<PAGE>
 
                      Securities and Exchange Commission
                            Washington, D.C.  20549
                            -----------------------

                                   FORM 10-Q
                                        

[X]  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934 for the Quarterly Period Ended March 31, 1998.

                                       OR

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


                        Commission File 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:

     Title of Class                 Shares outstanding at May 7, 1998
     --------------                 ---------------------------------

Common Stock, $.01 par value                     16,161,675
<PAGE>
 
                        PERITUS SOFTWARE SERVICES, INC.
                                   FORM 10-Q
                 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
                               TABLE OF CONTENTS
--------------------------------------------------------------------------------

PART I.  FINANCIAL INFORMATION
 
         Item 1.  Financial Statements
 
                  Consolidated Balance Sheet
                  as of March 31, 1998 and December 31, 1997                   3
 
                  Consolidated Statement of Operations
                  for the Three Months Ended March 31, 1998 and 1997           4
 
                  Consolidated Statement of Cash Flows
                  for the Three Months Ended March 31, 1998 and 1997           5
 
                  Notes to Unaudited Consolidated Financial Statements         6
 
         Item 2.  Management's Discussion and Analysis of Financial 
                  Condition and Results of Operations                          8
 
         Item 3. Quantitative and Qualitative Disclosures about Market Risk   14

PART II. OTHER INFORMATION
 
         Item 1.  Legal Proceedings                                           14
 
         Item 2.  Changes in Securities and Use of Proceeds                   14
 
         Item 6.  Exhibits and Reports on Form 8-K                            15
 
         Signatures                                                           16


                                       2
 
<PAGE>
 
                         PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
                        PERITUS SOFTWARE SERVICES, INC.
                          CONSOLIDATED BALANCE SHEET
                   (In thousands, except share-related data)
                                  (unaudited)
--------------------------------------------------------------------------------
<TABLE> 
<CAPTION> 
                                                                                      March 31,      December 31,
                                                                                        1998            1997
                                                                                   -------------   -------------
<S>                                                                                <C>           <C> 
Assets
Current assets:
   Cash and cash equivalents                                                       $       9,821   $      11,340
   Short-term investments                                                                  2,500           3,000
   Accounts receivable, net of allowance for doubtful accounts of
     $445 and $95, respectively, and including amounts receivable
     from related parties of $60 and $289, respectively                                    9,808          13,287
   Costs and estimated earnings in excess of billings on uncompleted
     contracts, including amounts on uncompleted contracts with
     related parties of $173 and $250, respectively                                        2,440           2,547
   Prepaid expenses and other current assets                                               1,865             710
                                                                                   -------------   -------------

        Total current assets                                                              26,434          30,884
 
   Property and equipment, net                                                             5,398           3,859
   Intangible and other assets, net                                                        5,525           5,787
                                                                                   -------------   -------------

                                                                                   $      37,357   $      40,530
                                                                                   =============   =============

Liabilities and Stockholders' Equity
Current liabilities:
   Current portion of capital lease obligations                                    $         255   $          51
   Current portion of long-term debt                                                         292             292
   Accounts payable                                                                        1,768           1,650
   Billings in excess of costs and estimated earnings on uncompleted contracts               980             976
   Deferred revenue                                                                        2,108           2,886
   Other accrued expenses and current liabilities                                          2,319           3,518
                                                                                   -------------   -------------
    
        Total current liabilities                                                          7,722           9,373

Capital lease obligations                                                                    379             144
Long-term debt                                                                               196             269
                                                                                   -------------   -------------

        Total liabilities                                                                  8,297           9,786
                                                                                   -------------   -------------

Minority interest in consolidated subsidiary                                                 110             159
                                                                                   -------------   -------------

Stockholders' equity:
   Common stock, $.01 par value; 50,000,000 shares authorized; 16,132,214 and
     15,361,800 shares issued and outstanding, respectively                                  161             154
   Additional paid-in capital                                                            104,677         103,808
   Accumulated deficit                                                                   (75,801)        (73,235)
   Note receivable from stockholder                                                            -             (58)
   Cumulative translation adjustment                                                         (87)            (84)
                                                                                   -------------   -------------

        Total stockholders' equity                                                        28,950          30,585
                                                                                   -------------   -------------

                                                                                   $      37,357   $      40,530
                                                                                   =============   =============
</TABLE> 
 The accompanying notes are an integral part of these unaudited consolidated 
                             financial statements.

