<PAGE>

                                   UNITED STATES
                         SECURITIES AND EXCHANGE COMMISSION
                              Washington, D.C. 20549


                                     FORM 10-Q

/X/  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

     For the quarterly period ended September 30, 1998
                                        OR

/ /  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934
     For the transition period from ______________ to ___________,

                          Commission File No.:  000-22073

                                DAOU SYSTEMS, INC.
              (Exact name of registrant as specified in its charter)

          Delaware                                       330284454
(State or other jurisdiction of              (IRS Employer Identification No.)
incorporation or organization)

                                5120 Shoreham Place
                            San Diego, California  92122
                (Address of principal executive offices) (Zip Code)

                                   (619) 452-2221
                (Registrant's telephone number, including area code)



Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days:
                                  Yes XX  No

The number of shares of Registrant's Common Stock outstanding as of September
30, 1998:

                                    17,685,722

                                                                       Page 1
<PAGE>


                                DAOU SYSTEMS, INC.

                                Index to Form 10-Q
<TABLE>
<CAPTION>

PART I.         FINANCIAL INFORMATION

Item 1.   Condensed Consolidated Financial Statements                    Page
<S>                                                                    <C>

Condensed Consolidated Balance Sheets (unaudited)
at September 30, 1998 and December 31, 1997                                3

Condensed Consolidated Statements of Operations (unaudited) for the 
Three Months and Nine Months Ended September 30, 1998 and 1997             4

Condensed Consolidated Statements of Cash Flows (unaudited) for the
Nine Months Ended September 30, 1998 and 1997                              5

Notes to Condensed Consolidated Financial Statements                     6-9

Item 2.     Management's Discussion and Analysis of
            Financial Condition and Results of Operations              10-12

PART II.    OTHER INFORMATION                                             13

Item 1.     Legal Proceedings                                             13

Item 2.     Changes in Securities and Use of Proceeds                     13

Item 6.     Exhibits and Reports on Form 8-K                           13-14

SIGNATURES                                                                15

</TABLE>

                                                                       Page 2

<PAGE>

PART I.    FINANCIAL INFORMATION 

Item 1.    Condensed Consolidated Financial Statements

                                 DAOU SYSTEMS, INC.
                       CONDENSED CONSOLIDATED BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
                                    (unaudited)


                                         ASSETS
<TABLE>
<CAPTION>

                                                    SEPTEMBER 30,   DECEMBER 31,
                                                         1998           1997
                                                    ------------    ------------
                                                             
<S>                                                 <C>             <C>
Current assets
   Cash and cash equivalents                           $  2,140       $  7,981
   Short-term investments                                 2,821         10,307
   Accounts receivable, net                              30,536         15,744
   Contract work in progress                             12,342         13,291
   Other current assets                                   2,198          2,089
                                                       --------       --------
       Total current assets                              50,037         49,412
Equipment, furniture and fixtures, net                    4,848          3,859
Other assets                                                741            839
                                                       --------       --------
                                                       $ 55,626       $ 54,110
                                                       --------       --------
                                                       --------       --------

                        LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
   Accounts payable and other accrued liabilities      $  6,529       $  5,727
   Accrued salaries and wages                             4,201          2,675
   Current portion of lines of credit and 
    long-term debt                                        4,708          1,437
                                                       --------       --------
       Total current liabilities                         15,438          9,839

Long-term liabilities                                     3,310          2,434
Commitments and contingencies

Stockholders' equity
   Preferred stock, $.001 par value
       Authorized shares - 5,000
       Issued and outstanding - none                          -              -
   Common stock, $.001 par value
       Authorized shares - 50,000
       Issued and outstanding - 17,686 and 16,945
             at September 30, 1998 and December 31, 
             1997, respectively                              18             17
   Additional paid-in capital                            37,407         36,040
   Deferred compensation                                   (713)          (907)
   Unrealized gain on short-term investments                  4            146
   Retained earnings                                        162          6,541
                                                       --------       --------
       Total stockholders' equity                        36,878         41,837
                                                       --------       --------
                                                       $ 55,626       $ 54,110
                                                       --------       --------
                                                       --------       --------

</TABLE>

See accompanying notes.

