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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 March 31, 1999.

[_]Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period from to .

COMMISSION FILE NUMBER 000-22647

PERITUS SOFTWARE SERVICES, INC.
(Exact Name of Registrant as Specified in its Charter)

MASSACHUSETTS 04-3126919
(State or Other Jurisdiction or (I.R.S. Employer
Incorporation or Organization) Identification No.)

2 FEDERAL STREET, 01821
BILLERICA, MASSACHUSETTS (Zip Code)
(Address of Principal Executive
Offices)

(978) 670-0800
(Registrant's Telephone Number, Including Area Code)

NOT APPLICABLE
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)

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 [X] No [_].

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:

Shares outstanding
Title of Class at May 7, 1999
-------------- ------------------

Common Stock, $0.01 par value 16,373,975

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PERITUS SOFTWARE SERVICES INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999

TABLE OF CONTENTS

Page
----

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of March 31, 1999 and December 31, 1998.... 3
Consolidated Statement of Operations for the Three Months Ended March 31,
1999
and 1998............................... ................................ 4
Consolidated Statement of Cash Flows for the Three Months Ended March 31,
1999
and 1998................................................................ 5
Notes to Unaudited Consolidated Financial Statements..................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk......... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................ ......................... 21
Item 6. Exhibits and Reports on Form 8-K................................... 22
Signatures................................ ................................ 23

From time to time, information provided by the Company or statements made by
its employees may contain "forward-looking" statements, as that term is
defined in the Private Securities Litigation Reform Act of 1995. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes", "anticipates", "plans", "expects", and
similar expressions are intended to identify forward-looking statements.

This Quarterly Report on Form 10-Q may contain forward looking statements
which involve risks and uncertainties. The Company's actual results may differ
materially from the results discussed in such statements. Certain factors that
could cause such a difference include, without limitation, the risks
specifically described in the Company's Annual Report on Form 10-K for the
year ended December 31, 1998 and other public documents, filed by the Company
with the Securities and Exchange Commission (the "Commission"), which factors
are incorporated herein by reference, the factors listed below in "Factors
That May Affect Future Results" and other factors such as the Company's
failure to achieve cash flow breakeven/strategic initiatives, financing, over
the counter listing, revenue risk, litigation risk, limited operating history,
potential fluctuation in quarterly performance, the need to develop additional
products and services, the concentration of clients and credit risk, the
impact of competitive products and services and pricing, competition for
qualified technical personnel, the offering of fixed-price, fixed time-frame
contracts rather than contracts on a time and materials basis, the potential
for contract liability related to the provision of year 2000 and other
products and services, the potential for software errors or bugs in the
Company's products, limited protection of proprietary rights, dependence on
third party technology, rapid technological change, dependence on Indian
offshore software development centers, the impact of the government regulation
of immigration, product or services demand and market acceptance risks,
product development and services capacity, commercialization and technological
difficulties, capacity and supply constraints or difficulties and the effect
of general business or economic conditions.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PERITUS SOFTWARE SERVICES, INC.

CONSOLIDATED BALANCE SHEET

(In Thousands, Except Share-related Data)
(Unaudited)

March 31, December 31,
1999 1998
--------- ------------

ASSETS
Current assets:
Cash and cash equivalents............................ $ 2,438 $ 2,809
Restricted cash...................................... -- 569
Short-term investments............................... 1,107 500
Accounts receivable, net of allowance for doubtful
accounts of $688 and $726, respectively, and
including amounts receivable from related parties of
$13 and $42, respectively........................... 1,627 3,720
Costs and estimated earnings in excess of billings on
uncompleted contracts............................... 918 951
Prepaid expenses and other current assets............ 552 816
--------- ---------
Total current assets............................... 6,642 9,365
Property and equipment, net.......................... 3,464 3,848
Intangible and other assets, net..................... 654 510
--------- ---------
$ 10,760 $ 13,723
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations......... $ 90 $ 90
Current portion of long-term debt.................... -- 269
Accounts payable..................................... 357 462
Customer advance..................................... 289 --
Billings in excess of costs and estimated earnings on
uncompleted contracts............................... 808 435
Deferred revenue..................................... 1,111 1,890
Other accrued expenses and current liabilities....... 4,003 4,414
--------- ---------
Total current liabilities.......................... 6,658 7,560
Capital lease obligations............................ 256 286
Long-term restructuring.............................. 996 1,067
--------- ---------
Total liabilities.................................. 7,910 8,913
--------- ---------
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 shares
authorized; 16,373,975 and 16,344,985 shares issued
and outstanding at March 31, 1999 and December 31,
1998, respectively.................................. 164 164
Additional paid-in capital........................... 105,135 105,135
Accumulated deficit.................................. (102,447) (100,488)
Accumulated other comprehensive income............... (2) (1)
--------- ---------
Total stockholders' equity......................... 2,850 4,810
--------- ---------
$ 10,760 $ 13,723
========= =========

The accompanying notes are an integral part of these unaudited consolidated
financial statements.

PERITUS SOFTWARE SERVICES, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(In Thousands, Except Per Share-related Data)
(Unaudited)

Three Months
Ended March 31,
-----------------
1999 1998
------- --------

Revenue:
Outsourcing services, including $0 and $1,214 from related
parties, respectively.................................... $ 1,853 $ 2,622
License................................................... 1,359 4,085
Other services............................................ 1,455 2,726
------- --------
Total revenue........................................... 4,667 9,433
------- --------
Cost of revenue:
Cost of outsourcing services, including $0 and $713 from
related parties, respectively............................ 1,923 2,111
Cost of license........................................... 96 536
Cost of other services.................................... 1,028 2,453
------- --------
Total cost of revenue................................... 3,047 5,100
------- --------
Gross profit............................................ 1,620 4,333
------- --------
Operating expenses:
Sales and marketing....................................... 1,050 3,109
Research and development.................................. 470 3,044
General and administrative................................ 1,776 1,747
Restructuring charge...................................... 291 --
------- --------
Total operating expenses................................ 3,587 7,900
------- --------
Loss from operations........................................ (1,967) (3,567)
Interest income, net........................................ 8 160
------- --------
Loss before minority interest in majority-owned subsidiary
........................................................... (1,959) (3,407)
Minority interest in majority-owned subsidiary.............. -- (49)
------- --------
Net loss................................................ $(1,959) $ (3,358)
======= ========
Net loss per share:
Basic..................................................... $ (0.12) $ (0.21)
======= ========
Diluted................................................... $ (0.12) $ (0.21)
======= ========
Weighted average shares outstanding:
Basic..................................................... 16,345 15,985
======= ========
Diluted................................................... 16,345 15,985
======= ========

The accompanying notes are an integral part of these unaudited consolidated
financial statements.

