIABILITY AND INDEMNIFICATION
The Company has adopted provisions in its Certificate of Incorporation that
limit the liability of directors to the maximum extent permitted by Delaware
law. Delaware law provides that directors of a corporation will not be
personally liable for monetary damages for breach of their fiduciary duties as
directors, except liability for (i) any breach of their duty of loyalty to the
corporation or its stockholders, (ii) acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (iii)
unlawful payments of dividends or unlawful stock repurchases or redemptions, or
(iv) any transaction from which the director derived an improper personal
benefit. Such limitation of liability does not apply to liabilities arising
under the federal securities laws and does not affect the availability of
equitable remedies such as injunctive relief or rescission.
The Company's Bylaws provide that the Company shall indemnify its directors
and executive officers and may indemnify its other officers and employees and
other agents to the fullest extent permitted by law. The Company believes that
indemnification under its Bylaws covers at least negligence and gross negligence
on the part of indemnified parties. The Company's Bylaws also permit it to
secure insurance on behalf of any officer, director, employee or other agent for
any liability arising out of his or her actions in such capacity, regardless of
whether the Bylaws permit such indemnification.
The Company has entered into agreements to indemnify its directors and
executive officers, in addition to indemnification provided for in the Company's
Bylaws. These agreements, among other things, indemnify the Company's directors
and executive officers against expenses (including attorneys' fees), judgments,
fines and settlement amounts incurred by any such person in any action or
proceeding, including expenses incurred in connection with any action by or in
the right of the Company, arising out of such person's services as a director or
executive officer of the Company, any subsidiary of the Company or any other
company or enterprise to which the person provides services at the request of
the Company. The Company believes that these provisions and agreements are
necessary to attract and retain qualified persons as directors and executive
officers.
The Company's indemnification provisions set forth in its Certificate of
Incorporation, Bylaws and agreements with directors and executive officers
provide for broad indemnification under Delaware law with no express exclusion
for liabilities arising under or in connection with the Securities Act. Insofar
as indemnification for liabilities arising under the Securities Act may be
permitted to directors, officers and controlling persons of the Company pursuant
to the foregoing provisions, or otherwise, the Company has been advised that, in
the opinion of the Securities and Exchange Commission, such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. At present, there is one lawsuit involving certain of the
Company's officers and directors in which indemnification may be required. See
"Business--Legal Proceedings."
34
<PAGE>
CERTAIN TRANSACTIONS
In October 1995, the Company issued and sold an aggregate of 1,603,430
shares of Preferred Stock at a purchase price of $4.99 per share, each of which
converted into one share of Common Stock in February 1997 upon effectiveness of
the Company's initial public offering. In connection with the Company's sale of
Preferred Stock, Georges Daou, Daniel Daou and Joseph Daou sold an aggregate of
818,416 shares of Common Stock to the same investors at $4.28 per share. The
purchasers of such shares of Common Stock and Preferred Stock included, among
others, the following entities affiliated with directors of the Company:
<TABLE>
<CAPTION>
SHARES OF
SHARES OF PREFERRED
NAME COMMON STOCK STOCK
- ---------------------------------------------------------------------------------- -------------- --------------
<S> <C> <C>
ENTITIES AFFILIATED WITH DIRECTORS
Galen Partners II, L.P. (1)..................................................... 256,251 502,041
Galen Partners International II, L.P. (1)....................................... 98,043 192,086
Galen Employee Fund, L.P. (1)................................................... 1,539 3,015
Information Associates, L.P. (2)................................................ 242,321 474,751
Information Associates, C.V. (2)................................................ 6,762 13,249
HLM Partners VII, L.P. (3)...................................................... 71,167 139,429
</TABLE>
- ------------------------
(1) David Jahns, a director of the Company, is a Vice President of Galen
Associates, which is affiliated with Galen Partners II, L.P., Galen Partners
International II, L.P. and Galen Employee Fund, L.P. Mr. Jahns disclaims
beneficial ownership of the shares held by these entities, except to the
extent of his interest in the shares of Galen Employee Fund, L.P. arising
from his limited partnership interest in such fund. In addition, the Company
has granted to Mr. Jahns options to purchase 21,045 shares of Common Stock
at a price of $4.28 per share.
(2) John Moragne, a director of the Company, is a member of Trident Capital
Management, LLC, the general partner of Information Associates, L.P. and
Information Associates, C.V. Mr. Moragne disclaims beneficial ownership of
the shares held by these entities, except to the extent of his interest in
such shares arising from his interest in Trident Capital Management, LLC. In
addition, the Company has granted to Mr. Moragne options to purchase 21,045
shares of Common Stock at a price of $4.28 per share.
(3) Bernard McDonagh, a director of the Company, is the Vice President, Investor
Relations and Business Research at United Healthcare Corporation, which is
affiliated with HLM Partners VII, L.P. Mr. McDonagh disclaims beneficial
ownership of the shares held by this entity. In addition, the Company has
granted to Mr. McDonagh options to purchase 21,045 shares of Common Stock at
a price of $4.28 per share.
The Company has an employment agreement with Robert McNeill, its Executive
Vice President and Chief Operating Officer. See "Management--Employment
Agreement."
Complex Network Solutions, Inc. ("CNS"), a company founded in October 1992
by Georges Daou, Daniel Daou and Joseph Daou and of which Daniel Daou served as
President, provided certain engineering services to the Company from October
1992 to December 1994. The Company paid an aggregate of approximately $1.6
million for these services in 1994, but does not intend to enter into any future
business arrangements with CNS.
The Company has from time to time granted options and other compensation to
its directors and executive officers. See "Management--Executive Compensation,"
"--Director Compensation," "--1996 Stock Option Plan" and "Principal and Selling
Stockholders."
The Company loaned to Georges Daou, Daniel Daou and Joseph Daou certain
amounts for personal use. As of December 31, 1996, the balances of these loans
to Messrs. Georges Daou, Daniel Daou and Joseph Daou were $79,709, $77,374 and
$70,797, respectively. These loans are unsecured, accrue interest at the rate of
6% per annum and will be repaid after the completion of this offering.
All future transaction, including any loans from the Company to its
officers, directors, principal stockholders or affiliates, will be approved by a
majority of the Board of Directors, including a majority of the disinterested
members of the Board of Directors or, if required by law, a majority of
disinterested stockholders, and will be on terms no less favorable to the
Company than could be obtained from unaffiliated third parties.
