<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): March 31, 1998
DAOU SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE
(State or other jurisdiction of incorporation)
0-22073 330284454
(Commission File Number) (IRS Employer Identification No.)
5120 Shoreham Place, San Diego, California 92122
(Address of principal executive offices, including zip code)
(619) 452-2221
(Registrant's telephone number, including area code)
-1-
<PAGE>
This Form 8-K/A amends and completes the registrant's Form 8-K that was filed
with the Securities and Exchange Commission on April 14, 1998.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(a) FINANCIAL STATEMENTS OF BUSINESSES ACQUIRED:
(1) AUDITED FINANCIAL STATEMENTS OF SENTIENT SYSTEMS, INC.:
(i) Report of Deloitte & Touche LLP, Independent Auditors
(ii) Balance Sheets - December 31, 1997 and 1996
(iii) Statements of Income - Year Ended December 31, 1997 and
1996 and the one month ended December 31, 1995
(iv) Statements of Stockholders' Equity - Year Ended December
31, 1997 and 1996 and the one month ended December 31,
1995
(v) Statements of Cash Flows - Year Ended December 31, 1997
and 1996 and the one month ended December 31, 1995
(vi) Notes to Financial Statements - December 31, 1997
(2) AUDITED FINANCIAL STATEMENTS OF SENTIENT SYSTEMS, INC.:
(i) Report of Coopers & Lybrand LLP, Independent Accountants
(ii) Balance Sheet - November 30, 1995
(iii) Statement of Income - Year Ended November 30, 1995
(iv) Statement of Stockholders' Equity - Year Ended November
30, 1995
(v) Statement of Cash Flows - Year Ended November 30, 1995
(vi) Notes to Financial Statements - November 30, 1995
-2-
<PAGE>
(b) PRO FORMA FINANCIAL INFORMATION:
The unaudited pro forma combined condensed balance sheets at December
31, 1997 and the pro forma combined condensed statements of operations for the
years ended December 31, 1997 1996 and 1995 give effect to the acquisition of
Sentient Systems, Inc. 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. The pro forma information is based on the historical
financial statements of Sentient Systems, Inc. and DAOU Systems, Inc. giving
effect to the transactions under the pooling-of-interests method of accounting
and assumptions and adjustments described in the accompanying notes to the
unaudited pro forma combined condensed financial statements.
(c) EXHIBITS.
The following exhibits are filed herewith or incorporated by reference
as part of this report:
<TABLE>
<CAPTION>
Exhibit
No. Document Description
--------- ---------------------------------------------------------
<S> <C>
2.1*+ Agreement and Plan of Merger, dated as of March 30, 1998,
by and among DAOU Systems, Inc., a Delaware corporation,
DAOU-Sentient, Inc., a Delaware corporation and
wholly-owned subsidiary of DAOU Systems, Inc., Sentient
Systems, Inc., a Maryland corporation, and the
stockholders of Sentient Systems, Inc.
2.2*+ Agreement and Plan of Merger, dated as of March 27, 1998,
by and among DAOU Systems, Inc., a Delaware corporation,
DAOU-Synexus, Inc., a Delaware corporation and
wholly-owned subsidiary of DAOU Systems, Inc., Synexus
Incorporated, a Pennsylvania corporation, and the
stockholders of Synexus Incorporated.
99.1** Press release entitled "DAOU Systems Merges with Sentient
Systems, Inc."
99.2** Press release entitled "DAOU Systems Merges with Synexus
Incorporated."
</TABLE>
-3-
<PAGE>
* Filed as an exhibit to the Company's Current Report on Form 8-K
which was filed with the Securities and Exchange Commission on April 14, 1998
and is incorporated herein by reference.
** Filed as an exhibit to the Company's Current Report on Form 8-K
which was filed with the Securities and Exchange Commission on April 2, 1998 and
is incorporated herein by reference.
+ Confidential treatment has been requested for portions of
this exhibit.
-4-
<PAGE>
----------------------------------------------------------
SENTIENT SYSTEMS, INC.
FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997
AND 1996, AND THE ONE MONTH ENDED DECEMBER 31, 1995,
AND INDEPENDENT AUDITORS' REPORT
-5-
<PAGE>
SENTIENT SYSTEMS, INC.
<TABLE>
<CAPTION>
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
PAGE
<S> <C>
INDEPENDENT AUDITORS' REPORT 7
FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 1997 AND 1996, AND THE ONE MONTH
ENDED DECEMBER 31, 1995:
Balance Sheets 8 - 9
Statements of Operations 10
Statements of Changes in Stockholders' Equity 11
Statements of Cash Flows 12
Notes to Financial Statements 13 - 17
</TABLE>
-6-
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Sentient Systems, Inc.
Kensington, Maryland
We have audited the accompanying balance sheets of Sentient Systems, Inc. (the
Company) as of December 31, 1997 and 1996, and the related statements of
operations, changes in stockholders' equity, and cash flows for the years ended
December 31, 1997 and 1996, and the one month ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1997 and
1996, and the results of its operations and its cash flows for the years ended
December 31, 1997 and 1996, and the one month ended December 31, 1995, in
conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
McLean, Virginia
February 13, 1998
-7-
<PAGE>
SENTIENT SYSTEMS, INC.
<TABLE>
<CAPTION>
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
ASSETS 1997 1996
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 933,161 $ 36,092
Investments 803,131 698,420
Accounts receivable - net of allowance of
$22,000 in 1997 and $90,000 in 1996 874,407 1,385,403
Income taxes receivable 329 327
Other current assets 38,584 67,009
---------- ----------
Total current assets 2,649,612 2,187,251
PROPERTY AND EQUIPMENT - At cost:
Computer equipment 1,163,711 970,244
Furniture and fixtures 168,582 190,999
Office equipment 87,400 90,808
Leasehold improvements 60,228 55,997
---------- ----------
1,479,921 1,308,048
Accumulated depreciation and amortization (1,014,089) (923,574)
---------- ----------
465,832 384,474
---------- ----------
OTHER ASSETS 45,491 35,278
---------- ----------
TOTAL ASSETS $3,160,935 $2,607,003
---------- ----------
---------- ----------
</TABLE>
See notes to financial statements.