                                       3
<PAGE>
 
                      PERITUS SOFTWARE SERVICES, INC.   
                     CONSOLIDATED STATEMENT OF OPERATIONS
                     (Im thousands, except per share data)
                                  (unaudited)
<TABLE> 
<CAPTION> 

                                                                                                   Three Months
                                                                                                       Ended
                                                                                                     March 31,
                                                                                           -------------------------------
                                                                                                 1998             1997
                                                                                           --------------   --------------
<S>                                                                                       <C>             <C> 
Revenue:
   Outsourcing services, including $1,214 and $975 from related parties, respectively      $       2,622    $       2,519
   License                                                                                         4,762            4,144
   Other services                                                                                  2,766            1,196
                                                                                           --------------   --------------
      Total revenue                                                                               10,150            7,859
                                                                                           --------------   --------------
Cost of revenue:
   Cost of outsourcing services, including $713 and $373 from
     related parties, respectively                                                                 2,105            2,045
   Cost of license                                                                                   533              127
   Cost of other services                                                                          2,437            1,289
                                                                                           --------------   --------------
      Total cost of revenue                                                                        5,075            3,461
                                                                                           --------------   --------------
Gross profit                                                                                       5,075            4,398
                                                                                           --------------   --------------
Operating expenses:  
   Sales and marketing                                                                             3,092            1,383
   Research and development                                                                        3,022            1,634
   General and administrative                                                                      1,736              925
                                                                                           --------------   --------------
      Total operating expenses                                                                     7,850            3,942
                                                                                           --------------   --------------
      Income (loss) from operations                                                               (2,775)             456
Interest income, net                                                                                 160               27
                                                                                           --------------   --------------
      Income (loss) before income taxes and minority interest in consolidated subsidiary          (2,615)             483
Provision for estimated income taxes                                                                   -               48
                                                                                           --------------   --------------
      Income (loss)  before minority interest in consolidated subsidiary                          (2,615)             435
Minority interest in consolidated subsidiary                                                         (49)              29
                                                                                           --------------   --------------
      Net income (loss)                                                                           (2,566)             406
Accrual of dividends on Series A and B preferred stock                                                 -             (233)
Accretion to redemption value of redeemable stock                                                      -              (26)
                                                                                           --------------   --------------
Net income (loss) available to common stockholders                                          $     (2,566)           $ 147
                                                                                           ==============   ==============
Net income (loss) per share:
   Basic                                                                                    $      (0.16)          $ 0.02
                                                                                           ==============   ==============
   Diluted                                                                                  $      (0.16)          $ 0.02
                                                                                           ==============   ==============
Weighted average shares outstanding:
   Basic                                                                                          15,985            5,888
                                                                                           ==============   ==============
   Diluted                                                                                        15,985            8,719
                                                                                           ==============   ==============

</TABLE> 
The accompanying notes are an integral part of these unaudited consolidated 
                             financial statements.
 

                                       4
<PAGE>
 
                        PERITUS SOFTWARE SERVICES, INC.
                     CONSOLIDATED STATEMENT OF CASH FLOWS
                                (In thousands)
                                  (unaudited)

<TABLE> 
<CAPTION> 
                                                                                             Three Months
                                                                                                 Ended
                                                                                               March 31,
                                                                                   -------------------------------
                                                                                         1998             1997
                                                                                   --------------   --------------
<S>                                                                            <C>                <C> 

Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities:
   Net income (loss)                                                               $      (2,566)   $         406
   Adjustments to reconcile net income (loss) to net cash
     used for operating activities:
      Depreciation and amortization                                                          813              262
      Minority interest in consolidated subsidiary                                           (49)              18
      Changes in assets and liabilities, net of effects from acquisitions:
        Accounts receivable                                                                3,479             (498)
        Costs and estimated earnings in excess of billings on uncompleted contracts          107              233
        Unbilled license revenue from related parties                                          -              200
        Prepaid expenses and other current assets                                         (1,155)            (102)
        Other assets                                                                         (48)               -
        Accounts payable                                                                     118              359
        Billings in excess of costs and estimated earnings on uncompleted contracts            4              112
        Deferred revenue                                                                    (778)          (2,356)
        Other accrued expenses and current liabilities                                    (1,198)            (485)
                                                                                   --------------   --------------