PERITUS SOFTWARE SERVICES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(In Thousands)
(Unaudited)

Three Months Ended
March 31,
--------------------
1999 1998
--------- ---------

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Cash flows from operating activities:
Net loss........................ ........................ $(1,959) $(3,358)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization.......................... 433 813
Minority interest in majority-owned subsidiary......... -- (49)
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable.................................. 2,093 3,719
Costs and estimated earnings in excess of billings on
uncompleted contracts............................... 33 339
Prepaid expenses and other current assets............ 264 (1,155)
Other assets ........................................ (223) (48)
Accounts payable .................................... (105) 118
Proceeds from customer advance....................... 289 --
Billings in excess of costs and estimated earnings on
uncompleted contracts............................... 373 4
Deferred revenue..................................... (779) (533)
Other accrued expenses and current liabilities
excluding accrued
restructuring....................................... (200) (1,124)
Accrued restructuring................................ (282) --
--------- ---------
Net cash used for operating activities............. ( 63) (1,274)
--------- ---------
Cash flows from investing activities:
Sale (purchase) of short-term investments.............. (607) 500
Proceeds from sale of property and equipment........... 64 --
Purchases of property and equipment.................... (34) (1,584)
--------- ---------
Net cash used for investing activities............. (577) (1,084)
--------- ---------
Cash flows from financing activities:
Restricted cash........................................ 569 --
Principal payments on long-term debt................... (269) (73)
Principal payments on capital lease obligations........ ( 30) (19)
Proceeds from exercise of stock options................ -- 876
Proceeds from repayment of note receivable from
stockholder........................................... -- 58
--------- ---------
Net cash provided by financing activities.......... 270 842
--------- ---------
Effects of exchange rates on cash and cash equivalents... (1) (2)
--------- ---------
Net decrease in cash and cash equivalents................ (371) (1,519)
Cash and cash equivalents, beginning of period........... 2,809 11,340
--------- ---------
Cash and cash equivalents, end of period................. $ 2,438 9,821
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS:
Cash paid for income taxes............................. $ 5 $ 78
Cash paid for interest................................. 7 20

The accompanying notes are an integral part of these unaudited consolidated
financial statements.

PERITUS SOFTWARE SERVICES, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation and Going Concern Matters

The accompanying unaudited consolidated financial statements include the
accounts of Peritus Software Services, Inc. and its subsidiaries (the
"Company") and have been prepared by the Company without audit in accordance
with the Company's accounting policies, as described in the Company's Annual
Report on Form 10-K for the year ended December 31, 1998, as filed with the
Securities and Exchange Commission ("SEC"). In the opinion of management, the
accompanying unaudited consolidated financial statements contain all
adjustments, which, other than the restructuring charge for the three months
ended March 31, 1999, consist only of those of a normal recurring nature,
necessary for a fair presentation of the Company's financial position, results
of operations and cash flows at the dates and for the periods indicated. While
the Company believes that the disclosures presented are adequate to make the
information not misleading, these financial statements should be read in
conjunction with the consolidated financial statements and related notes
included in the Company's 1998 Annual Report on Form 10-K. The operating
results for the three months ended March 31, 1999 are not necessarily
indicative of the results to be expected for the full year ending December 31,
1999.

The Company's consolidated financial statements have been presented on the
basis that it is a going concern, which contemplates continuity of operations,
realization of assets and the satisfaction of liabilities in the ordinary
course of business. However, the Company experienced net losses of $1,959,000,
$26,673,000 and $67,490,000 in the quarter ended March 31, 1999 and in the
years ended December 31, 1998 and December 31, 1997, respectively, which raise
doubt about its ability to continue as a going concern. The Company's cash
flow requirements will depend on the results of future operations. The
Company's continued existence is dependent upon its ability to achieve a cash
flow breakeven position and/or to obtain additional sources of financing. The
Company does not believe that it will be able to achieve a cash flow break
even position in the future and the Company is considering various
alternatives including the possibility of filing for the protection against
creditors or liquidation under applicable bankruptcy laws. The Company
announced its intention to restructure on March 29, 1999. The restructure plan
was finalized on March 31, 1999 and included the elimination of approximately
40 employees. On April 2, 1999, the Company announced the details of its
restructure plan that included a reduction in its workforce of approximately
40 people in the areas of sales, marketing and year 2000 delivery. The Company
currently maintains its outsourcing service delivery resources and limited
sales and year 2000 resources required to meet current support obligations. In
March 1999, the Company announced that it had retained Covington Associates to
render financial advisory and investment banking services in connection with
exploring strategic alternatives including the potential sale of the Company.
The engagement agreement was entered into in December 1998. The Company is
also exploring strategic initiatives to raise additional funds or sell all or
part of its assets. The Company's common stock is traded on the Over The
Counter ("OTC") Bulletin Board which has several requirements for listing.
Failure to meet listing requirements may result in the Company being de-
listed. There can be no assurance that the Company will not be de-listed.

During 1998, the Company's bank indicated that it would not renew or further
extend its revolving line of credit facility and demanded that cash collateral
be provided for all amounts outstanding under its equipment financing
agreement with the Company since the Company was in default of certain
financial and operating covenants thereunder. At December 31, 1998, $269,000
and $300,000 of cash was pledged as collateral for all amounts outstanding
under the equipment financing agreement and the standby letter of credit,
respectively. Accordingly, these amounts have been classified as restricted
cash on the accompanying consolidated balance sheet. As of March 31, 1999,
there were no amounts outstanding under the revolving credit facility or the
equipment financing agreement. There can be no assurance that the Company will
achieve a cash flow breakeven position or that it will be able to raise
additional funds through bank borrowings and/or debt and/or equity financings.
Further reductions in expenses or the sale of assets may not be adequate to
bring the Company to a cash breakeven position. In addition, there can be no
assurance that such actions will not have an adverse effect

PERITUS SOFTWARE SERVICES, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

on the Company's ability to generate revenue or successfully implement any
strategic alternatives under consideration. Failure to establish a cash flow
breakeven position or raise additional funds through bank borrowings and/or
equity and/or debt financings would adversely impact the Company's ability to
continue as a going concern.

2. Legal Proceedings

The Company and certain of its officers and directors were named as
defendants in purported class action lawsuits filed in the United States
District Court for the District of Massachusetts by Robert Downey on April 1,
1998, by Scott Cohen on April 7, 1998, by Timothy Bonnett on April 9, 1998, by
Peter Lindsay on April 17, 1998, by Harry Teague on April 21, 1998, by Jesse
Wijntjes on April 29, 1998, by H. Vance Johnson and H. Vance Johnson as
Trustee for the I.O.R.D. Profit-Sharing Plan on May 6, 1998, by John B.
Howard, M.D. on May 21, 1998 and by Helen Lee on May 28, 1998 (collectively,
the "complaints"). The complaints principally alleged that the defendants
violated federal securities laws by making false and misleading statements and
by failing to disclose material information concerning the Company's December
1997 acquisition of substantially all of the assets and assumption of certain
liabilities of the Millennium Dynamics, Inc. ("MDI") business from American
Premier Underwriters, Inc., thereby allegedly causing the value of the
Company's common stock to be artificially inflated during the purported class
periods. In addition, the Howard complaint alleged a violation of federal
securities laws as a result of the Company's purported failure to disclose
material information in connection with the Company's initial public offering
on July 2, 1997, and also named Montgomery Securities, Inc., Wessels, Arnold &
Henderson, and H.C. Wainwright & Co., Inc. as defendants. The complaints
further alleged that certain officers and/or directors of the Company sold
stock in the open market during the class periods and sought unspecified
damages.