35
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information known to the Company with respect
to the beneficial ownership of its Common Stock as of July 31, 1997, and as
adjusted to reflect the sale of shares by the Company and the Selling
Stockholders for (i) each person who is known by the Company to own beneficially
more than five percent of the Common Stock, (ii) each of the Company's
directors, (iii) each of the Named Executive Officers, (iv) all directors and
executive officers as a group and (v) each of the Selling Stockholders. Unless
otherwise indicated in the footnotes to the table set forth below, each person
or entity named below has an address in care of the Company's principal
executive offices.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED OWNED
BEFORE THE OFFERING SHARES AFTER THE OFFERING
------------------------ BEING ------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER (1) NUMBER PERCENT OFFERED NUMBER PERCENT
- ----------------------------------------------------------- ---------- ------------ --------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Georges J. Daou (2)........................................ 1,948,473 17.7% 391,250 1,557,223 13.6%
Chairman of the Board and
Chief Executive Officer
Daniel J. Daou (3)......................................... 1,932,363 17.6 391,250 1,541,113 13.4
President and Director
Joseph H. Daou (4)......................................... 1,617,328 14.7 300,000 1,317,328 11.5
Former Treasurer and Former Director
Entities Affiliated with Galen Associates (5).............. 1,059,990 9.6 360,767 699,223 6.1
610 Fifth Avenue, Fifth Floor
Rockefeller Center
New York, New York 10020
Entities Affiliated with Trident Capital (6)............... 744,098 6.8 251,857 492,241 4.3
2480 Sand Hill Road, Suite 100
Menlo Park, California 94025
HLM Partners VII, L.P. (7)................................. 217,611 2.0 74,876 142,735 1.2
222 Berkeley Street
Boston, Massachusetts 02116
The Eparchy of Our Lady of Lebanon of Los Angeles, on
behalf of St. John Maron Mission......................... 50,000 * 50,000 -- *
1546 E. La Palma Avenue
Anaheim, California 92805
The Eparchy of Our Lady of Lebanon of Los Angeles, on
behalf of St. Ephrem Maronite Mission.................... 45,000 * 45,000 -- *
6310 Rancho Mission Road #157
San Diego, California 92108
All directors and executive officers as a group
(8 persons) (8).......................................... 3,925,732 35.6% 782,500 3,143,232 27.3%
</TABLE>
- ------------------------
* Less than 1%.
(1) Except as otherwise indicated in the footnotes to this table and pursuant to
applicable community property laws, the persons named in the table have sole
voting and investment power with respect to all shares of Common Stock.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock subject
to options or warrants exercisable within 60 days of July 31, 1997 are
deemed outstanding for computing the percentage of the person or entity
holding such options but are not deemed outstanding for computing the
percentage of any other person.
(2) These shares are owned by the Georges J. Daou Trust dated May 2, 1996, of
which George J. Daou is trustee.
36
<PAGE>
(3) These shares are owned by the Daniel and Robin Daou Family Trust dated May
29, 1996, of which Daniel J. Daou and Robin Lyn Daou are trustees.
(4) These shares are owned by the Joseph and Marie Daou Family Trust dated March
11, 1996, of which Joseph H. Daou and Marie J. Daou are trustees.
(5) Of the total shares indicated as beneficially owned, Galen Partners II, L.P.
owned 758,292 shares (6.9% of total shares) before this offering and will
own 498,488 shares (4.3% of total shares) after this offering. Galen
Partners International II, L.P. owned 290,129 shares (2.6% of total shares)
before this offering and will own 190,726 shares (1.7% of total shares)
after this offering. Galen Employee Fund, L.P. owned 4,554 shares (less than
one percent of total shares) before this offering and will own 2,994 shares
(less than one percent of total shares) after this offering. The general
partner of Galen Partners II, L.P., a Delaware limited partnership, and
Galen Partners International II, L.P., a Delaware limited partnership, is
GWW Partners, L.P., a Delaware limited partnership, the general partners of
which are William R. Grant, L. John Wilkerson, Bruce F. Wesson and Rebound
Two (Delaware), L.L.C., a Delaware limited liability company. Mr. Wesson is
also the general partner of Galen Employee Fund, L.P., a Delaware limited
partnership. The total share amounts for the "Entities Affiliated with Galen
Associates" set forth in the above table include 7,015 shares issuable under
stock options held by David Jahns, a director of the Company, which are
exercisable within 60 days of July 31, 1997. Mr. Jahns is a Vice President
of Galen Associates, the investment manager of these entities, and a limited
partner of Galen Employee Fund, L.P. Mr. Jahns disclaims beneficial
ownership of the shares held by these entities, except to the extent of his
interest in the shares of Galen Employee Fund, L.P. arising from his
interest in such entity.
(6) Of the total shares indicated as beneficially owned, Information Associates,
L.P. owned 717,072 shares (6.5% of total shares) before this offering and
will own 472,054 shares (4.1% ot total shares) after this offering.
Information Associates, C.V. owned 20,011 shares (less than one percent of
total shares) before this offering and will own 13,172 shares (less than one
percent of total shares) after this offering. Information Associates, L.P.
is a Delaware limited partnership and Information Associates, C.V. is a
Netherlands Antilles limited partnership. The general partner of each of
these entities is Trident Capital Management, L.L.C., a Delaware limited
liability company ("Trident Capital"), the members of which include Donald
R. Dixon, Stephen M. Hall, Robert C. McCormack, Rockwell A. Schnabel and
John Moragne, a director of the Company. The total share amounts for the
"Entities Affiliated with Trident Capital" set forth in the above table
include 7,015 shares issuable under stock options held by Mr. Moragne which
are exercisable within 60 days of July 31, 1997. Mr. Moragne disclaims
beneficial ownership of the shares held by these entities, except to the
extent of his interest in such shares arising from his interest in Trident
Capital.
(7) Includes 7,015 shares issuable under stock options granted to Bernard
McDonagh, a director of the Company, which are exercisable within 60 days of
July 31, 1997. HLM Partners VII, L.P. is a Delaware limited partnership and
its general partner is HLM Associates VII, L.P., a Delaware limited
partnership. The general partners of HLM Associates VII, L.P. are Peter
Grua, James Mahoney, Frances Hawk, Judith Lawrie and A.R. Haberkorn, III.
(8) Includes 44,896 shares issuable under stock options held by directors and
executive officers exercisable within 60 days of July 31, 1997.
37
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 50,000,000 shares of
Common Stock, par value $0.001 per share, and 5,000,000 shares of Preferred
Stock, par value $0.001 per share. The following summaries of certain provisions
of the Common Stock and Preferred Stock do not purport to be complete and are
subject to, and qualified in their entirety by, the provisions of the Company's
Certificate of Incorporation and by applicable law.
COMMON STOCK
At July 31, 1997, there were 10,987,320 shares of Common Stock outstanding,
which were held of record by 48 stockholders. The holders of Common Stock are
entitled to one vote per share on all matters submitted to a vote of the
stockholders. Holders of Common Stock are entitled to receive ratably such
dividends, if any, as may be declared from time to time by the Board of
Directors out of funds legally available therefor. See "Dividend Policy." In the
event of a liquidation, dissolution or winding up of the Company, holders of
Common Stock are entitled to share ratably in all assets remaining after payment
of the Company's liabilities. Holders of Common Stock have no preemptive rights
and no rights to convert their shares of Common Stock into any other securities,
and there are no redemption or sinking fund provisions with respect to such
shares. All of the outstanding shares of Common Stock are fully paid and
non-assessable, and the shares of Common Stock to be outstanding upon the
completion of this offering will be fully paid and non-assessable. The rights,
preferences and privileges of holders of Common Stock are subject to, and may be
adversely affected by, the rights of the holders of shares of any series of
Preferred Stock which the Company may designate and issue in the future.
