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

                                 ---------------


                                    FORM 10-Q

(Mark One)

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

For the quarterly period ended              September 30, 1998
                                    -------------------------------

                                       OR

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

For the transition period from                   to

                        Commission file number 000-22327


                             PSW TECHNOLOGIES, INC.
             (Exact name of registrant as specified in its charter)


Delaware                                             74-2796054
(State or other jurisdiction
of incorporation or organization)           (I.R.S. Employer Identification No.)


6300 Bridgepoint Parkway, Building 3, Suite 200, Austin Texas              78730
(Address of principal executive offices)                              (Zip Code)

Registrant's telephone number, including area code                (512) 343-6666
                                                       -------------------------



         Indicate  by check x 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 __________


         As of October 30, 1998, the Registrant had outstanding 9,261,193 shares
of Common Stock, $.01 par value.


                                       1
<PAGE>


                             PSW TECHNOLOGIES, INC.

                      Index to September 30, 1998 Form 10-Q



                                                                            Page
                         Part I -- Financial Information

Item 1.     Financial Statements...............................................3

            Condensed Balance Sheets - September 30, 1998 and 
            December 31, 1997..................................................3

            Condensed Statements of Operations - Three Months 
            and Nine Months Ended September 30, 1998 and 1997..................4

            Condensed Statements of Cash Flows - Nine Months 
            Ended September 30, 1998 and 1997..................................5

            Notes to Condensed Financial Statements............................6

Item 2.     Management's Discussion and Analysis of
            Financial Condition and Results of Operations......................9

                          Part II -- Other Information

Item 2.     Use of Proceeds from Registered Securities........................19

Item 6.     Exhibits and Reports on Form 8-K..................................19

            Signatures........................................................20


                                       2
<PAGE>


                         Part 1 - FINANCIAL INFORMATION

Item 1. Financial Statements

                             PSW Technologies, Inc.
                            Condensed Balance Sheets
                        (in thousands, except share data)
<TABLE>
<CAPTION>

                                                                 September 30,
                                                                      1998            December 31,
                                                                  (Unaudited)             1997


Assets
Current assets:
<S>                                                              <C>                  <C>      
   Cash                                                          $        298         $     835
   Short-term investments                                              18,999            22,470
   Accounts receivable, net of allowance for doubtful
      accounts of  $250 and $165 at September 30, 1998
      and December 31, 1997, respectively                               7,828             7,429
   Unbilled revenue under customer contracts                              843               418
   Deferred tax asset                                                     792                 -
   Prepaid expenses and other current assets                              557               483
                                                                     --------         ---------    
Total current assets                                                   29,317            31,635
Other non-current assets                                                4,573             3,785
                                                                     --------         ---------

Total assets                                                       $   33,890        $   35,420
                                                                   ==========        ==========


Liabilities and stockholders' equity 
Current liabilities:
   Trade payables                                                         369               532
   Deferred revenue                                                       434                 -
   Accrued expenses and other current liabilities                       2,062             3,029
                                                                    ---------         ---------
Total current liabilities                                               2,865             3,561

Stockholders' equity:
  Preferred stock, par value $.01 per share, 1,000,000
     shares authorized and none issued and outstanding                      -                 -
  Common  stock,  par  value  $.01  per  share,  34,000,000  
     shares  authorized, 9,211,919 and 8,960,935 shares 
     issued and outstanding at September 30, 1998
     and December 31, 1997, respectively                                   92                90
  Additional paid-in capital                                           30,009            29,484
  Deferred compensation                                                  (125)             (243)
  Accumulated other comprehensive income                                   46               (27)
  Retained earnings                                                     1,003             2,555
                                                                    ---------          ---------
Total stockholders' equity                                             31,025            31,859
                                                                    ---------          ---------

Total liabilities and stockholders' equity                         $   33,890        $   35,420
                                                                   ==========        ==========

</TABLE>

                             See accompanying notes.


