Daou Systems, Inc. (DAOU)
Interview with: Daniel Malcolm, CEO
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Daou Systems – a professional IT consulting and managing services company dedicated exclusively to healthcare organizations

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Technology

Computer Networks

(OTC: DAOU)

Daou Systems, Inc.

412 Creamery Way
Suite 300
Exton, PA 19341
Phone: 610-594-2700

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Daniel Malcolm
Chief Executive Officer

Interview conducted by:
Diane Reynolds, Co Publisher

CEOCFOinterviews.com
February 2003

Bio of CEO,

Mr. Malcolm was appointed Chief Executive Officer effective January 1, 2003. Malcolm joined Daou in July 2001as Chief Marketing Officer and President of the Technical Services Division.  In his first year at Daou, Malcolm re-launched the brand and positioning of the Company, and achieved strong growth in the government sector business.  Additionally, he positioned the client relationship and IT management practice, also known as the Daou Technology Center, and the infrastructure services business for strategic growth in 2003.

This rebuilding effort was a primary initiative at Daou for 2002.  Prior to joining the Company, he served as Vice Chairman and Chief Operating Officer of LaserLink.net from March 1999 to March 2000. LaserLink.net was a branded Internet access firm, where Mr. Malcolm helped to grow and energize the Company for a subsequent sale to Covad Communications, Inc. [COVD]. From April 2000 to January 2001, following the acquisition of LaserLink.net by Covad, Mr. Malcolm was Vice President of Covad’s Consumer Business Division. From June 1996 to February 1999, he was the Chief Operating Officer of American Healthware Systems, Inc., a financial software and services vendor to acute care hospitals. Previously, he held senior executive positions with Integra, Inc. from January 1991 to May 1996 and Shared Medical Systems (SMS, now Siemens Medical Solutions) from March 1985 to December 1990. He served in various roles during his tenure at SMS, starting as a regional sales manager, then moving into executive-level business development and marketing positions and ultimately serving as Vice President of New Business Development. Mr. Malcolm held various management positions within IBM from July 1973 to February 1985. Previously, he was a commissioned Officer in the U.S. Army. Mr. Malcolm holds a B.S. in Marketing from Drexel University.

Company Profile:

Daou Systems, Inc., provides professional IT consulting and management services. The company provides these services to healthcare organizations in the design, deployment, integration and support of infrastructure and application systems. Daou offers a range of comprehensive services, from strategic consulting to IT application design and implementation, systems integration and functional outsourcing.

There are two vital components of every healthcare organization’s IT infrastructure: one is the information technology itself, the other is the expertise to manage it. Daou Systems provides both through a comprehensive range of services. They pride themselves on an infrastructure services team that has unparalleled expertise in the design, deployment and support of the infrastructure for today’s systems in healthcare organizations.

Daou provides services to more than 1,500 healthcare organizations, including leading private and public hospitals, integrated healthcare delivery networks (IDNs), managed care organizations, and government healthcare.

Some key services include:

-         Management consulting practice

-         systems integration practice

-         application support practice

A 20-year track record of assisting clients at every key point in the application system continuum from needs assessment to procurement to implementation to post-implementation support, offering specific solutions to specific needs.

Daou also understands emerging technologies and tries to prepare its clients to deal with the impending revolution. Daou feels they can bring better knowledge to this intersection in making new technologies work with legacy systems.

CEOCFOinterviews: Mr.  Malcolm, please tell us a little about Daou Systems.

Mr. Malcolm: “Daou Systems, Inc., provides professional IT consulting and management services. The company provides these services to healthcare organizations in the design, deployment, integration and support of infrastructure and application systems. Daou offers a range of comprehensive services, from strategic consulting to IT application design and implementation, systems integration and functional outsourcing.”

CEOCFOinterviews: Why just healthcare?

Mr. Malcolm: “I think healthcare is unique and very complex, but I think one of the benefits we offer is our dedication. Healthcare is where we grew up and what we understand as I take a look at the number of the clinical systems evolutions and the quality of care evolutions that we see. We are still a small company in terms of size at about $38 million dollars and we can’t really be all things to all people. Our roots are in healthcare and I think that is where we are going to stay for a long time.”

CEOCFOinterviews: Where are your revenues coming from?