-8-
<PAGE>
SENTIENT SYSTEMS, INC.
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 136,172 $ 14,762
Accrued expenses 383,002 425,085
Income taxes payable 5,410 6,118
Customer deposits - 11,686
Line of credit 66,000 42,000
Deferred rent 23,700 29,939
Deferred revenue 224,041 87,542
---------- ----------
Total current liabilities 838,325 617,132
Share units liability 18,679 13,642
---------- ----------
Total liabilities 857,004 630,774
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 8)
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value - 6,250,000 shares
authorized; 5,250,000 shares issued and outstanding
in 1997 and 1996 5,250 5,250
Additional paid-in capital 12,976 12,976
Retained earnings 2,142,659 1,839,681
Unrealized gain on investments 143,046 118,322
---------- ----------
Total stockholders' equity 2,303,931 1,976,229
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $3,160,935 $2,607,003
---------- ----------
---------- ----------
</TABLE>
See notes to financial statements.
-9-
<PAGE>
SENTINENT SYSTEMS, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996, AND
THE ONE MONTH ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
SALES:
Consulting sales $9,861,265 $9,632,485 $ 722,409
Acclaim sales - 99,747 1,636
---------- ---------- ----------
TOTAL SALES 9,861,265 9,732,232 724,045
COST OF SALES 4,887,198 5,107,299 397,258
---------- ---------- ----------
GROSS PROFIT 4,974,067 4,624,933 326,787
SELLING AND ADMINISTRATIVE EXPENSES 4,366,542 3,937,781 388,230
---------- ---------- ----------
INCOME FROM OPERATIONS 607,525 687,152 (61,443)
OTHER INCOME (EXPENSE):
(Loss) gain on disposal of property and equipment (162) 5,412 -
Gain on sale of investments - 5,698 -
Interest and dividend income 103,067 69,090 58,496
Interest expense (6,395) (23,327) -
---------- ---------- ----------
INCOME BEFORE INCOME TAXES 704,035 744,025 (2,947)
INCOME TAX EXPENSE 10,483 14,218 86,314
---------- ---------- ----------
NET INCOME (LOSS) $ 693,552 $ 729,807 $ (89,261)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See notes to financial statements.
-10-
<PAGE>
SENTIENT SYSTEMS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996, AND
THE ONE MONTH ENDED DECEMBER 31, 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL UNREALIZED TOTAL
------------------------ PAID-IN RETAINED GAIN ON STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS INVESTMENTS EQUITY
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 1, 1995 5,386,473 $ 5,387 $18,887 $1,379,036 $80,812 $1,484,122
Purchase and retirement of common
stock - - 5,364 (5,364) - -
Unrealized loss on investments - - - - (6,283) (6,283)
Net loss - - - (89,262) - (89,262)
--------- ------- ------- ---------- -------- ----------
BALANCE, DECEMBER 31, 1995 5,386,473 5,387 24,251 1,284,410 74,529 1,388,577
Purchase and retirement of common
stock (136,473) (137) (11,275) (28,164) - (39,576)
Unrealized gain on investments - - - - 43,793 43,793
Net income - - - 729,808 - 729,808
Cash dividends - - - (146,373) - (146,373)
--------- ------- ------- ---------- -------- ----------
BALANCE, DECEMBER 31, 1996 5,250,000 5,250 12,976 1,839,681 118,322 1,976,229
Unrealized gain on investments - - - - 24,724 24,724
Net income - - - 693,552 - 693,552
Cash dividends - - - (390,574) - (390,574)
--------- ------- ------- ---------- -------- ----------
BALANCE, DECEMBER 31, 1997 5,250,000 $ 5,250 $12,976 $2,142,659 $143,046 $2,303,931
--------- ------- ------- ---------- -------- ----------
--------- ------- ------- ---------- -------- ----------
</TABLE>
See notes to financial statements.
-11-
<PAGE>
SENTIENT SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996, AND
THE ONE MONTH ENDED DECEMBER 31, 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $693,552 $ 729,807 $(89,261)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 245,211 190,483 20,313
Deferred income tax - - 108,125
Loss/(gain) on disposal of property and equipment 162 (5,412) -
Gain on sale of investments - (5,698) -
Share units liability 5,037 13,642 -
Increase/(decrease) in cash resulting from changes in assets
and liabilities:
Accounts receivable 510,996 (176,491) 34,582
Other assets 18,212 34,291 (75,779)
Accounts payable 121,410 (176,845) 116,853
Accrued expenses (42,083) (381,954) 33,526
Income taxes payable/receivable (710) 52,092 (21,811)
Customer deposits (11,686) 11,411 -
Deferred rent (6,239) 7,700 -
Deferred revenue 136,499 44,142 (16,550)
--------- --------- ---------
Net cash provided by operating activities 1,670,361 337,168 109,998
--------- --------- ---------
INVESTING ACTIVITIES:
Purchases of investments (79,987) (130,386) (58,284)
Purchases of property and equipment (327,461) (202,811) (51,714)
Proceeds from sale of property and equipment 730 12,346 -
Proceeds from sale of investments - 163,724 -
--------- --------- ---------
Net cash used in investing activities (406,718) (157,127) (109,998)
--------- --------- ---------
FINANCING ACTIVITIES:
Increases in line of credit 96,000 96,000 -
Principal payment on line of credit (72,000) (54,000) -
Cash dividends paid (390,574) (146,373) -
Purchase and retirement of stock - (39,576) -
--------- --------- ---------
Net cash used in financing activities (366,574) (143,949) -
--------- --------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 897,069 36,092 -
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 36,092 - -
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 933,161 $ 36,092 $ -
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest $ 6,218 $ 23,327 $ -
--------- --------- ---------
--------- --------- ---------
Cash paid for income taxes $ 12,434 $ 16,437 $ -
--------- --------- ---------
--------- --------- ---------
Cash refunded for income taxes $ 441 $ 57,615 $ -
--------- --------- ---------
--------- --------- ---------
</TABLE>
See notes to financial statements.