                                       3
<PAGE>




                             PSW Technologies, Inc.
                       Condensed Statements of Operations
                      (in thousands, except per share data)
                                   (unaudited)
<TABLE>
<CAPTION>

                                                         Three Months Ended          Nine Months Ended
                                                           September 30,               September 30,
                                                     --------------------------- ---------------------------
                                                         1998           1997          1998         1997
                                                         ----           ----          ----         ----
<S>                                                      <C>          <C>            <C>          <C>     
Revenue                                                  $ 9,255      $ 11,258       $ 28,880     $ 32,267
Operating expenses:
   Technical staff                                         6,009         5,711         17,335       16,445
   Selling and administrative staff                        2,853         2,113          8,161        6,087
   Other expenses                                          2,772         1,946          6,678        5,825
   Special compensation expense                               36            71            118          259
                                                       ---------    ----------    -----------   ----------
Total operating expenses                                  11,670         9,841         32,292       28,616
                                                       ---------    ----------    -----------   ----------

Income (loss) from operations                             (2,415)        1,417         (3,412)       3,651

Interest income (expense), net                               215           264            690          161
                                                       ---------    ----------    -----------   ----------
Income (loss) before provision (benefit) for
   income taxes                                           (2,200)        1,681         (2,722)       3,812
                                                       ---------    ----------    -----------   ----------

Provision (benefit) for income taxes:
Nonrecurring charge for termination of
  Subchapter S election                                        -             -              -        1,200
C Corporation                                             (1,070)          570         (1,170)         670
                                                       ---------    ----------    -----------   ----------
Total provision (benefit) for income taxes                (1,070)          570         (1,170)       1,870
                                                       ---------    ----------    -----------   ----------

Net income (loss)                                     $   (1,130)   $    1,111    $    (1,552)   $   1,942
                                                      ==========    ==========   ============    =========

Basic earnings (loss) per share                       $    (0.12)   $     0.13    $     (0.17)
                                                      ==========    ==========   ============

Diluted earnings (loss) per share                     $    (0.12)   $     0.11    $     (0.17)
                                                      ==========    ==========   ============

Pro forma information:
Historical income before provision for
   income taxes                                                                                  $   3,812
Pro forma provision for income taxes                                                                 1,380
                                                                                                 ---------

Pro forma net income                                                                             $   2,432
                                                                                                   =======

Pro forma basic earnings per share                                                               $    0.35
                                                                                                  ========

Pro forma diluted earnings per share                                                             $    0.30
                                                                                                  ========

Shares used in basic earnings (loss) per share
   calculation                                             9,146         8,847          9,064        6,871
                                                       =========     =========      =========     ========

Shares used in diluted earnings (loss) per share
   calculation                                             9,146         9,973          9,064        8,001
                                                       =========     =========      =========     ========
</TABLE>

                             See accompanying notes.


                                       4
<PAGE>



                             PSW Technologies, Inc.
                       Condensed Statements of Cash Flows
                                 (in thousands)
                                   (unaudited)

<TABLE>
<CAPTION>

                                                                                  Nine Months
                                                                              Ended September 30,
                                                                   --------------------------------------
                                                                           1998              1997
                                                                           ----              ----
Operating activities
<S>                                                                   <C>                <C>        
Net income (loss)                                                     $    (1,552)       $     1,942
Adjustments to reconcile net income to net cash provided by
   (used in) operating activities:
     Special compensation                                                     118                259
     Depreciation and amortization                                            765                597
     Bad debt expense                                                         114                 45
     Changes in operating assets and liabilities:
        Accounts receivable                                                  (513)            (1,893)
        Due to/from related party                                               -               (258)
        Unbilled revenue under customer contracts                            (425)               106
        Prepaid expenses and other current assets                             (74)                40
        Trade payables                                                       (173)              (359)
        Deferred revenue                                                      434               (125)
        Accrued expenses and other current liabilities                       (188)             1,362
        Income taxes                                                       (1,519)               694
                                                                          --------        ----------
Net cash provided by (used in) operating activities                        (3,013)             2,410
                                                                          --------        ----------

