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 June 30, 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 of (I.R.S. Employer
Incorporation or Organization) Identification No.)

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

(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 AUGUST 6, 1999
- -------------------------------- ----------------------------------

Common Stock, $0.01 par value 16,673,975

PERITUS SOFTWARE SERVICES INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999

TABLE OF CONTENTS

Page
------
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheet as of June 30, 1999 and December 31, 1998................................ 3
Consolidated Statement of Operations for the Three and Six Months Ended June 30, 1999
and 1998.......................................................................................... 4
Consolidated Statement of Cash Flows for the Six Months Ended June 30, 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.................................. 22

PART II. OTHER INFORMATION

Item 1. Legal Proceedings........................................................................... 23
Item 2. Changes in Securities and Use of Proceeds................................................... 23
Item 6. Exhibits and Reports on Form 8-K............................................................ 24
Signatures............................................................................................ 25

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, as amended, Quarterly Report on Form 10-Q for the
Quarter ended March 31, 1999 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 per Share-related Data)
(UNAUDITED)

June 30, December 31,
1999 1998
--------- ---------
ASSETS

Current Assets:
Cash and cash equivalents ................................................................... $ 1,410 $ 2,809
Restricted cash ............................................................................. -- 569
Short-term investments ...................................................................... 1,126 500
Accounts receivable, net of allowance for doubtful accounts of $335 and $726,
respectively, and including amounts receivable from related parties of $0 and $42,
respectively .............................................................................. 1,175 3,720
Costs and estimated earnings in excess of billings on uncompleted contracts ................. 457 951
Prepaid expenses and other current assets ................................................... 197 816
--------- ---------

Total Current Assets ................................................................... 4,365 9,365
Property and equipment, net ...................................................................... 2,213 3,848
Intangible and other assets, net ................................................................. 562 510
--------- ---------
Total Assets ........................................................................... $ 7,140 $ 13,723
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of capital lease obligations ..................................................... $ 91 $ 90
Current portion of long-term debt ............................................................... -- 269
Accounts payable ................................................................................. 183 462
Customer advance ................................................................................. 296 --
Billings in excess of costs and estimated earnings on
uncompleted contracts ............................................................................ 557 435
Deferred revenue ................................................................................. 424 1,890
Other accrued expenses and other current liabilities ............................................. 2,306 4,414
--------- ---------
Total Current Liabilities .............................................................. 3,857 7,560
Capital lease obligations ........................................................................ 233 286
Long-term restructuring .......................................................................... 675 1,067
--------- ---------
Total Liabilities ...................................................................... 4,765 8,913
--------- ---------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 50,000,000 shares authorized; 16,673,975 and 16,344,985 shares
issues and outstanding at June 30, 1999 and December 31, 1998, respectively ...................... 167 164
Additional paid-in capital ....................................................................... 105,190 105,135
Accumulated deficit .............................................................................. (102,975) (100,488)
Accumulated other comprehensive loss ............................................................. (7) (1)
--------- ---------
Total Stockholders' Equity ............................................................. 2,375 4,810
--------- ---------
Total Liabilities and Stockholders' Equity ............................................. $ 7,140 $ 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 Six Months
Ended Ended
June 30, June 30,
----------------- ----------------
1999 1998 1999 1998
---- ---- ---- ----