Mr. Malcolm: “We really have three primary markets; the first, is the commercial provider marketplace, which is our primary market. It is made up of community hospitals, the specialty hospital such as the heart or children’s hospital, the regional integrated delivery networks and the national networks. Our two secondary markets are the payer and the provider markets. The payer market is only secondary based on size. In the provider market, 3,000 hospitals in the United States are greater than 100 beds in size. When I look at the payer marketplace, we target ourselves to that middle payer market and of those companies there are about 200 middle payers that go across the country. The third marketplace is government health, the Department of Defense, the Veteran Hospitals and The Bureau of Indian Affairs Hospitals.”

CEOCFOinterviews: What are the current challenges in the healthcare space?

Mr. Malcolm: “There are a couple of challenges in the healthcare space right now, one affecting the other, but these challenges only serve to enhance Daou’s creditability and position for growth. One is that there aren’t a lot of dollars in the provider and payer marketplaces. When you take a look at the payers, the insurance organizations or HMO’s, there is tremendous pressure to sustain or lower premiums and many of the payers out there find it very challenging to keep premium increases under check. On the provider side, there are also significant reimbursement challenges. The payers aren’t picking up a lot of money, so their reimbursement rates into the provider hospitals have not gone up.

One of the things that we have seen here is under the headline of “biting the hand that feeds you”. We had a hospital here outside of Philadelphia County, Chester Hospital that actually filed a lawsuit for monopolistic practices against their biggest insurance company, Independence Blue Cross responsible for over 70% of their reimbursement. Because their reimbursement rates were so low, it was creating a major problem and a crisis at this community hospital.”

CEOCFOinterviews: Can you tell us more on how this is affecting hospitals?

Mr. Malcolm: “Well, although there isn’t much money in the provider or payer market space, the need to improve the quality of healthcare stays prospectively strong. Hospitals and networks of providers need and want to retain and attract team medical staff and so they have to continue to evolve their clinical systems to improve the quality of care and make information more available. More and more physicians are coming into the system and want to order tests themselves and see the results in an independent setting, either in the hospital or in their own physician’s office or as they are traveling in their car. Therefore, what they need is image management across an enterprise. Many more people are having MRI’s done or x-rays done and physicians as well as patients want to be able to have that data available not only in the hospital but also in the doctor’s office or available for a specialist hospital that is making decisions about their care. Physicians want the ability to see a lifetime clinical record or to retrieve information on episodes of treatment, so they need the Internet capability there. In addition, there are departments that are also looking to gain increased functionality like the emergency room, the operating room and obstetric work in the delivery of a baby.”

CEOCFOinterviews: Whom do the hospitals usually turn to for help?

Mr. Malcolm: “Since the dollars are very tight to support this dramatic need to improve the quality of care, hospitals look to talk to their trusted advisor on the challenges that this represents. In many cases, the trusted advisor is the software company or the primary software company in which they have implemented their systems. The big four software companies that we talk about are Siemen’s; McKesson, Eclipses and Cerner. What they generally find out is that the current systems they have installed won’t get them where they want to be. Therefore, they will need to go to the software company’s new systems, their server-based systems. However, those new systems will cost somewhere between $12 million or $15 million dollars and take three or five years to install. Well these hospitals don’t have that kind of money to do that. They would like to go that way, but they do not have the money or the time to be able to do it. Therefore, a few of them, make the hard choices to upgrade, but many others are left with the problem and to try to cope with that, they will put together an inexpensive pilot to be able to keep some of the clinicians at bay until they figure out a better strategy.”

CEOCFOinterviews: Do you offer a solution?

Mr. Malcolm: “At Daou, we want to be able to drive and add value at the intersection of a hospital’s legacy applications. We want to take these legacy applications and integrate them with new and emerging technologies. We think we have the ability from all that we have done with our partners, our experience base, our know how, that we can integrate these new emerging technologies with a client’s current systems and give them about 75% of the function and value for about a third of the price and about a third of the cost. That is our true value proposition back into the marketplace.”

CEOCFOinterviews: I know you are there to ensure the dependability, the compatibility, but security seems to be biggest issue facing everyone.