On or about June 1, 1998, all of the named plaintiffs and additional
purported class members filed a motion for the appointment of several of those
individuals as lead plaintiffs, for approval of lead and liaison plaintiffs'
counsel and for consolidation of the actions. The Court granted that motion on
June 18, 1998.

On January 8, 1999, the plaintiffs filed a Consolidated Amended Complaint
applicable to all previously filed actions. The Consolidated Amended Complaint
alleges a class period of October 22, 1997 through October 26, 1998 and
principally claims that the Company and three of its former officers violated
federal securities laws by purportedly making false and misleading statements
(or omitting material information) concerning the MDI acquisition and the
Company's revenue during the proposed class period, thereby allegedly causing
the value of the Company's stock to be artificially inflated. Previously
stated claims against the Company and its underwriters alleging violations of
the federal securities laws as a result of purportedly inadequate or incorrect
disclosure in connection with the Company's initial public offering were not
included in the Consolidated Amended Complaint. The Company and the individual
defendents filed motions to dismiss the Consolidated and Amended Complaint on
March 5, 1999. Oral arguments on the motions were held on April 21, 1999 and
the court has taken the matter under advisement.

Although the Company believes that it has meritorious defenses to the claims
made in the Consolidated Amended Complaint and intends to contest the action
vigorously, an adverse resolution of the lawsuit could have a material adverse
effect on the Company's financial condition and results of operations in the
period in which the litigation is resolved. The Company is not able to
reasonably estimate potential losses, if any, related to the Consolidated
Amended Complaint.

PERITUS SOFTWARE SERVICES, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

unjustly enriched by the services performed by the Company, the Company is
entitled to recovery based on quantum meruit, and that Micah engaged in unfair
and/or deceptive trade practices or acts in violation of Massachusetts General
Laws Chapter 93A by allowing the Company to perform services when Micah did
not pay for such services. The lawsuit seeks unspecified damages on the breach
of contract and quantum meruit claims and double or triple damages on the
Chapter 93A claim. The Company has not yet received Micah's answer to the
lawsuit.

In addition to the matters noted above, the Company is from time to time
subject to legal proceedings and claims which arise in the normal course of
its business. In the opinion of management, the amount of ultimate liability
with respect to these other actions, currently known, will not have a material
adverse effect on the Company's financial position or results of operations
for the year ended December 31, 1998.

3. Restructuring Charge

On March 29, 1999, the Company announced its intention to restructure. The
restructure plan was finalized on March 31, 1999 and the Company recorded a
charge of $291,000 consisting of severance payments associated with the
termination of approximately 30% of the Company's employees representing
substantially all of its sales, marketing and year 2000 delivery personnel (40
employees). Payments related to terminated employees are expected to be
completed by May 28, 1999. The Company has estimated that the restructuring
will result in a quarterly reduction of approximately $1,000,000 in salary and
related costs beginning in the third quarter of 1999.

The amounts accrued to and payments against the accrued restructuring during
the first quarter of 1999 and the composition of the remaining balance at
March 31, 1999 were as follows:

Balance Q1 1999 Q1 1999 Balance
December 31, 1998 Accrual Payments March 31, 1999
----------------- ------- -------- --------------
(in thousands)

Provision for severance and
benefit payments to
terminated employees........ $ 536 $291 $(212) $ 615
Provisions related to closure
of facilities and reduction
of occupied space........... 2,144 -- (361) 1,783
------ ---- ----- ------
Total...................... $2,680 $291 $(573) $2,398
====== ==== ===== ======

As of March 31, 1999, $1,402,000 of the remaining balance of the
restructuring accrual is expected to be paid by March 31, 2000 with the
remaining balance of $996,000 being paid thereafter.

4. Other Accrued Expenses and Current Liabilities

Other accrued expenses and current liabilities consist of the following:

March 31, December 31,
1999 1998
---------- ------------

Restructuring costs.................................... $1,402,000 $1,613,000
Employee-related costs................................. 456,000 548,000
Rent levelization...................................... 453,000 357,000
Professional costs..................................... 208,000 342,000
Other.................................................. 1,484,000 1,554,000
---------- ----------
$4,003,000 $4,414,000
========== ==========

PERITUS SOFTWARE SERVICES, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

5. Comprehensive Income (Loss)

Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from non-owner sources. It includes all changes in equity during
a period except those resulting from investments by owners and distributions
to owners. This standard requires that an enterprise display an amount
representing total comprehensive income for the period.

For the three months ended March 31, 1999 and 1998, the Company's
comprehensive loss was comprised as follows:

Three months ended
March 31,
-------------------------
1999 1998
------------ ------------

Net loss............................................. $(1,959,000) $(3,358,000)
Translation adjustment............................... (1,000) (3,000)
------------ ------------
$(1,960,000) $(3,361,000)
============ ============

6. Net Loss Per Share

In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings per Share", which supersedes Accounting Principles
Board Opinion Accounting ("APB") No. 15 and specifies the computation,
presentation and disclosure requirements of earnings per share. SFAS No. 128
requires the presentation of "basic" earnings per share and "diluted" earnings
per share. Basic earnings per share is computed by dividing the net income
(loss) available to common stockholders by the weighted average shares of
outstanding common stock. For purposes of calculating diluted earnings per
share, the denominator includes both the weighted average shares of common
stock outstanding and, when not anti-dilutive, potential common stock
including outstanding stock options.

7. Recently Issued Accounting Standards

In October 1997, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants issued Statement of
Position ("SOP") 97-2, "Software Revenue Recognition." SOP 97-2 provides
guidance on the timing and amount of revenue recognition when licensing,
selling, leasing or otherwise marketing computer software and is effective for
transactions entered into by the Company beginning on January 1, 1998. The
Company adopted SOP 97-2 for the year ended December 31, 1998. Subsequently,
in March 1998, AcSEC issued SOP 98-4, "Deferral of the Effective Date of a
Provision of SOP 97-2, Software Revenue Recognition." SOP 98-4 deferred
certain provisions of SOP 97-2 pertaining to its requirements for what
constitutes vendor-specific objective evidence ("VSOE") of the fair value of
individual elements of a multiple-element arrangement for a one-year period.
At the same time, AcSEC immediately began a project to further clarify the
requirements surrounding VSOE. This project resulted in SOP 98-9,
"Modification of SOP 97-2, 'Software Revenue Recognition,' with Respect to
Certain Transactions," which was issued in December 1998. In SOP 98-9, AcSEC
decided to retain the limitations on what is considered VSOE of fair value in
a software arrangement, except in limited circumstances. Generally, the
limitations on VSOE of fair value that were deferred by SOP 98-4 will be
effective for transactions that are entered into in fiscal years beginning
after March 15, 1999. The Company believes that its current revenue
recognition policies and practices are consistent with the provisions of SOP
98-9. Accordingly, the adoption of this guidance has not materially affected
its financial position or results of operations and is not expected to have a
material impact in future periods.