                                                                       Page 3

<PAGE>

                               DAOU SYSTEMS, INC.
               CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                  (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
                                  (UNAUDITED)


<TABLE>
<CAPTION>
                                           PERIODS ENDED SEPTEMBER 30,
                                       THREE MONTHS           NINE MONTHS
                                     1998        1997       1998       1997
                                   --------    --------   --------   --------
<S>                                <C>         <C>        <C>        <C>
Revenues                           $ 27,351    $ 18,540   $ 79,379   $ 46,485
Cost of revenues                     22,905      12,316     56,340     30,961
                                   --------    --------   --------   --------
Gross profit                          4,446       6,224     23,039     15,524
Operating expenses:
   Sales and marketing                3,536       1,725      9,338      5,572
   General and administrative         5,606       2,569     12,279      7,507
   Merger and related costs               -         684      2,825        684
                                   --------    --------   --------   --------
       Total operating expenses       9,142       4,978     24,442     13,763
                                   --------    --------   --------   --------
Income(loss)from operations          (4,696)      1,246     (1,403)     1,761
Other income (expense), net            (177)        249        (50)       621
                                   --------    --------   --------   --------
Income (loss) before income taxes    (4,873)      1,495     (1,453)     2,382
Provision (benefit)for income taxes  (1,785)        705      1,325        799
                                   --------    --------   --------   --------
Net income(loss)                   $ (3,088)   $    790   $ (2,778)   $ 1,583
                                   --------    --------   --------   --------
                                   --------    --------   --------   --------
Net income(loss) per share:
  Basic                            $   (.17)   $    .05   $   (.16)   $   .10
                                   --------    --------   --------   --------
                                   --------    --------   --------   --------
  Diluted                          $   (.17)   $    .04   $   (.16)   $   .09
                                   --------    --------   --------   --------
                                   --------    --------   --------   --------

Shares used in calculation of
   net income (loss) per share:

   Basic                             17,681      16,878     17,640     16,062
                                   --------    --------   --------   --------
                                   --------    --------   --------   --------
   Diluted                           17,681      17,933     17,640     16,956
                                   --------    --------   --------   --------
                                   --------    --------   --------   --------

</TABLE>

See accompanying notes.

                                                                       Page 4

<PAGE>

                                DAOU SYSTEMS, INC.
               CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                  (UNAUDITED)


<TABLE>
<CAPTION>

                                                   NINE MONTHS ENDED SEPTEMBER 30,
                                                         1998           1997
                                                       --------       --------
<S>                                                    <C>            <C>
Operating activities:
   Net income (loss)                                    $(2,778)        $1,583
   Adjustments to reconcile net income (loss) to net
     cash provided by (used in) operating activities:
     Depreciation and amortization                        1,217            800
Changes in operating assets and liabilities             (10,723)        (1,257)
                                                        -------        -------

Net cash (used in) provided by operating
    activities                                          (12,284)         1,126


Investing activities:
   Additions to equipment, furniture
     and fixtures                                        (2,012)        (2,361)
   Proceeds from (purchases of) short-term
      investments                                         7,344         (9,974)
   Changes in other assets                                   93         (1,499)
                                                        -------        -------

Net cash provided by (used in)
   investing activities                                   5,425        (13,834)


Financing activities:
   Sale of common stock, net                              1,368         25,338
   Proceeds from lines of credit and long-term debt,
      net                                                 3,251          1,994
   Distributions to stockholders of acquired companies   (3,601)        (1,646)
                                                        -------        -------

Net cash provided by financing activities                 1,018         25,686
                                                        -------        -------

Net (decrease) increase in cash and cash equivalents     (5,841)        12,978

Cash and cash equivalents at
   beginning of period                                    7,981          3,123
                                                        -------        -------
Cash and cash equivalents at
   end of period                                        $ 2,140        $16,101
                                                        -------        -------
                                                        -------        -------

</TABLE>

See accompanying notes.

                                                                       Page 5
<PAGE>

                               DAOU SYSTEMS, INC.
            NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The unaudited condensed consolidated financial statements of DAOU Systems, 
Inc. ("DAOU" or the "Company") at September 30, 1998 and for the three and 
nine-month periods ended September 30, 1998 and 1997 have been prepared in 
accordance with generally accepted accounting principles ("GAAP") for interim 
financial information. Accordingly, they do not include all information and 
footnotes required by GAAP for a complete set of financial statements.  These 
financial statements reflect all adjustments, consisting of normal recurring 
adjustments, which in the opinion of management are necessary to fairly 
present the financial position of the Company at September 30, 1998 and the 
results of operations for the three and nine-month periods ended September 
30, 1998 and 1997.  The results of operations for the three and nine months 
ended September 30, 1998 are not necessarily indicative of the results to be 
expected for the year ending December 31, 1998.  For more information, these 
financial statements should be read in conjunction with the Company's Form 
10-KSB,as amended,  and the audited supplemental consolidated financial 
statements included in the Company's Current Report on Form 8-K filed with 
the Securities and Exchange Commission ("SEC") on May 19, 1998.

