<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ___________,
-------------------
Commission File No.: 000-22073
DAOU SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 330284454
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5120 Shoreham Place
San Diego, California 92122
(Address of principal executive offices) (Zip Code)
(619) 452-2221
(Registrant's telephone number, including area code)
-------------------
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days: Yes XX No
-- --
The number of shares of Registrant's Common Stock outstanding as of June
30, 1998:
17,670,393
-------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
DAOU SYSTEMS, INC.
Index to Form 10-Q
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements Page
Condensed Consolidated Balance Sheets (unaudited)
June 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations
(unaudited) Three Months and Six Months Ended
June 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows
(unaudited) Six Months Ended June 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10-13
PART II. OTHER INFORMATION 14
SIGNATURES 16
2
<PAGE>
Item 1. Condensed Consolidated Financial Statements
DAOU SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(unaudited)
<S> <C> <C>
Current assets
Cash and equivalents $ 5,795 $ 7,973
Short-term investments 3,004 10,170
Accounts receivable, net 19,978 15,743
Contract work in progress 22,329 13,292
Other current assets 3,057 2,089
-------- --------
Total current assets 54,163 49,267
Equipment, furniture and fixtures, net 4,629 3,860
Other assets 1,095 983
-------- --------
$ 59,887 $ 54,110
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 6,945 $ 4,341
Accrued liabilities 6,692 4,061
Current portion of long-term debt 2,355 1,437
-------- --------
Total current liabilities 15,992 9,839
Long-term liabilities 3,877 2,433
Commitments and contingencies
Stockholders' equity
Preferred stock, $.001 par value
Authorized shares - 5,000
Issued and outstanding - none - -
Common stock, $.001 par value
Authorized shares - 50,000
Issued and outstanding - 17,670 and 17,551
at June 30, 1998 and December 31, 1997,
respectively 18 18
Additional paid-in capital 37,226 36,043
Deferred compensation (778) (907)
Unrealized gain on short-term investments 232 146
Retained earnings 3,320 6,538
-------- --------
Total stockholders' equity 40,018 41,838
-------- --------
$ 59,887 $ 54,110
-------- --------
-------- --------
</TABLE>
See accompanying notes.
3
<PAGE>
DAOU SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
PERIODS ENDED JUNE 30,
THREE MONTHS SIX MONTHS
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 28,043 $ 14,848 $ 52,028 $ 27,945
Cost of revenues 18,947 9,822 33,435 18,646
-------- -------- -------- --------
Gross profit 9,096 5,026 18,593 9,299
Operating expenses:
Sales and marketing 3,069 2,036 5,802 3,856
General and administrative 3,545 2,561 6,673 4,918
Merger and related costs 1,029 - 2,825 -
-------- -------- -------- --------
Total operating expenses 7,643 4,597 15,300 8,774
-------- -------- -------- --------
Income from operations 1,453 429 3,293 525
Other income, net 59 237 201 364
-------- -------- -------- --------
Income before income taxes 1,512 666 3,494 889
Provision for income taxes 2,200 215 3,114 95
-------- -------- -------- --------
Net income (loss) $ (688) $ 451 $ 380 $ 794
-------- -------- -------- --------
-------- -------- -------- --------
Net income (loss) per share:
Basic $ (.04) $ .03 $ .02 $ .05
-------- -------- -------- --------
-------- -------- -------- --------
Diluted $ (.04) $ .03 $ .02 $ .05
-------- -------- -------- --------
-------- -------- -------- --------
Shares used in calculation of
net income (loss) per share:
Basic 17,645 16,910 17,620 16,161
-------- -------- -------- --------
-------- -------- -------- --------
Diluted 17,645 17,513 18,513 16,978
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
See accompanying notes.