Mr. Malcolm: “There are a couple of pieces, and clearly one of what we call our pillars of excellence is advance security and patient privacy. Advance security is what we call Enterprise Image Management or the capability to move your x-rays or MRI across the regional network or into your physician’s office. That is one of major issues that the hospital faces, if you are taking your patient record and making it available across the Internet to your physician or to yourself in a patient point of view you want to make sure that information is secure and not being shared or not given to anyone else. Therefore, to be able to have the capability for advanced security and to be HIPAA, which is the government’s standards for patient privacy, in order to be HIPAA compliant you clearly need to take a number of steps to do that. We do that with our network, our firewall protection and some of our advanced security protection software that is implemented.  That is one of the pillars, which is needed to be able to improve the quality of care and to give this independent location capability for patient data.

Another need is for physicians who want to generate orders and see results in a location in an independent basis, they need the ability to have a single sign-on to the lab system, the radiology system, the pharmacy system and the lifetime clinical record. Right now in many hospitals, a physician does not have that capability and paper records are not necessarily readily available. Therefore, the physician must ask the patient, how he or she is feeling or maybe even what medication they were previously given. This is because the data is not easy to get to. The physician needs the capability to sign on once and get to any of the systems available.

We aren’t a single software vendor, but we looked at the major single software vendors that are out there, the MD Exchange, Sentillion, Common Access and Integrate, and we know the pluses and minuses of those and based on a hospital needs we can represent an appropriate one for them. The final aspect we look at is how do you support the physician after they are using this technology as well. These are the areas that we call our pillars of excellence. We’ve invested a lot of time and know-how and what we feel is that we can offer to a hospital that trusted advisor roll or our experience to help them make the appropriate decisions based on their budgets.”

CEOCFOinterviews: Can you tell us why you executed a work force reduction?

Mr. Malcolm: “There was a piece of Daou that was built on an acquisition strategy. Our original heritage company focused around network infrastructure, the capability of bandwidth, of security, of implementing new networks that would allow physicians access to data. Our network infrastructure was our core business, but to that core, my predecessors had the vision that other, what I call, strategic surround, services would compliment that core. Application support would be an example. We have what we call the Daou technology center for ongoing and user support to be a third. In addition, we have an integration group that develops integration methodology and integration software to have systems talk together. We grew up through acquisition and had a number of complimentary business units. However, in many cases as in any internal organization, business units can grow into silos, where there are hurdles to cross-reference the added value that they bring. We were facing some of that hurdle, where it was more difficult to put together a number of pieces that would be a solution to a hospital, because we had these various business-sized silos. 

We have reorganization to where we have one person, Vince Roach, who is my Executive Vice President of Commercial Operations, and Vince now has ownership over top of what used to be these business units. Now he can more easily cross-mesh the needed types of services or applications or network knowledge in order to offer a solution to our clients. When we started to break down some the business unit silo affect, we found that there was a redundancy in some of our administrative support and some of our overall resources, so what we ended up doing is this consolidation. Unfortunately, there was a slight pairing off of some of our redundant resources.”

CEOCFOinterviews: Do you see acquisitions in the future or do you want to concentrate more on internal driven growth?

Mr. Malcolm: “We started up a very active business development program last year in May (2002) and Bill Carlson, who has been in the healthcare marketplace for a long time heads that up for me. However, the majority of what we see here will be of organic growth or growth through our strategic partners. We announced our strategic partner program and our first two strategic partners with the vision of being able to extend the Life of Legacy systems and integrate emerging technology. Our partner program will assist us and enhance the value that we bring to our hospitals. Therefore, we are looking at our partner program and primarily organic growth in the near future in order to fuel our revenue growth.”

CEOCFOinterviews: You are fairly new at the CEO position and have done some reorganization of the management team, how has this affected the company overall?

Mr. Malcolm: “I would tell you from a customer standpoint it has been transparent.  From a company standpoint, I think we improved our efficiencies. I’ve been with Daou for 15 months and at that point in time I had about half of Daou that I was responsible for and that was the technology services. I went to the CEO position and Vince Roach now has taken over the Application and Business units. From that standpoint I think our folks realize we are leaner and feeling the pulse rate of our customer at the senior management level.  Since I’ve given Vince all four primary business unit operations, they see a potential benefit and a synergy to do that.”

CEOCFOinterviews: Do you think you will see profitability in 2003?