2. Use of Estimates

The preparation of financial statements in conformity with generally accepted 
accounting principles requires management to make estimates and assumptions 
about the future that affect the amounts reported in the financial statements 
and disclosures made in the accompanying notes of the financial statements.  
The actual results could differ from those estimates.

3. Acquisitions

During March 1998, the Company acquired Synexus Incorporated ("Synexus"), a 
privately-held company specializing in the planning, design and 
implementation of enterprise networks in healthcare environments, and 
Sentient Systems, Inc. ("Sentient"), a privately-held company that provides 
integration and support services primarily to healthcare organizations.  The 
shareholders of Synexus and Sentient received a total of 161,235 and 
1,397,550 shares, respectively, of the Company's common stock in exchange for 
all of the outstanding stock of each of these companies. The acquisitions 
have been accounted for under the pooling-of-interests method of accounting, 
and accordingly, the historical financial statements of periods prior to the 
consummation of the combinations have been restated as though the companies 
had been combined for all periods presented.

During June 1998, the Company acquired (i) Technology Management, 
Inc.("TMI"), a privately-held company that provides information technology  
consulting services primarily to the healthcare industry, (ii) International 
Health Care Systems, Inc. ("IHCS"), a privately-held company with a common 
shareholder of TMI that provides information technology consulting services 
primarily to the healthcare industry on behalf of TMI, (iii) Resources in   
Healthcare Innovations, Inc. ("RHI"), a privately-held information technology 
services firm that provides contract management services for healthcare 
information systems to hospitals and managed care organizations, and (iv)   
Healthcare Transition Resources, Inc. ("HTR"), Ultitech Resources Group, Inc. 
("URG"), Innovative Systems Solutions, Inc. ("ISS") and Grand Isle 
Consulting, Inc. ("GIC"), each a privately-held company with common 
shareholders of RHI that implements software applications from third parties 
and provides support services to healthcare enterprises. Shareholders of TMI, 
IHCS, RHI, HTR, URG, ISS and GIC received a total of 1,078,963, 224,668, 
1,839,381, 275,662, 282,551, 308,583 and 223,645 shares, respectively, of the 
Company's common stock  in exchange for all of the outstanding stock of each 
of these companies.  The acquisitions have been accounted for under the 
pooling-of-interests method of accounting, and accordingly, the historical 
financial statements of periods prior to the consummation of the combinations 
have been restated as though the companies had been combined for all periods 
presented.

                                                                       Page 6

<PAGE>

Separate results for each of DAOU, Sentient, Synexus, TMI (including IHCS), 
and RHI (including HTR, URG, ISS and GIC) for the three and nine months ended 
September 30, 1998 and 1997 were as follows:

(In thousands)

<TABLE>
<CAPTION>

                                                  DAOU            SENTIENT         SYNEXUS      TMI        RHI            COMBINED
                                                ----------------------------------------------------------------------------------
<S>                                             <C>               <C>              <C>        <C>         <C>             <C>
Three months ended September 30, 1998:
    Total revenues                              $14,436            $3,509            $508     $3,039      $5,859           $27,351
    Net income (loss)                            (4,213)              289              64        429         343            (3,088)

Three months ended September 30,
1997:
    Total revenues                                11,305            2,493             390      1,866       2,486            18,540
    Net income (loss)                                (38)             142             100        532          54               790

Nine months ended September 30,
1998:
    Total revenues                                45,257            9,873           1,601      8,787      13,861            79,379
    Net income (loss)                             (5,376)             301             174        832       1,291            (2,778)

Nine months ended September 30,
1997:
    Total revenues                                27,191            7,280           1,204      4,225       6,585            46,485
    Net income                                       255              315             228        445         340             1,583

</TABLE>


In connection with these acquisitions, the Company recorded direct merger and 
related costs (before income taxes) during March 1998 and June 1998 totaling 
$1.8 million and $1.0 million, respectively.  These costs include transaction 
costs of approximately $720,000, estimated costs to combine and integrate 
operations of approximately $570,000, and other merger related costs of 
approximately $1.5 million.