Investing activities
Purchase securities                                                             -            (21,277)
Proceeds from sale of short term investments                                3,544                  -
Acquisition of property and equipment                                      (1,442)            (2,410)
                                                                          --------         ---------
Net cash provided by (used in) investing activities                         2,102            (23,687)
                                                                          --------         ---------

Financing activities
Repayments of line of credit                                                    -             (5,125)
Dividend to S corporation stockholders                                          -             (1,400)
Issuance of common stock                                                      374             25,970
                                                                          --------         ---------
Net cash provided by financing activities                                     374             19,445
                                                                          --------         ---------

Net decrease in cash                                                         (537)            (1,832)
Cash, beginning of period                                                     835              3,182
                                                                          --------         ---------

Cash, end of period                                                    $      298          $   1,350
                                                                       ==========          =========

Non-cash activities:
Unrealized gain on investments                                         $       73       $         52
Reduction of income taxes payable associated with the
   exercise of stock options                                           $      153       $        115


</TABLE>

                             See accompanying notes.


                                       5
<PAGE>



                             PSW Technologies, Inc.
                     Notes to Condensed Financial Statements
                               September 30, 1998
                                   (unaudited)

1.    Basis of Presentation

PSW  Technologies,  Inc.  (the  "Company")  commenced  operations as a separate,
stand-alone  corporation  effective October 1, 1996. The accompanying  unaudited
financial statements have been prepared by the Company pursuant to the rules and
regulations  of the  Securities and Exchange  Commission  (the "SEC")  regarding
interim  financial  reporting.   Accordingly,   they  do  not  include  all  the
information and notes required by generally accepted  accounting  principles for
complete  financial  statements  and  should  be read in  conjunction  with  the
financial  statements  and notes  thereto for the year ended  December  31, 1997
included in the Company's annual report on Form 10-K. The accompanying financial
statements reflect  adjustments,  all of which are of a normal recurring nature,
which are, in the opinion of management, necessary for a fair presentation.
The results for interim  periods  are not  necessarily  indicative  of full year
results.

2.    Significant Accounting Policies

Use of Estimates

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
could affect the financial  statements and  accompanying  notes.  Actual results
could differ from those estimates.

3.    Pro Forma Provision for Income Taxes

From commencement  through June 5, 1997 the Company had elected to be treated as
an S  Corporation  under  Subchapter S of the Internal  Revenue Code of 1986, as
amended.  As such,  federal income taxes  attributable to income through June 5,
1997 were the responsibility of the individual stockholders. Pro forma provision
for income taxes  reflect the  estimated  corporate  income tax expense that the
Company  would  have  recognized  had  it  not  elected  to be  treated  as an S
corporation for the period  presented.  The Company also paid a dividend of $1.4
million to its S corporation  stockholders during the third quarter of 1997. The
dividend  was  estimated to  approximate  the tax that the S  stockholders  were
required to pay on the 1997 taxable income allocated to them.

4.    Pro Forma Earnings Per Share

The pro  forma  basic  and  diluted  earnings  per  share  amounts  prior to the
Company's  initial public offering,  which occurred during the second quarter of
1997,  have been  restated as required to comply  with  Statement  of  Financial
Accounting  Standards  No.  128,  Earnings  Per Share,  and the  Securities  and
Exchange Commission Staff Accounting Bulletin 98.


                                       6
<PAGE>


                             PSW Technologies, Inc.
               Notes to Condensed Financial Statements (Continued)
                                   (unaudited)


5.    Comprehensive Income

As of January 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive
Income.  SFAS No. 130  establishes  new rules for the  reporting  and display of
comprehensive income and its components; however, the adoption of this Statement
had no impact on the Company's net income or stockholders'  equity. SFAS No. 130
requires  unrealized  gains  or  losses  on  the  Company's   available-for-sale
securities,  which prior to adoption were reported  separately in  shareholders'
equity,  to be  included in other  comprehensive  income.  Prior year  financial
statements  have been  reclassified  to conform to the  requirements of SFAS No.
130.