REVENUE:
Outsourcing services, including $0, $1,034, $0 and
$2,248 from related parties, respectively....................................... $1,639 $2,793 $3,492 $5,415
License, including $0, $277, $0 and $277 from related
parties, respectively........................................................... 429 3,754 1,788 7,839
Other services, including $0, $317, $0 and $317 from
related parties, respectively................................................... 1,045 4,536 2,500 7,262
------ ------ ------ ------
Total Revenue:............................................................ 3,113 11,083 7,780 20,516
------ ------ ----- ------
COST OF REVENUE:
Cost of outsourcing services, including $0, $421, $0
and $1,134 from related parties, respectively................................... 1,251 1,896 3,174 4,007
Cost of license................................................................... 51 510 147 1,046
Cost of other services, including $0, $56, $0 and $56
from related parties, respectively.............................................. 655 2,632 1,683 5,085
----- ----- ----- -----
Total Cost of Revenue:.................................................... 1,957 5,038 5,004 10,138
----- ----- ----- ------
Gross Profit:............................................................. 1,156 6,045 2,776 10,378
----- ----- ----- ------
OPERATING EXPENSES:
Sales and marketing............................................................... 205 3,266 1,255 6,375
Research and development.......................................................... 344 2,001 814 5,045
General and administrative........................................................ 707 1,301 2,483 3,048
Impairment of long-lived assets................................................... 754 - 754 -
Restructuring charge.............................................................. (296) 1,439 (5) 1,439
---- ----- ----- -----
Total Operating Expenses.................................................. 1,714 8,007 5,301 15,907
----- ----- ----- ------
Loss from Operations................................................................ (558) (1,962) (2,525) (5,529)
Interest income, net................................................................ 30 185 38 345
---- ------ ------ ------
Loss before income taxes and minority interest in majority-owned
subsidiary...................................................................... (528) (1,777) (2,487) (5,184)
Provision for income taxes.......................................................... - 25 - 25
---- ------ ------ ------
Loss before minority interest in majority-owned
subsidiary...................................................................... (528) (1,802) (2,487) (5,209)
Minority interest in majority-owned subsidiary...................................... - 37 - (12)
---- ------ ------ ------
Net Loss.................................................................... $(528) $(1,839) $(2,487) $(5,197)
===== ======= ======= =======
Net Loss per common share:
Basic............................................................................. $(0.03) $ (0.11) $ (0.15) $ (0.32)
====== ====== ====== ======
Diluted........................................................................... $(0.03) $(0.11) $ (0.15) $ (0.32)
====== ====== ====== ======
Weighted average common shares outstanding:
Basic............................................................................. 16,381 16,179 16,363 16,082
====== ====== ====== ======
Diluted........................................................................... 16,381 16,179 16,363 16,082
====== ====== ====== ======

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)

Six Months Ended
June 30,
------------------
1999 1998
---- ----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

Cash flows from operating activities:
Net loss.................................................................................. $(2,487) $(5,197)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization........................................................... 934 1,660
Minority interest in majority-owned subsidiary.......................................... - (12)
Impairment of long-lived assets......................................................... 754 -
Changes in assets and liabilities:
Accounts receivable.................................................................. 2,545 3,230
Costs and estimated earnings in excess of billings on uncompleted contracts.......... 494 (236)
Prepaid expenses and other current assets............................................ 619 (885)
Other assets......................................................................... (188) (52)
Accounts payable..................................................................... (279) (680)
Proceeds from customer advance....................................................... 296 -
Billings in excess of costs and estimated earnings on uncompleted contracts.......... 122 138
Deferred revenue..................................................................... (1,466) (1,071)
Other accrued expenses and current liabilities excluding accrued restructuring....... (1,602) (103)
Accrued restructuring................................................................ (898) (567)
------- -------
Net cash used for operating activities .................................. (1,156) (3,775)
------- -------
Cash flows from investing activities:
Purchase of short-term investments...................................................... (626) (1,000)
Proceeds from sale of property and equipment............................................ 117 -
Purchases of property and equipment..................................................... (34) (2,415)
------- -------
Net cash used for investing activities................................... (543) (3,415)
------- -------
Cash flows from financing activities:
Restricted cash......................................................................... 569 -
Principal payments on long-term debt.................................................... (269) (146)
Principal payments on capital lease obligations......................................... (52) (45)
Proceeds from repayment of note receivable from stockholder............................. - 58
Proceeds from issuance of common stock net of issuance cost............................. 58 1,257
------- -------
Net cash provided by financing activities................................ 306 1,124
------- -------
Effects of exchange rates on cash and cash equivalents.................................... (6) 11
------- -------
Net decrease in cash and cash equivalents................................................. (1,399) (6,055)
Cash and cash equivalents, beginning of period............................................ 2,809 11,340
------- -------
Cash and cash equivalents, end of period.................................................. $ 1,410 $ 5,285
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS:
Cash paid for income taxes........................................................... $24 $78
Cash paid for interest............................................................... 23 34

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, as amended, 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 and asset impairment
charges 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, as amended. The operating results for the six
months ended June 30, 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 $2,487,000,
$26,673,000 and $67,490,000 in the six months ended June 30, 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
has serious concerns that it will be unable to achieve a cash flow breakeven
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. 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 June 30, 1999, there were no amounts
outstanding under the revolving credit facility or the equipment financing
agreement. 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. 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 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. The Consolidated Financial Statements do not include any adjustments
that might result from the outcome of this uncertainty.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

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 Amended Complaint on March
5, 1999. Oral arguments on the motions were held on April 21, 1999 and the Court
granted the Company's and the individual defendants' motions to dismiss pursuant
to an order dated June 1, 1999. The plaintiffs have appealed the Court's order
of dismissal. The Company intends to contest the appeal and support the Court's
order of dismissal. The First Circuit Court of Appeals has indicated that the
case may be ready for argument or submission in the January 2000 session.