        Net cash used for operating activities                                            (1,273)          (1,851)
                                                                                   --------------   --------------

Cash flows from investing activities:
   Sale of short-term investments                                                            500                -
   Investment in less than majority-owned company                                              -             (161)
   Purchases of property and equipment                                                    (1,585)            (287)
                                                                                   --------------   --------------

        Net cash used for investing activities                                            (1,085)            (448)
                                                                                   --------------   --------------

Cash flows from financing activities:
   Principal payments on long-term debt                                                      (73)             (31)
   Principal payments on capital lease obligations                                           (19)             (31)
   Proceeds from exercise of stock options                                                   876                2
   Proceeds from payment of note receivable from stockholder                                  58                -
                                                                                   --------------   --------------
                                                                                   
        Net cash (used for) provided by financing activities                                 842              (60)
                                                                                   --------------   --------------

Effects of exchange rates on cash and cash equivalents                                        (3)              (7)
                                                                                   --------------   --------------

Net decrease in cash and cash equivalents                                                 (1,519)          (2,366)
Cash and cash equivalents, beginning of period                                            11,340            7,388
                                                                                   --------------   --------------

Cash and cash equivalents, end of period                                           $       9,821    $       5,022
                                                                                   ==============   ==============

Supplemental disclosure of cash flows:
   Cash paid for income taxes                                                      $          78    $           -
   Cash paid for interest                                                                     20               46

</TABLE> 


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

                                       5
<PAGE>
 
                        PERITUS SOFTWARE SERVICES, INC.
             NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

   The accompanying unaudited consolidated financial statements include the
   accounts of Peritus Software Services, Inc. and its subsidiaries (the
   "Company") and have been prepared by the Company without audit in accordance
   with the Company's accounting policies, as described in the Company's Annual
   Report on Form 10-K for the year ended December 31, 1997, as filed with the
   Securities and Exchange Commission ("SEC"). In the opinion of management, the
   accompanying unaudited consolidated financial statements contain all
   adjustments, consisting 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 audited consolidated financial statements and related
   notes included in the Company's 1997 Annual Report on Form 10-K. The
   operating results for the three months ended March 31, 1998 are not
   necessarily indicative of the results to be expected for the full year ending
   December 31, 1998.


2. LEGAL PROCEEDINGS

   The Company and certain of its officers and directors have been named as
   defendants in purported class action lawsuits filed in the United States
   District Court for the District of Massachusetts by Scott Cohen on April 7,
   1998, by Timothy Bonnett on April 9, 1998, by Robert Downey on April 12,
   1998, by Peter Lindsay on April 17, 1998, by Harry Teague on April 21, 1998,
   by Jesse Wijntjes on April 29, 1998 and by H. Vance Johnson and H. Vance
   Johnson as Trustee for the I.O.R.D. Profit-Sharing Plan on May 6, 1998
   (collectively, the "complaints").  The Downey complaint alleges a class
   period of October 22, 1997 to March 27, 1998.  The Cohen, Bonnett and
   Wijntjes complaints allege a class period of January 27, 1998 to March 27,
   1998.  The Lindsay, Teague and Johnson complaints allege a class period of
   January 28, 1998 to March 27, 1998.  The complaints principally allege 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. 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. The complaints also allege that certain
   officers and/or directors of the Company sold stock in the open market during
   the class periods and seek unspecified damages. Although the Company believes
   that it and the other defendants have meritorious defenses to the claims made
   in the complaints and intends to contest the lawsuits vigorously, an adverse
   resolution of the lawsuits 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.

3. COMPREHENSIVE INCOME (LOSS)

   The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
   130, "Reporting Comprehensive Income" effective January 1, 1998. This
   statement establishes standards for the reporting and display of
   comprehensive income and its components. 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. 