PREFERRED STOCK
The Board of Directors has the authority, without action by the
stockholders, to designate and issue Preferred Stock in one or more series and
to designate the rights, preferences and privileges of each series, any or all
of which may be greater than the rights of the Common Stock. It is not possible
to state the actual effect of the issuance of any shares of Preferred Stock upon
the rights of holders of the Common Stock until the Board of Directors
determines the specific rights of the holders of such Preferred Stock. However,
the effects might include, among other things, restricting dividends on the
Common Stock, diluting the voting power of the Common Stock, impairing the
liquidation rights of the Common Stock and delaying or preventing a change in
control of the Company without further action by the stockholders. The Company
has no present plans to issue any shares of Preferred Stock.
WARRANTS
Upon the completion of this offering, the Company will have two warrants
outstanding, exercisable into a total of 133,285 shares of Common Stock at an
exercise price of $4.99 per share. The warrants expire on October 26, 2000.
REGISTRATION RIGHTS
After the completion of this offering, the beneficial owners of
approximately 1.7 million shares of Common Stock and 133,285 shares of Common
Stock issuable upon the exercise of outstanding warrants (collectively the
"Registrable Securities"), or their transferees, will be entitled to certain
rights with respect to the registration of the Registrable Securities under the
Securities Act. These rights are provided under the terms of the Investors'
Rights Agreement between the Company and such holders. Subject to certain
limitations in such agreement, the holders of a majority of the Registrable
Securities have the right to require on one occasion that the Company register
their shares for public resale. In addition, if the Company registers any of its
Common Stock either for its own account or for the account of any other
stockholders, the holders of Registrable Securities are entitled to include
their shares of Common Stock in one registration. A holder's right to include
shares in an underwritten registration is subject to the good faith
determination by the Company that the inclusion of such shares is
38
<PAGE>
compatible with the success of the offering. All expenses incurred in connection
with any registration effected pursuant to the Investors' Rights Agreement
(other than the underwriting discounts and commissions) will be borne by the
Company. The foregoing registration rights terminate on February 12, 2004.
CERTAIN CHANGE OF CONTROL PROVISIONS
As a Delaware corporation, the Company is subject to Section 203 of the
Delaware General Corporation Law, an anti-takeover law. In general, Section 203
prohibits a publicly-held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years
following the date that the person became an interested stockholder, unless
(with certain exceptions) the "business combination" or the transaction in which
the person became an interested stockholder is approved in a prescribed manner.
Generally, a "business combination" incudes a merger, asset or stock sale, or
other transaction resulting in a financial benefit to the interested
stockholder. Generally, an "interested stockholder" is a person who, together
with affiliates and associates, owns (or within three years prior to the
determination of interested stockholder status, did own) 15% or more of a
corporation's voting stock. The existence of this provision would be expected to
have anti-takeover effects with respect to transactions not approved in advance
by the Board of Directors, such as discouraging takeover attempts that might
result in a premium over the market price of the Common Stock.
The Company's Certificate of Incorporation provides that the Board of
Directors will be divided into three classes of directors, with each class
serving a staggered three-year term. The classification system of electing
directors may tend to discourage a third party from making a tender offer or
otherwise attempting to obtain control of the Company and may maintain the
incumbency of the Board of Directors, as a classified board of directors
generally increases the difficulty of replacing a majority of the directors. The
Certificate of Incorporation and Bylaws do not provide for cumulative voting in
the election of directors and allow for the removal of directors only for cause
and with a two-thirds vote of the Company's outstanding shares. In addition, the
Company's Certificate of Incorporation and Bylaws eliminate the right of
stockholders to act by written consent without a meeting and require advanced
stockholder notice to nominate directors and raise matters at the annual
stockholders meeting. Furthermore, the authorization of undesignated Preferred
Stock makes it possible for the Board of Directors to issue Preferred Stock with
voting or other rights or preferences that could impede the success of any
attempt to change control of the Company. These and other provisions may have
the effect of deferring hostile takeovers or delaying changes in control or
management of the Company. The amendment of any of these provisions would
require approval by holders of at least two-thirds of the outstanding shares of
Common Stock.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Company's Common Stock is
Continental Stock Transfer & Trust Company. Its telephone number is (212)
509-4000.
39
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of Common Stock in the public market
could adversely affect market prices prevailing from time to time and the
ability of the Company to raise equity capital in the future.
Upon the completion of this offering, the Company will have 11,487,320
shares of Common Stock outstanding, assuming no exercise of the Underwriters'
over-allotment option and no exercise of outstanding warrants or outstanding
options granted under the 1996 Stock Option Plan after July 31, 1997. Of these
shares, 4,384,642 shares of Common Stock will be freely tradeable without
restriction under the Securities Act, unless held by "affiliates" of the
Company, as that term is defined in Rule 144 under the Securities Act ("Rule
144"). The remaining 7,102,678 shares of Common Stock held by existing
stockholders will be "restricted securities" as that term is defined in Rule 144
(the "Restricted Shares"). The Restricted Shares may be sold in the public
market only if registered under the Securities Act or if they qualify for an
exemption from registration under Rule 144. Sales of the Restricted Shares in
the public market, or the availability of such shares for sale, could adversely
affect the market price of the Common Stock.
Holders of approximately 8.3 million shares of Common Stock entered into
lock-up agreements in connection with the Company's initial public offering
whereby they agreed not to offer, sell, contract to sell, grant any option to
purchase or otherwise dispose of, or agree to dispose of, directly or
indirectly, any shares of Common Stock, options or warrants to acquire shares of
Common Stock or securities exchangeable for or convertible into shares of Common
Stock owned by them for a period of 180 days after the effective date of the
registration statement for the Company's initial public offering. This 180-day
period expired, and such holders of those shares of Common Stock were released
from such lock-up agreements, on August 11, 1997, at which time those shares of
Common Stock could be sold in the public market if registered under the
Securities Act or if they qualified for an exemption from registration under
Rule 144. Sales of such shares in the public market, or the availability of such
shares for sale, could adversely affect the market price for the Common Stock.
From the date of this Prospectus, approximately 5.7 million shares of Common
Stock will become subject to new lock-up agreements as set forth below.
The Selling Stockholders and the directors and executive officers of the
Company have entered into lock-up agreements, under which they have agreed not
to offer, sell, contract to sell, grant any option to purchase or otherwise
dispose of, or agree to dispose of, directly or indirectly, any shares of Common
Stock, options or warrants to acquire shares of Common Stock or securities
exchangeable for or convertible into Common Stock owned by them for a period of
60 days after the date of this Prospectus, without the prior written consent of
Hambrecht & Quist LLC. At the end of this period, 50% of these shares will
become eligible for sale and the remaining 50% will become eligible for sale 90
days after the date of this Prospectus. The Company has entered into a similar
agreement, except that it may issue, and grant options to purchase, shares of
Common Stock under the 1996 Stock Option Plan and pursuant to currently
outstanding warrants and may issue shares of Common Stock in connection with
certain acquisition transactions. Upon expiration of these lock-up agreements,
the underlying shares of Common Stock will become eligible for immediate public
resale, subject in some cases to volume limitations pursuant to Rule 144.