The  components  of  comprehensive  income for the three and nine  months  ended
September 30, 1998 and 1997 are as follows: 
<TABLE>
<CAPTION>
                                                          
                                                         Three months ended              Nine months ended
                                                           September 30,                    September 30,
                                                        1998           1997              1998         1997(a)
                                                     -----------    -----------        ----------    ----------
<S>                                                      <C>             <C>              <C>           <C>   
Net income (loss)                                        $(1,130)        $1,111           $(1,552)      $2,432

Unrealized gain (loss) on short term
  investments                                                 63            (79)              128          (79)
Income tax (expense) benefit related to items
  of other comprehensive income                              (27)            27               (55)          27

                                                     
                                                      ===========    ===========        ==========    ==========
Comprehensive income (loss)                              $(1,094)        $1,059           $(1,479)      $2,380
                                                      ===========    ===========        ==========    ==========
</TABLE>

(a)            Net income and  comprehensive  income  amounts are presented on a
               pro forma basis as if the Company had been subject to federal and
               state income taxes.

The components of accumulated other  comprehensive  income at September 30, 1998
and December 31, 1997 are as follows:
<TABLE>
<CAPTION>
                                                                                          1998             1997
                                                                                       ------------    --------------

<S>                                                                                            <C>              <C>  
Unrealized gain (loss) on short term investments                                               $46              $(27)
                                                                                       ============    ==============
</TABLE>

                                       7
<PAGE>


                             PSW Technologies, Inc.
               Notes to Condensed Financial Statements (Continued)
                                   (unaudited)


6.    Earnings per Share

The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share data) for the three months and nine months
ended September 30:
<TABLE>
<CAPTION>

                                                         Three Months Ended                     Nine Months Ended
                                                            September 30,                         September 30,
                                                      1998                1997              1998              1997(1)
                                                  --------------     ---------------    --------------     --------------
Numerator:
<S>                                               <C>                <C>                <C>                      <C>    
  Net income (loss)                               $     (1,130)      $        1,111     $     (1,552)            $ 2,432
                                                  ==============     ===============    ==============     ==============

Denominator:
  Shares used in basic earnings (loss) per
    share calculation                                     9,146               8,847             9,064              6,871

  Effect of dilutive securities:
    Employee stock options                                    -                 620                 -                624
    Warrants                                                  -                 506                 -                506
                                                  --------------     ---------------    --------------     --------------
  Shares used in diluted earnings (loss) per
    share calculation                                     9,146               9,973             9,064              8,001
                                                  ==============     ===============    ==============     ==============

Basic earnings (loss) per share                   $      (0.12)      $         0.13     $      (0.07)      $        0.35 
                                                  ==============     ===============    ==============     ==============

Diluted earnings (loss) per share                 $      (0.12)      $         0.11     $      (0.17)      $        0.30
                                                  ==============     ===============    ==============     ==============

</TABLE>


(1) Net income and earnings per share amounts are presented on a pro forma basis
as if the Company had been  subject to federal and state income  taxes.  The pro
forma  basic and pro forma  diluted  earnings  per  share  amounts  prior to the
Company's  initial public offering,  which occurred during the second quarter of
1997,  have  been  restated  as  required  to comply  with SFAS No.  128 and the
Securities and Exchange  Commission Staff Accounting Bulletin 98 ("SAB 98"). The
adoption of the provisions of SFAS 128 and SAB 98 resulted in an increase to pro
forma diluted earnings per share for the nine months ended September 30, 1997 of
$0.01 per share.