PERITUS SOFTWARE SERVICES, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

In February 1998, AcSEC issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". SOP 98-1
establishes the accounting for costs of software products developed or
purchased for internal use, including when such costs should be capitalized.
SOP 98-1, which became effective for the Company beginning January 1, 1999,
does not have a significant impact on the Company's financial condition or
results of operations.

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to
as derivatives) and for hedging activities. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. The Company
does not invest in derivative instruments or engage in hedging activities. As
a result, SFAS No. 133 is not expected to have a material affect on its
financial position or results of operations.

8. Segment, Geographic, and Product Information

The Company operates in one reportable segment under SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," due to
its centralized structure and single industry segment: software maintenance,
tools and services. The Company currently derives its revenue from software
maintenance outsourcing services, software and methodology licensing and other
services (including direct delivery of Year 2000 renovation services and
renovation quality evaluation ("RQE") sold directly to end users or indirectly
via value added integrators. Information by geographic area at March 31, 1999
and 1998, is summarized below (in thousands):

Outsourcing Services License Revenue Other Services Revenue Long-lived
Unaffilated Affilated Unaffilated Affiliated Unaffiliated Affiliated Assets
--------------------- ---------------------- ----------------------- ----------

March 31, 1999
United States........... $ 1,853 -- $ 1,359 -- $ 1,455 -- $ 3,725
Foreign................. -- -- -- -- -- -- --
----------- --------- ------------- --------- ------------- ---------- -------
$ 1,853 -- $ 1,359 -- $ 1,455 -- $ 3,725
=========== ========= ============= ========= ============= ========== =======
March 31, 1998
United States........... $ 2,049 -- $ 4,085 -- $ 2,652 -- $10,805
Foreign................. 128 445 -- -- 74 -- 119
----------- --------- ------------- --------- ------------- ---------- -------
$ 2,177 $ 445 $ 4,085 -- $ 2,726 -- $10,924
=========== ========= ============= ========= ============= ========== =======

The geographic classification of revenue is determined based on the country
in which the legal entity providing the services is located. Revenue from no
single foreign country was greater than 10% of the consolidated revenues of
the Company in quarters ended March 31, 1999 and 1998.

Item 2. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations

Overview and Going Concern Matters

Peritus Software Services, Inc. (the "Company") was founded in 1991 to
address the growing market for managing and maintaining the installed base of
software in organizations. The Company focused its efforts on the delivery of
software maintenance outsourcing services until 1995, when it began to devote
significant resources to the development of software tools addressing the
problems associated with mass changes to application systems and their
associated databases, particularly the year 2000 problem. In 1996, the Company
began licensing its AutoEnhancer/2000 software, which was designed to address
the year 2000 problem, to value added integrators and directly to end users.
In 1996, the Company expanded its research and development efforts through the
acquisition of Vista Technologies Incorporated ("Vista"), a developer of
computer-aided engineering software. In 1997, the Company expanded its product
offerings by releasing an enhanced version of the AutoEnhancer/2000 software
which enables a client to perform logic correction only changes with regard to
year 2000 renovations, and through the acquisition of substantially all of the
assets and the assumption of certain of the liabilities of the business of
Millennium Dynamics, Inc. ("MDI"), a software tools company with year 2000
products for the IBM mainframe and AS/400 platforms, from American Premier
Underwriters, Inc. ("APU").

In response to changes in the markets for the Company's products and
services, the Company emphasized the direct delivery of year 2000 renovation
services and renovation quality evaluation ("RQE") services in the beginning
of 1998, and also began to refocus business on software maintenance
outsourcing services. As the market continued to shift from the Company's year
2000 products and services during the third quarter of 1998, the Company's
overall strategy was to grow its software maintenance outsourcing business
over the long term and to meet its clients needs for year 2000 renovation
services and RQE services. In July 1998, the Company announced its software
maintenance outsourcing offerings, "Software Asset Maintenance for Software
Providers" and "Software Asset Maintenance for Information Systems", which are
outsourcing solutions designed specifically for the manufacturers of system
software and software products and for information technology departments that
maintain application software, respectively.

In the second half of 1998, the overall market for the year 2000 tools and
services of the Company contracted dramatically, resulting in substantial
financial losses, and, in response, the Company substantially reduced its
workforce in September and December of 1998. As a result of the Company's
degraded financial condition, the Company began encountering major obstacles
in obtaining new outsourcing business. Since most outsourcing engagements are
multi-year and involve critical applications, prospective new clients,
although interested in the capabilities and technology of the Company, were
reluctant or unwilling to commit to contracts. In addition, existing
outsourcing customers were and may continue to be unwilling to renew existing
contracts based on their own business requirements and/or because of the
Company's degraded financial condition. Based upon its continued difficulties,
the Company announced an additional reduction in workforce in March 1999 and
has experienced significant voluntary attrition in its workforce.

The Company experienced net losses in the years ended December 31, 1997 and
1998, and the quarter ended March 31, 1999, which raise doubt about its
ability to continue as a going concern. Based on the Company's existing fixed
cost commitments, its limited cash resources, and the reluctance of new and
existing customers to commit to long-term outsourcing engagements, the Company
does not anticipate that it will be able to achieve a

cash flow breakeven position in the future and is considering various
alternatives including the possibility of filing for the protection from
creditors or liquidation under applicable bankruptcy laws. However, the
Company will continue to attempt to achieve a cash flow breakeven position at
the same time it seeks potential buyers.

The Company currently derives its revenue from software maintenance
outsourcing services, software and methodology licensing and other services
sold directly to end users and its clients include primarily Fortune 1000
companies and similarly sized business and government organizations worldwide.
The Company's current sales organization includes two employees. In addition,
the Company has engaged a few of its former sales representatives as sales
agents.

Three Months Ended March 31, 1999 Compared To Three Months Ended March 31,
1998

Revenue

Total revenue decreased 50.5% to $4,667,000 in the three months ended March
31, 1999 from $ 9,433,000 in the three months ended March 31, 1998. This
decrease in revenue was primarily due to a decrease in the licensing of the
Company's AutoEnhancer/2000 and Vantage YR2000 software products and other
software tools as well as from decreases in other services revenue and, to a
lesser extent, outsourcing services revenue. International revenue decreased
70.9% to $560,000 in 1999 from $1,924,000 in 1998. The reduction was primarily
attributable to the divestiture of the Company's equity interest in its
majority-owned Spanish Subsidiary, Persist, S.A. ("Persist"), and a reduction
in license revenue from other international clients.