                                       6
<PAGE>
 
                        PERITUS SOFTWARE SERVICES, INC.
             NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

   For the three months ended March 31, 1998 and 1997, the Company's
   comprehensive income (loss) was as follows:

   
                                                Three months ended March 31,
                                               -----------------------------
                                                     1998           1997
                                                     ----           ----
       Net income (loss)                         $(2,566,000)     $406,000
       Cumulative translation adjustment              (3,000)       (7,000)
                                                 -----------      --------
                                                 $(2,569,000)     $399,000
                                                 ===========      ========      


4. NET INCOME (LOSS) PER SHARE

   In February 1997, the Financial Accounting Standards Board ("FASB") issued
   SFAS No. 128, "Earnings per Share", which supersedes Accounting Principles
   Board Opinion Accounting ("APB") No. 15 and specifies the computation,
   presentation and disclosure requirements of earnings per share. SFAS No. 128
   requires the presentation of "basic" earnings per share and "diluted"
   earnings per share. Basic earnings per share is computed by dividing the net
   income (loss) available to common stockholders by the weighted average shares
   of outstanding common stock. For purposes of calculating diluted earnings per
   share, the denominator includes both the weighted average shares of common
   stock outstanding and dilutive potential common stock.

   The Company adopted SFAS No. 128 in the fourth quarter of 1997 and has
   restated earnings per share amounts for all periods presented herein, as
   required.


5. RECENTLY ISSUED ACCOUNTING STANDARDS

   In October 1997, the Accounting Standards Executive Committee ("AcSEC") of
   the American Institute of Certified Public Accountants issued Statement of
   Position ("SOP") 97-2, "Software Revenue Recognition." SOP 97-2 provides
   guidance on the timing and amount of revenue recognition when licensing,
   selling, leasing or otherwise marketing computer software and is effective
   for transactions entered into during fiscal years beginning after December
   15, 1997. On March 18, 1998, the FASB cleared a new SOP that provides for the
   one-year deferral of certain provisions of SOP 97-2 pertaining to its
   requirements for what constitutes vendor-specific evidence of the fair value
   of multiple elements included in an arrangement. It is AcSEC's stated
   intention to immediately begin a project to consider whether guidance is
   needed on any restrictions that should be placed on what constitutes evidence
   of fair value and, if so, what the guidance should be. Because of the
   uncertainties with respect to the outcome of any such project, the Company
   believes that the impact of the deferred provisions of SOP 97-2 on its
   financial position or results of operations upon expiration of the one-year
   deferral period is not currently determinable. However, the Company believes
   that those provisions of SOP 97-2 that have not been deferred, and,
   therefore, were effective as of January 1, 1998, have not materially affected
   its financial position or results of operations.

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

   In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
   Enterprise and Related Information" which supersedes SFAS No. 14.  This
   statement changes the way that public business enterprises report segment
   information, including financial and descriptive information about their
   selected segment information.  Operating segments are defined as revenue-
   producing components of  the enterprise which are generally used internally
   for evaluating segment performance.  SFAS No. 131 will be effective for the
   Company's fiscal year ending December 31, 1998 and will not affect the
   Company's financial position or results of operations.

                                       7
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

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
Millenium 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").

The Company derives its revenue from software maintenance outsourcing services,
software and methodology licensing and other services sold directly to end users
or indirectly via value added integrators and distributors, and its clients
include primarily Fortune 1000 companies and similarly sized business and
government organizations worldwide.  The Company's products and services are
marketed through its direct sales force, both domestically and in Europe,
through value added integrators operating worldwide and through international
distributors in Canada, Europe and Japan.


THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997

Revenue
Total revenue increased 29.2% to $ 10,150,000 in the three months ended March
31, 1998 from $ 7,859,000 in the three months ended March 31, 1997. This
increase in revenue was primarily due to an increase in the licensing of the
Company's Auto Enhancer/2000 and Vantage YR2000 software products as well as
from increases in other services revenue and, to a lesser extent, outsourcing
services revenue. International revenue increased 162.8% to $ 1,924,000 in 1998
from $ 732,000 in 1997. Persist, S.A. ("Persist"), the Company's majority-owned
Spanish subsidiary, and value added integrators, distributors and end users
generated 33.6% and 66.4%, respectively, of the Company's international revenue
in the three months ended March 31, 1998. Persist generated substantially all of
the Company's international revenue in the three months ended March 31, 1997.