Approximately 1.2 million additional shares held by existing stockholders will
become eligible for public resale at various times over a period of less than
one year following the completion of this offering, subject in some cases to
vesting provisions and volume limitations. After the completion of this
offering, the beneficial owners of approximately 1.7 million shares of Common
Stock and 133,285 shares of Common Stock issuable upon the exercise of
outstanding warrants will be entitled to certain registration rights with
respect to such shares upon the release of applicable lock-up agreements. The
number of shares sold in the public market could increase if such rights are
exercised.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least one
year (including the holding period of any prior owner, except an affiliate) is
entitled to sell in "broker's transactions" or to market makers, within any
three-month period, a number of shares that does not exceed the greater of (i)
one percent of the number of shares of Common Stock then outstanding
(approximately 110,000 shares immediately after this offering) or (ii) the
average weekly
40
<PAGE>
trading volume of the Common Stock during the four calendar weeks preceding the
required filing of a Form 144 with respect to such sale (approximately 350,000
shares based on the four calendar week period ending August 8, 1997). Sales
under Rule 144 are generally subject to certain manner of sale provisions and
notice requirements and to the availability of current public information about
the Company. Under Rule 144(k), a person who is not deemed to have been an
affiliate of the Company at any time during the 90 days preceding a sale, and
who has beneficially owned the shares proposed to be sold for at least two
years, is entitled to sell such shares without having to comply with the manner
of sale, public information, volume limitation or notice provisions of Rule 144.
As of June 30, 1997, an aggregate of 1,169,157 shares were subject to
outstanding options under the 1996 Stock Option Plan, an additional 140,300
shares of Common Stock were subject to other outstanding stock options and
133,285 shares were subject to outstanding warrants. All shares issuable under
the 1996 Stock Option Plan (including shares subject to then outstanding
options) are registered on a Form S-8 Registration Statement, thus permitting
the resale of such shares in the public market without restriction under the
Securities Act after expiration of any applicable lock-up agreements.
Accordingly, shares registered under such registration statement will, subject
to Rule 144 volume limitations applicable to affiliates, be available for sale
in the public market, unless such shares are subject to vesting restrictions
with the Company or the lock-up agreements described above.
41
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, Hambrecht
& Quist, Alex. Brown & Sons Incorporated and Cowen & Company (the
"Underwriters") have severally agreed to purchase from the Company and the
Selling Stockholders the following respective number of shares of Common Stock:
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
- ------------------------------------------------------------------------ ----------
<S> <C>
Hambrecht & Quist LLC................................................... 1,064,250
Alex. Brown & Sons Incorporated......................................... 827,750
Cowen & Company......................................................... 473,000
----------
Total................................................................... 2,365,000
----------
----------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent, including the absence of any
material adverse change in the Company's business and the receipt of certain
certificates, opinions and letters from the Company and its counsel and
independent auditors. The nature of the Underwriters' obligation is such that
they are committed to purchase all shares of Common Stock offered hereby if any
of such shares are purchased.
The Underwriters propose to offer the shares of Common Stock directly to the
public at the public offering price set forth on the cover page of this
Prospectus and to certain dealers at such price less a concession not in excess
of $0.65 per share. The Underwriters may allow, and such dealers may reallow, a
concession not in excess of $0.10 per share to certain other dealers. After the
public offering of the shares, the offering price and other selling terms may be
changed by the Underwriters.
The Selling Stockholders have granted to the Underwriters an option,
exercisable no later than 30 days after the date of this Prospectus, to purchase
up to 354,750 additional shares of Common Stock at the public offering price,
less the underwriting discount, set forth on the cover page of this Prospectus.
To the extent that the Underwriters exercise this option, each of the
Underwriters will have a firm commitment to purchase approximately the same
percentage thereof which the number of shares of Common Stock to be purchased by
it shown in the above table bears to the total number of shares of Common Stock
offered hereby. The Selling Stockholders will be obligated, pursuant to the
option, to sell shares to the Underwriters to the extent the option is
exercised. The Underwriters may exercise such option only to cover
over-allotments made in connection with the sale of shares of Common Stock
offered hereby.
The offering of the shares is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of this offering without notice. The Underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments the Underwriters may be required
to make in respect thereof.
The Selling Stockholders and the directors and executive officers of the
Company, who will own in the aggregate approximately 5.7 million shares of
Common Stock after this offering (assuming no exercise of the Underwriters'
over-allotment option), have agreed, subject to certain exceptions, not to
offer, sell or otherwise dispose of any shares of Common Stock beneficially
owned by them during the 60-day period following the date of this Prospectus
without the prior approval of Hambrecht & Quist LLC. At the end of this period,
50% of these shares will become eligible for sale and the remaining 50% will
become eligible for sale 90 days after the date of this Prospectus. In addition,
the Company has agreed not to offer, sell, grant any option to purchase or
otherwise dispose of any shares of Common Stock during the 90-day period after
the date of this Prospectus without the prior approval of Hambrecht & Quist LLC,
except that the Company may issue, and grant options to purchase, shares of
Common Stock under the 1996 Stock Option Plan and pursuant to currently
outstanding warrants and may issue shares of Common Stock in connection with
certain acquisition transactions, provided such shares are
42
<PAGE>
subject to the 90-day lock-up agreement. Sales of such shares in the future
could adversely affect the market price of the Common Stock. Hambrecht & Quist
LLC may, in its sole discretion, release any of the shares subject to the
lock-up agreements at any time without notice. See "Shares Eligible for Future
Sale."
In general, the rules of the Commission will prohibit the Underwriters from
making a market in the Common Stock during the "cooling off" period immediately
preceding the commencement of sales in this offering. The Commission has,
however, adopted exemptions from these rules that permit passive market making
under certain conditions. These rules permit an underwriter to continue to make
a market subject to the conditions, among others, that its bid not exceed the
highest bid by a market maker not connected with the offering and that its net
purchases on any one trading day not exceed prescribed limits. Pursuant to these
exemptions, certain Underwriters, selling group members (if any) or their
respective affiliates intend to engage in passive market making in the Common
Stock during the "cooling off" period.
Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Common Stock at levels above those which might otherwise prevail in the open
market, including by entering stabilizing bids or effecting syndicate covering
transactions. A stabilizing bid means the placing of any bid or effecting of any
purchase, for the purpose of pegging, fixing or maintaining the price of the
Common Stock. A syndicate covering transaction means the placing of any bid on
behalf of the underwriting syndicate or the effecting of any purchase to reduce
a short position created in connection with the offering. Such transactions may
be effected on the Nasdaq National Market, in the over-the-counter market, or
otherwise. Such stabilizing, if commenced, may be discontinued at any time.
The Underwriters have advised the Company that the Underwriters do not
intend to confirm sales to accounts over which they exercise discretionary
authority.
43
<PAGE>
LEGAL MATTERS
Certain legal matters with respect to the legality of the issuance of the
shares of Common Stock offered hereby will be passed upon for the Company by
Baker & McKenzie, San Diego, California. Certain legal matters related to this
offering will be passed upon for the Underwriters by Cooley Godward LLP, San
Diego, California.