4. Lines of Credit

During September 1998, the Company secured two borrowing facilities, a $2.0 
million revolving line of credit, under which none is available for future 
borrowings at September 30, 1998, and an additional $8,000,000 line of 
credit, under which $6.0 million is available for future borrowings at 
September 30, 1998.  Advances under both the revolving line of credit and 
line of credit bear interest at the bank's prime rate (8.25% at September 30, 
1998) plus 0.25% per annum. Through September 30, 1998, borrowings under the 
revolving line of credit, which expires July 31, 1999, total approximately 
$2.0 million, while borrowings under the line of credit, which expires July 
31, 1999, total approximately $2.0 million. These lines of credit are secured 
by substantially all of the assets of the Company and contain customary 
covenants and restrictions. As of September 30, 1998, the Company was not in 
compliance with certain of these covenants and restrictions, however, the 
Company has obtained a waiver from the financial institutions for the
violation.

In addition, through its acquisition of RHI (and related companies), the Company
has an additional $700,000 line of credit with a bank, under which outstanding
borrowings totaled $670,000 at September 30, 1998.  The $700,000 line of credit
bears interest at prime plus 0.25%, is due on May 1, 1999 and is secured by
all of the assets of RHI.

                                                                       Page 7
<PAGE>

5. Net Income (Loss) Per Share Information

The following table details the computation of basic and diluted net income 
(loss) per share:

(In thousands, except per share information)

<TABLE>
<CAPTION>
                                                                     THREE MONTHS ENDED                   NINE MONTHS ENDED
                                                                         SEPTEMBER 30,                       SEPTEMBER 30,
                                                                   1998                1997               1998             1997
                                                                 ------------------------------------------------------------------
<S>                                                              <C>                <C>                <C>               <C>
Numerator:
   Net income (loss)                                             $  (3,088)         $      790         $  (2,778)        $   1,583

Denominator:
  Denominator for basic net income (loss) per share -
  weighted average common shares outstanding                        17,681              16,878            17,640            16,062

   Effect of dilutive securities:
     Warrants                                                            -                 105                 -                74
     Common stock options                                                -                 950                 -               642
     Convertible preferred stock                                         -                   -                 -               178
                                                                 ------------------------------------------------------------------
                                                                         -               1,055                 -               894
                                                                 ------------------------------------------------------------------

   Denominator for diluted net income (loss) per
     share - adjusted weighted average common shares 
     outstanding and assumed conversion of preferred stock          17,681              17,933            17,640            16,956
                                                                 ------------------------------------------------------------------
                                                                 ------------------------------------------------------------------

Basic net income (loss) per share                                $    (.17)         $      .05         $    (.16)        $     .10
                                                                 ------------------------------------------------------------------
                                                                 ------------------------------------------------------------------

Diluted net income (loss) per share                              $    (.17)         $      .04         $    (.16)        $     .09
                                                                 ------------------------------------------------------------------
                                                                 ------------------------------------------------------------------

</TABLE>


Recent interpretations by the SEC of Financial Accounting Standard No. 128, 
"Earnings per Share", have changed the treatment of convertible preferred 
stock previously included in the computation of basic net income (loss) per 
share. For periods prior to its initial public offering ("IPO"), the Company 
previously included preferred stock which converted into common stock upon 
completion of the IPO as outstanding from the date of original issuance ("as 
if converted method") in the computation of basic net income (loss) per share.  
To conform with recent interpretations, the effect of assuming the conversion 
of these securities prior to their actual conversion in the basic net income 
(loss) per share calculation has been excluded.

6. New Accounting Standards

In June 1997, the Financial Accounting Standards Board issued Statement 
No. 130, "Reporting Comprehensive Income," and Statement No. 131, 
"Disclosures About Segments of an Enterprise and Related Information," both 
of which are effective for fiscal periods beginning after December 15, 1997.  
The adoption of Statements No. 130 and 131 did not have a material effect on 
the Company's financial statements.

                                                                       Page 8
<PAGE>

Comprehensive income (loss) for the three months ended September 30, 1998 and 
1997 totaled $(3,316,000) and $900,000, respectively. Comprehensive income 
(loss) for the nine months ended September 30, 1998 and 1997 totaled 
$(2,920,000) and  $1,750,000, respectively.  The difference from reported net 
income (loss) arises from the unrealized gains and losses on short-term 
investments.