Outsourcing Services
Outsourcing services revenue increased 4.1% to $ 2,622,000 in the three months
ended March 31, 1998 from $ 2,519,000 in the three months ended March 31, 1997.
The increase in outsourcing services revenue in absolute dollars was primarily
attributable to the addition of one new significant outsourcing contract in
1997 and was partially offset by the recognition of lesser amounts of revenue
under the percentage-of-completion method on existing outsourcing contracts that
were in their later phases during 1998.  As a percentage of total revenue,
outsourcing services revenue decreased to 25.8% in the three months ended March
31, 1998 from  32.1% for the three months ended March 31, 1997.  The decrease in
outsourcing services revenue as a percentage of total revenue reflects the
increased contribution of license and other services revenue to total revenue
during the three months ended March 31, 1998 when compared to the same period in
the prior year. Outsourcing services remain a major component of the solutions
offered by the Company, and the Company anticipates that such services will
continue to account for a significant portion of total revenue for the
foreseeable future.

                                       8
<PAGE>
 
License
License revenue increased 14.9% to $ 4,762,000 in the three months ended March
31, 1998 or 46.9% of total revenue, compared to $ 4,144,000, or 52.7% of total
revenue, in the three months ended March 31, 1997. The increase in license
revenue for 1998 in absolute dollars was primarily attributable to the delivery
of licensed software to additional end users and increased license fees from
value added integrators.

Other Services
Other services revenue increased 131.3% to $ 2,766,000 in the three months ended
March 31, 1998 from $1,196,000 in the three months ended March 31, 1997.  As a
percentage of total revenue, other services revenue increased to 27.3% in the
three months ended March 31, 1998 from 15.2% in the three months ended March 31,
1997.  The increase in other services revenue in absolute dollars was primarily
attributable to an increase in consulting, training and client support services
relating to the Company's year 2000 products and services and the increase in
year 2000 renovation services.

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 increased 2.9% to $ 2,105,000 in the
three months ended March 31, 1998 from $ 2,045,000 for the three months ended
March 31, 1997.  Cost of outsourcing services revenue as a percentage of
outsourcing services revenue remained relatively flat at approximately 80% in
the three months ended March 31, 1998 and 1997. The increase in costs of
outsourcing services revenue in absolute dollars was due primarily to the
addition of resources necessary to provide services under one new significant
outsourcing contract.

Cost of License Revenue
Cost of license revenue consists primarily of salaries, benefits, amortization
expense of intangibles related to the MDI acquisition and related overhead costs
associated with license-related materials packaging and freight.  Cost of
license revenue was $ 533,000 in the three months ended March 31, 1998, or 11.1%
of license revenue.  Cost of license revenue was $ 127,000, or 3.1% of license
revenue, in the three months ended March 31, 1998.  The increase in cost of
license revenue in absolute dollars was primarily attributable to the addition
of employees and related resources to support additional end users and value
added integrators and distributors and the amortization of intangibles related
to the MDI acquisition.

Cost of Other Services Revenue
Cost of other services revenue consists primarily of salaries, benefits and
related overhead costs associated with delivering other services to clients.
Cost of other services revenue increased 89.1% to $ 2,437,000 in the three
months ended March 31, 1998 from $ 1,289,000 in the three months ended March 31,
1997.  Cost of the other services revenue as a percentage of other services
revenue decreased to 88.1% in the three months ended March 31, 1998 from 107.8%
in the three months ended March 31 1997.  Costs exceeded revenues in the three
months ended March 31, 1997 primarily as a result of expected overruns on one
significant pilot engagement, which subsequently became a significant product
license in 1997.  Costs increased in absolute dollars in the three months ended
March 31, 1998 due to additional staffing for  the Company's client support,
training and consulting organizations related to additional customers for the
Company's year 2000 products and services, including year 2000 renovations.

                                       9
<PAGE>
 
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 increased 123.6% to $ 3,092,000 in the three months ended
March 31, 1998 from $ 1,383,000 in the three months ended March 31, 1997. As a
percentage of total revenue, sales and marketing expenses increased to 30.5% in
the three months ended March 31, 1998 from 17.6% in the three moths ended March
31, 1997. The increase in expenses in absolute dollars and as a percentage of
revenue was primarily attributable to increased staffing, commissions and
promotional activities in connection with the Company's year 2000 software
products and services in 1998.