While the District Court has dismissed the Consolidated Amended Complaint, the
First Circuit Court of Appeals could reinstate it. While the Company believes it
would have meritorious defenses to the action if it were reinstated, 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.

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 ("M.G.L.") 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.
Micah has denied the Company's allegations and has filed a counterclaim against
the Company principally alleging fraud, negligent misrepresentations, breach of
contract and that the Company engaged in unfair and/or deceptive trade practices
or acts in violation of M.G.L. Chapter 93A by its misrepresentations and breach
of contract. The Company denied the allegations contained in Micah's
counterclaim and intends to contest the counterclaim vigorously.

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 six months ended June 30, 1999.

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 were 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
====== ==== ===== ======

In April of 1999, the Company decided to further reduce the amount of space it
occupies in its Billerica, MA headquarters facility. The space consolidation
was completed in the second quarter of 1999 and the Company increased the amount
of space it is offering for sublease from 50,000 to 75,000 square feet.
Accordingly, the Company recorded an additional restructure accrual of $517,000
consisting of the cost of lease expenses and real estate commissions associated
with the additional vacated 25,000 square feet net of estimated sublease income.
The Company has estimated that this additional restructuring will result in a
quarterly reduction of $87,000 beginning in the third quarter of 1999. Payments
and reclassifications during the second quarter of 1999 included a settlement
payment of $136,000 associated with termination of the Company's leased facility
in Cincinnati, Ohio and a $296,000 adjustment to reclassify the rent
levelization accrual associated with the vacated space in its Billerica
headquarters facility from other accrued expenses into the restructure accrual.
At the end of the second quarter of 1999, the Company re-evaluated the estimated
costs associated with its previous restructure charges based upon activity and
experience to date. Based upon its revised estimates, the Company recorded a
release of $813,000 from the restructure accrual. The combination of the second
quarter accrual and the second quarter release resulted in a net favorable
impact of $296,000 to the results of operations for the three months ended June
30, 1999.

The amounts accrued to and released from and payments and adjustments made
against the restructure accrual along with the composition of the remaining
balance at June 30, 1999 were as follows:

BALANCE Q2 1999 Q2 1999 Q2 1999 BALANCE
-------------- ------------------ ------- -------- -------------
MARCH 31, 1999 PAYMENTS/ ACCRUAL RELEASE JUNE 30, 1999
-------------- ------------------ ------- -------- -------------
RECLASSIFICATIONS
------------------

Provision for severance and benefit payments to
terminated employees............................. $ 615 $(425) $ - $ (75) $ 115
Provisions related to closure of facilities and
reduction of occupied space...................... 1,783 105 517 (738) 1,667
------ ----- ---- ----- ------

Total............................................ $2,398 $(320) $517 $(813) $1,782
====== ===== ==== ===== ======

As of June 30, 1999, $1,107,000 of the remaining balance of the restructure
accrual is expected to be paid by June 30, 2000 with the remaining balance of
$675,000 being paid thereafter.

4. IMPAIRMENT OF LONG-LIVED ASSETS

The Company periodically assesses whether any events or changes in
circumstances have occurred that would indicate that the carrying amount of a
long-lived asset might not be recoverable. When such an event or change in
circumstance occurs, the Company evaluates whether the carrying amount of such
asset is recoverable by comparing the net book value of the asset to estimated
future undiscounted cash flows, excluding interest charges, attributable to such
asset. If it is determined that the carrying amount is not recoverable, the
Company recognizes an impairment loss equal to the excess of the carrying amount
of the asset over the estimated fair value of such asset.

In June 1999, as a result of the continuing downsizing of the Company's
operations and continuing decline in operating results, the Company reviewed
the carrying amount of its property and equipment and committed to a plan to
dispose certain of its assets, primarily excess computer equipment and furniture
relating to the restructured operations, either by sale or by abandonment. The
plan is expected to be completed by September 30, 1999. The fair value of the
assets to be disposed of was measured at management's best estimate of salvage
value, by using the current market values or the current selling prices for
similar assets. Costs to sell are not expected to be significant. Based upon
management's review, the carrying amount of assets having a net book value of
$1,143,000 was written-down to a total amount of $389,000, representing the
lower of carrying amount or fair value (salvage value) and the Company recorded
an impairment charge totaling $754,000. The assets to be disposed of are not
depreciated or amortized while they are held for disposal and the reduction in
depreciation expenses resulting from this write-down is approximately $82,000 on
a quarterly basis beginning in the third quarter of 1999. Management's
estimates of the impairment charges discussed above required an evaluation of
various alternatives, risks and uncertainties. Although management has made its
best estimate of these factors based on current conditions and expected trends
and events, it is reasonably possible that changes could occur in the near term
which could adversely affect management's estimates. If such changes occur,
asset impairment write-downs could be required in the future and such write-
downs could be material to the Company's financial statements.