7. Income Tax Expense

The effective income tax rate for the three and nine months ended September 
30, 1998 was (37%) and 91%, respectively, due to the non-deductibility of 
certain merger and related costs and adjustments made to convert the former S 
corporation status of certain acquired businesses to the C corporation status 
of the Company.

                                                                       Page 9
<PAGE>

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements within 
the meaning of Section 27A of the Securities Act of 1933, as amended, and 
Section 21E of the Securities Exchange Act of 1934, as amended. Prospective 
investors are cautioned that such statements are only predictions and that 
actual events or results may differ materially. Forward-looking statements 
usually contain the words "estimate," "anticipate," "believe", "expect" or 
similar expressions. All forward-looking statements are inherently uncertain 
as they are based on various expectations and assumptions concerning future 
events and are subject to numerous known and unknown risks and uncertainties. 
The forward-looking statements included herein are based on current 
expectations and entail various risks and uncertainties as those set forth 
herein and the Company's other SEC filings, including those more fully set 
forth in the "Risk Factors," "Management's Discussion and Analysis of 
Financial Condition and Results of Operations" and other sections of the 
Company's Form 10-KSB, as amended, for the most recently completed fiscal 
year on file with the SEC. These risks and uncertainties could cause the 
Company's actual results to differ materially from those projected in the 
forward-looking statements. The Company disclaims any obligation to update or 
publicly announce revisions to any such statements to reflect future events 
or developments.

Overview

The Company designs, implements, supports and manages advanced computer 
network systems primarily for hospitals, integrated delivery networks 
("IDNs") and other provider organizations. The Company's design services 
include an assessment of the customer's existing computer network system, the 
preparation of voice, video and data network specifications, technical design 
documentation and diagrams. DAOU's implementation services include the 
purchase, delivery and installation of enterprise-wide computer network 
systems. Implementation service revenues consist of third-party hardware and 
software products, as well as the Company's professional services. The 
Company's gross margin with respect to implementation services varies 
significantly depending on the percentage of such services consisting of 
products (with respect to which the Company obtains a lower margin) versus 
professional services. Also, the Company often hires employees in 
anticipation of commencement of a project and if delays in contract signing 
occur the Company's gross margin could vary due to the associated loss of 
revenues to cover fixed labor costs. The Company's support and management 
services include remote and on-site network management, as well as 
information systems function outsourcing. The Company typically provides 
these services under multi-year contracts.

During March 1998, the Company acquired all of the issued and outstanding 
shares of Synexus, a privately-held company, that specializes in the 
planning, design and implementation of enterprise networks in healthcare 
environments, and Sentient, a privately-held company that provides 
integration and support services primarily to healthcare organizations. The 
shareholders of Synexus and Sentient received a total of 161,235 and 
1,397,550 shares, respectively, of the Company's common stock in exchange for 
all of the outstanding stock of each of these companies. The acquisitions 
have been accounted for under the pooling-of-interests method of accounting, 
and accordingly, the historical financial statements of periods prior to the 
consummation of the combinations have been restated as though the companies 
had been combined for all periods presented.

During June 1998, the Company acquired (i) TMI, a privately-held company that
provides information technology consulting services primarily to the healthcare
industry, (ii) IHCS, a privately-held company with a common shareholder with TMI
that provides information technology consulting services primarily to the
healthcare industry on behalf of TMI, (iii) RHI, a privately-held information
technology services firm that provides contract management services for
healthcare information systems to hospitals and managed care organizations, and
(iv) HTR, URG, ISS and GIC, each a privately-held company with common
shareholders with RHI that implements software applications from third parties
and provides support services to healthcare enterprises. Shareholders of TMI,
IHCS, RHI, HTR, URG, ISS and GIC received a total of 1,078,963, 224,668,
1,839,381, 275,662, 282,551, 308,583 and 223,645 shares, respectively, of the
Company's common stock in exchange for all of the outstanding stock of each of
these companies. The acquisitions have been accounted for under the
pooling-of-interests method of accounting, and accordingly, the historical
financial statements of periods prior to the consummation of the combinations
have been restated as though the companies had been combined for all periods
presented.