-12-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996, AND
THE ONE MONTH ENDED DECEMBER 31, 1995
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS - Sentient Systems, Inc. (the Company) was
incorporated in the State of Maryland on December 8, 1980. The Company is
a healthcare information technology consulting firm, dedicated to assisting
healthcare organizations with improving patient care and lowering costs by
providing systems integration and support services. The Company has a
contract with the U.S. Government to provide database systems and support
that accounted for approximately 18%, 19%, and 15% of revenues in 1997,
1996, and 1995, respectively.
CHANGE IN TAX STATUS AND FISCAL YEAR - The Company, with the consent of its
stockholders, filed an S corporation election effective December 1, 1995.
Along with this election, the Company changed its fiscal-year end from
November 30 to December 31. Accordingly, all references to activity
occurring during 1995 refer to the one-month period ended December 31,
1995.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual amounts could differ from
these estimates.
REVENUE RECOGNITION - Revenues on programming services and support are
recognized at contractual rates as labor hours and other expenses are
incurred. Revenues on long-term, fixed-price contracts are recognized
using the percentage-of-completion method based on actual labor hours
incurred in relation to total estimated labor hours. Anticipated losses
estimated to be sustained in completion of contracts are charged to income
in the period such estimates are determined.
PROPERTY AND EQUIPMENT - Property and equipment, other than leasehold
improvements, are recorded at cost and depreciated using the straight-line
method over their estimated useful lives, ranging from three to seven
years. Leasehold improvements are amortized over the lesser of the lease
term or the estimated useful life, using the straight-line method.
CASH EQUIVALENTS - The Company considers all highly liquid investments with
original maturities of three months or less to be cash equivalents. The
Company's cash equivalents are composed of investments in money market
funds.
INVESTMENTS - The Company has classified its investments in equity
securities as AVAILABLE-FOR-SALE securities. Accordingly, its securities
are reported at fair value as determined by publicly available quotations,
with unrealized gains and losses excluded from earnings and reported in a
separate component of stockholders' equity until realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying value of cash and cash
equivalents, investments, accounts receivable, accounts payable, accrued
expenses and line of credit approximates fair value at December 31, 1997
and 1996 due to their short term nature.
-13-
<PAGE>
INCOME TAXES - Effective December 1, 1995, the Company elected to be taxed
under Subchapter S of the Internal Revenue Code. As a result, instead of
the Company paying U.S. corporate income taxes, the stockholders of an "S"
corporation are taxed individually on their proportionate share of the
Company's taxable income. Therefore, except to the extent the Company has
taxable income in a state that does not recognize S corporations or the
Company has elected to be taxed on a composite basis, no liability for
income taxes has been included in these financial statements.
2. INVESTMENTS
Investments at December 31, 1997 and 1996, as discussed in Note 1 are
classified as AVAILABLE FOR SALE and are stated at fair value. The
Company's short-term investments are in mutual funds consisting of equity
securities with a large public investment firm. The basis for determining
costs when computing realized gains or losses is specific identification.
The investments consist of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Cost $660,085 $580,098
Unrealized gains 143,046 118,322
-------- --------
Aggregate fair value $803,131 $698,420
-------- --------
-------- --------
Proceeds from sales of investments $ - $163,724
Gross realized gains on sales - 7,480
Gross realized losses on sales - (1,782)
</TABLE>
There were no sales of investments during 1995. The change in net
unrealized gain of $24,724 and $37,510 for 1997 and 1996, respectively, is
included in stockholders' equity under a separate account entitled
"Unrealized Gain on Investments."
3. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Payroll and related benefits $141,874 $166,736
Accrued vacation 130,246 132,328
Accrued professional fees 48,595 63,230
Other accrued expenses 62,287 62,791
-------- --------
$383,002 $425,085
-------- --------
-------- --------
</TABLE>
4. LINE OF CREDIT
As of December 31, 1996, the Company had no outstanding borrowings under a
$600,000 bank line-of-credit agreement. This line-of-credit agreement
bore interest at the bank's base rate plus 1% (9.25% as of December 31,
1996) and was guaranteed by the Company's principal stockholders.
Borrowings under this line of credit facility were subject to certain loan
covenants and were collateralized by the general assets of the Company.
This line of credit expired on March 20, 1997.
-14-
<PAGE>
In addition to the bank line-of-credit agreement, the Company has
established in 1996 a five-year term note for capital asset acquisitions.
Amounts may be advanced under this agreement at 80% of asset cost, with a
maximum borrowing capability of $360,000. This note bears interest at the
Wall Street Journal prime rate plus 1.25% (9.75% as of December 31, 1997),
and is payable in monthly installments of $6,000 principal plus accrued
interest. This note is collateralized by the general assets of the Company
and is guaranteed by the Company's principal stockholders. During 1997 and
1996, the Company borrowed $96,000 in each year against this note. The
Company made principal repayments of $72,000 and $54,000 in 1997 and 1996,
respectively, with an outstanding balance of $66,000 and $42,000 at
December 31, 1997 and 1996, respectively.
5. INCOME TAXES
The liability method requires the recognition of deferred tax assets and
liabilities for expected future tax consequences of temporary differences
between the reported amounts of assets and liabilities and their tax bases.