5. OTHER ACCRUED EXPENSES AND CURRENT LIABILITIES

Other accrued expenses and current liabilities consist of the following:

June 30, DECEMBER 31,
------------------------ --------------------------
1999 1998
------------------------ --------------------------

Restructuring costs ......................... $1,107,000 $1,613,000
Employee-related costs ............................ 54,000 548,000
Rent levelization ............................ 133,000 357,000
Professional costs ................................ 50,000 342,000
Accrued Sales & Use tax.................. 495,000 185,000
Other ......................................... 467,000 1,369,000
---------- ----------
$2,306,000 $4,414,000
========== ==========

6. 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. At June 30, 1999, the balance of
accummulated other comprehensive loss was comprised of translation adjustments
only.

For the three and six months ended June 30, 1999 and 1998, the Company's
comprehensive loss was comprised as follows:

Three Months Ended SIX MONTHS ENDED
------------------------ --------------------------
JUNE 30, DECEMBER 30,
------------------------ --------------------------
1999 1998 1999 1998
---------- ------------ ------------ ------------

Net loss $(528,000) $(1,839,000) $(2,487,000) $(5,197,000)
..........................
Translation adjustment ....... (5,000) 14,000 (6,000) 11,000
--------- ----------- ----------- -----------
$(533,000) $(1,825,000) $(2,493,000) $(5,186,000)
========= =========== =========== ===========

7. 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 for the six months
ended and at June 30, 1999 and 1998, is summarized below (in thousands):

OUTSOURCING REVENUE LICENSE REVENUE OTHER SERVICES REVENUE LONG-LIVED
------------------------ ------------------------ ------------------------ -----------
ASSETS
-----------
UNAFFILIATED AFFILIATED UNAFFILIATED AFFILIATED UNAFFILIATED AFFILIATED
------------ ---------- ------------ ---------- ------------ ----------

June 30, 1999
United States................... $3,492 - $1,788 - $2,500 - $ 2,418
Foreign......................... - - - - - - -
------ ---- ------ ---------- ------ ---------- -------
$3,492 - $1,788 - $2,500 - $ 2,418
====== ==== ====== ========== ====== ========== =======
June 30, 1998
United States................... $4,427 - $7,839 - $7,160 - $10,464
Foreign......................... 217 771 - - 102 - -
------ ---- ---------- ------ ---------- -------
$4,644 $771 $7,839 - $7,262 - $10,464
====== ==== ====== ========== ====== ========== =======

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 the six months ended June 30, 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 of $2,487,000, $26,673,000 and $67,490,000
in the six months ended June 30, 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 has serious concerns that it will
be unable to achieve a cash flow breakeven 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. 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.

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. 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 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.

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 one employee.

THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30, 1998

Revenue

Total revenue decreased 71.9% to $3,113,000 in the three months ended June 30,
1999 from $11,083,000 in the three months ended June 30, 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.

Outsourcing Services. Outsourcing services revenue decreased 41.3% to
$1,639,000 in the three months ended June 30, 1999 from $2,793,000 in the three
months ended June 30, 1998. The decrease in outsourcing services revenue in
absolute dollars was primarily attributable to the divestiture of Persist, S.A.
("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 52.7% in
the three months ended June 30, 1999 from 25.2% for the three months ended June
30, 1998. The increase in outsourcing services revenue as a percentage of total
revenue reflects the decreased contribution of license and other services
revenue to total revenue during the three months ended June 30, 1999 when
compared to the same period in the prior year. During the second quarter of
1999, the Company was unable to renew a contract with one of its clients that
expired at the end of the quarter. The Company was also informed by another
client (with a contract expiration date in January 2000) that it was exercising
its six-month termination option effective in early November of 1999. Together,
the two contracts contributed $345,000 to second quarter 1999 outsourcing
revenue. 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 continue to have difficulty attracting new
outsourcing customers and that it will also be difficult to renew or extend
outsourcing contracts from existing customers. Without the addition of new
business, the Company will experience a significant reduction in revenue from
outsourcing services in the future.