Outsourcing Services. Outsourcing services revenue decreased 29.3% to
$1,853,000 in the three months ended March 31, 1999 from $2,622,000 in the
three months ended March 31, 1998. The decrease in outsourcing services
revenue in absolute dollars was primarily attributable to the divestiture of
Persist, and the termination of an Engineering Consulting Services Agreement
between the Company and one of its clients that specifically provided that the
client could terminate the Agreement for convenience on 180 days notice. As a
percentage of total revenue, outsourcing services revenue increased to 39.7%
in the three months ended March 31, 1999 from 27.8% for the three months ended
March 31, 1998. The increase in outsourcing services revenue as a percentage
of total revenue reflects the decreased contribution of license revenue to
total revenue during the three months ended March 31, 1999 when compared to
the same period in the prior year. Outsourcing services remain a major
component of the Company's business. However, due to the Company's degraded
financial condition, the Company anticipates that it will not be able to
attract new outsourcing customers. In addition, existing outsourcing customers
have been and may continue to be unwilling to renew existing contracts based
on their own business requirements and/or because of the Company's degraded
financial condition. The Company, therefore, anticipates a significant
reduction in revenue from outsourcing services in the future.

License. License revenue decreased 66.7% to $1,359,000 in the three months
ended March 31, 1999, or 29.1% of total revenue, compared to $4,085,000, or
43.3% of total revenue, in the three months ended March 31, 1998. The decrease
in license revenue for 1999 in absolute dollars was primarily attributable to
a decrease in the delivery of licensed software to end users and decreased
license fees from value added integrators. The market for the Company's year
2000 tools significantly eroded in 1998 and the Company anticipates limited
year 2000 related license revenue in the future. The Company will continue to
pursue licenses of its tools associated with outsourcing.

Other Services. Other services revenue decreased 46.6% to $1,455,000 in the
three months ended March 31, 1999 from $2,726,000 in the three months ended
March 31, 1998. As a percentage of total revenue, other services revenue
increased to 31.2% in the three months ended March 31, 1999 from 28.9% in the
three months ended March 31,1998. The decrease in other services revenue in
absolute dollars was primarily attributable to a decrease in direct delivery,
consulting and client support services relating to the Company's year 2000
products and services. Given the reduction in demand for its year 2000
services and the reduction in internal resources announced at the end of March
1999, the Company anticipates significant reductions in its year 2000 related
service revenue in the future.

Cost of Revenue

Cost of Outsourcing Services Revenue. Cost of outsourcing services revenue
consists primarily of salaries, benefits and overhead costs associated with
delivering outsourcing services to clients. The cost of outsourcing services
revenue decreased 8.9% to $1,923,000 in the three months ended March 31, 1999
from $2,111,000 for the three months ended March 31, 1998. Cost of outsourcing
services revenue as a percentage of outsourcing services revenue increased to
103.8% in the three months ended March 31, 1999 from 80.5% in the three months
ended March 31, 1998. Costs exceeded revenue in the first quarter of 1999 as a
result of additional costs being expended in anticipation of and to generate
new business that did not materialize. In addition, the Company expended costs
in connection with an agreement with Micah Technology Services, Inc. ("Micah")
for which it received no payments. The Company has filed a lawsuit against
Micah to attempt to recover amounts due under such agreement See "Part II-Item
3. Legal Proceedings." The Company has taken action to reduce its outsourcing
costs in the future.

Cost of License Revenue. Cost of license revenue consists primarily of
amortization of expense of intangibles related to the MDI acquisition and
salaries, benefits and related overhead costs associated with license-related
materials packaging and freight. Cost of license revenue was $96,000 in the
three months ended March 31, 1999, or 7.1% of license revenue. Cost of license
revenue was $536,000, or 13.1% of license revenue, in the three months ended
March 31, 1998. The decrease in cost of license revenue was primarily related
to the reduction of amoritization expense of intangibles related to the MDI
acquisition as a result of the impairment charge recorded against the MDI
related intangibles by the Company in the third quarter of 1998.

Cost of Other Services Revenue. Cost of other services revenue consists
primarily of salaries, benefits and related overhead costs associated with
delivering other services to clients. Cost of other services revenue decreased
58.1% to $1,028,000 in the three months ended March 31, 1999 from $2,453,000
in the three months ended March 31, 1998. Cost of other services revenue as a
percentage of other services revenue decreased to 70.7% in the three months
ended March 31, 1999 from 90.0% in the three months ended March 31, 1998.
Costs decreased in absolute dollars in the three months ended March 31, 1999
due to reduced staffing for the Company's client support, training and
consulting organizations related to fewer customers for the Company's year
2000 products and services, including year 2000 renovations and RQE services.
The Company has taken action to reduce its future cost of other services in
anticipation of significant reductions in other services revenue in the
future.

Operating Expenses

Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related overhead costs for sales and marketing
personnel; sales referral fees to third parties; advertising programs; and
other promotional activities. Sales and marketing expenses decreased 66.2% to
$1,050,000 in the three months ended March 31, 1999 from $3,109,000 in the
three months ended March 31, 1998. As a percentage of total revenue, sales and
marketing expenses decreased to 22.5% in the three months ended March 31, 1999
from 33.0% in the three months ended March 31, 1998. The decrease in expenses
in absolute dollars and as a percentage of revenue was primarily attributable
to significant decreases in staffing, commissions and promotional activities.
As a result of actions announced at the end of March 1999, the Company
anticipates dramatically reduced sales and marketing expenses in the future.

Research and Development. Research and development expenses consist
primarily of salaries, benefits and related overhead costs for engineering and
technical personnel and outside engineering consulting services associated
with developing new products and enhancing existing products. Research and
development expenses decreased 84.6% to $470,000 in the three months ended
March 31, 1999 from $3,044,000 in the three months ended March 31, 1998. As a
percentage of total revenue, research and development expenses decreased to
10.1% in the three months ended March 31, 1999 from 32.3% in the three months
ended March 31, 1998. The decrease in research and development expenses in
absolute dollars was primarily attributable to dramatically reduced staffing
for the product development efforts for the Company's year 2000 products and
services, mass change technologies and other software tools.

General and Administrative. General and administrative expenses consist
primarily of salaries and related costs for the finance and accounting, human
resources, legal services, information systems and other administrative
departments of the Company, as well as legal and accounting expenses and the
amortization of intangible assets associated with the Vista acquisition. The
cost of excess space was also charged to general and administrative expense in
the first quarter of 1999. General and administrative expenses increased 1.7%
to $1,776,000 in the three months ended March 31, 1999 from $1,747,000 in the
three months ended March 31, 1998. As a percentage of total revenue, general
and administrative expenses increased to 38.1% in the three months ended March
31, 1999 from 18.5% in the three months ended March 31, 1998. The increase in
general and administrative expenses in absolute dollars was primarily due to
the cost of excess space and increased legal and accounting fees.