Results of Operations

The Company's revenues were $27.4 million and $18.5 million for the quarters 
ended September 30, 1998 and 1997, respectively, representing an increase of 
48%. This increase was due primarily to the increased number of professional 
services consulting contracts, which accounted for $5.2 million of the 
increase for the three months ended September 30, 1998. Increases in 
professional services management contracts ($2.4 million) and large network 
implementation contracts ($1.2 million) accounted for the remainder of the 
increase. Services to five customers accounted for $5.4 million of total 
revenues in this quarter, representing 20% of total revenues. For the nine 
months ended September 30, 1998 and 1997, respectively, revenues were $79.4 
million and $46.5 million, representing an increase of 71%. This increase was 
primarily the result of increased revenues from professional services 
consulting contracts ($15.0 million), large network implementation contracts 
($12.2 million) and increased revenues in professional services management 
contracts ($5.7 million).

                                                                       Page 10
<PAGE>

Cost of revenues was $22.9 million and $12.3 million for the quarters ended 
September 30, 1998 and 1997, respectively, representing an increase of 86%. 
Gross margin was 16% and 34% for the quarters ended September 30, 1998 and 
1997, respectively.  Cost of revenues for the nine-month period ended 
September 30, 1998 and 1997 were $56.3 million and $31.0 million, 
respectively, which is an increase of 82%. Gross margin for the nine months 
ended September 30, 1998 and 1997, was 29% and 33%, respectively. The 
decrease in gross margins for the three and nine month periods ended 
September 30, 1998 were primarily due to the following: i) an increase in the 
product content of the Company's large network implementation contracts, ii) 
increased labor costs as a result of delays in project delivery schedules due 
to both external and internal customer delays and the associated loss of 
revenues to cover the fixed labor costs, iii) an unforeseen requirement on 
one fixed price contract to use an alternate labor union at a higher than 
projected cost and iv) increased labor costs as a result of a shortfall in 
planned revenue which the Company believes was caused by delays in 
contract signings due to the negative publicity and shareholder lawsuits 
surrounding the Company's accounting practices. The Company's margins were 
also affected by a decision to provide additional services on certain fixed 
price contracts at no additional cost to certain customers to increase the 
probability of closing large long-term professional services management 
contracts.

Sales and marketing expenses were $3.5 million and $1.7 million for the 
quarters ended September 30, 1998 and 1997, respectively, representing an 
increase of 105%. This increase was primarily due to continued development of 
a regional sales structure, an increase in sales personnel and related 
expenses due to increased sales volume and activity.  Sales and marketing 
expenses were 13% and 9% of revenues for the quarters ended September 30, 
1998 and 1997, respectively. For the nine-month periods ended September 30, 
1998 and 1997, sales and marketing expenses were $9.3 million and $5.6 
million, respectively, representing 12% of revenues in those periods.  
Although the Company believes it can achieve a decrease in these expenses as a 
percentage of revenue, the Company also expects that sales and marketing 
expenses will continue to increase in dollar terms to support the anticipated 
growth in the Company's business.

General and administrative expenses were $5.6 million and $2.6 million for 
the quarters ended September 30, 1998 and 1997, respectively, representing an 
increase of 118%.  The primary factors contributing to this increase were 
costs associated with additional administrative staffing and other increased 
infrastructure requirements to support growth and integration of acquired 
companies, increased recruiting costs and increased legal and accounting fees 
associated with the negative publicity and shareholder lawsuits surrounding 
the Company's accounting practices. General and administrative expenses were 
20% and 14% of revenues for the quarters ended September 30, 1998 and 1997, 
respectively. General and administrative expenses for the nine-month periods 
ended September 30, 1998 and 1997 were $12.3 million and $7.5 million, or 15% 
and 16% of revenues, respectively.  The Company expects some increase in 
general and administrative expenses in dollar terms to support the 
anticipated growth in the Company's business and the anticipated integration 
of subsidiaries.

Direct merger and related costs totaled $2.8 million during the nine months 
ended September 30, 1998, which include costs recorded during the first and 
second quarters of 1998 in connection with the acquisitions of Sentient, 
Synexus, TMI, IHCS, RHI, HTR, URG, ISS and GIC. The $2.8 million total costs 
include transaction fees of approximately $720,000, estimated costs to 
combine and integrate operations of approximately $570,000 and other 
acquisition related costs of approximately $1.5 million.

Other income (expense), net, was ($177,000) and $249,000 for the quarters 
ended September 30, 1998 and 1997, respectively.  For the nine-month period 
ended September 30, 1998 and 1997, respectively, other income, net, was 
($50,000) and $621,000. Other income is primarily interest income on cash and 
cash equivalents, and short-term investments. Interest expense consists of 
interest associated with the Company's business lines of credit.  The 
decrease in other income (expense), net, was primarily due to overall lower 
average cash reserves available for investment for the three and nine-month 
periods ended September 30, 1998 as compared to the same period in 1997.