License. License revenue decreased 88.6% to $429,000 in the three months
ended June 30, 1999 (13.8% of total revenue), compared to $3,754,000 (33.9% of
total revenue), in the three months ended June 30, 1998. The decrease in license
revenue 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 first half of 1999, 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 77.0% to $1,045,000 in the
three months ended June 30, 1999 from $4,536,000 in the three months ended June
30, 1998. As a percentage of total revenue, other services revenue decreased to
33.6% in the three months ended June 30, 1999 from 40.9% in the three months
ended June 30, 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 34.0 % to $1,251,000 in the three months ended June 30, 1999
from $1,896,000 for the three months ended June 30, 1998. Cost of outsourcing
services revenue as a percentage of outsourcing services revenue increased to
76.3% in the three months ended June 30, 1999 from 67.9% in the three months
ended June 30, 1998. The cost percentage increased due to the

fixed cost content impact on lower revenue as well as a change in the mix among
contracts. Cost of outsourcing services revenue as a percentage of outsourcing
services revenue improved to 76.3% in the second quarter of 1999 from 103.8%
recorded in the first quarter of 1999.

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 $51,000 in the
three months ended June 30, 1999, or 11.9% of license revenue. Cost of license
revenue was $510,000, or 13.6% of license revenue, in the three months ended
June 30, 1998. The 90.0% 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, subcontracting costs and related overhead costs
associated with delivering other services to clients. Cost of other services
revenue decreased 75.1% to $655,000 in the three months ended June 30, 1999
from $2,632,000 in the three months ended June 30, 1998. Cost of other services
revenue as a percentage of other services revenue increased to 62.7% in the
three months ended June 30, 1999 from 58.0% in the three months ended June 30,
1998. Costs decreased in absolute dollars in the three months ended June 30,
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 93.7% to
$205,000 in the three months ended June 30, 1999 from $3,266,000 in the three
months ended June 30, 1998. As a percentage of total revenue, sales and
marketing expenses decreased to 6.6% in the three months ended June 30, 1999
from 29.5% in the three months ended June 30, 1998. The decrease in expenses in
absolute dollars and as a percentage of revenue was primarily attributable to
dramatically reduced staffing, commissions and promotional activities.

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 82.8% to $344,000 in the three months ended June 30, 1999 from
$2,001,000 in the three months ended June 30, 1998. As a percentage of total
revenue, research and development expenses decreased to 11.1% in the three
months ended June 30, 1999 from 18.1% in the three months ended June 30, 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 that could not be segregated and, therefore, not included
in restructuring, was also charged to general and administrative expenses in
1999. General and administrative expenses decreased 45.7% to $707,000 in the
three months ended June 30, 1999 from $1,301,000 in the three months ended June
30, 1998. As a percentage of total revenue, general and administrative expenses
increased to 22.7% in the three months ended June 30, 1999 from 11.7% in the
three months ended June 30, 1998. During the second quarter of 1999, several
non-recurring entries were recorded in general and administrative expenses
including a reduction in the allowance for doubtful accounts, a favorable impact
as a result of a settlement of amounts owed to American Financial Group, Inc.
("AFG") and its affiliates, and an increase in the sales and use tax accrual to
cover potential costs of settling unbilled tax amounts with certain states. The
net impact of all of the non-recurring entries was a reduction in general and
administrative expenses of $208,000. The remaining reduction is primarily a
result of reduced staffing from the second quarter of 1998.

Restructuring Charge

Payments and reclassifications during the second quarter of 1999 included a
settlement payment of $136,000 associated with termination of the Company's
leased facility in Cincinnati, Ohio and a $296,000 adjustment to reclassify the
rent levelization accrual associated with the vacated space in its Billerica
headquarters facility from other accrued expenses into the restructure accrual.
At the end of the second quarter of 1999, the Company re-evaluated the estimated
costs associated with its previous restructure charges based upon activity and
experience to date. Based upon its revised estimates, the Company recorded a
release of $813,000 from the restructure accrual. The combination of the second
quarter accrual and the second quarter release resulted in net favorable impact
of $296,000 to the results of operations for the three months ended June 30,
1999.

The amounts accrued to and released from and payments and adjustments made
against the restructure accrual along with the composition of the remaining
balance at June 30, 1999 were as follows:

Provision for severance and benefit payments to
terminated
employees........................................ $ 615 $(425) $ - $ (75) $ 115
Provisions related to closure of facilities and
reduction of occupied space...................... 1,783 105 517 (738) 1,667
------ ----- ---- ----- ------
Total............................................ $2,398 $(320) $517 $(813) $1,782
====== ===== ==== ===== ======

As of June 30, 1999, $1,107,000 of the remaining balance of the restructuring
accrual is expected to be paid by June 30, 2000 with the remaining balance of
$675,000 being paid thereafter.

Impairment of Long-Lived Assets

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 $30,000 in the three months ended June 30, 1999
compared to interest income, net, of $185,000 in the three months ended June 30,
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 for the three months ended June
30, 1999 and $25,000 for the three months ended June 30, 1998. The Company did
not record a tax provision or benefit in the three months ended June 30, 1999
due to operating losses incurred. The Company continues to maintain a full
valuation allowance for its net deferred tax assets since, based on the weight
of available evidence, management has concluded that it is more likely than not
that these future benefits will not be realized.

