<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended March 31, 1998
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the
transition period from to , 1998
Commission File No.: 000-22073
DAOU SYSTEMS, INC.
(Exact name of small business issuer 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)
(619) 452-2221
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days: Yes /X/
The number of shares of Registrant's Common Stock outstanding as of
May 15, 1998: 13,405,447
Transactional Small Business Disclosure Format (check one): Yes / / No /X/
<PAGE>
DAOU SYSTEMS, INC.
Index to Form 10-Q
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements Page
Condensed Consolidated Balance Sheets
(unaudited) March 31, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations (unaudited)
Three Months Ended March 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (unaudited)
Three Months Ended March 31, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7-8
PART II. OTHER INFORMATION 9
SIGNATURES 10
2
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Item 1. Condensed Consolidated Financial Statements
DAOU SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------- -------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 887 $ 5,699
Short-term investments 7,111 9,949
Accounts receivable, net 16,546 12,411
Contract work in progress 20,126 12,412
Other current assets 3,077 2,033
--------- ---------
Total current assets 47,747 42,504
Equipment, furniture and fixtures, net 4,005 3,501
Other assets 804 831
--------- ---------
$ 52,556 $ 46,836
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,268 $ 1,032
Accrued liabilities 10,454 5,070
--------- ---------
Total current liabilities 11,722 6,102
Long Term Liabilities 482 494
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 - 13,391 and 13,318
at March 31, 1998 and December 31, 1997,
respectively 13 13
Additional paid-in capital 36,225 35,828
Deferred compensation (842) (907)
Unrealized gain on short-term investments 249 143
Retained earnings 4,707 5,163
--------- ---------
Total stockholders' equity 40,352 40,240
--------- ---------
$ 52,556 $ 46,836
--------- ---------
--------- ---------
</TABLE>
See accompanying notes.
3
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DAOU SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
-------- --------
<S> <C> <C>
Revenues $ 18,063 $ 10,087
Cost of revenues 10,772 6,607
-------- --------
Gross profit 7,291 3,480
Operating expenses
Sales and marketing 2,194 1,495
General and administrative 2,847 2,087
Merger and related expenses 1,796 -
-------- --------
Total operating expenses 6,837 3,582
-------- --------
Income (loss) from operations 454 (102)
Other income, net 153 114
-------- --------
Income before income taxes 607 12
Provision (benefit) for
income taxes 911 (148)
-------- --------
Net income (loss) $ (304) $ 160
-------- --------
-------- --------
Basic earnings (loss) per share $ (.02) $ .01
-------- --------
-------- --------
Diluted earnings (loss) per share $ (.02) $ .01
-------- --------
-------- --------
Shares used in calculation of:
Basic earnings (loss) per share 13,362 11,721
-------- --------
-------- --------
Diluted earnings (loss) per share 13,362 12,210
-------- --------
-------- --------
</TABLE>
See accompanying notes.
4
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DAOU SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
-------------- ------------
<S> <C> <C>
Operating activities:
Net income (loss) $ (304) $ 160
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization 401 121
Changes in operating assets and liabilities (7,281) 94
-------- -------
Net cash flows provided by (used in) operating
activities (7,184) 375
Investment activities:
Maturities/sales of short-term investments 2,944 -
Additions to equipment, furniture
and fixtures (840) (904)
Changes in other assets 27 53
-------- -------
Net cash flows provided by (used in)
investing activities 2,131 (851)
Financing activities:
Distribution to stockholders (152) (249)
Sale of common stock 397 15,856
Other (4) (9)
-------- -------
Net cash flows provided by
financing activities 241 15,598
-------- -------
Net increase (decrease) in cash and cash
equivalents (4,812) 15,122
Cash and cash equivalents at
beginning of period 5,699 2,520
-------- -------
Cash and cash equivalents at
end of period $ 887 $17,642
-------- --------
-------- --------
</TABLE>
See accompanying notes.