The effective income tax rate for the three and nine months ended September 
30, 1998 was (37%) and 91%, respectively, due to the non-deductibility of 
certain merger and related costs and adjustments made relative to the former 
S corporation status of certain acquired businesses.

                                                                       Page 11
<PAGE>

Liquidity and Capital Resources

At September 30, 1998, the Company had working capital of $34.6 million, 
which is slightly down from the $39.6 million on December 31, 1997.  The 
Company has a $2.0 million revolving line of credit, under which none is 
available for future borrowings at September 30, 1998.  In addition, the 
Company has secured an additional $8,000,000 line of credit, of which $6.0 
million is available for future borrowings at September 30, 1998.  Advances 
under both the revolving line of credit and line of credit bear interest at 
the bank's reference rate (8.25% at September 30, 1998) plus 0.25% per annum. 
Through September 30, 1998, borrowings under the revolving line of credit, 
which expires July 31, 1999, are approximately $2.0 million, while borrowings 
under the line of credit, which expires July 31, 1999, total approximately 
$2.0 million.  These lines of credit are secured by substantially all of the 
assets of the Company and contain customary covenants and restrictions. As of 
September 30, 1998, the Company was not in compliance with certain of these 
covenants and restrictions, however, the Company has obtained a waiver from 
the financial institutions for the violation. For the nine months ended 
September 30, 1998, cash used in operating activities was $12.3 million which 
resulted primarily from an increase in the Company's accounts receivable due 
to timing of billings.

The Company believes that its present sources of liquidity will be sufficient 
to finance operations for the foreseeable future and such sources of 
liquidity may be used to fund additional acquisitions of complimentary 
businesses, although the Company does not have any specific proposals, 
arrangements or understandings with respect to any future acquisitions. The 
Company may sell additional equity or debt securities or obtain additional 
credit facilities.  The sale of additional equity securities or issuance of 
same in future acquisitions could result in additional dilution to the 
Company's stockholders and the incurrence of debt could result in additional 
interest expense.

Business Risks

In addition to the factors addressed in the preceding sections, certain 
dynamics of the Company's markets and operations create fluctuations in the 
Company's quarterly results.  Uncertainty and cost containment in healthcare 
and competitive conditions present certain other risks to operating results 
which are more fully described in the Company's Form 10-KSB filed with the 
Securities and Exchange Commission (SEC) and other SEC filings. Except for 
the historical information presented herein, the matters discussed in this 
document are forward-looking statements that involve numerous risks and 
uncertainties. The Company's actual results could differ materially from 
those projected in such forward-looking statements and will depend upon a 
number of factors, including those discussed in this document and in prior 
SEC filings, press releases and other public filings of the Company.

Year 2000

The Company provides information, communications technology and services to 
its customers and must therefore address two critical areas of Year 2000 
readiness: i) internal readiness; and, ii) external system readiness. The 
Company is currently conducting a detailed assessment of its internal Year 
2000 status and developing an aggressive action plan to address all required 
upgrades in computer systems, applications, equipment and facilities. This 
assessment and plan includes an ongoing review of the Company and its 
Subsidiaries information systems and the integration of these systems into 
the existing Year 2000 ready systems. The current plan calls for complete 
internal readiness by April 1999. Financial impact for internal compliance 
should be minimal. The Company's current internal equipment and applications 
are substantially compliant and the costs to integrate the subsidiary 
applications were planned for as part of the recent mergers.

The Company is initiating communications with its critical external 
relationships including customers and suppliers to determine the extent to 
which the Company may be vulnerable to such parties' failure to resolve their 
own Year 2000 issues. Where practicable, the Company will assess and attempt 
to mitigate its risks with respect to the failure of these entities to be 
Year 2000 ready. The effect if any, on the Company's results of operations 
from the failure of such parties to be Year 2000 ready, is not reasonably 
estimable.

The costs of the project and the date on which the Company plans to complete 
the Year 2000 modifications are based on management's best estimates, which 
were derived utilizing numerous assumptions of future events including the 
continued availability of certain resources, third party modification plans 
and other factors. However, there can be no guarantee that these estimates 
will be achieved and actual results could differ materially from those plans. 
Specific factors that might cause such material differences include, but are 
not limited to, availability and cost of personnel trained in this area and 
the ability to locate and correct all relevant computer systems.