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 June 30, 1999 since it divested its minority interest in July 1998.

SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998

Revenue

Total revenue decreased 62.1% to $7,780,000 in the six months ended June 30,
1999 from $20,516,000 in the six months ended June 30, 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.

Outsourcing Services. Outsourcing services revenue decreased 35.5% to
$3,492,000 in the six months ended June 30, 1999 from $5,415,000 in the six
months ended June 30, 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 44.9% in the six months
ended June 30, 1999 from 26.4% for the six months ended June 30, 1998. The
increase in outsourcing services revenue as a percentage of total revenue
reflects the decreased contribution of license and other sources revenue to
total revenue during the six months ended June 30, 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 continue to have difficulty
attracting new outsourcing customers and that it will also be difficult to renew
or extend outsourcing contracts from existing customers. Without the addition of
new business, the Company will experience a significant reduction in revenue
from outsourcing services in the future.

License. License revenue decreased 77.2% to $1,788,000 in the six months
ended June 30, 1999 (23.0% of total revenue), compared to $7,839,000 (38.2% of
total revenue), in the six months ended June 30, 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 first half of 1999, 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 65.6% to $2,500,000 in the
six months ended June 30, 1999 from $7,262,000 in the six months ended June 30,
1998. As a percentage of total revenue, other services revenue decreased to
32.1% in the six months ended June 30, 1999 from 35.4% in the six months ended
June 30, 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. The cost of outsourcing services
revenue decreased 20.8% to $3,174,000 in the six months ended June 30, 1999 from
$4,007,000 for the six months ended June 30, 1998. Cost of outsourcing services
revenue as a percentage of outsourcing services revenue increased to 90.9% in
the six months ended June 30, 1999 from 74.0% in the six months ended June 30,
1998. Costs in the first six months of 1999 were negatively impacted by
expenditures in anticipation of and to generate new business that did not
materialize. In addition, the Company incurred 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 1. Legal Proceedings.'' The
Company has taken action to reduce its outsourcing costs in the future.

Cost of License Revenue. Cost of license revenue was $147,000 in the six
months ended June 30, 1999, or 8.2% of license revenue. Cost of license revenue
was $1,046,000, or 13.3% of license revenue, in the six months ended June 30,
1998. The 85.9% 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 decreased
66.9% to $1,683,000 in the six months ended June 30, 1999 from $5,085,000 in the
six months ended June 30, 1998. Cost of other services revenue as a percentage
of other services revenue decreased to 67.3% in the six months ended June 30,
1999 from 70.0% in the six months ended June 30, 1998. Costs decreased in
absolute dollars in the six months ended June 30, 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 decreased 80.3% to
$1,255,000 in the six months ended June 30, 1999 from $6,375,000 in the six
months ended June 30, 1998. As a percentage of total revenue, sales and
marketing expenses decreased to 16.1% in the six months ended June 30, 1999 from
31.1% in the six months ended June 30 1998. The decrease in expenses in absolute
dollars and as a percentage of revenue was primarily attributable to
dramatically reduced staffing, commissions and promotional activities.

Research and Development. Research and development expenses decreased 83.9%
to $814,000 in the six months ended June 30, 1999 from $5,045,000 in the six
months ended June 30, 1998. As a percentage of total revenue, research and
development expenses decreased to 10.5% in the six months ended June 30, 1999
from 24.6% in the six months ended June 30, 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 decreased
18.5% to $2,483,000 in the six months ended June 30, 1999 from $3,048,000 in the
six months ended June 30, 1998. As a percentage of total revenue, general and
administrative expenses increased to 31.9% in the six months ended June 30, 1999
from 14.9% in the six months ended June 30, 1998. The decrease in general and
administrative expenses in absolute dollars was primarily due to reduced
staffing and the positive $218,000 second quarter of 1999 net impact of
non-recurring entries.