Deferred income taxes are computed based upon current tax rates in effect
under existing laws at the balance sheet date. The components of the
Company's provision for income taxes are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Current:
Federal $ - $ 3,762 $ -
State 10,483 10,456 -
------- ------- -------
10,483 14,218 -
Deferred:
Federal - - 71,839
State - - 14,475
------- ------- -------
- - 86,314
------- ------- -------
$10,483 $14,218 $86,314
------- ------- -------
------- ------- -------
</TABLE>
The Company's net deferred income tax asset, totaling $57,000 at November
30, 1995, consisted of deferred tax assets of $112,548 and deferred tax
liabilities of $55,548. The deferred tax assets were eliminated on
December 1, 1995, upon the Company's change in tax status (see Note 1), and
the effect has been included in net income for the one month ended December
31, 1995.
6. EMPLOYEE BENEFIT PLANS
The Company formerly had an employee stock purchase plan available to
certain employees of the Company. During 1994, the Board of Directors
discontinued issuance of new shares under the plan. During 1996, the
Company purchased and retired all 136,473 shares held by employees at
approximately $0.29 per share. Concurrently with the repurchase of the
shares, each employee holding stock was issued an equivalent number of
nontransferable "share units." These share units entitle the holder, upon
termination of employment or other liquidating event, to a payment equal to
the increase in the book value per share of the Company between the most
recent audited financial statements at the liquidating event date and the
most recent audited financial statements prior to the issuance of the share
units, multiplied by the number of share units held. As of December 31,
1997 and 1996, 114,370 and
-15-
<PAGE>
135,203 share units, respectively, were outstanding. The Company recorded
$7,139 and $13,642 of expense associated with these share units in 1997 and
1996, respectively.
The Company has a 401(k) savings plan available to employees who have
completed at least 1,000 hours of service. Matching contributions to the
plan are at the Company's discretion. The Company made matching
contributions to the plan for 1997, 1996, and 1995 of approximately
$84,000, $62,000, and $3,000, respectively. The Company pays all
administrative costs associated with the plan, which were $3,981, $2,410,
and $-0- in 1997, 1996, and 1995, respectively.
7. RELATED PARTY TRANSACTIONS
During 1997, 1996, and 1995, the Company leased certain office space from
certain officers and stockholders of the Company on a month-to-month basis.
The total amount paid to the officers and stockholders under the lease
agreement was approximately $24,000, $24,000, and $2,000 in 1997, 1996, and
1995, respectively.
8. COMMITMENTS AND CONTINGENCIES
The Company leases office space under a long-term, noncancelable operating
lease that commenced in 1994 and terminates in 1999. The office space
lease is subject to annual escalations of 2.5% beginning on the second
anniversary of the lease term as well as to a proportionate share for
increases in operating expenses. Rent expense under this lease was
approximately $515,000, $470,000, and $35,000 in 1997, 1996, and 1995,
respectively.
The Company leased additional office space under a noncancelable operating
lease that commenced in 1995 and terminated in 1996. Rent expense under
this lease was approximately $30,000 and $3,000 in 1996 and 1995,
respectively.
The Company leased temporary housing on a short-term basis under a
non-cancelable operating lease that commenced in 1995 and terminated in
1996. Rent expense under this lease was approximately $2,500 and $500 in
1996 and 1995, respectively.
The Company also leases temporary housing on a month-to-month basis for
certain employees temporarily assigned to work at customer locations,
commencing in 1996. Rent expense under this series of leases in 1997 and
1996 was approximately $31,000 and $16,000, respectively.
Minimum lease commitments are as follows:
<TABLE>
<S> <C>
1998 $535,856
1999 89,674
--------
Total $625,530
--------
--------
</TABLE>
In early 1997, a customer filed a complaint against the Company for breach
of contract alleging damages of $1.1 million, and subsequently increased
the claim to approximately $3 million. Management believes that the claim
does not have contractual support and therefore that the ultimate outcome
will not have a material adverse effect on the accompanying financial
statements.
-16-
<PAGE>
9. SUBSEQUENT EVENTS (UNAUDITED)
In March, 1998, the Company was acquired by DAOU Systems, Inc. ("DAOU"), a
publicly held company. As a subsidiary of a public company, the Company
will lose its "S" Corporation status for tax purposes.
In May, 1998, the breach of contract claim discussed in Note 8 was settled,
with both parties agreeing to undertake certain continuing obligations.
DAOU has agreed to assume all responsibilities to the Company under the
settlement, which is less than the original claim amount of $1.1 million.
* * * * * *
-17-
<PAGE>
SENTIENT SYSTEMS, INC.
--------
FINANCIAL STATEMENTS
FOR THE YEAR ENDED NOVEMBER 30, 1995
WITH REPORT OF INDEPENDENT ACCOUNTANTS
--------
-18-
<PAGE>
SENTIENT SYSTEMS, INC.
TABLE CONTENTS
--------
<TABLE>
<CAPTION>
PAGE
<S> <C>
Report of Independent Accountants 20
Audited Financial Statements
Balance Sheet 21 - 22
Statement of Operations 23
Statement of Changes in Stockholders' Equity 24
Statement of Cash Flows 25
Notes to Financial Statements 26 - 32
</TABLE>
-19-
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors
Sentient Systems, Inc.
We have audited the accompanying balance sheet of Sentient Systems, Inc. (the
Company) as of November 30, 1995 and the related statements of operations,
changes in stockholders' equity, and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis. evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Sentient Systems, Inc. as of
November 30, 1995, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
McLean, Virginia
March 8, 1996
-20-
<PAGE>
SENTIENT SYSTEMS, INC.