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 increased 84.9%
to $ 3,022,000 in the three months ended March 31, 1998 from $ 1,634,000 in the
three months ended March 31, 1997.  As a percentage of total revenue, research
and development expenses increased to 29.8% in the three months ended March 31,
1998 from 20.8% in the three months ended March 31, 1997.  The increase in
research and development expenses in absolute dollars was primarily attributable
to increased staffing for the product development efforts for the Company's year
2000 products and services and mass change technologies, including an increase
in staffing effected through new hires and internal transfers.

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.  General and administrative expenses
increased 87.7% to $ 1,736,000 in the three months ended March 31, 1998 from 
$925,000 in the three months ended March 31, 1997.  As a percentage of total
revenue, general and administrative expenses increased to 17.1% in the three
months ended March 31, 1998 from 11.8% in the three months ended March 31, 1997.
The increase in general and administrative expenses in absolute dollars and as a
percentage of revenues was primarily due to additions to the Company's
administrative staff to support growth, higher professional fees and increases
in other general corporate expenses as well as increased costs associated with
being a publicly traded company.

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 $160,000 in the three months ended March 31, 1998
compared to interest income, net, of $ 27,000 in the three months ended March
31, 1997.  This change in interest income, net, was primarily attributable to
increased interest income derived from additional cash balances resulting from
the Company's initial public offering.

Provision for Income Taxes
The Company's income tax provision was $ 0 and $ 48,000 in the three months
ended March 31, 1998 and 1997, respectively.  The Company did not record a tax
provision or benefit in the three months ended March 31, 1998 due to operating
losses incurred in this period offset by potential international tax
obligations.

                                       10
<PAGE>
 
Minority Interest in Consolidated Subsidiary
The minority interest in consolidated 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
minority interest in consolidated subsidiary decreased to a loss of $49,000 in
the three months ended March 31, 1998 from income of $29,000 in the three months
ended March 31, 1997.  This change was the result of the decreased profitability
of Persist.  As of March 31, 1998, the Company held a 63.0% equity interest in
Persist.

LIQUIDITY AND CAPITAL RESOURCES
Historically, 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 $ 9,821,000 and $ 11,340,000 at March
31, 1998 and December 31,1997, respectively. The Company's working capital was
$18,712,000 and $21,512,000 at March 31, 1998 and December 31, 1997,
respectively.

The Company's operating activities used cash of $ 1,272,000 and $ 1,851,000
during the three months ended March 31, 1998 and 1997, respectively. The
Company's use of cash during the three months ended March 31, 1998 was primarily
caused by a net loss of $ 2,566,000 less non-cash depreciation and amortization
expense of $ 813,000, an increase in prepaid expenses and other current assets
of $1,203,000 and a decrease in other accrued expenses and current liabilities
of $ 1,198,000. These decreases were partially offset by a decrease in accounts
receivable of $ 3,479,000.

The Company used cash of $ 1,085,000 and $ 448,000 for investing activities
during the three months ended March 31, 1998 and 1997, respectively.  Investing
activities in  the three months ended March 31, 1998 consisted principally of
the  purchases of  property and equipment, most notably computer equipment and
software, furniture and fixtures and leasehold improvements related to the
Company's relocations of its headquarters and regional offices.  Although the
Company has no significant commitments for capital expenditures in the remainder
of 1998, the Company expects to continue to purchase property and equipment to
further develop its infrastructure.

The Company's financing activities provided cash of $ 841,000 and used cash of
$ 60,000 during the three months ended March 31, 1998 and 1997, respectively.
Financing activities in the three months ended March 31, 1998 primarily reflect
proceeds from the exercise of stock options.

In September 1996, the Company obtained a revolving line of credit facility from
a bank which bears interest at the bank's prime rate plus 0.5% (9.00% at March
31, 1998).  The maximum borrowing under this line of credit is $3,500,000 and is
limited to 75% of certain receivables plus 50% of costs and estimated earnings
in excess of billings on uncompleted contracts, as defined by the line of credit
agreement.  The line of credit expires and all borrowings are payable in full on
June 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 are payable during the period July 1, 1997 through June 1,
2000, and bear interest at the bank's prime rate plus 1% (9.50% at March 31,
1998). Both of these agreements require the Company to comply with certain
financial covenants and are secured by all of the assets of the Company.
Although the Company was out of compliance with certain of these covenants at
March 31, 1998, the Bank granted the Company a waiver thereof. As of March 31,
1998, there were no borrowings outstanding, and $3,500,000 remained available,
under the revolving credit facility and $ 488,000 was outstanding under the
equipment financing agreement.