7.    Income Taxes

During the third quarter, the Company revised its estimated annual effective tax
rate for 1998 from 19%, which was used during the second quarter of 1998, to 43%
due to changes in management's  estimate of projected levels of operating income
relative to tax-exempt income.  Using a 43% annual effective tax rate during the
first,  second and third quarters of 1998, net loss would have been $178,000 for
the three months ended March 31, 1998,  $120,000 for the three months ended June
30, 1998 and $1,254 for the three months ended  September 30, 1998.  The diluted
loss per share would have remained at $0.02 for the three months ended March 31,
1998,  would have  increased  $0.01 to a diluted loss per share of $0.01 for the
three months ended June 30, 1998,  and would have  decreased  $0.02 to a diluted
loss per share of $0.14 for the three months ended September 30, 1998.


                                       8
<PAGE>


Item 2.

MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

This report contains forward-looking  statements,  within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, that involve risks and  uncertainties,  such as statements  concerning:
growth and future operating  results;  developments in the Company's markets and
strategic  focus;  and future  economic  and business  conditions.  Such forward
looking   statements  are  generally   accompanied  by  words  such  as  "plan,"
"estimate," "expect," "believe," "could," "would," "anticipate," "may," or other
words  that   convey   uncertainty   of  future   events  or   outcomes.   These
forward-looking  statements and other  statements  made elsewhere in this report
are made in reliance on the Private  Securities  Litigation  Reform Act of 1995.
The section below  entitled  "Certain  Factors That May Affect  Future  Results,
Financial  Condition and Market Price of Securities" sets forth and incorporates
by  reference  certain  factors that could cause  actual  future  results of the
Company to differ materially from these statements.

Overview

PSW Technologies,  Inc. (the "Company"),  is a software services firm, operating
in one industry  segment,  that  provides  high value  solutions to  information
technology  ("IT")  vendors  and IT users by  mastering  and  applying  critical
emerging  technologies,   including  Web  based  distributed  computing,  object
oriented   development,   advanced  operating  systems  and  systems  management
technologies. IT vendors primarily consist of software companies who utilize the
Company's  services to help bring  their  products  to market  faster.  IT users
generally  utilize the Company's  services to help define,  develop and complete
high value,  mission critical  enterprise software systems for internal use. PSW
provides  joint  project-based  development,  porting  and  testing  services to
selected IT vendor  clients and applies the technical  expertise  learned to the
design and  development  of high value,  mission  critical  enterprise  business
systems for its Fortune 1000 IT user clients.

To  date,  revenue  has  been  generated  principally  from   time-and-materials
contracts for the Company's software services.  Revenue from  time-and-materials
contracts is  recognized  during the period in which the services are  provided.
The Company also enters into fixed price  contracts  for its software  services.
Revenue    from   fixed    price    contracts    is    recognized    using   the
percentage-of-completion  method over the term of the client contract,  measured
by the  labor  incurred  as a  percentage  of the  estimated  total  labor.  The
cumulative  impact  of  revisions  in  percentage  of  completion  estimates  is
reflected  in the  period  in which  the  revisions  are  made.  Provisions  for
estimated  losses on  uncompleted  contracts  are made on a contract by contract
basis and are  recognized  in the  period in which such  losses are  determined.
There  can  be no  assurance  of  the  accuracy  of the  Company's  future  work
completion  estimates,  and  operating  results  may be  adversely  affected  by
inaccurate estimates of contract related labor.


                                       9
<PAGE>


Results of Operations

The  following  table sets  forth the  percentage  of  revenue of certain  items
included in the  Company's  condensed  statement  of  operations  for the period
indicated:

<TABLE>
<CAPTION>
                                                        Three Months                       Nine Months
                                                    ended September 30,                  ended September 30,
                                                    -------------------                  -------------------
                                                     1998       1997                       1998       1997
                                                     ----       ----                       ----       ----


