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Case 1:04-cv-01006-RPM

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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLORADO Civil Action No. 04-cv-01006-RPM SPECIAL SITUATIONS FUND III, L.P.; SPECIAL SITUATIONS CAYMAN FUND, L.P.; SPECIAL SITUATIONS TECHNOLOGY FUND NEW, L.P.; and SPECIAL SITUATIONS TECHNOLOGY FUND II, L.P., on behalf of themselves and others similarly situated, Plaintiffs, v. QUOVADX, INC., Defendant.

AFFIDAVIT OF JEFFREY M. KRAUSS

STATE OF NEW YORK

) ) ss. COUNTY OF NEW YORK ) I, Jeffrey M. Krauss, being first duly sworn upon my oath, state as follows: 1. I am a member of the Board of Directors of Quovadx, Inc. ("the Board") and a

member of the Board's Audit Committee. In this affidavit I aver facts in support of Defendant Quovadx, Inc.'s Opposition to Lead Plaintiffs' Motion for Partial Summary Judgment. Unless otherwise stated, these averments are based on my personal knowledge. If called and sworn as a witness, I could and would competently testify under oath as follows: 2. On September 8, 2003, Quovadx entered into a Distributor Agreement with

Infotech Network (India) Pvt. Ltd. ("Infotech India"), Infotech Network (USA) Inc. ("Infotech

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Texas"), and Infotech Network Inc. ("Infotech California") (collectively, "Infotech"). On September 25, 2003, Quovadx and Infotech executed Amendment No. 1 to Distributor Agreement. Together, the Distributor Agreement and Amendment No. 1 are referred to as the "Distributor Agreement," wherein Quovadx agreed to sell to Infotech software, training, maintenance, and support services for a total sum of $7,600,000 and that provided that Infotech would be the exclusive distributor of Quovadx products in India and certain African countries, which agreement Quovadx publicly announced in an October 22, 2003, press release. A true and correct copy of the Distributor Agreement is attached to my affidavit as Exhibit A. 3. On September 8, 2003, Quovadx entered into a Strategic Partner Outsourcing

Agreement with Infotech India ("Outsourcing Agreement"), wherein Quovadx agreed to purchase from Infotech India certain research and development, back office, and call center services, as requested by Quovadx through Statements of Work to be negotiated between the parties to the Outsourcing Agreement. A true and correct copy of the Outsourcing Agreement is attached hereto as Exhibit B. At the time that Quovadx executed the Outsourcing Agreement, Quovadx estimated that, during the first year after the execution of the Outsourcing Agreement, Quovadx would purchase from Infotech India up to $2,460,000 in outsourcing services. 4. On or about March 19, 2004, I received information from several senior officers

that Lorine R. Sweeney ("Sweeney"), former President, Chief Executive Officer, and member of the Board of Directors of Quovadx, and Gary T. Scherping ("Scherping"), former Executive Vice President and Chief Financial Officer of Quovadx, had authorized Infotech to draw down the remaining $1,960,000 in Quovadx's letter of credit maintained as required by the Outsourcing Agreement. The Audit Committee directed Quovadx's outside counsel Wilson

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Sonsini Goodrich & Rosati, P.C. ("WSGR"), to conduct an inquiry into the circumstances surrounding Quovadx's March 10 payment to Infotech. Jared Kopel, Esq. of WSGR submitted a summary of the results of his inquiry to the Audit Committee, and WSGR recommended that the Audit Committee conduct a full investigation into the matter. After receiving Mr. Kopel's summary and WSGR's recommendation, the Audit Committee retained Hogan & Hartson LLP to conduct an investigation into Quovadx's relationship with Infotech and Quovadx's public disclosures regarding the Distributor Agreement. The attorneys who conducted that investigation were Daniel Shea, Thomas Strickland, and Geri House. 5. On May 10, 2004, Hogan & Hartson orally presented to Quovadx's Audit

Committee the investigating attorneys' report regarding the investigation authorized by the Audit Committee. The Board of Directors' minutes of its May 10, 2004, meeting reflect the fact that Hogan & Hartson made the presentation at that meeting. Further, in a May 13, 2004, press release, Quovadx announced the Audit Committee's findings. 6. Through the Audit Committee's investigation and meetings of the Board of

Directors, I learned the following facts regarding the Quovadx's agreements and relationship with Infotech: a. Quovadx knew that Infotech was an outsourcing agent for Indian

companies seeking outsourcing work at the time Quovadx first came in contact with Infotech in Spring 2003. Quovadx was actively seeking an outsourcing agent in India, and Quovadx initiated discussions with Infotech for the purpose of exploring potential outsourcing arrangements. The negotiations in August and September 2003 that led to the Distributor Agreement arose out of, and were subsequent to, the first negotiations