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, investment grade securities.

                                       11
<PAGE>
 
The Company anticipates that the net proceeds from the sale of common stock in
its initial public offering, together with cash generated from operations,
existing cash balances and advances available under its revolving credit line
agreement will be adequate to finance its operations for at least the next
twelve months.  Thereafter, the Company's cash requirements will depend on the
results of future operations, which cannot be foreseen.  To the extent that such
sources are insufficient to finance the Company's capital requirements, the
Company will be required to raise additional funds through bank borrowings or
equity or debt financing. No assurance can be given that the Company will be
able to borrow under, extend or increase its bank borrowings, or that such
financing will be available on terms acceptable to the Company and, if
available, such financing may result in further dilution to the Company's
stockholders and higher interest expense.

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.

ACCOUNTING PRONOUNCEMENTS

In October 1997, the Accounting Standards Executive Committee ("AcSEC") of the
American Institute of Certified Public Accountants issued Statement of Position
("SOP") 97-2, "Software Revenue Recognition."  SOP 97-2 provides guidance on the
timing and amount of revenue recognition when licensing, selling, leasing or
otherwise marketing computer software and is effective for transactions entered
into during fiscal years beginning after December 15, 1997. On March 18, 1998,
the Financial Accounting Standards Board ("FASB") cleared a new SOP that
provides for the one-year deferral of certain provisions of SOP 97-2 pertaining
to its requirements for what constitutes vendor specific evidence of the fair
value of multiple elements included in an arrangement. It is AcSEC's intention
to immediately begin a project to consider whether guidance is needed on any
restrictions that should be placed on what constitutes evidence of fair value
and, if so, what the guidance should be. Because of the uncertainties with
respect to the outcome of any such project, the Company believes that the impact
of the deferred provisions of SOP 97-2 on its financial position or results of
operations upon expiration of the one-year deferral period is not currently
determinable. However, the Company believes that those provisions of SOP 97-2
that have not been deferred and, therefore, were effective as of January 1,
1998, have not materially affected its financial position or results of
operations.

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

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" which supersedes SFAS No. 14.  This
statement changes the way that public business enterprises report segment
information, including financial and descriptive information about their
selected segment information.  Operating segments are defined as revenue-
producing components of  the enterprise which are generally used internally for
evaluating segment performance.  SFAS No. 131 will be effective for the
Company's fiscal year ending December 31, 1998 and will not affect the Company's
financial position or results of operations.

                                       12
<PAGE>
 
FACTORS THAT MAY AFFECT FUTURE RESULTS

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, 1997 and other public documents, filed by the Company with
the Securities and Exchange Commission (the "Commission"), which factors are
incorporated herein by reference, and other factors such as the Company's
limited operating history, the dependence on the year 2000 market, the need to
develop additional products and services, the concentration of clients and
credit risk, the management of growth and increases in expenditures in sales and
marketing, research and development and finance and administration, the
dependence upon third-party channels and potential for channel conflict, 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,
the operating difficulties and expenditures associated with acquisitions
including the Company's MDI acquisition, limited protection of proprietary
rights, dependence on third party technology, rapid technological change, risks
associated with international operations and dependence on Indian offshore
software development centers, the impact of the government regulation of
immigration, dependence on government contracts, 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.

In addition, 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.

The Company began an assessment of certain of its internal computer hardware and
software in connection with the year 2000 problem and expects to complete its 
assessment of such hardware and software in 1998. The Company expects that its 
business systems installed in 1997 will be year 2000 compliant through upgrades
and maintenance thereto. The Company expects that costs related to providing
that its internal computer hardware and software will be year 2000 compliant
will not be material to the financial condition or results of
operations of the Company are not expected to be significant.

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.
                                       13
<PAGE>
 
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.  