BALANCE SHEET
AS OF NOVEMBER 30, 1995
--------
<TABLE>
ASSETS
<S> <C>
Current assets:
Cash and cash equivalents $ -
Short-term investments 681,391
Accounts receivable, less allowance of $38,000
in 1995 1,243,494
Current income taxes receivable 24,490
Other current assets 22,089
Deferred income taxes 49,220
------------
Total current assets 2,020,684
------------
Property and equipment, at cost:
Computer equipment 840,227
Furniture and fixtures 161,928
Office equipment 90,808
Vehicles 47,341
Leasehold improvements 16,045
------------
1,156,349
Accumulated depreciation and amortization (808,670)
------------
347,679
Other assets 38,710
Deferred income taxes 7,780
------------
Total assets $ 2,414,853
------------
------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
-21-
<PAGE>
SENTIENT SYSTEMS, INC.
BALANCE SHEETS
AS OF NOVEMBER 30, 1995
-------
<TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C>
Current liabilities:
Accounts payable $ 75,029
Accrued expenses 453,513
Accrued payroll 320,000
Deferred rent 22,239
Deferred revenue 59,950
------------
Total current liabilities 930,731
------------
Commitments and contingencies
Stockholders' equity
Common stock, $.001 par value - authorized shares -
6,250,000, issued and outstanding shares - 5,386,473 5,387
Additional paid-in capital 18,887
Retained earnings 1,379,036
Unrealized gain on investments, net of tax 80,812
------------
Total stockholders' equity 1,484,122
------------
Total liabilities and stockholders' equity $ 2,414,853
------------
------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
-22-
<PAGE>
SENTIENT SYSTEMS, INC.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 1995
--------
<TABLE>
<S> <C>
SALES
Consulting sales $ 6,510,294
Acclaim sales 1,653,341
------------
Net sales 8,163,635
Cost of sales 3,790,405
------------
Gross profit 4,373,230
Selling and administrative expenses 4,318,515
Loss on disposal of property and equipment 8,347
------------
Income from operations 46,368
Other income (expense):
Loss on disposal of investment (6,877)
Interest and dividend income 56,979
Interest expense (444)
------------
Income before provision for income taxes 96,026
Provision for income taxes 13,292
------------
Net income $ 82,734
------------
------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
-23-
<PAGE>
SENTIENT SYSTEMS, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED NOVEMBER 30, 1995
--------
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL UNREALIZED TOTAL
------------------------ PAID-IN RETAINED GAIN ON STOCKHOLDERS'
SHARES AMOUNT CAPITAL Earnings INVESTMENTS EQUITY
--------- --------- ---------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at November 30, 1994 5,387,827 $ 5,388 $ 19,218 $ 1,296,302 $ - $ 1,320,908
Purchase and retirement of common stock (1,354) (1) (331) - - (332)
Unrealized gain on investments - - - - 80,812 80,812
Net income - - - 82,734 - 82,734
--------- --------- ---------- ----------- ----------- -------------
Balance at November 30, 1995 5,386,473 $ 5,387 $ 18,887 $ 1,379,036 $ 80,812 $ 1,484,122
--------- --------- ---------- ----------- ----------- -------------
--------- --------- ---------- ----------- ----------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
-24-
<PAGE>
SENTIENT SYSTEMS, INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 1995
--------
<TABLE>
<CAPTION>
1995
-----------
<S> <C>
OPERATING ACTIVITIES $ 82,734
Net income
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization 148,333
Deferred income taxes (96,127)
Loss on disposal of fixed assets 8,347
Loss on disposal of investments 6,877
Increase/(decrease) in cash resulting from changes in assets and
liabilities
Accounts receivable (679,442)
Other assets 50,826
Accounts payable (157,340)
Accrued expenses 9,869
Deferred rent 10,051
Current income taxes receivable (200,056)
Deferred revenue 21,767
-----------
Net cash used in operating activities (794,161)
-----------
INVESTING ACTIVITIES
Cash proceeds from sale of Acclaim product line 300,000
Purchases of short term investments (472,360)
Purchase of property and equipment (198,661)
Proceeds from sale of property and equipment 674
Proceeds from sale of short term investments 160,992
-----------
Net cash used in investing activities (209,355)
-----------
FINANCING ACTIVITIES
Principal payment on long term debt and advances (1,765)
Purchase and retirement of stock (332)
-----------
Net cash used in financing activities (2,097)
-----------
Net decrease in cash and cash equivalents (1,005,613)
Cash and cash equivalents at beginning of year 1,005,613
-----------
Cash and cash equivalents at end of year $ -
-----------
-----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for interest $ 444
-----------
-----------
Cash paid during the year for income taxes $ 309,486
-----------
-----------
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING ACTIVITIES
Non-cash transactions affecting current assets and liabilities
Unrealized gain on investments $ 80,812
-----------
-----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
-25-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
------
1. ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Sentient Systems, Inc. ("the Company") was incorporated in the
State of Maryland on December 8, 1980. The Company provides computer
programming services and support, primarily to the medical services
industry. The Company has a major contract with the National
Institute of Health to provide database systems and support which
accounted for approximately 19% of revenue in 1995.
USE OF ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
These estimates involve judgments with respect to, among other things,
various future economic factors which are difficult to predict and are
beyond the control of the Company. Therefore, actual amounts could
differ from these estimates.
REVENUE RECOGNITION
Revenue on programming services and support is recognized at
contractual rates as labor hours and other expenses are incurred.
Deferred revenue on service contracts is amortized by the straight
line method ratably over the life of the contracts. Revenue on long
term, fixed price contracts is recognized on the percentage of
completion method. Anticipated losses, estimated to be sustained upon
completion of contracts, are charged to income in the year such
estimates are determined.
CONTINUED
-26-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
------
1. ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated on a
straight line method over their useful lives which range from three to
seven years. Gains and/or losses from the retirement or disposal of
fixed assets are included in operations of the year in which the
retirement or disposal occurs.
CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. The
Company's cash equivalents are primarily composed of investments in
money market funds. These money market funds are not subject to
significant market fluctuations and readily convertible to cash, and
therefore, are considered to be cash equivalents.
CONCENTRATION OF CREDIT RISK
The Company's short-term investments are in mutual funds,
consisting of equity securities with a large public investment firm.
The Company grants uncollateralized credit in the form of
accounts receivable to its customers, who are primarily hospitals
throughout the United States.
CONTINUED
-27-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
------
1. ACCOUNTING POLICIES (CONTINUED)
SHORT-TERM INVESTMENTS
Effective December 1, 1994, the Company adopted Statement of
Financial Accounting Standard No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS 115). Pursuant to
SFAS 115, the Company has classified its investments in equity
securities as AVAILABLE-FOR-SALE securities. Accordingly, its
securities are reported at fair value as determined by publicly
available quotations, with unrealized gains and losses excluded from
earnings and reported net of taxes of $51,125 in a separate component
of stockholders' equity.
INCOME TAXES
Deferred income taxes are recognized for the future tax
consequences of differences between tax bases of assets and
liabilities and financial reporting amounts, based on enacted tax laws
and statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax
assets to amounts expected to be realized. Income tax expense is the
tax payable for the period and the change during the period in
deferred tax assets and liabilities.
2. COMMITMENTS AND CONTINGENCIES
The Company leases office space under a long-term, noncancelable
operating lease that commenced in 1994 and terminates in 1999. The office
space lease is subject to annual escalations of 2.5% beginning on the
second anniversary of the lease term for increases in operating expenses.
The Company amortizes rent expense over the life of the lease using the
straight line method. Rent expense under this lease was approximately
$438,000 in 1995. The Company has committed to leasing additional space
within the terms and conditions of this lease. Additionally, the Company
has committed to approximately $20,000 in upgrades in the buildout of this
space.
CONTINUED
-28-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
------
2. COMMITMENTS AND CONTINGENCIES, CONTINUED
The Company leases additional office space under a noncancelable
operating lease that commenced in 1995 and terminates in 1996. Rent
expense under this lease was approximately $3,000 in 1995.
The Company also leases temporary housing on a short term basis under
a noncancelable operating lease that commenced in 1995 and terminates in
1996. Rent expense under this lease was approximately $2,000 in 1995.
Minimum lease commitments are as follows:
<TABLE>
<S> <C>
1996 503,207
1997 504,956
1998 526,437
1999 132,417
----------
Total $1,667,017
----------
----------
</TABLE>
3. LINE OF CREDIT
As of November 30, 1995, the Company had no outstanding borrowings
under a $300,000 bank line of credit agreement. This line of credit
agreement bears interest at the bank's base rate plus 1% and is guaranteed
by the Company's principal stockholders. Borrowings under this line of
credit facility are subject to certain loan covenants and are
collateralized by the Company's accounts receivable.
CONTINUED
-29-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
------
4. INVESTMENTS
The Company's short-term investments are in mutual funds consisting of
equity securities with two large public investment firms. The aggregate
fair value of these investments as of November 30, 1995, is $681,391 with a
cost of $549,454 resulting in an unrealized holding gain of $131,937.
During fiscal year 1995, a total of $160,991 of securities were sold,
resulting in realized losses of $6,878. The basis for determined costs
when computing realized gains or losses is specific identification.
5. RELATED PARTY TRANSACTIONS
During 1995, the Company leased certain office space from the officers
and stockholders of the Company on a month to month basis. The total
amount paid to the officers and stockholders under the lease agreement was
approximately $48,400.
6. INCOME TAXES
The components of the Company's provision for income taxes are as
follows:
<TABLE>
<S> <C>
Current
Federal $ 91,065
State 18,354
--------
109,419
--------
Deferred:
Federal (80,002)
State (16,125)
--------
(96,127)
--------
$ 13,292
--------
--------
</TABLE>
CONTINUED
-30-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
------
6. INCOME TAXES, CONTINUED
The components of the Company's net deferred tax asset are as follows:
<TABLE>
<S> <C>
Deferred tax assets:
Property and equipment $ 7,780
Accrued expenses 69,350
Reserves and allowances 24,358
Deferred revenue 11,060
--------
112,548
--------
Deferred tax liability:
Unrealized gain on investments (51,125)
Prepaid expenses (4,423)
--------
(55,548)
--------
Net deferred tax asset $ 57,000
--------
--------
</TABLE>
The Company's tax provision (benefit) for year ended November 30, 1995
differs from statutory rate for federal income taxes as a result of tax
effect of the following factors:
<TABLE>
<S> <C>
Statutory rate 34%
State income tax, net of federal
benefit 4%
Non-deductible meals and entertainment 11%
Adjustment of prior year accrual (35)%
----
14%
----
----
</TABLE>
CONTINUED
-31-
<PAGE>
SENTIENT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
------
7. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan available to employees who have
completed at least 1,000 hours of service. Matching contributions to the
plan are at the Company's discretion. The Company made matching
contributions to the plan for 1995 of approximately $51,000. The Company
pays all administrative costs associated with the plan, which were $1,380
in 1995.
8. SALE OF ACCLAIM PRODUCT LINE
In November 1994, the Company recorded a gain related to the sale of
assets associated with its Acclaim product line to Physician Computer
Network, Inc. (PCN), a public software company. The Company received
consideration totaling $600,000, in the form of cash downpayment of
$300,000 in 1994 and notes receivable of $300,000, which were paid in 1995.
Under the terms of the asset purchase agreement with PCN, the Company
continued to provide maintenance services for the Acclaim product line
primarily on a time and material basis. During 1995, the Company
recognized $1,653,341 in revenue related to this agreement.