4
<PAGE>
DAOU SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1998 1997
-------- --------
<S> <C> <C>
Operating activities:
Net income $ 380 $ 794
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 899 468
Changes in operating assets and liabilities (7,365) (440)
------- -------
Net cash flows provided by (used in) operating
activities (6,086) 822
Investment activities:
Additions to equipment, furniture
and fixtures (1,539) (1,534)
Proceeds from (purchases of) short-term
investments 7,166 (9,475)
Changes in other assets (173) (307)
------- -------
Net cash flows provided by (used in)
investing activities 5,454 (11,316)
Financing activities:
Sale of common stock, net 1,183 15,703
Proceeds from lines of credit and long-term debt,
net 869 118
Distributions to stockholders of acquired companies (3,598) (451)
------- -------
Net cash flows provided by (used in)
financing activities (1,546) 15,370
------- -------
Net increase (decrease) in cash and cash equivalents (2,178) 4,876
Cash and cash equivalents at
beginning of period 7,973 3,123
------- -------
Cash and cash equivalents at
end of period $ 5,795 $ 7,999
------- -------
------- -------
</TABLE>
See accompanying notes.
5
<PAGE>
DAOU SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The condensed consolidated financial statements of DAOU Systems, Inc. (the
"Company") at June 30, 1998 and for the six-month periods ended June 30, 1998
and 1997 are unaudited. These financial statements reflect all adjustments,
consisting of only normal recurring adjustments, which in the opinion of
management are necessary to fairly present the financial position of the
Company at June 30, 1998 and the results of operations for the three and
six-month periods ended June 30, 1998 and 1997. The results of operations
for the three or six months ended June 30, 1998 are not necessarily
indicative of the results to be expected for the year ending December 31,
1998. For more information, these financial statements should be read in
conjunction with the Company's Form 10-KSB and the audited supplemental
financial statements included in the Company's Current Report on Form 8-K
filed with the Securities and Exchange Commission ("SEC") on May 19, 1998.
However, these documents do not reflect the acquisitions discussed in
paragraph 2 of Note 3.
2. 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.
3. Acquisitions
During March 1998, the Company acquired Synexus Incorporated ("Synexus"), a
privately-held company specializing in the planning, design and
implementation of enterprise networks in healthcare environments, and
Sentient Systems, Inc. ("Sentient"), a privately-held company which provides
integration and support services primarily to healthcare organizations. The
shareholders of Synexus and Sentient received a total of 161,235 and
1,397,550 shares, respectively, of the Company's common stock in exchange for
all of the outstanding stock of each of these companies. The acquisitions
have been accounted for under the pooling-of-interests method of accounting,
and accordingly, the historical financial statements of periods prior to the
consummation of the combinations have been restated as though the companies
had been combined for all periods presented.
During June 1998, the Company acquired (i) Technology Management,
Inc.("TMI"), a privately-held company that provides information technology
consulting services primarily to the healthcare industry, (ii) International
Health Care Systems, Inc.("IHCS"), a privately-held company with a common
shareholder with TMI that provides information technology consulting services
primarily to the healthcare industry on behalf of TMI, (iii) Resources in
Healthcare Innovations, Inc. ("RHI"), a privately-held information technology
services firm that provides contract management services, for healthcare
information systems to hospitals and managed care organizations, and (iv)
Healthcare Transition Resources, Inc. ("HTR"), Ultitech Resources Group, Inc.
("URG"), Innovative Systems Solutions, Inc. ("ISS") and Grand Isle
Consulting, Inc. ("GIC"), each a privately held company with common
shareholders with RHI that implements software applications from third
parties and provides support services to healthcare enterprises. Shareholders
of TMI, IHCS, RHI, HTR, URG, ISS and GIC received a total of 1,078,963,
224,668, 1,839,381, 275,662, 282,551, 308,583 and 223,645 shares,
respectively, of the Company's common stock
6
<PAGE>
in exchange for the outstanding stock of each of these companies. The
acquisitions have been accounted for under the pooling-of-interests method of
accounting, and accordingly, the historical financial statements of periods
prior to the consummation of the combinations have been restated as though
the companies had been combined for all periods presented.