5
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DAOU SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1998
1. Basis of Presentation
The condensed consolidated financial statements of DAOU Systems, Inc. (the
"Company") for the three-month periods ended March 31, 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 at March 31, 1998 and the
results of operations for the three-month periods ended March 31,1998 and
1997. The results of operations for the three months ended March 31, 1998 are
not necessarily indicative of the results to be expected for the year ending
December 31, 1998. For more complete financial information, these financial
statements, and the notes thereto, should be read in conjunction with the
audited financial statements for the year ended December 31, 1997 included in
the Company's Form 10-KSB filed with the Securities and Exchange Commission.
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.
2. Acquisitions
During March 1998, the Company acquired Synexus Incorporated ("Synexus"), a
a Pennsylvania Corporation specializing in the planning, design and
implementation of enterprise networks in healthcare environments, and
Sentient Systems, Inc., a Maryland Corporation, which provides integration
and support services primarily to health-care organizations. 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. 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 consumation of the
combinations have been restated as though the companies had been combined for
all periods presented.
Separate results for each of DAOU, Sentient and Synexus for the three months
ended March 31, 1998 and 1997 were as follows (in thousands):
<TABLE>
<CAPTION>
DAOU SENTIENT SYNEXUS COMBINED
------- -------- ------- --------
<S> <C> <C> <C> <C>
Three Months ended March 31, 1998
Total Revenues $15,070 $2,526 $467 $18,063
Net Income (loss) 233 (480) (57) (304)
Three Months ended March 31, 1997
Total Revenues 7,094 2,514 479 10,087
Net Income (loss) (129) 168 121 160
</TABLE>
In connection with these acquisitions, the Company recorded acquisition and
related costs during March 1998 totaling $1.8 million. These costs include
transaction fees of approximately $341,000, estimated costs to combine and
integrate operations of approximately $420,000 and other acquisition related
costs of approximately $1.0 million.
6
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3. Per Share Information
The following table details the computation of basic and diluted income
(loss) per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1997
-------------------
<S> <C> <C>
Numerator:
Net income (loss) $ (304) $ 160
------ ------
Denominator:
Weighted average common shares 13,362 10,118
Effect of assumed conversion of
convertible preferred stock to
common stock from the date of
issuance - 1,603
------ ------
Denominator for basic income (loss)
per share - adjusted weighted
average common shares 13,362 11,721
Effect of dilutive securities:
Warrants - 52
Common stock options - 437
------ ------
- 489
------ ------
Denominator for diluted income (loss)
per share -- adjusted weighted average
shares and assumed conversions 13,362 12,210
------ ------
------ ------
Basic income (loss) per share $(0.02) $0.01
------ ------
------ ------
Diluted income (loss) per share $(0.02) $0.01
------ ------
------ ------
</TABLE>
4. 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 Statement No. 131 did not have a material effect on the Company's
financial statements.
Comprehensive income (loss) for the three months ended March 31, 1998 and
1997 totalled $(198,000) and $97,000. The difference from reported net income
arises from the unrealized gains and losses on short-term investments.
5. Income Tax Expense
The effective income tax rate for the quarter ended March 31, 1998 was 150%
due to the non-deductibility of certain merger and related costs and
adjustments made relative to Sentient's and Synexus' former S corporation
status.
7
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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.
In March 1998, the Company acquired through a pooling-of-interests merger all
of the issued and outstanding shares of Synexus, a Pennsylvania Corporation,
which specializes in the planning, design and implementation of enterprise
networks in healthcare environments, and Sentient, Maryland Corporation,
which provides integration and support services primarily to health-care
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.
Results of Operations
The Company's revenues were $18.1 million and $10.1 million for the quarters
ended March 31, 1998 and 1997, respectively, representing an increase of 79%.
This increase was primarily due to growth of I/S outsourcing, voice and video
design, and cabling services.
Cost of revenues was $10.8 million and $6.6 million for the quarters ended
March 31, 1998 and 1997, respectively, representing an increase of 63%
primarily due to increased revenues. Gross margin was 40% and 34% for the
quarters ended March 31, 1998 and 1997, respectively. This increase in gross
margin was primarily due to an increase in the professional service component
of the Company's services which provides higher gross margin revenue.