Restructuring Charge On March 29, 1999, the Company announced its intention
to restructure. The restructure plan was finalized on March 31, 1999 and the
Company recorded a charge of $291,000 consisting of severance payments
associated with the termination of approximately 30% of the Company's
employees, representing substantially all of its sales, marketing and year
2000 delivery personnel (40 employees). Payments related to terminated
employees are expected to be completed by May 28, 1999. The Company has
estimated that the restructuring will result in a quarterly reduction of
approximately $1,000,000 in salary and related costs beginning in the third
quarter of 1999.

The amounts accrued to and payments against the restructuring accrual during
the first quarter of 1999 and the composition of the remaining balance at
March 31, 1999 were as follows:

Balance Q1 1999 Q1 1999 Balance
December 31, 1998 Accrual Payments March 31, 1999
----------------- -------------- -------- --------------
(in thousands)

Provision for severance
and benefit payments to
terminated employees... $ 536 $291 $(212) $ 615
Provisions related to
closure of facilities
and reduction of
occupied space......... 2,144 -- (361) 1,783
------ ---- ----- ------
Total................... $2,680 $291 $(573) $2,398
====== ==== ===== ======

As of March 31, 1999, $1,402,000 of the remaining balance of the
restructuring accrual is expected to be paid by March 31, 2000 with the
remaining balance of $996,000 being paid thereafter.

Interest Income (Expense), Net

Interest income and expense is primarily comprised of interest income from
cash balances, partially offset by interest expense on debt. The Company had
interest income, net, of $8,000 in the three months ended March 31, 1999
compared to interest income, net, of $160,000 in the three months ended March
31, 1998. This
change in interest income, net, was primarily attributable to reduced interest
income derived from declining cash balances resulting from the Company's
continued losses from operations.

Provision for Income Taxes

The Company's income tax provision was zero in each of the three months
ended March 31, 1999 and 1998. The Company did not record a tax provision or
benefit in the three months ended March 31, 1999 due to losses incurred.

Minority Interest in Majority-owned Subsidiary

The minority interest in majority-owned subsidiary represents the equity
interest in the operating results of Persist, the Company's majority-owned
Spanish subsidiary, held by stockholders of Persist other than the Company.
The Company had no minority interest in majority-owned subsidiary in the three
months ended March 31, 1999 since it divested its minority interest in July
1998.

Liquidity And Capital Resources

Further reductions in expenses or the sale of assets may not be adequate to
bring the Company to a cash breakeven position. In addition, there can be no
assurance that such actions will not have an adverse affect on the Company's
ability to generate revenue or successfully implement any strategic
alternatives under consideration. Failure to establish a cash flow breakeven
position or raise additional funds through bank borrowings and/or equity
and/or debt financing would adversely impact the Company's ability to continue
as a going concern. The Company does not believe it will be able to achieve a
cash flow breakeven position in the future and is considering various
alternatives including the possibility of filing for the protection against
creditors or liquidation under applicable bankruptcy laws.

The Company has financed its operations and capital expenditures primarily
with the proceeds from sales of the Company's convertible preferred stock and
common stock, borrowings, and advance payments for services from clients. The
Company's cash balances were $2,438,000 and $3,378,000 at March 31, 1999 and
December 31, 1998, respectively. The Company's working capital (deficit) was
$(16,000) and $1,805,000 at March 31, 1999 and December 31, 1998,
respectively.

The Company's operating activities used cash of $63,000 and $1,274,000
during the three months ended March 31, 1999 and 1998, respectively. The
Company's use of cash during the three months ended March 31, 1999 was
primarily caused by a net loss of $1,959,000 less non-cash depreciation and
amortization expense of $433,000, an increase in other assets of $223,000, a
decrease in deferred revenue of $779,000, a decrease in the current portion of
accrued restructuring of $282,000, and a decrease in other accrued liabilities
of 200,000. These decreases were partially offset by a decrease in accounts
receivable of $2,093,000, a decrease in prepaid expenses and other current
assets of $264,000, the receipt of an advance payment from a customer of
$289,000, and the increase in billings in excess of costs and estimated
earnings on uncompleted contracts of $373,000.

The Company used cash of $577,000 and $1,084,000 for investing activities
during the three months ended March 31, 1999 and 1998, respectively. Investing
activities in the three months ended March 31, 1999 consisted principally of
the purchases of short-term investments.

The Company's financing activities provided cash of $270,000 and $842,000
during the three months ended March 31, 1999 and 1998, respectively. Financing
activities in the three months ended March 31, 1999 primarily reflect a
decrease in the amount of restricted cash of $569,000 partially offset by
principal payments on long-term debt of $269,000.

In September 1996, the Company obtained a revolving line of credit facility
from a bank which bore interest at the bank's prime rate plus 0.5%. The line
of credit expired and all borrowing was paid in full on September 30, 1998. In
addition to this line of credit, the Company also entered into an equipment
financing agreement in September 1996. Under this agreement, the bank agreed
to provide up to $1,500,000 for the purchase of certain equipment (as defined
by the agreement) through June 30, 1997. Ratable principal and interest
payments were

payable during the period July 1, 1997 through June 1, 2000, and bore interest
at the bank's prime rate plus 1%. Both of these agreements required the
Company to comply with certain financial covenants and were secured by all of
the assets of the Company. The bank notified the Company in October, 1998 that
the Company was in default under its line of credit facility and equipment
financing agreement and requested that the Company provide cash collateral for
the amount of equipment financing outstanding and provide cash collateral for
a $300,000 standby letter of credit issued by the bank. The Company provided
cash collateral for all amounts outstanding under the equipment financing
agreement in December 1998 and for the $300,000 letter of credit in October
1998. The letter of credit was drawn upon and the equipment financing debt was
paid in the first quarter of 1999. There were no borrowings outstanding under
the revolving credit facility and under the equipment financing agreement at
March 31, 1999. In 1998, the bank indicated that it would not renew or further
extend the Company's revolving credit facility. There can be no assurance that
the Company will be able to raise additional funds through bank borrowings
and/or debt and/or equity financings.

To date, the Company has not invested in derivative securities or any other
financial instruments that involve a high level of complexity or risk. Excess
cash has been, and the Company contemplates that it will continue to be,
invested in interest-bearing, short-term investment grade securities.

Foreign Currency

Assets and liabilities of the Company's subsidiaries are translated into
U.S. dollars at exchange rates in effect at the balance sheet date. Income and
expense items are translated at average exchange rates for the period.
Accumulated net translation adjustments are included in stockholders' equity.

Inflation

To date, inflation has not had a material impact on the Company's results of
operations.