Separate results for each of DAOU, Sentient, Synexus, TMI (including IHCS),
and RHI (including HTR, URG, ISS and GIC) for the three and six months ended
June 30, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
(In thousands)
DAOU SENTIENT SYNEXUS TMI RHI COMBINED
---- -------- ------- --- --- --------
<S> <C> <C> <C> <C> <C> <C>
Three Months ended June 30,
1998:
Total Revenues $ 15,752 $ 3,839 $ 626 $ 2,991 $ 4,835 $ 28,043
Net Income (loss) (1,333) 493 167 (40) 25 (688)
Three Months ended June 30,
1997:
Total Revenues 8,792 2,274 335 1,186 2,261 14,848
Net Income (loss) 117 120 96 (157) 275 451
Six Months ended June 30,
1998:
Total Revenues 30,821 6,364 1,093 5,748 8,002 52,028
Net Income (loss) (1,106) 14 110 860 502 380
Six Months ended June 30,
1997:
Total Revenues 15,886 4,787 814 2,359 4,099 27,945
Net Income (loss) (12) 288 217 (184) 485 794
</TABLE>
In connection with these acquisitions, the Company recorded acquisition and
related costs during March 1998 and June 1998 totaling $1.8 million and $1.0
million, respectively. These costs include transaction costs of
approximately $720,000, estimated costs to combine and integrate operations
of approximately $570,000, and other acquisition related costs of
approximately $1.5 million.
4. Lines of Credit
During June 1998, the Company secured two borrowing facilities, a $2.0
million revolving line of credit, under which $1.5 million is available for
future borrowings at June 30, 1998 and an additional $8,000,000 line of
credit, under which no borrowings are outstanding at June 30, 1998. Advances
under both the revolving line of credit and line of credit bear interest at
the bank's prime rate (currently 8.5%) plus 0.25% per annum. Through June
30, 1998, borrowings under the revolving line of credit, which expires July
31, 1999, total approximately $485,000. These lines of credit are secured by
substantially all of the assets of the Company and contain customary
covenants and restrictions. As of June 30, 1998, the Company was in
compliance with all such covenants and restrictions.
In addition, through its acquisition of RHI (and related companies), the
Company has an additional $700,000 line of credit with a bank, under which
outstanding borrowings totaled $700,000 at June 30, 1998, and a $1,000,000
note payable to a bank. The $700,000 line of credit bears interest at prime
plus 0.25%
7
<PAGE>
and the $1,000,000 note payable bears interest at 8.5%. Both obligations are
due on October 30, 1998 and the line of credit is secured by all of the
assets of RHI.
5. Per Share Information
The following table details the computation of basic and diluted earnings (loss)
per share:
(In thousands, except per share information)
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
-----------------------------------------
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) $ (688) $ 451 $ 380 $ 794
-----------------------------------------
Denominator:
Denominator for basic earnings
(loss) per share - weighted
average common shares 17,645 16,910 17,620 16,161
Effect of dilutive securities:
Warrants - 65 102 58
Common stock options - 538 791 488
Convertible preferred stock - - - 271
-----------------------------------------
- 603 893 817
-----------------------------------------
Denominator for diluted earnings
(loss) per share -- adjusted
weighted average shares and
assumed conversions 17,645 17,513 18,513 16,978
-----------------------------------------
-----------------------------------------
Basic earnings (loss) per share $ (0.04) $ 0.03 $ 0.02 $ 0.05
-----------------------------------------
-----------------------------------------
Diluted earnings (loss) per share $ (0.04) $ 0.03 $ 0.02 $ 0.05
-----------------------------------------
-----------------------------------------
</TABLE>
Recent interpretations by the SEC of Financial Accounting Standard No. 128,
"Earnings per Share", have changed the treatment of convertible preferred
stock previously included in the computation of basic earnings (loss) per
share. For periods prior to its initial public offering ("IPO"), the Company
previously included preferred stock which converted into common stock upon
completion of the IPO as outstanding from the date of original issuance ("as
if converted method") in the computation of basic earnings (loss) per share.