<S>                                                   <C>       <C>                         <C>       <C> 
Revenue............................................   100%....  100%                        100%      100%
Operating expenses:
   Technical staff.................................    65        51                          60        51             
   Selling and administrative staff................    31        19                          28        19           
   Other expenses..................................    30        17                          23        18
   Special compensation expense....................    -          1                          -          1
                                                     -----     -----                       -----     -----
Total operating expense............................   126        88                         111        89
                                                     -----     -----                       -----     -----
Income (loss) from operations......................   (26)       12                         (11)       11
Interest income (expense), net.....................     2         2                           2        -
Provision (benefit) from income taxes..............   (12)        5                          (4)        4 (a)
                                                     -----     -----                       -----     -----
Net income (loss).................................    (12)%       9%                         (5)%       7%(a)
                                                     ======    =====                       =====     =====
</TABLE>

(a)      Net income is presented on a pro forma basis as if the Company had been
         fully subject to federal and state income taxes.

Third Quarter of 1998 Compared with Third Quarter of 1997

Revenue

The Company's revenue consists primarily of fees for software services provided.
Revenue  was $9.3  million  in the third  quarter  of 1998,  down 18% from $11.3
million  for the third  quarter of 1997,  principally  due to the decline in the
scope and number of IT user projects.  Revenue attributable to software services
rendered to IT vendors was $6.3 million and $6.6 million in the third quarter of
1998 and the  third  quarter  of 1997,  respectively.  Revenue  attributable  to
software services rendered to IT users was $3.0 million and $4.6 million for the
third quarter of 1998 and the third quarter of 1997, respectively, a decrease of
35% in the third quarter of 1998 over the third quarter of 1997.

One client, including its wholly-owned  subsidiaries,  accounted for 36% and 35%
of  revenue in each of the third  quarters  of 1998 and 1997,  respectively.  No
other client accounted for more than 10% of revenue for either period.

 Technical Staff

Technical staff expenses consist of the cost of salaries,  payroll taxes, health
insurance and workers'  compensation,  for technical staff personnel assigned to
client  projects and  unassigned  technical  staff  personnel,  and fees paid to
subcontractors for work performed in connection with a client project. Technical
staff expenses were $6.0 million in the third quarter of 1998, an increase of 5%
over $5.7 million for the third quarter of 1997. The increase in technical staff
expenses  was  primarily  due  to the  addition  of  personnel  during  1998  in
anticipation of new  engagements.  Technical staff expenses  increased to 65% of
revenue  in the third  quarter  of 1998 from 51% in the third  quarter  of 1997,
primarily  as a  result  of lower  utilization  of  technical  staff  and  lower
revenues.


                                       10
<PAGE>


Selling and Administrative Staff

Selling  and  administrative  staff  expenses  consist of the cost of  salaries,
payroll taxes, health insurance and workers' compensation for selling, marketing
and  administrative  personnel  and all  commissions  and  bonuses.  Selling and
administrative staff expenses were $2.9 million in the third quarter of 1998, an
increase of 35% from $2.1 million in the third quarter of 1997.  The increase in
selling and  administrative  staff  expenses was  primarily due to the increased
focus on sales and marketing  initiatives  which  resulted in an increase to the
sales and marketing staff during 1998. Selling and administrative staff expenses
were 31% of revenue in the third  quarter of 1998  compared to 19% of revenue in
the third quarter of 1997, primarily as a result of increases in the sales staff
and lower revenues.

Other Expenses

Other expenses consist of all non-staff  related costs, such as occupancy costs,
travel,  business  insurance,  business  development,  recruiting,  training and
depreciation.  Other expenses were $2.8 million in the third quarter of 1998 and
$1.9 million in the third quarter of 1997.  The increase is  principally  due to
the addition of a facility in Mountainview,  California, severance costs related
to an overall  reduction in headcount,  meeting  costs,  an increase in bad debt
reserves, along with higher travel and project related costs, offset slightly by
lower recruiting costs.  Other expenses were 30% of revenue in the third quarter
of 1998 compared to 17% in the third quarter of 1997.