Sales and marketing expenses were $2.2 million and $1.5 million for the
quarters ended March 31, 1998 and 1997, respectively, representing an
increase of 47%. This increase was primarily due to expansion of the
Company's marketing programs, increase in sales personnel, and
implementation of a regional sales structure . Sales and marketing expenses
were 12% and 15% of revenues for the quarters ended March 31, 1998 and 1997,
respectively. The Company expects that sales and marketing expenses will
continue to decrease as a percentage of revenue, but will likely increase in
dollar terms to support the anticipated growth in the Company's business.
General and administrative expenses were $2.8 million and $2.1 million for
the quarters ended March 31, 1998 and 1997, respectively, representing an
increase of 36%. The primary factors contributing to this increase are
associated with the addition of senior management, increased support staff,
and other infrastructure expansion. General and administrative expenses were
16% and 21% of revenues for the quarters ended March 31, 1998 and 1997
8
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respectively. The Company expects general and administrative expenses will
continue to decrease as a percentage of revenue, but will likely increase in
dollar terms to support anticipated growth.
Merger and related costs totaled $1.8 million during the quarter ended March
31, 1998 in connection with the acquisitions of Synexus and Sentient. These
transaction costs include transaction fees of approximately $341,000,
estimated costs to combine and integrate operations of approximately $420,000
and other acquisition related costs of approximately $1.0 million.
Other income net was $153,000 and $114,000 for the quarters ended March 31,
1998 and 1997, respectively. Other income is primarily interest income which
consists of interest on cash and cash equivalents, short-term investments,
and notes receivable from officers and stockholders. Interest expense
consisted of interest associated with auto loans from Ford Motor Credit
Corporation, but was not significant during either period.
Liquidity and Capital Resources
At March 31, 1998, the Company had working capital of $36.0 million, compared
to $36.4 million at December 31, 1997. The decrease in working capital was
primarily due to a net post merger loss during the first quarter. During the
quarter ended March 31, 1998, cash used in operating activities was $7.2
million relating to an increase in the Company's investment in
work-in-process due to higher contract volume.
The Company believes that through the collection of accounts receivable and
reduction of contract work-in-process, through subsequent billings, will
provide sufficient liquidity to finance operations for the foreseeable
future. The Company may sell additional equity or debt securities or obtain
additional credit facilities, however, there are no assurances that such
financings can be obtained at terms favorable to the Company. The sale of
additional equity securities could result in additional dilution to the
Company's stockholders and the incurrence of debt could result in additional
interest expense.
Business Risks
In addition to the factors addressed in the preceding sections, certain
dynamics of the Company's markets and operations create fluctuations in the
Company's quarterly results. Uncertainty and cost containment in healthcare
and competitive conditions present certain other risks to operating results
which are more fully described in the Company's Form 10-KSB for the year
ended December 31, 1997 filed with the Securities and Exchange Commission 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.
9
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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 alleged 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
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 un-stated
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.
6. Exhibits and Reports on Form 8-K
(a) Exhibits
EXHIBIT NO. DESCRIPTION 27 Financial Data Schedule
(b) The Company did not file any reports on Form 8-K during the three
months ended March 31, 1998.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
DAOU SYSTEMS, INC.
Date: May 15, 1998 By: /s/Daniel J. Daou
Daniel J. Daou President
Date: May 15, 1998 By: /s/Fred C. McGee
Fred C. McGee Chief
Financial Officer
10
<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 MARCH
31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 887
<SECURITIES> 7,111
<RECEIVABLES> 16,746
<ALLOWANCES> 200
<INVENTORY> 20,126
<CURRENT-ASSETS> 47,747
<PP&E> 6,899
<DEPRECIATION> 2,894
<TOTAL-ASSETS> 52,556
<CURRENT-LIABILITIES> 11,722
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 40,339
<TOTAL-LIABILITY-AND-EQUITY> 52,556
<SALES> 18,063
<TOTAL-REVENUES> 18,063
<CGS> 10,772
<TOTAL-COSTS> 17,609
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 607
<INCOME-TAX> (911)
<INCOME-CONTINUING> (304)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (304)
<EPS-PRIMARY> (.02)
<EPS-DILUTED> (.02)
</TABLE>