To conform with recent interpretations, the effect of assuming the conversion
of these securities prior to their actual conversion in the basic earnings
(loss) per share calculation has been excluded.
6. New Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income," and Statement No. 131, "Disclosures
About Segments of an Enterprise and Related Information," both of which are
effective for fiscal periods beginning after December 15, 1997. The adoption
of Statements No. 130 and 131 did not have a material effect on the Company's
financial statements.
8
<PAGE>
Comprehensive income (loss) for the three months ended June 30, 1998 and
1997 totaled $(708,000) and $570,000, respectively. Comprehensive income
for the six months ended June 30, 1998 and 1997 totaled $466,000 and
$850,000, respectively. The difference from reported net income arises from
the unrealized gains and losses on short-term investments.
7. Income Tax Expense
The effective income tax rate for the three and six months ended June 30,
1998 was 146% and 89%, respectively, due to the non-deductibility of certain
merger and related costs and adjustments made to convert the former S
corporation status of certain acquired businesses to the C corporation status
of the Company.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
This report contains certain statements of a forward-looking nature relating
to future performance of the Company. Prospective investors are cautioned
that such statements are only predictions and that actual events or results
may differ materially.
Overview
The Company designs, implements, supports and manages advanced computer
network systems primarily for hospitals, integrated delivery networks
("IDNs") and other provider organizations. 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 information systems
function outsourcing. The Company typically provides these services under
multi-year contracts.
During March 1998, the Company acquired through a pooling-of-interests merger
all of the issued and outstanding shares of Synexus, a Pennsylvania
Corporation, that specializes in the planning, design and implementation of
enterprise networks in healthcare environments, and Sentient, a Maryland
Corporation that provides integration and support services primarily to
healthcare organizations. The shareholders of Synexus and Sentient received a
total of 161,235 and 1,397,550 shares, respectively, of the Company's common
stock in exchange for the outstanding stock of each of these companies.
During June 1998, the Company acquired (i) TMI, a privately-held company that
provides information technology consulting services primarily to the
healthcare industry, (ii) IHCS, a privately-held company with a common
shareholder with TMI that provides information technology consulting services
primarily to the healthcare industry on behalf of TMI, (iii) RHI, a
privately-held information technology services firm that provides contract
management services for healthcare information systems to hospitals and
managed care organizations, and (iv) HTR, URG, ISS and GIC, each a privately
held company with common shareholders with RHI that implements software
applications from third parties and provides support services to healthcare
enterprises. Shareholders of TMI, IHCS, RHI, HTR, URG, ISS and GIC received a
total of 1,078,963, 224,668, 1,839,381, 275,662, 282,551, 308,583 and 223,645
shares, respectively, of the Company's common stock in exchange for all of
the outstanding stock of each of these companies. The acquisistions have been
accounted for under the pooling-of-interests method of accounting, and
accordingly, the historical financial statements of periods prior to the
consummation of the combinations have been restated as though the companies
had been combined for all periods presented.
10
<PAGE>
Results of Operations
The Company's revenues were $28.0 million and $14.8 million for the quarters
ended June 30, 1998 and 1997, respectively, representing an increase of 89%.
This increase was due primarily to the increased number of professional
consulting contracts and large network implementation contracts. Services to
five customers accounted for $6.7 million of total revenues in this quarter,
representing 24% of total revenues. For the six months ended June 30, 1998
and 1997, respectively, sales were $52.0 million and $27.9 million, which
represents an increase of 86%. This increase was primarily the result of
increased revenues from professional services consulting contracts, cabling
services, and large network implementation contracts.