EXPERTS
The Consolidated Financial Statements of the Company at December 31, 1995
and 1996 and for each of the three years in the period ended December 31, 1996
appearing in this Prospectus and Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein and in the Registration Statement, and are included
in reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
AVAILABLE INFORMATION
The Company is subject to the information requirements of the Exchange Act,
and in accordance therewith files reports and other information with the
Securities and Exchange Commission (the "Commission"). Reports, proxy statements
and other information filed by the Company with the Commission in accordance
with the Exchange Act may be inspected and copied at the public reference
facilities of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549, and at the following regional offices of the
Commission: 7 World Trade Center, Suite 1300, New York, New York 10048 and at
Northwestern Atrium Center, 500 West Madison Street, Chicago, Illinois 60661.
Copies of such material can be obtained from the Public Reference Section of the
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates.
In addition, such material concerning the Company can be inspected at the
National Association of Securities Dealers, Inc., 1735 K Street, N.W.,
Washington, D.C. 20006.
The Company has filed with the Commission a Registration Statement on Form
SB-2 under the Securities Act, with respect to the Common Stock offered hereby.
As permitted by the rules and regulations of the Commission, this Prospectus,
which is part of the Registration Statement, omits certain information,
exhibits, schedules and undertakings set forth in the Registration Statement.
For further information pertaining to the Company and the Common Stock,
reference is made to such Registration Statement and the exhibits and schedules
thereto. Statements contained in this Prospectus as to the contents or
provisions of any documents referred to herein are not necessarily complete, and
in each instance, reference is made to the copy of the document filed as an
exhibit to the Registration Statement. The Registration Statement may be
inspected without charge at the office of the Commission at 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of the Registration Statement may be
obtained from the Commission at prescribed rates from the Public Reference
Section of the Commission at such address, and at the Commission's regional
offices located at 7 World Trade Center, Suite 1300, New York, New York 10048,
and at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661.
In addition, registration statements and certain other filings made with the
Commission through its Electronic Data Gathering, Analysis and Retrieval
("EDGAR") system are publicly available through the Commission's site on the
Internet's World Wide Web, located at http://www.sec.gov. The Registration
Statement, including all exhibits thereto and amendments thereof, has been filed
with the Commission through EDGAR.
44
<PAGE>
DAOU SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- --------- JUNE 30,
1997
-----------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents.................................................... $ 2,701 $ 2,447 $ 5,677
Short-term investments....................................................... 3,686 -- 9,513
Accounts receivable.......................................................... 5,851 5,287 6,907
Income taxes receivable...................................................... -- -- --
Contract work in progress.................................................... 394 3,600 5,297
Deferred income taxes........................................................ 209 176 176
Other current assets......................................................... 108 602 624
--------- --------- -----------
Total current assets....................................................... 12,949 12,112 28,194
Due from officers/stockholders................................................. 211 228 253
Equipment, furniture and fixtures, net......................................... 393 1,033 2,189
Deferred income taxes.......................................................... 10 23 23
Other assets................................................................... 25 128 86
--------- --------- -----------
$ 13,588 $ 13,524 $ 30,745
--------- --------- -----------
--------- --------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit............................................................... $ 180 $ 150 $ --
Trade accounts payable....................................................... 762 555 2,399
Accrued salaries and wages................................................... 512 875 1,085
Deferred revenue............................................................. 492 1,011 842
Other accrued liabilities.................................................... 1,306 745 472
Income taxes payable......................................................... 975 99 23
--------- --------- -----------
Total current liabilities.................................................. 4,227 3,435 4,821
Deferred rent.................................................................. 2 62 55
Commitments and contingencies..................................................
Redeemable preferred stock..................................................... 7,705 8,190 --
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--7,329 at December 31, 1995 and 7,364 at
December 31, 1996 (10,977 at June 30, 1997).............................. 8 8 12
Additional paid-in capital................................................... 74 1,347 24,664
Deferred compensation........................................................ -- (1,166) (1,037)
Accretion of redeemable preferred stock...................................... (87) (572) --
Retained earnings............................................................ 1,659 2,220 2,230
--------- --------- -----------
Total stockholders' equity................................................. 1,654 1,837 25,869
--------- --------- -----------
$ 13,588 $ 13,524 $ 30,745
--------- --------- -----------
--------- --------- -----------
</TABLE>
See accompanying notes.
F-3
<PAGE>
DAOU SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues...................................................... $ 9,514 $ 16,878 $ 23,767 $ 9,640 $ 14,177
Cost of revenues.............................................. 6,881 10,471 16,875 6,910 9,687
--------- --------- --------- --------- ---------
Gross profit.................................................. 2,633 6,407 6,892 2,730 4,490
Operating expenses:
Sales and marketing......................................... 860 1,055 2,158 831 2,344
General and administrative.................................. 1,591 3,155 4,260 1,898 2,384
--------- --------- --------- --------- ---------
2,451 4,210 6,418 2,729 4,728
--------- --------- --------- --------- ---------
Income (loss) from operations................................. 182 2,197 474 1 (238)
Interest income (expense), net................................ 13 73 208 123 329
--------- --------- --------- --------- ---------
Income before income taxes.................................... 195 2,270 682 124 91
Provision for income taxes.................................... 19 851 121 22 31
--------- --------- --------- --------- ---------
Net income.................................................... 176 1,419 561 102 60
Accretion of redeemable preferred stock....................... -- 87 485 39 --
--------- --------- --------- --------- ---------
Net income attributable to common stock....................... $ 176 $ 1,332 $ 76 $ 63 $ 60
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income per share.......................................... $ 0.02 $ 0.17 $ 0.06 $ 0.01 $ 0.01
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Shares used in computing net income per common share.......... 7,826 8,116 9,553 9,465 11,029
</TABLE>
See accompanying notes.
F-4
<PAGE>
DAOU SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCRETION OF
COMMON STOCK ADDITIONAL REDEEMABLE
-------------- PAID-IN DEFERRED PREFERRED RETAINED
SHARES AMOUNT CAPITAL COMPENSATION STOCK EARNINGS TOTAL
------ ------ ---------- ------------ ------------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1993........................ 7,259 $ 7 $ 52 $ -- $ -- $ 64 $ 123
Net income.................. -- -- -- 176 176
--
------ ---------- ------------ ----- ------- -------
Balance at December 31,
1994........................ 7,259 7 52 -- -- 240 299
Accretion of redeemable
preferred stock........... -- -- -- -- (87 ) -- (87)
Issuance of common stock in
exchange for services..... 70 1 22 -- -- -- 23
Net income.................. -- -- -- -- -- 1,419 1,419
--
------ ---------- ------------ ----- ------- -------
Balance at December 31,
1995........................ 7,329 8 74 -- (87 ) 1,659 1,654
Deferred compensation....... -- -- 1,243 (1,243 ) -- -- --
Amortization of deferred
compensation -- -- -- 77 -- -- 77
Issuance of common stock in
exchange for services..... 35 -- 30 -- -- -- 30
Accretion of redeemable
preferred stock........... -- -- -- -- (485 ) -- (485)
Net income.................. -- -- -- -- -- 561 561
--
------ ---------- ------------ ----- ------- -------
Balance at December 31,
1996........................ 7,364 8 1,347 (1,166 ) (572 ) 2,220 1,837
Issuance of common stock
upon initial public
offering, net
(unaudited)............... 2,000 2 15,788 -- -- -- 15,790
Conversion of redeemable
preferred stock upon
initial public offering
(unaudited)............... 1,603 2 7,616 -- 572 -- 8,190
Issuance of common stock
upon exercise of stock
options (unaudited)....... 10 -- 42 -- -- -- 42
Amortization of deferred
compensation
(unaudited)............... -- -- (129 ) 129 -- -- --
Distribution to Integrex
stockholders
(unaudited)............... -- -- -- -- -- (50 ) (50)
Net income (unaudited)...... -- -- -- -- -- 60 60
--
------ ---------- ------------ ----- ------- -------
Balance at June 30, 1997
(unaudited)................. 10,977 $ 12 $ 24,664 $ (1,037 ) $ -- $2,230 $25,869
--
--
------ ---------- ------------ ----- ------- -------
------ ---------- ------------ ----- ------- -------
</TABLE>
See accompanying notes.