-32-
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS
The following unaudited pro forma combined condensed financial statements give
effect to the Merger of DAOU and Sentient accounted for using the
pooling-of-interests method of accounting. These pro forma financial statements
are presented for illustrative purposes only and therefore are not necessarily
indicative of the operating results or financial position that might have been
achieved had the Merger occurred as of an earlier date, nor are they necessarily
indicative of operating results or financial position which may occur in the
future.
A pro forma combined condensed balance sheet is provided as of December 31,
1997, giving effect to the Merger as though it had been consummated on that
date. Pro forma combined condensed statements of operations are provided for
the years ended December 31, 1997, 1996 and 1995, giving effect to the Merger as
though it had occurred at the beginning of the earliest period presented.
The pro forma combined condensed statements of operations for the years ended
December 31, 1997, 1996 and 1995 are derived from the audited historical
financial statements of DAOU and audited historical financial statements of
Sentient.
-33-
<PAGE>
DAOU Systems, Inc.
UNAUDITED PRO FORMA COMBINED CONDENSED
BALANCE SHEETS
December 31, 1997
(in thousands)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
DAOU SENTIENT FOR THE PRO FORMA
HISTORICAL HISTORICAL TRANSACTION COMBINED
---------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,759 $ 933 $ - $ 5,692
Short-term investments 9,146 803 - 9,949
Accounts receivable, net 11,061 874 - 11,935
Contract work-in-progress 12,412 - - 12,412
Other current assets 1,990 39 - 2,029
---------------------------------------------------------
Total current assets 39,368 2,649 - 42,017
Due from officers/stockholders 371 - - 371
Equipment, furniture and fixtures, net 3,017 466 - 3,483
Other assets 411 46 - 457
---------------------------------------------------------
$43,167 $ 3,161 $ - $46,328
---------------------------------------------------------
---------------------------------------------------------
LIABILTIIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 891 $ 136 $ - $ 1,027
Accrued salaries and wages 1,701 51 - 1,752
Deferred revenue 145 224 - 369
Other accrued liabilities 2,488 337 1,722 (b) 4,547
Line of credit 21 66 - 87
---------------------------------------------------------
Total current liabilities 5,246 814 1,722 7,782
Deferred rent 31 24 - 55
Other long-term liabilities 420 19 - 439
Stockholders' equity:
Common stock 12 5 (4)(a) 13
Additional paid-in capital 35,811 13 4 (a) 35,828
Deferred compensation (907) - - (907)
Unrealized gain on short-term
investments - 143 - 143
Retained earnings 2,554 2,143 (1,722)(b) 2,975
---------------------------------------------------------
Total stockholders' equity 37,470 2,304 (1,722) 38,052
---------------------------------------------------------
$43,167 $3,161 $ - $46,328
---------------------------------------------------------
---------------------------------------------------------
</TABLE>
(a) Reclassifications to conform presentation to DAOU's financial data.
(b) Estimated charge, net of tax, for merger related costs, including costs to
integrate the operations of the two companies.
-34-
<PAGE>
DAOU Systems, Inc.
UNAUDITED PRO FORMA COMBINED CONDENSED
STATMENTS OF OPERATIONS
Year ended December 31, 1997
(in thousands, except per share data)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
DAOU SENTIENT FOR THE PRO FORMA
HISTORICAL HISTORICAL TRANSACTION COMBINED
---------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $41,700 $9,861 $ - $51,561
Cost of revenues 29,013 4,887 402 (a) 34,302
---------------------------------------------------------
Gross profit 12,687 4,974 (402) 17,259
Operating expenses:
Sales and marketing 5,619 1,002 182 (a) 6,803
General and administrative 6,188 3,365 (584)(a) 8,969
Merger and related expenses 718 - - 718
---------------------------------------------------------
12,525 4,367 (402) 16,490
---------------------------------------------------------
Income from operations 162 607 769
Interest income, net 744 97 841
---------------------------------------------------------
Income before income taxes 906 704 1,610
Provision for income taxes 819 10 279 (b) 1,108
---------------------------------------------------------
Net income $ 87 $ 694 $ (279) $ 502
---------------------------------------------------------
---------------------------------------------------------
Earnings per share data:
Net income per common share:
Basic $ 0.04
---------
---------
Diluted $ 0.04
---------
---------
Shares used in computing net
income per common share:
Basic 12,503
---------
---------
Diluted 13,330
---------
---------
</TABLE>
(a) Certain reclassifications have been made to conform Sentient's Historical
financial statements to DAOU's presentation.
(b) Adjust the income tax provision for income taxes based on an incremental
tax rate of 41%. Prior to merger transaction, Sentient was an S
corporation, therefore income taxes were the responsibility of the
individual shareholders.
-35-
<PAGE>
DAOU Systems, Inc.
UNAUDITED PRO FORMA COMBINED CONDENSED
STATMENTS OF OPERATIONS
Year ended December 31, 1996
(in thousands, except per share data)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
DAOU SENTIENT FOR THE PRO FORMA
HISTORICAL HISTORICAL TRANSACTION COMBINED
---------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $28,383 $ 9,732 $ - $38,115
Cost of revenues 20,107 5,107 297(a) 25,511
---------------------------------------------------------
Gross profit 8,276 4,625 (297) 12,604
Operating expenses:
Sales and marketing 2,226 927 300 (a) 3,453
General and administrative 5,200 3,011 (597)(a) 7,614
---------------------------------------------------------
7,426 3,938 (297) 11,067
---------------------------------------------------------
Income from operations 850 687 - 1,537
Interest income, net 198 57 - 255
---------------------------------------------------------
Income before income taxes 1,048 744 - 1,792
Provision for income taxes 126 14 291(b) 431
---------------------------------------------------------
Net income $ 922 $ 730 $ (291) $ 1,361
---------------------------------------------------------
---------------------------------------------------------
Earnings per share data:
Net income per common share:
Basic $ 0.13
---------
---------
Diluted $ 0.13
---------
---------
Shares used in computing net
income per common share:
Basic 10,485
---------
---------
Diluted 10,687
---------
---------
</TABLE>
(a) Certain reclassifications have been made to conform Sentient's Historical
financial statements to DAOU's presentation.