Cost of revenues was $18.9 million and $9.8 million for the quarters ended
June 30, 1998 and 1997, respectively, representing an increase of 93%. Gross
margin was 32% and 34% for the quarters ended June 30, 1998 and 1997,
respectively. This decrease in gross margin was primarily due to an increase
in the product content of the Company's large network implementation
contracts during the quarter. Cost of revenues for the six-month period
ended June 30, 1998 and 1997 were $33.4 million and $18.6 million,
respectively, which is an increase of 79%. Gross margin for the six months
ended June 30, 1998 and 1997, was 36% and 33%, respectively. The increase in
gross margin for the latest period is primarily attributable to increased
professional services from consulting contracts, which have higher margins.
Sales and marketing expenses were $3.1 million and $2.0 million for the
quarters ended June 30, 1998 and 1997, respectively, representing an increase
of 51%. This increase was primarily due to continued development of a
regional sales structure, an increase in sales personnel and related expenses
due to increased sales volume and activity. Sales and marketing expenses
were 11% and 14% of revenues for the quarters ended June 30, 1998 and 1997,
respectively. For the six-month periods ended June 30, 1998 and 1997, sales
and marketing expenses were $5.8 million and $3.9 million, respectively,
representing 11% and 14% of revenues in those periods. Although these
expenses continue to decrease as a percentage of revenue, 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 $3.5 million and $2.6 million for
the quarters ended June 30, 1998 and 1997, respectively, representing an
increase of 38%. The primary factors contributing to this increase were
costs associated with additional administrative staffing and other increased
infrastructure requirements to support growth. General and administrative
expenses were 13% and 17% of revenues for the quarters ended June 30, 1998
and 1997, respectively. General and administrative expenses for the six-month
periods ended June 30, 1998 and 1997 were $6.7 million and $4.9 million, or
13% and 18% of revenues, respectively. The Company expects some increase in
general and administrative expenses in dollar terms to support the
anticipated growth in the Company's business. As a percentage of revenues,
these expenses should decrease with the increase in revenue.
11
<PAGE>
Merger and related costs totaled $1.0 million during the quarter ended June
30, 1998 in connection with the acquisitions of TMI, IHCS, RHI, HTR, URG, ISS
and GIC. Merger and related costs totaled $2.8 million during the six months
ended June 30, 1998, which include costs recorded during the first quarter of
1998 in connection with the acquisitions of Sentient and Synexus. The $2.8
million total costs include transaction fees of approximately $720,000,
estimated costs to combine and integrate operations of approximately $570,000
and other acquisition related costs of approximately $1.5 million.
Other income, net, was $59,000 and $237,000 for the quarters ended June 30,
1998 and 1997, respectively. For the six months ended June 30, 1998 and
1997, respectively, other income, net, was $201,000 and $364,000. Other
income, net, is primarily interest income on cash and cash equivalents, and
short-term investments. Interest expense consists of interest associated with
the Company's business lines of credit and term financing of insurance
premiums, but was not significant during either period.
The effective income tax rate for the three and six months ended June 30,
1998 was 146% and 89%, respectively, due to the non-deductibility of certain
merger and related costs and adjustments made relative to the former S
corporation status of certain acquired businesses.
Liquidity and Capital Resources
At June 30, 1998, the Company had working capital of $38.3 million, which is
slightly down from the $39.5 million on December 31, 1997. The Company has a
$2.0 million revolving line of credit, under which $1.5 million is available
for future borrowings at June 30, 1998. In addition, the Company has secured
an additional $8,000,000 line of credit, all of which is available for future
borrowings at June 30, 1998. Advances under both the revolving line of
credit and line of credit bear interest at the bank's reference rate
(currently 8.5%) plus 0.25% per annum. Through June 30, 1998, borrowings
under the revolving line of credit, which expires July 31, 1999, are
approximately $485,000. These lines of credit are secured by substantially
all of the assets of the Company and contain customary covenants and
restrictions. As of June 30, 1998, the Company was in compliance with all
such covenants and restrictions. For the six months ended June 30, 1998, cash
used in operating activities was $6.1 million which resulted primarily from
an increase in the Company's investment in work in process and accounts
receivable due to increased contract volume and timing of billings.