F-5
<PAGE>
DAOU SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income..................................................... $ 176 $ 1,419 $ 561 $ 102 $ 60
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization................................ 105 268 301 96 421
Provision for uncollectible accounts......................... -- -- 108 1 15
Common stock issued in exchange for services................. -- 23 30 -- --
Deferred income taxes........................................ (24) (192) 20 -- --
Changes in operating assets and liabilities:
Accounts receivable........................................ (369) (5,197) 456 1,056 (1,635)
Contract work in progress.................................. 138 305 (3,206) (58) (1,697)
Other assets............................................... (24) (90) (597) (286) 20
Trade accounts payable..................................... 328 224 (207) (324) 1,844
Accrued salaries and wages................................. 8 268 363 106 210
Deferred revenue........................................... (399) (415) 519 (271) (169)
Other accrued liabilities.................................. 296 1,208 (561) -- (273)
Income taxes payable....................................... -- 932 (876) 134 (76)
Deferred rent.............................................. 1 (29) 60 (982) (7)
--------- --------- --------- --------- ---------
Net cash provided by (used in) operating activities............ 236 (1,276) (3,029) (426) (1,287)
INVESTING ACTIVITIES
Purchases of equipment, furniture and fixtures................. (327) (316) (864) (369) (1,448)
Purchase of short-term investments............................. -- (3,686) -- -- (9,513)
Maturities of short-term investments........................... -- -- 3,686 2,451 --
Advances to officers/stockholders.............................. (149) (306) (17) 4 (25)
Proceeds from repayment of due from officers................... 213 209 -- -- --
--------- --------- --------- --------- ---------
Net cash (used in) provided by investing activities............ (263) (4,099) 2,805 2,086 (10,986)
FINANCING ACTIVITIES
Advances (repayments) under line of credit..................... 15 165 (30) -- --
Repayment of long-term debt.................................... (4) -- -- (180) (150)
Distribution to Integrex stockholders.......................... -- -- -- -- (50)
Proceeds from issuance of common stock and redeemable preferred
stock........................................................ -- 7,618 -- -- 15,703
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing activities............ 11 7,783 (30) (180) 15,503
--------- --------- --------- --------- ---------
(Decrease) increase in cash and cash equivalents............... (16) 2,408 (254) 1,480 3,230
Cash and cash equivalents at beginning of period............... 309 293 2,701 2,701 2,447
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of period..................... $ 293 $ 2,701 $ 2,447 $ 4,181 $ 5,677
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid.............................................. $ -- $ 111 $ 975 $ 965 $ 97
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
See accompanying notes.
F-6
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
DAOU Systems, Inc. (the "Company") designs, implements, supports and manages
advanced computer network systems for hospitals, integrated healthcare delivery
systems and other healthcare provider organizations.
The Company's design services include an assessment of the customer's
existing computer network system and the preparation of voice, video and data
network specifications, technical design documentation and diagrams. DAOU's
implementation services include the purchase, delivery and installation of
enterprise-wide computer network systems. The Company's support and management
services are typically provided under multi-year contracts and include remote
and on-site network management services, as well as information systems
outsourcing. DAOU typically provides its services on a fixed-price, fixed-time
frame basis.
As described more fully in Note 9, on July 9, 1997, the Company acquired all
of the issued and outstanding shares of Integrex Systems Corporation
("Integrex"). The acquisition was accounted for as a pooling-of-interests and,
accordingly, the consolidated financial statements reflect the combined
financial position and operating results for the Company and Integrex for all
periods presented.
INTERIM FINANCIAL INFORMATION (UNAUDITED)
The consolidated financial statements at June 30, 1997 and for the six-month
periods ended June 30, 1996 and 1997 are unaudited, but include all adjustments
(consisting of normal recurring adjustments) which management considers
necessary for a fair presentation of the financial position at such date and the
operating results and cash flows for those periods. Results for interim periods
are not necessarily indicative of results for the entire year or any future
periods.
REVENUE RECOGNITION
Contract revenue for the development and implementation of network solutions
is recognized on the percentage-of-completion method with progress to completion
measured by labor costs incurred to date compared to total estimated labor
costs. Provisions for estimated losses on contracts, if any, are made during the
period when the loss becomes probable and can be reasonably estimated. Revenues
recognized in excess of amounts billed and project costs are classified as
contract work in progress. Revenue from technical support and network management
services is recognized over the period the services are performed. Payments
received in advance of services performed are recorded as deferred revenue.
CONCENTRATION OF CREDIT RISK
Substantially all of the Company's accounts receivable are from hospitals
and other healthcare providers. Generally, the Company obtains a significant
deposit from its customers upon signing a contract and collateral is not
required. The Company provides for losses from uncollectible accounts and such
losses have historically not exceeded management's expectations.
F-7
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash and cash equivalents consist of cash and highly liquid investments with
maturities of three months or less when purchased. Short-term investments are
recorded at amortized cost plus accrued interest which approximates market
value. The Company generally invests its excess cash in U.S. government
securities. The Company has established guidelines relative to diversification
and maturities that are periodically reviewed and modified to take advantage of
trends in yields and interest rates. The Company historically has not
experienced any losses on its cash equivalents or short-term investments.
The Company applies Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" to value its
investments. Under the statement, the Company classifies its short-term
investments as "Available-for-Sale" and records such assets at estimated fair
value in the balance sheet. As of December 31, 1995 and 1996, the cost of cash
equivalents and short-term investments was equal to estimated fair value.
EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures are carried at cost. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets, generally three years. Leasehold improvements are amortized over the
estimated useful lives of the assets or the remaining lease term, whichever is
less.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions about the future that affect the amounts reported in the financial
statements and disclosures made in the accompanying notes of the financial
statements. The actual results could differ from those estimates.
IMPAIRMENT OF LONG-LIVED ASSETS
Effective January 1, 1996, DAOU Systems, Inc. adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). SFAS 121
establishes accounting standards for recording the impairment of long-lived
assets, certain identifiable intangibles and goodwill. The adoption of SFAS 121
did not have a material impact on DAOU's financial position or the results of
its operations.