(b) Adjust the income tax provision for income taxes based on an incremental
tax rate of 41%. Prior to merger transaction, Sentient was an S
corporation, therefore income taxes were the responsibility of the
individual shareholders.
-36-
<PAGE>
DAOU Systems, Inc.
UNAUDITED PRO FORMA COMBINED CONDENSED
STATMENTS OF OPERATIONS
Year ended December 31, 1995
(in thousands, except per share data)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
DAOU SENTIENT FOR THE PRO FORMA
HISTORICAL HISTORICAL TRANSACTION COMBINED
----------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $19,863 $ 8,157 $ - $28,020
Cost of revenues 12,156 3,790 634 (a) 16,580
----------------------------------------------------------
Gross profit 7,707 4,367 (634) 11,440
Operating expenses:
Sales and marketing 1,120 894 305 (a) 2,319
General and administrative 4,656 3,418 (939)(a) 7,135
----------------------------------------------------------
5,776 4,312 (634) 9,454
----------------------------------------------------------
Income from operations 1,931 55 - 1,986
Interest income, net 62 41 103
----------------------------------------------------------
Income before income taxes 1,993 96 - 2,089
Provision for income taxes 875 13 - 888
----------------------------------------------------------
Net income $ 1,118 $ 83 $ - $ 1,201
----------------------------------------------------------
----------------------------------------------------------
Earnings per share data:
Net income per common share:
Basic $ 0.13
---------
---------
Diluted $ 0.13
---------
---------
Shares used in computing net
income per common share:
Basic 9,140
---------
---------
Diluted 9,140
---------
---------
</TABLE>
(a) Certain reclassifications have been made to conform Sentient's Historical
financial statements to DAOU's presentation.
(b) During 1996 Sentient changed its fiscal year end to December 31. Prior to
1996, Sentient's fiscal year end was November 30.
-37-
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS
1. The unaudited pro forma combined condensed financial statements of DAOU
Systems, Inc. ("DAOU") and Sentient Systems, Inc. ("Sentient") give
retroactive effect to the Merger using the pooling-of-interests method of
accounting and as a result, the unaudited pro forma combined condensed
balance sheets and statements of operations are presented as if the
condensed financial statements will become the historical financial
statements of DAOU upon issuance of financial statements for a period that
includes the Merger date. The unaudited pro forma combined condensed
financial statements reflect the issuance of 1,397,550 fully paid and
nonassessable shares of DAOU's common stock for 5,250,000 shares of
Sentient common stock to effect the Merger.
2. The unaudited pro forma combined condensed balance sheets combine DAOU's
December 31, 1997 balance sheet with Sentient's December 31, 1997 balance
sheet. The adjustments relate to the estimated costs of the merger
transaction and integration of the businesses and are estimated to be
approximately $1,722,000, net of estimated tax benefits of approximately
$74,000.
3. The unaudited pro forma combined condensed statements of operations combine
DAOU's historical results for the years ended December 31, 1997, 1996 and
1995 with the Sentient historical results for the years ended December 31,
1997 and 1996 and the year ended November 30, 1995, respectively. During
1996, Sentient changed its fiscal year end from November 30 to December 31.
The results of operations for the one month ended December 31, 1995 were
not significant.
4. The unaudited pro forma data are presented for informational purposes only
and do not give effect to any synergies that may occur due to the combining
of DAOU's and Sentient's existing operations. DAOU expects to incur
charges currently estimated to approximate $1,722,000, net of taxes, in the
quarter ending March 31, 1998, the quarter in which the Merger was
consummated, to reflect costs associated with combining the operations of
the two companies and transaction fees and costs incident to the Merger.
This non-recurring charge is reflected in the unaudited pro forma combined
condensed balance sheet but is not included in the unaudited pro forma
combined condensed statement of operations.
5. The accounting policies of the separate companies are currently being
studied from a conformity perspective. The impact of conforming accounting
policies, if any, is not presently estimatable.
-38-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: May 18, 1998 DAOU SYSTEMS, INC.
By: /s/ FRED C. MCGEE
----------------------------------------
Fred C. McGee, Chief Financial Officer
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Document Description
--------- -----------------------------------------------------------
<S> <C>
2.1*+ Agreement and Plan of Merger, dated as of March 30, 1998,
by and among DAOU Systems, Inc., a Delaware corporation,
DAOU-Sentient, Inc., a Delaware corporation and wholly-
owned subsidiary of DAOU Systems, Inc., Sentient Systems,
Inc., a Maryland corporation, and the stockholders of
Sentient Systems, Inc.
2.2*+ Agreement and Plan of Merger, dated as of March 27, 1998,
by and among DAOU Systems, Inc., a Delaware corporation,
DAOU-Synexus, Inc., a Delaware corporation and wholly-
owned subsidiary of DAOU Systems, Inc., Synexus
Incorporated, a Pennsylvania corporation, and the
stockholders of Synexus Incorporated.
99.1** Press release entitled "DAOU Systems Merges with Sentient
Systems, Inc."
99.2** Press release entitled "DAOU Systems Merges with Synexus
Incorporated."
</TABLE>
* Filed as an exhibit to the Company's Current Report on Form 8-K
which was filed with the Securities and Exchange Commission on April 14, 1998
and is incorporated herein by reference.
** Filed as an exhibit to the Company's Current Report on Form 8-K
which was filed with the Securities and Exchange Commission on April 2, 1998 and
is incorporated herein by reference.
+ Confidential treatment has been requested for portions of
this exhibit.