The Company believes that its present sources of liquidity will be sufficient
to finance operations for the foreseeable future and such sources of
liquidity may be used to fund additional acquisitions of complimentary
businesses, although the Company does not have any specific proposals,
arrangements or understandings with respect to any future acquisitions. The
Company may sell additional equity or debt securities or obtain additional
credit facilities. The sale of additional equity securities or issuance of
same in future acquisitions could result in additional dilution to the
Company's stockholders and the incurrence of debt could result in additional
interest expense.
12
<PAGE>
Business Risks
In addition to the factors addressed in the preceding sections, certain
dynamics of the Company's markets and operations create fluctuations in the
Company's quarterly results. Uncertainty and cost containment in healthcare
and competitive conditions present certain other risks to operating results
which are more fully described in the Company's Form 10-KSB filed with the
Securities and Exchange Commission (SEC) and other SEC filings. Except for
the historical information presented herein, the matters discussed in this
document are forward-looking statements that involve numerous risks and
uncertainties. The Company's actual results could differ materially from
those projected in such forward-looking statements and will depend upon a
number of factors, including those discussed in this document and in prior
SEC filings, press releases and other public filings of the Company.
13
<PAGE>
PART II OTHER INFORMATION
1. Legal Proceedings
On February 25, 1997, Gary Colvin, an ex-employee of the Company filed a
lawsuit 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. On February 9,
1998, the parties stipulated to the dismissal of the ex-employee's remaining
Federal claim under the Fair Labor Standards Act. As a result, on March 4,
1998, the lawsuit was dismissed without prejudice after the court declined to
exercise supplemental jurisdiction over the remaining state law claims.
On September 18, 1997, seven present and/or former employees of the Company
filed a lawsuit in the Superior Court of the State of California for the
County of San Diego, titled Smyth, et al. V. DAOU Systems, Inc. (Case No.
714187), purporting to represent a class of all present and former DAOU
employees classified as exempt under Federal and California law from overtime
pay and are entitled to pay for unpaid overtime and penalties in an unstated
amount. The Plaintiffs also claim that, in response to their filing
complaints with the Labor Board for the State of California, they were
subjected to retaliatory discrimination by the Company. The lawsuit
currently is in the preliminary stages of discovery. On April 2, 1998, the
Court denied a motion by the Plaintiffs requesting the court to assist them
in notifying potential Plaintiffs of the opportunity to join this lawsuit
against the Company. As of the date of this report, the potential amount of
exposure to the Company from this lawsuit, in the event of an unfavorable
outcome, cannot be determined. The Company believes that the lawsuit is
without merit and intends to defend the lawsuit vigorously.
Item 4. Submission of Matters to a Vote of Security Holders.