NET INCOME PER SHARE
For periods subsequent to the completion of the Company's initial public
offering of common stock (the "IPO") in February 1997, net income (loss) per
share is computed using the weighted average number of shares of common stock
and common stock equivalents outstanding during the periods presented. Common
stock equivalents result from outstanding options and warrants to purchase
shares of common stock. For loss periods, common stock equivalents were not
included in computing net loss per share since the effect would have been
antidilutive. For periods prior to the IPO, net income (loss) per share is
computed pursuant to the requirements of the Securities and Exchange Commission
which require that shares of common stock issued during the twelve months
immediately preceding the IPO, plus the number of equivalent shares of common
stock granted
F-8
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
or issued during the same period, be included in the calculation of shares used
in computing net income (loss) per share as if these shares were outstanding for
all periods presented (using the treasure stock method and the assumed IPO
price). In addition, the calculation of the shares used in computing net income
(loss) per share also gives effect to the conversion and exchange of the shares
of preferred stock upon completion of the IPO using the if-converted method from
the original date of issuance.
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128, EARNINGS PER SHARE, which
supersedes APB Opinion 15. Statement No. 128 replaces the presentation of
primary EPS with "Basic EPS" which includes no dilution and is based on
weighted-average commons shares outstanding for the period. Companies with
complex capital structures, including the Company, will also be required to
present "Diluted EPS" that reflects the potential dilution of securities like
employee stock options and warrants to purchase common stock. Statement No. 128
is effective for financial statements issued for periods ending after December
15, 1997. The Company has not yet determined what the impact of Statement No.
128 will be on the calculation of earnings per share.
STOCK OPTIONS
Effective January 1, 1996, the Company adopted SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION. SFAS No. 123 allows companies to either account for
stock-based compensation under the new provisions of SFAS No. 123 or under the
provisions of Accounting Principles Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES("APB 25"), but requires pro forma disclosure in the footnotes to
the financial statements as if the measurement provisions of SFAS No. 123 had
been adopted. The Company has continued accounting for its stock-based
compensation in accordance with the provisions of APB 25.
2. SELECTED BALANCE SHEET DETAILS
Equipment, furniture and fixtures consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- --------- JUNE 30,
1997
-----------
(UNAUDITED)
<S> <C> <C> <C>
Equipment and furniture............................................................ $ 824 $ 1,603 $ 3,051
Leasehold improvements............................................................. 6 91 91
--------- --------- -----------
830 1,694 3,142
Less accumulated depreciation and amortization..................................... (437) (661) (953)
--------- --------- -----------
$ 393 $ 1,033 $ 2,189
--------- --------- -----------
--------- --------- -----------
</TABLE>
Other accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- --------- JUNE 30,
1997
-------------
(UNAUDITED)
<S> <C> <C> <C>
Accrued contract costs........................................................... $ 932 $ 626 $ 434
Other accrued liabilities........................................................ 374 119 38
--------- --------- ---
$ 1,306 $ 745 $ 472
--------- --------- ---
--------- --------- ---
</TABLE>
F-9
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
3. LINE OF CREDIT
In October 1996, the Company entered into a $1.5 million line of credit. The
line bears interest at a rate equal to the Bank's reference rate plus 0.5%
(8.75% at December 31, 1996 and June 30, 1997) and expires October 1, 1997. At
December 31, 1996 and June 30, 1997, no amounts were outstanding under the line
of credit.
In July 1996, Integrex entered into a $300,000 line of credit for the
purpose of financing receivables. The line of credit is due on demand but if not
demanded is due in full on July 31, 1997. Interest is payable monthly at the
prime plus 1% (9.25% at December 31, 1996 and June 30, 1997.) At December 31,
1996, the outstanding balance under the line of credit was $150,000. At June 30,
1997, there were no amounts outstanding under the line of credit.
4. LEASE COMMITMENTS
The Company leases its facilities and certain equipment under operating
lease agreements. The facility leases provide for abatement of rent during
certain periods and escalating rent payments during the lease term. Rent expense
for 1994, 1995 and 1996 totaled $125,000, $160,000 and $448,000, respectively.
Rent expense for the six months ended June 30, 1996 and 1997 was $145,000 and
$223,000, respectively.
Future minimum lease payments under noncancellable operating leases with
initial terms of one year or more consist of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
- -----------------------------------------------------------
<S> <C>
1997....................................................... $ 646
1998....................................................... 328
1999....................................................... 12
2000....................................................... 12
2001....................................................... 7
------
$ 1,005
------
------
</TABLE>
In October 1995, the Company's Board of Directors approved a relocation to a
larger facility. In connection with the relocation, the Company recorded a
provision for relocation costs and expenses of $205,000 which included an
accrual for future rent commitments on the Company's former facility, losses on
non-recoverable leaseholds and other assets and other costs directly associated
with the relocation. This charge is included in general and administrative
expenses in the 1995 statement of operations. During 1996, the Company's former
facility was subleased to a related party. Aggregate future minimum rentals to
be received under the sublease are $126,000.
5. MAJOR CUSTOMERS
Sales to individual customers exceeding 10% or more of revenues in the years
ended December 31 were as follows: during 1994, one customer accounted for 27%
of revenues; during 1995, two customers accounted for 41% and 9% of revenues,
respectively; and during 1996, three customers accounted for 17%, 14% and 12% of
revenues, respectively.
F-10
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
6. REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
REDEEMABLE PREFERRED STOCK
During 1995, 1,603,430 shares of redeemable preferred stock were issued at
$4.99 per share for proceeds of $7,618,000 net of issuance costs. Holders of the
redeemable preferred stock are entitled to receive cumulative dividends at the
rate of $0.03 per share per annum, when and if declared by the Board of
Directors and prior to any dividends on the common shares. The redeemable
preferred stock had a liquidation preference of $4.99 per share plus any
declared but unpaid dividends and was convertible at the option of the holder
into one share of common stock, subject to certain antidilution adjustments. The
shares of preferred stock were automatically converted in connection with the
initial public offering of the Company's common stock which closed in February
1997. The holder of each share of preferred stock was entitled to one vote for
each share into which it would convert.
On or after August 31, 2000, the redeemable preferred stock was redeemable
subject to a written request from the holders of a majority of the then
outstanding shares. The price of the redemption was equal to the original issue
price plus 6% of the original issue price compounded annually, less any
dividends paid. The increase in the redemption value of the redeemable preferred
stock was $87,000 in 1995 and $485,000 in 1996.
STOCK OPTION PLANS
During 1996, the Company adopted the 1996 Stock Option Plan (the "Plan"),
under which 947,025 shares of the Company's common stock were initially reserved
for issuance upon exercise of options granted by the Company. During November
1996, the Board of Directors increased the number of shares reserved for
issuance under the plan to 1,367,925. The Plan provides for the grant of both
incentive and nonstatutory stock options to officers, directors, employees and
consultants of the Company. Options granted by the Company generally vest over a
three to five-year period and are exercisable for a period of ten years from the
date of the grant.
The Company recorded $1,243,000 of deferred compensation for options granted
during the year ended December 31, 1996, representing the difference between the
option exercise price and the deemed fair market value for financial statement
presentation purposes. The Company is amortizing the deferred compensation
ratably over the vesting period of the options.