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regarding the Outsourcing Agreement, which occurred during Summer 2003. As of September 8, 2003, Quovadx knew that Infotech India, Infotech Texas, and Infotech California had not been software distributors or sellers before Infotech entered into the Distributor Agreement. Some of the B.K. Birla companies that backed Infotech, however, did have prior distribution experience. b. Infotech's first payment to Quovadx under the Distributor Agreement was

due on December 12, 2003. This payment was owed on the first purchase order under the September 8, 2003, Distributor Agreement, for approximately $5,460,000 in licenses for various Quovadx products. Infotech's first payment became overdue on December 13, 2003. Infotech's second payment to Quovadx under the Distributor Agreement was due on December 25, 2003, for approximately $2,140,000 in licenses for various Quovadx products. This payment was owed on a purchase order under Amendment No. 1 to the Distributor Agreement. Infotech's second payment became overdue on December 26, 2003. c. Under the Distributor Agreement, there was no contractual requirement

for Infotech to maintain a letter of credit at an Indian bank. The Distributor Agreement only required Infotech to establish a letter of credit with an international bank in the amount of $5,460,000 by the end of September 2003 to pay for the first software purchase and to establish a letter of credit in the amount of $2,140,000 by October 15, 2003, to pay for the second software purchase. In December 2003, Quovadx confirmed the existence of Infotech's letters of credit at international banks outside of India, but Quovadx was never able to draw down on those letters of credit.

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d.

Although Infotech had not established the letters of credit before Quovadx

shipped the software, Quovadx's former management had sufficient confidence in Infotech's ability to make payment to warrant the shipment. Further, it was Quovadx's standard business practice to ship software products before Quovadx had received payment from its customer. Infotech represented that there were unexpected glitches in establishing its letters of credit. Infotech, however, provided a letter from Century Co-op Bank in Surat, India, dated October 17, 2003, stating that Infotech had met the final requirements for opening one letter of credit valued at $2,460,000 and another letter of credit valued at $3,000,000. Infotech also provided a letter from Century Co-op Bank, dated October 21, 2003, stating that Infotech had been approved for a $10,000,000 line of credit that could be used for purchasing information technology services. Infotech represented that this line of credit would be used to establish Infotech letters of credit at other banks. Quovadx does not dispute that Infotech had established the line of credit and two letters of credit at Infotech's banks. Although there had been delays, Quovadx's former management believed that arrangements for Infotech's payment were being put in place, and in any event the first payment was not due under the terms of the Distributor Agreement until December 12, 2003. e. In October 2003, Quovadx's internal business personnel performed an

analysis of the Infotech transaction in accordance with generally accepted accounting principles ("GAAP"), and Quovadx's former management concluded that the GAAP factors supported recognition of $4,600,000 in revenue associated with the Distributor Agreement during the third quarter of 2003. At that time, Quovadx sought the opinion of

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its outside auditors, Ernst & Young LLP ("E&Y"), regarding the proposed recognition of revenue, and the outside auditors concurred with Quovadx's internal GAAP analysis. Quovadx's and E&Y's GAAP analyses were supported by Quovadx's due diligence before entering into the Distributor Agreement, which confirmed that Infotech was financially backed by the B.K. Birla Group of Companies that are owned and operated by one of India's wealthiest families and that had substantial assets. f. Quovadx believes that the two reported letters of credit were issued in

favor of Infotech, but Quovadx was never able to draw down on Infotech's letters of credit. Quovadx first encountered difficulty drawing down on Infotech's letters of credit in late December 2003, when Quovadx's finance department attempted to draw down on the first letter of credit established by Infotech, in the amount of $2,000,000. Quovadx was advised that First American Bank in Chicago, Illinois, the issuing bank, required an inspection certificate demonstrating that the software had been inspected on receipt in India. Infotech contended that bureaucratic problems prevented Indian customs officials from providing the required certificate to the Reserve Bank of India, which in turn was necessary for the Reserve Bank to permit a draw-down by Quovadx on Infotech's letter of credit at First American Bank. Quovadx retained Ashford Enterprises to conduct an inspection of the shipments that would result in the necessary inspection certificate. Infotech informed Quovadx that the inspections were performed on December 26, 2003, at Infotech's facility in Bangalore, India, and that the inspection certificate would be received within two to three weeks. Throughout January and early February 2004, Quovadx continued efforts to collect payment from Infotech, but Infotech stated that