                          PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

The Company and certain of its officers and directors have been named as
defendants in purported class action lawsuits filed in the United States
District Court for the District of Massachusetts by Scott Cohen on April 7,
1998, by Timothy Bonnett on April 9, 1998, by Robert Downey on April 12, 1998,
by Peter Lindsay on April 17, 1998, by Harry Teague on April 21, 1998, by Jesse
Wijntjes on April 29, 1998 and by H. Vance Johnson and H. Vance Johnson as
Trustee for the I.O.R.D. Profit-Sharing Plan on May 6, 1998 (collectively, the
"complaints"). The Downey complaint alleges a class period of October 22, 1997
to March 27, 1998. The Cohen, Bonnett and Wijntjes complaints allege a class
period of January 27, 1998 to March 27, 1998. The Lindsay, Teague and Johnson
complaints allege a class period of January 28, 1998 to March 27, 1998. The
complaints principally allege 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. 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. The complaints also
allege that certain officers and/or directors of the Company sold stock in the
open market during the class periods and seek unspecified damages. Although the
Company believes that it and the other defendants have meritorious defenses to
the claims made in the complaints and intends to contest the lawsuits
vigorously, an adverse resolution of the lawsuits 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.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

The Company is furnishing the following information with respect to the use of
proceeds from its initial public offering of common stock, $0.01 par value per
share on July 2, 1997:

     (1)  The effective date of the registration statement of the offering and
          the commission file number were July 1, 1997 and 333-27087,
          respectively.

                                       14
<PAGE>
 
     (vi)  The net offering proceeds to the Company after expenses were
           approximately $ 40,664,000.

     (vii) From July 1, 1997 to March 31, 1998, $500,000 of the offering
           proceeds were used to repay certain indebtedness under a secured
           subordinated note, $ 30,000,000 were paid to APU in connection with
           the MDI acquisition and $2,000,000 were used to fund the Company's
           operations. The balance of the offering proceeds ($8,164,000) was
           invested in commercial paper, corporate bonds and money market
           accounts.

     Except for the $ 30,000,000 paid to APU which, as a result of the MDI
acquisition, owns 10% or more of the Company's common stock, payment of the
offering proceeds were to persons other than directors, officers, general
partners of the Company or their associates, persons owning 10% or more of the
equity securities of the Company or affiliates of the Company.
 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits:

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

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

(b)  Reports on Form 8-K:

     A Current Report on Form 8-K dated December 1, 1997 was filed by the
Company on December 16, 1997 and amended on February 17, 1998 to include certain
financial statements of MDI and pro forma financial information of the Company.
The Company reported under Item 2 (Acquisition or Disposition of Assets) that on
December 1, 1997, Twoquay, Inc., a wholly owned subsidiary of the Company,
acquired substantially all of the assets and assumed certain of the liabilities
of the business of MDI from APU.  Financial statements filed therewith include 
the following:  

A.  Financial Statements of MDI.  
    (i)    Report of Independent Auditors (Ernst & Young LLP).  
    (ii)   Balance Sheets as of December 31, 1995 and 1996 and September 30,
           1997.
    (iii)  Statements of Operations for the Two Years in the Period Ended 
           December 31, 1996 and for the Nine Months Ended September 30, 1997.
    (iv)   Statements of Stockholder's Equity for the Two Years in the Period
           Ended December 31, 1996 and for the Nine Months Ended September 30,
           1997.
    (v)    Statements of Cash Flows for the Two years in the Period Ended
           December 31, 1996 and for the Nine Months Ended September 30, 1997.
    (vi)   Notes to Financial Statements.  

B.  Pro Forma Financial Information of the Company:  
    (i)    Unaudited Pro Forma Condensed Consolidated Balance Sheet as of 
           September 30, 1997.  
    (ii)   Unaudited Pro Forma Condensed Consolidated Statement of Operations 
           for the Year Ended December 31, 1996.  
    (iii)  Unaudited Pro Forma Condensed Consolidated Statement of Operations 
           for the Nine Months Ended September 30, 1997.  

                                       15
<PAGE>
 
                                   SIGNATURES

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


Dated:  May 15, 1998



                                 Peritus Software Services, Inc.       
                                 By:  /s/ Allen K. Deary               
                                      ------------------               
                                                                       
                                 Allen K. Deary                        
                                 Vice President, Finance and           
                                 Chief Financial Officer (Principal    
                                 Financial Officer)                     

                                       16
<PAGE>
 
                        PERITUS SOFTWARE SERVICES, INC.
                                   FORM 10-Q
                                 EXHIBIT INDEX
--------------------------------------------------------------------------------

    EXHIBIT NO.                  DESCRIPTION

       11          Statement Re computation of per share earnings
       27          Financial Data Schedule

                                       17