On May 19, 1998, the Company held its Annual Meeting of Stockholders. At the
meeting, the stockholders approved management's slate of directors and the
other two additional proposals with the following vote distribution:
<TABLE>
<CAPTION>
WITHHELD/ BROKER/
ITEM AFFIRMATIVE NEGATIVE ABSTENTIONS NON-VOTE
- ---------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ELECTION OF BOARD MEMBERS
CLASS I DIRECTORS (term
expiring at annual meeting
of stockholders in 2001)
Georges J. Daou 6,598,377 - 20,950 -
Richard B. Jaffe 6,598,377 - 20,950 -
CLASS II DIRECTORS (term
expiring at annual meeting
of stockholders in 2000)
Daniel J. Daou 6,598,377 - 20,950 -
John H. Moragne 6,598,377 - 20,950 -
CLASS III DIRECTOR (term
expiring at annual meeting
of stockholders in 1999)
David W. Jahns 6,598,377 - 20,950 -
OTHER MATTERS
1) Increase the number of
shares issuable under the
Company's 1996 Stock Option
Plan to 4,000,000 shares of
Common Stock (subject to limit of
25% of outstanding shares at
end of immediately preceding
fiscal quarter) and limit
the number of stock options
issuable to any one optionee
to 150,000. 2,733,653 2,372,384 13,655 1,499,635
2) Reappoint Ernst & Young L.L.P. as
independent auditors for fiscal
year 1998. 6,614,504 2,300 2,523 -
</TABLE>
6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
- ----------- -----------
27 Financial Data Schedule
(b) On June 19, 1998, a Form 8-K was filed to report that the Company entered
into an Agreement and Plan of Merger Agreement on June 16, 1998 to exchange
shares of the Company's common stock valued at $22.5 million for all of the
outstanding shares of Technology Management, Inc. The merger will be
accounted for as a pooling of interests.
(c) On May 19, 1998, a Form 8-K was filed which included audited supplemental
consolidated financial statements, selected supplemental consolidated
financial data and Management's Discussion and Analysis of Financial
Condition and Results of Operations (supplemental) which reflect the
Company's acquisitions of Sentient Systems, Inc. ("Sentient") and Synexus
Incorporated ("Synexus") on March 31, 1998. Each of the acquisitions was
accounted for as
<PAGE>
a pooling-of-interests.
(d) On May 19, 1998, a Form 8-K/A was filed which included audited financial
statements of Sentient as of December 31, 1997 and 1996 and for the two
years then ended and the one month ended December 31, 1995 and as of
November 30, 1995 and the year then ended. Also included was the unaudited
pro forma combined condensed balance sheet at December 31, 1997 and
unaudited pro forma combined condensed statements of operations for the
years ended December 31, 1997, 1996 and 1995 which give effect to the
acquisition of Sentient as of December 31, 1997 for the combined condensed
pro forma balance sheet and January 1, 1995 for the combined condensed pro
forma statements of operations.
(e) On May 8, 1998, a Form 8-K was filed to report the unaudited revenue and
net income of the Company for the 30 day period ended April 30, 1998.
(f) On April 14, 1998, a Form 8-K was filed to report that the Company acquired
Sentient Systems, Inc. and Synexus Incorporated through the issuance of
1,397,550 and 161,235 shares, respectively, of the Company's common in
exchange for all of the outstanding shares of Sentient and Synexus. The
mergers were effective on March 31, 1998 and will be accounted for as a
pooling-of-interests.
(g) On April 2, 1998, a Form 8-K was filed to report that the Company entered
into merger agreements to exchange shares of the Company's common stock
in exchange for all of the outstanding shares of Sentient and Synexus.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DAOU SYSTEMS, INC.
Date: August __, 1998 By: /s/ Daniel J. Daou
Daniel J. Daou -------------------------------------
President
Date: August __, 1998 By: /s/Fred C. McGee
Fred C. McGee -------------------------------------
Chief Financial Officer
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANT'S FINANCIAL STATEMENTS AS OF AND FOR THE QUARTER ENDED JUNE 30, 1998
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 5,795
<SECURITIES> 3,004
<RECEIVABLES> 20,403
<ALLOWANCES> 425
<INVENTORY> 22,329
<CURRENT-ASSETS> 54,163
<PP&E> 8,342
<DEPRECIATION> 3,713
<TOTAL-ASSETS> 59,887
<CURRENT-LIABILITIES> 15,992
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 40,000
<TOTAL-LIABILITY-AND-EQUITY> 59,887
<SALES> 52,028
<TOTAL-REVENUES> 52,028
<CGS> 33,435
<TOTAL-COSTS> 48,735
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 3,494
<INCOME-TAX> 3,114
<INCOME-CONTINUING> 380
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 380
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
</TABLE>