Mr. Malcolm: “Yes, we can see profitability in 2003. We look to achieve a 15% growth in revenue this year. We will see our operating costs increase based on the increase in revenue but not on a linear basis. We will recognize economy as a scale and we will achieve profitability in 2003. We think profitability will show itself on inconsistent monthly profitability on the first half of the year and then come in to a more consistent profitability on a monthly and quarterly basis starting with the third quarter of ’03 and moving forward.“

CEOCFOinterviews: Do you have short or long-term contracts with your customers?

Mr. Malcolm: “That is a great question. We have a blending of both. The majority of our revenue comes from projects that have a finite useful life that is traditionally less than a year in length, they come from project work. The minority of our revenue comes from on-going multi-year contracts. One of the objectives that we have is to start to change that blend over time, shifting more into a recurring revenue, multi-year contract but continuing the project work. What is nice about Daou is that Daou did the hard thing first and that was to provide a quality and valued service to our clients. If you look back at our revenue history, you would see that we have had many long-term loyal customers that would seem like recurring revenue. However, in reality Daou was only as good as its last project and because it continued to do quality valued work for them, they continued to give us more and more work, but it was on a project to project basis. I want to continue that type of working relationship, but I also want to be able now that we are moving into the clinical systems evolution, grow more long-term relationships and partnerships and be able to blend both the project and long-term growth.”

CEOCFOinterviews: From an investor’s standpoint, they want a company that has had long term standings with their clients so they know that there is income coming in for the next five or ten years.

Mr. Malcolm: “Yes, and I think I need that blend quite honestly to give the investors confidence on a quarter-by-quarter projection on where Daou is going. Hence, that is why I want to mix the blend between maintaining our project work with our customers, while signing some multi year recurring contracts as well.”

CEOCFOinterviews:  Are you relying on any one client over another for the majority of the revenue?

Mr. Malcolm: “No! What is nice is that there are a number of large clients; there isn’t one major client that has a significant impact or a significant percentage of our overall revenue.”

CEOCFOinterviews: You just signed a contract with the University of Chicago.  How is this going to affect the revenues coming up?

Mr. Malcolm: “I love to say it will increase them. The University of Chicago is one of our long-term clients. The contract really has two parts to it from our side. We have a long-term departmental outsourcing agreement, whereby we are their internal network staff. Daou manages and staffs that department for the University of Chicago and as part of our overall relationship, they wanted a new network design and implementation that will carry them through their systems evolution. They were able to acquire Daou and Cisco to be able to provide that and we are right in the process now of implementing that $3 million dollar job. The other terrific part of it is that we had a great deal of short-term anecdotal references that I can point to. A smaller hospital, Memorial Hospital in Springfield Illinois just signed for a major network design and implementation by us.  Catholic Healthcare Partners, a very large regional delivery network of services is doing significant business with us.  Therefore, there are a number of pieces that in fact we have been able to do and partnership arrangements indirectly that are providing the revenue growth that we are hoping for in years to come.”

CEOCFOinterviews: What do you feel will gives Daou a competitive edge?

Mr. Malcolm: “There are two pieces that give us our competitive edge. Number one it is our vision. We are putting together all of the pieces that in a cash-strapped market place we can extend the useful life and value of current systems and also give them the emerging technologies. We are putting all of the parts together based on our experience and know-how and we able to give a total solution. It is a unique packaging alternative with strategic partners. Number two; I think our company size is a benefit. Being a $40 million dollar company, I think we are large enough to be professional, we have best practices, sound professional management and implementation skills but we are small enough to be very nimble and very flexible. We listen to our customers and understand exactly what they need. I think a combination of our vision and size puts together a good argument of why Daou.

CEOCFOinterviews: What do you feel is something that can get a potential investor excited about Daou?

Mr. Malcolm: “I think that we have to do it the old fashioned way, we have to earn it.  I think that the biggest thing for the investors, is the healthcare IT market or healthcare in general is a fragmented market that has an awful lot of hype. One of the key elements for us is to come out with imaginative and creative vision of packaging and then execute on that performance. From an investor prospective, we need to be able to show the execution and implementation of that vision to be able to allow them to see traction. Once they see that and understand that it was planned then I think the investors will have a significant interest in Daou.”

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