Recently Issued Accounting Standards

In February 1998, AcSEC issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1
establishes the accounting for costs of software products developed or
purchased for internal use, including when such costs should be capitalized.
SOP 98-1, which became effective for the Company beginning January 1, 1999
does not have a significant impact on the Company's financial condition or
results of operations.

Factors That May Affect Future Results

Failure to Achieve Cash Flow Breakeven/Strategic Initiatives

The Company's ability to achieve a cash flow breakeven position is critical
for achieving financial stability. The Company does not believe that it will
be able to achieve a cash flow breakeven and is considering various
alternatives including the possibility of filing for the protection against
creditors or liquidation under applicable bankruptcy laws. Further reductions
in expenses or the sale of assets may not be sufficient to bring the Company
to a cash breakeven position. In addition, there can be no assurance that any
actions taken to sell assets or reduce expenses will not have a material
adverse impact on the Company's ability to generate revenue or successfully
implement any strategic alternatives under consideration. Failure to establish
a cash flow break even position or raise additional funds through bank
borrowings and/or equity and/or debt financings, has and will continue to
adversely impact the Company's ability to continue as a going concern.

Financing

In 1998, the Company's bank indicated that it would not renew or further
extend the Company's revolving credit facility. There can be no assurance that
the Company will be able to successfully negotiate a borrowing arrangement
with a bank or obtain additional funds through equity and/or debt financings.
Failure to establish a cash flow break even position or raise additional funds
through bank borrowings and/or equity and/or debt financings will continue to
adversely impact the Company's ability to continue as a going concern.

Over the Counter Listing

The Company's common stock trades on the OTC Bulletin Board which has
certain continued listing criteria. Failure to meet those listing requirements
may result in the Company being de-listed. There can be no assurance that the
Company will not be de-listed. Trading of the common stock is conducted in the
over-the-counter market which could make it more difficult for an investor to
dispose of, or obtain accurate quotations as to the market value of, the
common stock. In addition, there are additional sales practice requirements on
broker-dealers who sell such securities to persons other than established
customers and accredited investors. For transactions covered by this rule, the
broker-dealer must make a special suitability determination for the purchaser
and must have received the purchaser's written consent to the transaction
prior to sale. Consequently, delisting, if it occurred, may affect the ability
of broker-dealers to sell the Company's common stock and the ability of the
stockholders to sell their common stock. In addition, if the trading price of
the common stock is below $5.00 per share, trading in the common stock would
also be subject to the requirements of certain rules promulgated under the
Securities Exchange Act of 1934, which require additional disclosure by
broker-dealers in connection with any trades involving a stock defined as a
penny stock (generally any non-Nasdaq equity security that has a market price
of less than $5.00 per share, subject to certain exceptions). Such rules
require the delivery, prior to any penny stock transaction, of a disclosure
schedule explaining the penny stock market and the risks associate therewith,
and impose various sales practice requirements on broker-dealers who sell
penny stocks to persons other than established customers and accredited
investors (generally institutions). For these types of transactions, the
broker-dealer must make a special suitability determination for the purchaser
and have

received the purchaser's written consent to the transaction prior to sale. The
additional burdens imposed upon broker-dealers by such requirements may
discourage broker-dealers from effecting transactions in the common stock,
which could severely limit the market liquidity of the common stock and the
ability of purchasers in this offering to sell the common stock in the
secondary market.

Revenue Risk

The Company's current strategy is to minimize expenses, while preserving its
principal saleable assets: its outsourcing business and its technology. Along
with Covington Associates, its investment banker, the Company is actively
pursuing strategic relationships with an emphasis on the sale of all or parts
of its assets. The Company is continuing to selectively pursue sales of its
software. The Company is also focusing on renewing its existing outsourcing
contracts and licensing its methodology and providing limited consulting
services. However, due to its degraded financial condition, the Company
anticipates that it will not be able to attract new outsourcing customers. In
addition, existing outsourcing customers have been and may continue to be
unwilling to renew existing outsourcing contracts based on their own business
requirements and/or because of the Company's degraded financial condition,
there can be no assurance that this current strategy will generate revenues
sufficient for the Company to achieve a cash flow breakeven position.

Litigation Risk

The future course of the class action claims against the Company described
in footnote 2 to the consolidated financial statements could have a material
adverse impact on the Company's financial condition and results of operations
in the period in which the litigation is resolved.

Potential Fluctuations in Quarterly Performance

The Company's quarterly revenue, expenses and operating results have varied
significantly in the past and are likely to vary significantly from quarter to
quarter in the future. A significant portion of the Company's revenue in any
quarter is typically derived from a limited number of large client
transactions. In addition, the sales cycle associated with these transactions
is lengthy and is subject to a number of uncertainties, including clients'
budgetary constraints, the timing of clients' budget cycles and clients'
internal approval processes. Accordingly, the timing of significant
transactions is unpredictable and, as a result, the Company's revenue and
results of operations for any particular period are subject to significant
variability. The complexity of certain projects and the requirements of
generally accepted accounting principles can also result in a deferral of
revenue recognition, in whole or in part, on a particular contract during a
quarter, even though the contract has been executed or payment has actually
been received by the Company. Quarterly fluctuations may also result from
other factors such as new product and service introductions or announcements
of new products and services by the Company's competitors, changes in the
Company's or its competitors' pricing policies, changes in the mix of
distribution channels through which the Company's products and services are
sold, the timing and nature of sales and marketing expenses, changes in
operating expenses, the financial stability of major clients, changes in the
demand for software maintenance products and services, foreign currency
exchange rates and general economic conditions.

Year 2000 Issue

The Year 2000 issue relates to computer programs and systems that recognize
dates using two-digit year data rather than four-digit year data. As a result,
such programs and systems may fail or provide incorrect information when using
dates after December 31, 1999. If the Year 2000 issue were to disrupt the
Company's internal information technology systems, or the information
technology systems of entities with whom the Company has significant
commercial relationships, the Company's business and financial condition could
be materially adversely affected.

The Year 2000 issue is relevant to three areas of the Company's business:
(1) the Company's products and services, (2) the Company's internal computer
systems and (3) the computer systems of significant suppliers or customers of
the Company. Each such area is addressed below.

1. The Company's Products. In some cases, the Company warrants to its
clients that its software will be year 2000 compliant generally subject to
certain limitations or conditions. The Company also provides solutions
consisting of products and services to address the year 2000 problem involving
key aspects of a client's computer systems. A failure in a client's system or
failure of the Company's software to be year 2000 compliant would result in
substantial damages and therefore have a material adverse effect on the
Company's business, financial condition and results of operations. Although
the Company does not intend to adopt a formal Year 2000 compliance program for
its existing products it will use commercially reasonable efforts to make new
products Year 2000 compliant. There can be no assurance that these future
efforts will be successful.