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 were 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:

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
====== ==== ===== ======

In April of 1999, the Company decided to further reduce the amount of space it
occupies in its Billerica, MA headquarters facility. The space consolidation
was completed in the second quarter of 1999 and the Company increased the amount
of space it is offering for sublease from 50,000 to 75,000 square feet.
Accordingly, the Company recorded an additional restructure accrual of $517,000
consisting of the cost of lease expenses and real estate commissions associated
with the additional vacated 25,000 square feet net of estimated sublease income.
The Company has estimated that this additional restructuring will result in a
quarterly reduction of $87,000 beginning third quarter of 1999. Payments and
reclassifications during the second quarter of 1999 included a settlement
payment of $136,000 associated with termination of the Company's leased facility
in Cincinnati, Ohio and a $296,000 adjustment to reclassify the rent
levelization accrual associated with the vacated space in its Billerica
headquarters facility from other accrued expenses into the restructure accrual.
At the end of the second quarter of 1999, the Company re-evaluated the estimated
costs associated with its previous restructure charges based upon activity and
experience to date. Based upon its revised estimates, the Company recorded a
release of $813,000 from the restructure accrual. The combination of the second
quarter accrual and the second quarter release resulted in net favorable impact
of $296,000 to the results of operations for the three months ended June 30,
1999.

The amounts accrued to and released from and payments and adjustments made
against the restructure accrual along with the composition of the remaining
balance at June 30, 1999 were as follows:

Provision for severance and benefit payments to
terminated employees.............................. $ 615 $(425) $ - $ (75) $ 115
Provisions related to closure of facilities and
reduction of occupied space....................... 1,783 105 517 (738) 1,667
------ ----- ---- ----- ------
Total............................................. $2,398 $(320) $517 $(813) $1,782
====== ===== ==== ===== ======

As of June 30, 1999, $1,107,000 of the remaining balance of the restructuring
accrual is expected to be paid by June 30, 2000 with the remaining balance of
$675,000 being paid thereafter.

Impairment of Long-Lived Assets

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 $38,000 in the six months ended June 30, 1999 compared
to interest income, net, of $345,000 in the six months ended June 30, 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 for the six months ended June 30,
1999 and $25,000 in the six months ended June 30, 1998. The Company did not
record a tax provision or benefit in the six months ended June 30, 1999 due to
losses incurred. The Company continues to maintain a full valuation allowance
for its net deferred tax assets since, based on the weight of available
evidence, management has concluded that it is more likely than not that these
future benefits will not be realized.

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 six months
ended June 30, 1999 since it divested its minority interest in July 1998.

LIQUIDITY AND CAPITAL RESOURCES

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 in the years ended
December 31, 1997 and 1998 and the six months ended June 30, 1999, which raise
doubt about its ability to continue as a going concern. The Company's cash flow
requirements 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 has
serious concerns that it will be unable 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 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 has also experienced significant voluntary
attrition due to its degraded financial condition.

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 a part of its assets. 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 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 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 $1,410,000 and $2,809,000 at June 30, 1999 and
December 31, 1998, respectively. The Company's working capital was $508,000 and
$1,805,000 at June 30, 1999 and December 31, 1998, respectively.

The Company's operating activities used cash of $1,156,000 and $3,775,000
during the six months ended June 30, 1999 and 1998, respectively. The Company's
use of cash during the six months ended June 30, 1999 was primarily caused by a
net loss of $2,487,000 less non-cash depreciation and amortization expense of
$934,000, and a charge for impairment of long-lived assets of $754,000. Other
uses included a decrease in other accrued liabilities of $1,602,000, a decrease
in deferred revenue of $1,466,000, a decrease in accrued restructuring of
$898,000, and a decrease in other assets of $188,000. These amounts were
partially offset by a decrease in accounts receivable of $2,545,000, a decrease
in prepaid expenses and other current assets of $619,000, the receipt of advance
payments from customers of $296,000, and the increase in billings in excess of
costs and estimated earnings on uncompleted contracts of $122,000.

The Company used cash of $543,000 and $3,415,000 for investing activities
during the six months ended June 30, 1999 and 1998, respectively. Investing
activities in the six months ended June 30, 1999 consisted principally of the
purchases of short-term investments.

The Company's financing activities provided cash of $306,000 and $1,124,000
during the six months ended June 30, 1999 and 1998, respectively. Financing
activities in the six months ended June 30, 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 June 30, 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.

Pursuant to a settlement agreement and release dated June 29, 1999 among the
Company, AFG and affiliates of AFG, the Company settled all obligations among
the parties including those related to the lease of its facility in Cincinnati,
Ohio for $200,000 and 300,000 shares of common stock.

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.

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 has serious concerns that it will
be unable 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. 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 a part of its
assets. Further reductions in expenses or the sale of assets may not be
sufficient to bring the Company to a cash flow 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 breakeven 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 breakeven 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 focus is on minimizing expenses, while preserving its
principal saleable assets: its outsourcing business and its technology. During
the second quarter of 1999, the Company spent considerable effort to reduce its
fixed costs. Along with Covington Associates, its investment banker, the Company
is actively pursuing strategic relationships. 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 continue to have difficulty
attracting 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 the
Company's 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 MATTERS

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, including AutoEnhancer 2000 and Vantage YR2000, it will use
commercially reasonable efforts to make any new products, including SAM
Workbench and RQE Tool Year 2000 compliant. The Company is analyzing whether it
will adopt a Year 2000 compliance program for its SAM Relay product. 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 recent
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 may 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 and/or software 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 and it expects to identify
the related risks and uncertainties in the fourth 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 it plans to undertake will
be material.