F-11
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
6. REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (CONTINUED)
A summary of stock option transactions is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
OPTION PRICE PRICE PER
SHARES PER SHARE SHARE
---------- -------------- -----------
<S> <C> <C> <C>
Outstanding at January 1, 1996........................................... -- -- --
Granted................................................................ 962,458 $ 4.28 - 10.69 $ 5.16
Exercised.............................................................. -- -- --
Canceled............................................................... (21,045) 4.28 4.28
---------- -------------- -----
Outstanding at December 31, 1996......................................... 941,413 4.28 - 10.69 5.16
Granted (unaudited).................................................... 543,339 4.28 - 16.00 6.70
Exercised (unaudited).................................................. (9,821) 4.28 4.28
Canceled (unaudited)................................................... (165,474) 4.28 - 10.69 5.68
---------- -------------- -----
Outstanding at June 30, 1997 (unaudited)................................. 1,309,457 $ 4.28 - 16.00 $ 5.75
---------- -------------- -----
---------- -------------- -----
</TABLE>
At December 31, 1996, no options to purchase common shares were exercisable
and 426,512 options to purchase common shares were available for future grant.
Adjusted pro forma information regarding net income is required by SFAS 123,
and has been determined as if the Company had accounted for its employee stock
options under the fair value method of that Statement. The fair value for these
options was estimated at the date of grant using the "minimal value" method for
option pricing with the following weighted-average assumptions: risk-free
interest rate of 6%; dividend yield of 0%; and a weighted-average expected life
of the option of seven years.
For purposes of adjusted pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period. The
Company's adjusted pro forma information is as follows (in thousands, except for
per share information):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
-------------------
<S> <C>
Adjusted pro forma net income.................................................................. $ 438
Adjusted pro forma net income per share........................................................ $ 0.05
</TABLE>
The weighted-average fair value of options granted during 1996 was $2.81.
WARRANTS
In connection with the issuance of the redeemable preferred stock, the
Company issued two warrants to purchase an aggregate of 133,285 shares of common
stock at an exercise price of $4.99 per share. The warrants are exercisable
immediately and expire on October 26, 2000.
F-12
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
6. REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (CONTINUED)
COMMON STOCK RESERVED
At December 31, 1996, a total of 3,104,640 shares of the Company's common
stock have been reserved for the conversion of redeemable preferred stock and
the exercise of stock options and warrants.
7. INCOME TAXES
The provision for income taxes consists of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal.............................................................................. $ 36 $ 816 $ 64
State................................................................................ 7 227 37
--- --------- ---------
43 1,043 101
Deferred:
Federal.............................................................................. (21) (166) 32
State................................................................................ (3) (26) (12)
--- --------- ---------
(24) (192) 20
--- --------- ---------
$ 19 $ 851 $ 121
--- --------- ---------
--- --------- ---------
</TABLE>
Deferred income taxes are provided for temporary differences in recognizing
certain income and expense items for financial and tax reporting purposes.
Significant components of the Company's deferred tax assets and liabilities
consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
<S> <C> <C>
Deferred tax assets (liabilities):
Reserves and allowances.......................................................................... $ 209 $ 201
Tax depreciation differences..................................................................... 10 (2)
--- ---
Net deferred tax assets............................................................................ $ 219 $ 199
--- ---
--- ---
</TABLE>
The reconciliation of income tax computed at the federal statutory rate to
the total provision for income taxes is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
Tax at federal statutory rate...................................................... 34.0% 34.0% 34.0%
S Corporation income not subject to corporate income taxes......................... (26.4) (2.7) (23.8)
Nondeductible expenses............................................................. 2.1 2.1 5.0
Other, including compensatory stock options........................................ -- 4.1 2.5
--------- --------- ---------
9.7% 37.5% 17.7%
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-13
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1996 AND PERTAINING TO JUNE 30, 1997
AND FOR THE SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
7. INCOME TAXES (CONTINUED)
For the six months ended June 30, 1996 and 1997, income taxes have been
provided based upon the estimated annual effective tax rate applied to pre tax
income for the interim period. For 1997 the effective tax rate will increase due
to the non-deductibility of the Integrex merger costs (See Note 9).
8. BENEFIT PLAN
The Company sponsors the DAOU Systems, Inc. 401(k) Salary Savings Plan which
covers employees who meet certain age and service requirements. Employees may
contribute a portion of their earnings each plan year subject to certain
Internal Revenue Service limitations. The Company made elective contributions to
the Plan of $2,000, $13,000 and $16,000 for the years ended December 31, 1994,
1995 and 1996, respectively.
In October 1994, Integrex adopted a retirement benefit plan effective
January 1, 1995. The plan is intended to qualify under Internal Revenue Code
Section 401(a) and provides for employee salary deferrals under Internal Revenue
Code Section 401(k), company matching payments, and company profit sharing
payments.
9. SUBSEQUENT EVENT
On July 9, 1997, the Company acquired all of the issued and outstanding
shares of Integrex, which provides advanced network design, integration and
consulting support services primarily to healthcare organizations and also to
educational and governmental institutions. Integrex specializes in voice and
video networks and also designs integrated cable plants capable of supporting
voice, video and high-speed data transmission. The acquisition will be accounted
for as a pooling-of-interests and, accordingly, the historical financial
statements for all periods prior to the consummation of the combination have
been restated as though the companies had been combined. Merger costs are
expected to approximate $400,000 (net of tax benefits) and the Company will
charge merger costs to operating results in the third quarter of 1997.
Total revenues and net income (loss) of DAOU and Integrex for the periods
preceding the acquisition were:
<TABLE>
<CAPTION>
DAOU INTEGREX COMBINED
------------- ----------- -----------
<S> <C> <C> <C>
Year ended December 31, 1994
Total revenues................................................... $ 8,521 $ 993 $ 9,514
Net income....................................................... 26 150 176
Year ended December 31, 1995
Total revenues................................................... 14,330 2,548 16,878
Net income....................................................... 1,240 179 1,419
Year ended December 31, 1996
Total revenues................................................... 19,311 4,456 23,767
Net income....................................................... 83 478 561
Six months ended June 30, 1996 (unaudited)
Total revenues................................................... 7,530 2,110 9,640
Net income (loss)................................................ (156) 258 102
Six months ended June 30, 1997 (unaudited)
Total revenues................................................... 11,208 2,969 14,177
Net income (loss)................................................ (320) 380 60
</TABLE>
F-14
<PAGE>
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NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING
STOCKHOLDERS OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY TO ANY PERSON IN ANY JURISDICTION
IN WHICH SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL OR TO ANY PERSON TO WHOM
IT IS UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE
MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
---
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 5
The Company........................... 12
Use of Proceeds....................... 12
Price Range of Common Stock........... 12
Dividend Policy....................... 12
Capitalization........................ 13
Selected Consolidated Financial
Data................................ 14
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 15
Business.............................. 20
Management............................ 29
Certain Transactions.................. 35
Principal and Selling Stockholders.... 36
Description of Capital Stock.......... 38
Shares Eligible for Future Sale....... 40
Underwriting.......................... 42
Legal Matters......................... 44
Experts............................... 44
Available Information................. 44
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>
2,365,000 SHARES
[LOGO]
COMMON STOCK
----------------
PROSPECTUS
----------------
HAMBRECHT & QUIST
ALEX. BROWN & SONS
INCORPORATED
COWEN & COMPANY
AUGUST 15, 1997
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