                                                                       Page 12
<PAGE>

PART II       OTHER INFORMATION

1. Legal Proceedings

On August 24, 1998, August 31, 1998, September 14, 1998 and September 23, 
1998, separate complaints were filed against the Company and certain of its 
officers and directors in the United States District Court for the Southern 
District of California. These complaints assert violations of the federal 
securities laws based on the alleged improper use of the 
percentage-of-completion accounting method for revenue recognition. These 
complaints were brought on behalf of a purported class of Investors in the 
Company's Common Stock and do not allege specific damage amounts. In 
addition, on October 7, 1998 and October 15, 1998, separate complaints were 
filed in the the Superior Court of San Diego, California. These additional 
complaints mirror the allegations set forth in the federal complaints and 
assert common law fraud and the violation of certain California statutes. The 
Company believes that the allegations set forth in all of the foregoing 
complaints are without merit and intends to defend against these allegations 
vigorously. No assurance as to the outcome of this matter can be given, 
however, and an unfavorable resolution of this matter could have a material 
adverse effect on the Company's business, results of operations and financial 
condition.

Item 2.   Changes in Securities and Use of Proceeds.

Effective July 24, 1998, the Company issued 1,839,381, 275,662, 282,551, 
308,583 and 223,645 shares of Common Stock, respectively, to the former 
shareholders of RHI, HTR,URG,ISS and GIC, in exchange for all of the 
outstanding capital stock of each of these companies. These share issuance's 
were exempt from registration under the Securities Act of 1933, as amended, 
pursuant to Section 4(2) thereof.

See Note 3 of Notes to the Condensed Consolidated Financial Statements in 
Part I Item 1 of this report for further information concerning these share 
issuance's.

Item 6.   Exhibits and Reports on Form 8-K

(a)  Exhibits
<TABLE>
<CAPTION>
Exhibit No.                              Description
-----------                              -----------
<S>                                      <C>
27.1                                       Financial Data Schedule
27.2                                       Financial Data Schedule
                                           (1997 Restated)
</TABLE>

a)   On September 8, 1998, a Form 8-K was filed which included audited 
     financial statements of TMI and affiliate as of December 31, 1997 and 
     1996 and for the two years then ended and audited financial statements 
     of RHI and affiliates as of December 31, 1997 and for the year then 
     ended.  Also included was the unaudited pro forma combined condensed 
     balance sheet at June 30, 1998 and December 31, 1997 and unaudited pro 
     forma combined condensed statements of operations for the six months 
     ended June 30, 1998 and the years ended December 31, 1997 and 1996 which 
     give effect to the acquisition of TMI, IHCS, RHI, HTR, ISS, GIC and URG as 
     of December 31, 1997 for the combined condensed pro forma balance sheet 
     and January 1, 1996 for the combined condensed pro forma statements of 
     operations.

                                                                       Page 13
<PAGE>

b)   On August 31, 1998, a Form 8-K was filed to report the announcement of the
     filing of a purported class action lawsuit against the Company and certain
     of its directors and officers.

c)   On August 7, 1998, a Form 8-K was filed to report that the Company acquired
     RHI, HTR, URG, ISS and GIC through the issuance of 1,839,381, 275,662,
     282,551, 308,583 and 223,645  shares of the Company's common stock in
     exchange for all of the outstanding shares of RHI, HTR, URG, ISS and GIC.
     The merger was effective on July 24, 1998 and will be accounted for as a
     pooling-of-interests.

d)   On August 5, 1998, a Form 8-K was filed to report the unaudited revenue and
     net income of the Company for the month ended  July 31, 1998.

e)   On July 10, 1998, a Form 8-K was filed to report that the Company acquired
     TMI and IHCS through the issuance of 1,078,963 and 224,668 shares of the
     Company's common stock in exchange for all of the outstanding shares of TMI
     and IHCS.  The merger was effective on June 25, 1998 and will be accounted
     for as a pooling-of-interests.

f)   On July 6, 1998, a Form 8-K was filed to report that the Company had
     entered into a merger agreement to exchange shares of the Company's common
     stock in exchange for all of the outstanding shares of RHI and affiliates.

                                                                       Page 14
<PAGE>

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

DAOU SYSTEMS, INC.

Date:  November 14, 1998                            By:  /s/ Daniel J. Daou
                                                         Daniel J. Daou
                                                         President

Date: November 14, 1998                             By:  /s/ Fred C. McGee
                                                         Fred C. McGee
                                                         Chief Financial Officer


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