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additional problems had emerged that were delaying the issuance of the inspection certificate and the draw down on the first letter of credit. As of March 15, 2004, Quovadx still had expectations that it would ultimately be able to draw down on Infotech's letters of credit, but those expectations diminished over time. On May 13, 2004, Quovadx publicly announced that it no longer expected letters of credit to be a source of payment by Infotech. g. In early May 2004, after Quovadx had conducted a review of the

circumstances surrounding the Outsourcing Agreement, the Board of Directors concluded that Quovadx probably had selected Infotech as an outsourcing services provider and entered into the Outsourcing Agreement as an inducement for Infotech to enter into the Distributor Agreement. If Infotech had fulfilled its contractual obligations under the Distributor Agreement, Quovadx's relationship with Infotech would have been profitable for Quovadx, especially considering Infotech's financial obligations to Quovadx far exceeded Quovadx's financial obligations to Infotech. The Outsourcing Agreement did not require Quovadx to pay Infotech $2,460,000 for outsourcing services. The Outsourcing Agreement provided that Infotech would perform outsourcing services on an as-requested basis and that Quovadx would pay Infotech for outsourcing services that actually were provided under the agreement pursuant to Statements of Work. Quovadx estimated that it would purchase from Infotech up to $2,460,000 in outsourcing services during the first 12 months under the Outsourcing Agreement, but the Outsourcing Agreement did not require Quovadx to purchase any minimum amount of outsourcing services. Quovadx never pledged or contracted to purchase an additional $10,000,000 in

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outsourcing services annually from Infotech. Based on the information it received, the Audit Committee concluded that Quovadx employees had engaged in discussions with Infotech regarding the possibility that Quovadx would purchase from Infotech up to $10,000,000 in outsourcing services annually. h. Based on its investigation into the Infotech relationship, it is the Board of

Directors' opinion that Infotech probably would not have entered into the Distributor Agreement without concurrently entering into the Outsourcing Agreement. i In early May 2004, the Board of Directors concluded that Quovadx's

$410,000 payment to Infotech in October 2003 was authorized, in part, for the purpose of providing a margin payment to Infotech's bank in India that would assist Infotech in establishing a letter of credit needed to secure Infotech's payment obligations under the Distributor Agreement. Quovadx made subsequent payments to Infotech in December 2003 and March 2004, respectively. The Board determined that Quovadx's $500,000 in payments to Infotech in December 2003 were made pursuant to Statements of Work under the Outsourcing Agreement and that Quovadx received value in exchange for those payments in the form of outsourcing services provided by Infotech. On March 10, 2004, Sweeney and Scherping authorized a payment of $1,960,000 to Infotech. In early May 2004, the Board concluded that Quovadx's $1,960,000 payment was not a legitimate prepayment for Infotech's outsourcing services pursuant to a Statement of Work. As of September 2004, Infotech had provided approximately $1,200,000 in outsourcing services in connection with Quovadx's March 2004 payment, but Quovadx has never received the full value of services in exchange for that payment. The Board concluded

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that Sweeney and Scherping authorized that draw-down of Quovadx's letter of credit in a misguided attempt to facilitate Infotech's payment of the initial $2,000,000 owed to Quovadx under the Distributor Agreement. 7. In April 2004, Quovadx's Board of Directors requested that Sweeney and

Scherping resign from Quovadx because the Board had lost confidence in Sweeney's and Scherping's leadership, business judgment, and competence. Among the factors that contributed to this loss of confidence was information that Sweeney and Scherping had authorized a payment to Infotech of approximately $1,960,000 in March 2004 and had failed to disclose that payment to the Board. The payment appeared to have been authorized for the purpose of enabling Infotech to meet Infotech's payment obligations under the Distributor Agreement, though Sweeney and Scherping insisted that the draw down on Quovadx's line of credit was a legitimate prepayment under the Outsourcing Agreement. The Board concluded that the approximately $1,960,000 payment in March 2004 was not a legitimate prepayment for Infotech's outsourcing services pursuant to Statements of Work under the Outsourcing Agreement, and that Sweeney and Scherping had exercised poor business judgment in authorizing this payment. Another factor contributing to the loss of confidence was Quovadx's need to restate its financial statements for the third quarter of 2003 and its previously announced preliminary results for the fourth quarter of fiscal 2003.

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Further affiant sayeth not.

s/Jeffrey M. Krauss Jeffrey M. Krauss

Subscribed and sworn to before me this 29th day of August, 2006.

s/Margaret A. Beck Notary Public My commission expires: 2/3/09

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