Daou struggles to staunch the financial bleeding

November 15, 2000

Daou struggles to staunch the financial bleedingCompany losses mount as income dwindlesAs the Internet economy seeks to find viable, profitable business models, e-health companies like WebMD have been publicly-and, in some cases,

Daou struggles to staunch the financial bleeding

Company losses mount as income dwindles

As the Internet economy seeks to find viable, profitable business models, e-health companies like WebMD have been publicly-and, in some cases, drastically-tightening their belts. But dot-coms are not the only vendors taking significant steps to improve their bottom lines. ADAC, Agilent, and Dynamic Healthcare are just a few of the established medical equipment firms that have reacted to the health IT market slowdown with restructuring, reevaluating, and just plain retreating.

Systems integrator Daou Systems is also on this growing list of struggling healthcare IT companies. In fact, the firm's cash flow problems in the past two years mirror the healthcare market's ups-and-downs. After a 1997 IPO and 1998 acquisition spree, the San Diego-based company's financials began to seriously falter. Costs of integrating its acquisitions, combined with the closure of one division and lower revenue for the communications infrastructure group, ate up what profits there were in 1999.

And there appears to be no relief in sight. The company reported losses of $4.1 million on revenue of $15.3 million, or 23¢ per share, for third quarter 2000 (end-Sept. 30), compared to income of $625,000 on revenue of $25.4 million, or 4¢ per share, for the same period in 1999. According to Daou CFO Neil Cassidy, gross margin for third quarter 2000 decreased to 14% from 19% in the second quarter and from 30% in third quarter 1999, due to a decline in utilization rates, nonrecurring employee benefit and severance charges, and investment in Enosus, Daou's e-commerce start-up. Like many of its compadres in this market, Daou attributes the poor performance to reduced demand for healthcare IT products and services.

Even so, the company says it is actively pursuing a return to profitability. After the breakdown of merger talks with Perot Systems earlier this year (HNN 8/23/00), Daou has opted not to seek another buyer and instead has engaged the services of a turnaround specialist, Kibel Green Issa (KGI). The firm also has a new management team in place; in addition to Cassidy, James Roberto has stepped in as CEO. Former CEO Larry Grandia announced his intention to resign in October, and his departure coincides with the conclusion of KGI's initial analysis phase. Grandia will remain on Daou's board of directors.

Daou dodged another bullet by renegotiating the provision for the holders of Daou's Series A preferred stock that enabled those shareholders (primarily Galen Partners) to redeem their shares at $5.50 per share and to receive the dividends that have accrued, which kicked in on Grandia's resignation. The company has agreed to pay $2 million cash and issue warrants to buy approximately 3.5 million shares of Daou's common stock for 1¢ per share in consideration of the permanent removal of the preferred shareholders' redemption right. In addition, the company will record $4 million as a one-time dividend in fourth quarter 2000.

"We believe that the renegotiation with our preferred shareholders and the appointment of Jim Roberto will enable Daou to maintain cash resources and provide additional management skills we need to maximize shareholder value," said Georges Daou, chairman of the board.

Another potential path out of the red is through Daou's new e-commerce subsidiary, Enosus, which takes the firm outside of pure play healthcare. Enosus provides consulting services to enable its clients to get their businesses on the 'Net, offering applications hosting, monitoring services, and technical support. The company also claims expertise in integrating legacy systems, just like daddy Daou.

Despite Daou's overall financial struggles, the company has consistently stressed its ability to cover Enosus start-up costs in its financial reporting. In the long run, however, given the increasingly crowded B2B marketplace, it is unclear whether Enosus will be able to rescue Daou. Daou's stock was trading at 56¢ per share at press time, far below its 52-week high of $5.75 per share and its all-time high of $34.38 in 1997.