2. Internal Systems. The Company's internal computer programs and operating
systems relate to certain segments of the Company's business, including
customer database management, marketing, order processing, order fulfillment,
inventory management, customer service, accounting and financial reporting.
These programs and systems consist primarily of:

Business Systems. These systems automate and manage business functions such
as customer database management, marketing, order-taking and order-
processing, inventory management, customer service, accounting and
financial reporting,

Personal Computers and Networks. These systems are used for word
processing, document management and other similar administrative functions,
and

Telecommunications Systems. These systems provide telephone, voicemail, e-
mail, Internet and intranet connectivity, and enable the Company to manage
overall internal and external communications.

The Company's business systems are licensed from an outside vendor and the
Company expects that these business systems installed in 1997 will be Year
2000 compliant through upgrades and maintenance. Other internal systems
consist of widely available office applications and application suites for
word-processing, voicemail and other office-related functions. The Company
maintains current versions of all such key applications and all are, or are
expected to be, Year 2000 compliant. Accordingly, the Company does not intend
to adopt a formal Year 2000 compliance program for these systems. However,
there can be no assurance that these internal systems will be Year 2000
compliant.

3. Third-Party Systems. The computer programs and operating systems used by
entities with whom the Company has commercial relationships pose potential
problems relating to the Year 2000 issue, which may affect the Company's
operations in a variety of ways. These risks are more difficult to assess than
those posed by internal programs and systems, and the Company has not yet
begun the process of formulating a plan for assessing them. The Company
believes that the programs and operating systems used by entities with whom it
has commercial relationships generally fall into two categories: (A) First,
the Company relies upon programs and systems used by providers of basic
services necessary to enable the Company to reach, communicate and transact
business with its suppliers and customers. Examples of such providers include
the United States Postal Service, overnight delivery services, telephone
companies, other utility companies and banks. Services provided by such
entities affects almost all facets of the Company's operations. However, these
third-party dependencies are not specific to the Company's business, and
disruptions in their availability would likely have a negative impact on most
enterprises within the software and services industry and on many enterprises
outside the software and services industry. The Company believes that all of
the most reasonably likely worst-case scenarios involving disruptions to its
operations stemming from the Year 2000 issue relate to programs and systems in
this first category. (B) Second, the Company relies upon third parties for
certain software code or programs that are embedded in, or work with, its
products. The Company believes that the functionality of its products would
not be materially adversely affected by a failure of such third-party software
to be Year 2000 compliant.

There can be no assurance that the Company may not experience unanticipated
expenses or be otherwise adversely impacted by a failure of third-party
systems or software to be Year 2000 compliant. The most reasonably likely
worst-case scenarios may include: (i) corruption of data contained in the
Company's internal

information systems, (ii) hardware failure, and (iii) failure of
infrastructure services provided by utilities and/or government. The Company
intends to include an evaluation of such scenarios in its plan for assessing
the programs and systems of the entities with whom it has commercial
relationships.

The Company has substantially completed the formulation of its plan for
assessing its internal programs and systems and the programs and systems of
the entities with whom it has commercial relationships by the end of the
second quarter of 1999 and it expects to identify the related risks and
uncertainties by the end of the third quarter of 1999. Once such
identification has been completed, the Company intends to resolve any material
risks and uncertainties that are identified by communicating further with the
relevant vendors and providers, by working internally to identify alternative
sourcing and by formulating contingency plans to deal with such material risks
and uncertainties. To date, however, the Company has not formulated such a
contingency plan. The Company expects the resolution of such material risks
and uncertainties to be an ongoing process until all key year 2000 problems
are satisfactorily resolved. The Company does not currently anticipate that
the total cost of any Year 2000 remediation efforts that may be needed will be
material.

Euro-Currency Issue

The participating member countries of the European Union have agreed to
adopt the Euro as the common legal currency on January 1, 1999. On that same
date, they established the fixed conversion rates between their existing
sovereign currencies and the Euro. The Company does not expect the Euro
conversion to have a material impact on financial results because the Company
does not have a significant number of transactions within the European market.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of March 31, 1999, the Company was exposed to market risks which
primarily include changes in U.S. interest rates. The Company maintains a
significant portion of its cash and cash equivalents in financial instruments
with purchased maturities of three months or less. These financial instruments
are subject to interest rate risk and will decline in value if interest rates
increase. Due to the short duration of these financial instruments, an
immediate increase in interest rates would not have a material effect of the
Company's financial condition or results of operations.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

On or about April 28, 1999, the Company filed a lawsuit in the United States
District Court for the District of Massachusetts against Micah Technology
Services, Inc. and Affiliated Computer Services, Inc. (collectively, "Micah").
The lawsuit principally alleges that Micah breached its contract with the
Company by failing to pay for services performed by the Company under such
contract. The lawsuit further alleges that since Micah was unjustly enriched
by the services performed by the Company, the Company is entitled to recovery
based on quantum meruit, and that Micah engaged in unfair and/or deceptive
trade practices or acts in violation of Massachusetts General Laws Chapter 93A
by allowing the Company to perform services when Micah did not pay for such
services. The lawsuit seeks unspecified damages on the breach of contract and
quantum meruit claims and double or triple damages on the Chapter 93A claim.
The Company has not yet received Micah's answer to the lawsuit.

ITEM 6. Exhibits And Reports On Form 8-K

(a) Exhibits:

Documents listed below, except for documents identified by footnotes, are
being filed as exhibits herewith. Documents identified by footnotes, if any,
are not being filed herewith and, pursuant to Rule 12b-32 of the General Rules
and Regulations promulgated by the Commission under the Securities Exchange
Act of 1934 (the "Exchange Act") reference is made to such documents as
previously filed as exhibits with the Commission. The Company's file number
under the Exchange Act is 000-22647.

Exhibit 11. Statement re computation of per share earnings
Exhibit 27. Financial Data Schedule

(b) Reports on Form 8-K:

A Current Report on Form 8-K dated February 3, 1999 was filed by the Company
on February 11, 1999. The Company reported under Item 5 (Other Events) that,
on February 3, 1999, the Nasdaq Qualifications Listing Panel determined to
delist the Company's securities from the Nasdaq Stock Market on such date.

A Current Report on Form 8-K dated February 18, 1999 was filed by the
Company on March 3, 1999. The Company reported under Item 5 (Other Events)
that, on February 18, 1999, the Company announced its financial results for
the quarter and year ended December 31, 1998 and the engagement of Covington
Associates to render financial advisory and investment banking services.

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.

Dated: May 24, 1999

Peritus Software Services, Inc.

/s/ John D. Giordano
By:__________________________________
John D. Giordano
President, Chief Executive Officer
and Chief Financial Officer
(Principal Financial Officer)

PERITUS SOFTWARE SERVICES, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999

EXHIBIT INDEX

Exhibit No. Description
----------- -----------

11 Statement Re computation of net loss per common share
27 Financial Data Schedule