EURO-CURRENCY MATTERS

The participating member countries of the European Union adopted 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 June 30, 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 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
defendants filed motions to dismiss the Consolidated Amended Complaint on March
5, 1999. Oral arguments on the motions were held on April 21, 1999 and the Court
granted the Company's and the individual defendants' motions to dismiss pursuant
to an order dated June 1, 1999. The plaintiffs have appealed the Court's order
of dismissal. The Company intends to contest the appeal and support the Court's
order of dismissal. The First Circuit Court of Appeals has indicated that the
case may be ready for argument or submission in the January 2000 session.

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 ("M.G.L.") 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.
Micah has denied the Company's allegations and has filed a counterclain against
the Company principally alleging fraud, negligent misrepresentations, breach of
contract and that the Company engaged in unfair and/or deceptive trade practices
or acts in violation of M.G.L. Chapter 93A by its misrepresentations and breach
of contract. The Company denied the allegations contained in Micah's
counterclaim and intends to contest the counterclaim vigorously.

Item II. Changes in Securities and Use of Proceeds

Pursuant to a settlement agreement and release dated June 29, 1999 among
the Company, AFG and affiliates of AFG, the Company agreed to issue 300,000
shares of its common stock to AFG in a transaction exempt from registration
under the Securities Act of 1933. The securities were issued in consideration
for the release by AFG and its affiliates of the Company's obligations to those
persons. The securities were issued in a transaction by an issuer not involving
any public offering and pursuant to an exemption from registration under Section
4(2) of the Securities Act of 1933 and/or the rules and regulations promulgated
thereunder. No underwriters were utilized in connection with the issuance of the
securities and no underwriting discounts or commissions were paid or incurred
thereby.

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 10. Settlement Agreement and Release dated June 29, 1999 among the
Company, American Financial Group, Inc. ("AFG") and affiliates of
AFG.
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 March 29, 1999 was filed by the Company on
April 7, 1999. The Company reported under Item 5 (Other Events) that it
anticipated a $2 to $2.5 million net loss for the quarter ended March 31, 1999,
that the net loss would sufficiently erode the Company's cash balances and
jeopardize its ability to continue as a going concern. The Company also
announced that it did not believe that it would be able to achieve a cash flow
breakeven position in the future and that its Board of Directors was considering
various alternatives. The Company also announced that it would significantly
reduce its workforce.

A Current Report on Form 8-K dated April 2, 1999 was filed by the Company on
April 20, 1999. The Company reported under Item 5 (Other Events) that, on April
2, 1999, Dominic K. Chan resigned his office as President and Chief Executive
Officer and as a member of the Board of Directors. The Board appointed John
Giordano, the Company's Chief Financial Officer and Vice President, to the
additional positions of President and Chief Executive Officer. The Company also
announced that it was reducing its workforce by approximately 40 people and that
the restructuring charge associated with the reduction was estimated to be
$250,000.

A Current Report on Form 8-K dated May 10, 1999 was filed by the Company on
May 13, 1999. The Company reported under Item 5 (Other Events) that Dominic K.
Chan had been engaged by the Company to consult, without renumeration, on
strategic alliances and sales related matters and, that after careful
consideration, he did not intend to make an offer to purchase certain of the
Company's assets. The Company also announced the appointment of Andrea
Campbell, Ronald Garabedian, Charistopher Bailey and James Dunleavy as Vice
President - Sales and Marketing, Treasurer, Vice President - Research and
Development and Vice President - Outsourcing Services, respectively.

A Current Report on Form 8-K dated June 4, 1999 was filed by the Company on
June 8, 1999. The Company reported under Item 5 (Other Events) that the United
States District Court for the District of Massachusetts upheld the defendents'
motion to dismiss the consolidated class action lawsuit alleging violations of
federal securities laws against the Company and three of its former officers.

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: August 11, 1999

Peritus Software Services, Inc.

By: /s / JOHN D. GIORDANO
--------------------------------
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 JUNE 30, 1999

EXHIBIT INDEX

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

10 Settlement Agreement and Release dated July 29, 1999 by and
amount the Company, American Financial Group, Inc. ("AFG") and
affiliates of AFG.
11 Statement Re computation of net loss per common share
27 Financial Data Schedule