Special Compensation Expense

Special compensation expense consists of stock-based  compensation in connection
with  the  grants  of  replacement   options  to  the  Company's  employees  who
participated  in the Pencom  Systems  Incorporated  stock option  plan.  Special
compensation  expense  was  $36,000,  or less than 1% of  revenue,  in the third
quarter of 1998 and $71,000, or 1% of revenue, in the third quarter of 1997.

Income (Loss) from Operations

The Company recorded a loss from operations of $2.4 million in the third quarter
of 1998,  down from $1.4 million of income from  operations in the third quarter
of 1997.  Loss from  operations was 26% of revenue in the third quarter of 1998,
down from income from operations of 12% of revenue in the third quarter of 1997.

First Nine Months of 1998 Compared with First Nine Months of 1997

Revenue

The Company's revenue consists primarily of fees for software services provided.
Revenue was $28.9 million in the first nine months of 1998,  down 10% from $32.3
million for the first nine months of 1997, principally due to the decline in IBM
business.  Revenue  attributable to software services rendered to IT vendors was
$19.1  million and $19.3  million in the first nine months of 1998 and the first
nine months of 1997,  respectively.  Revenue  attributable to software  services
rendered  to IT users was $9.8  million  and $13.0  million  for the first  nine
months of 1998 and the first nine  months of 1997,  respectively,  a decrease of
25% in the first nine months of 1998 over the first nine months of 1997.

One client,  including its wholly owned subsidiaries,  accounted for 36% and 42%
of revenue in each of the first nine months of 1998 and 1997,  respectively.  No
other client accounted for more than 10% of revenue for either period.


                                       11
<PAGE>


 Technical Staff

Technical staff expenses consist of the cost of salaries,  payroll taxes, health
insurance and workers'  compensation,  for technical staff personnel assigned to
client  projects and  unassigned  technical  staff  personnel,  and fees paid to
subcontractors for work performed in connection with a client project. Technical
staff  expenses were $17.3 million in the first nine months of 1998, an increase
of 5% over $16.4  million  for the first nine  months of 1997.  The  increase in
technical  staff  expenses  was  primarily  due to the  addition of personnel to
service the  anticipated  increase in scope and number of client projects during
1998.  Technical  staff  expenses  increased to 60% of revenue in the first nine
months of 1998 from 51% in the first nine months of 1997,  primarily as a result
of lower utilization of technical staff and lower revenues.

Selling and Administrative Staff

Selling  and  administrative  staff  expenses  consist of the cost of  salaries,
payroll taxes, health insurance and workers' compensation for selling, marketing
and  administrative  personnel  and all  commissions  and  bonuses.  Selling and
administrative  staff  expenses  were $8.2  million in the first nine  months of
1998, an increase of 34% from $6.1 million in the first nine months of 1997. The
increase in selling and  administrative  staff expenses was primarily due to the
addition of sales and  administrative  personnel,  and  increased  training  for
technical staff.  Selling and administrative  staff expenses were 28% of revenue
in the first nine  months of 1998  compared  to 19% of revenue in the first nine
months of 1997,  primarily as a result of increases in the sales staff,  greater
technical staff involvement in sales and lower revenues.

Other Expenses

Other expenses consist of all non-staff  related costs, such as occupancy costs,
travel,  business  insurance,  business  development,  recruiting,  training and
depreciation.  Other expenses were $6.7 million in the first nine months of 1998
and $5.8  million  in the  first  nine  months of 1997,  principally  due to the
addition of a facility,  severance costs related to an overall reduction in head
count during the third quarter,  third quarter meeting costs, an increase in bad
debt  reserves,  along with higher  travel and  project  related  costs,  offset
slightly by lower  recruiting  costs.  Other expenses were 23% of revenue in the
first nine  months of 1998  compared to 18% in the first nine months of 1997 due
to the previously mentioned expenses and lower revenues.

Special Compensation Expense

Special compensation expense consists of stock-based  compensation in connection
with  the  grants  of  replacement   options  to  the  Company's  employees  who
participated  in the Pencom  Systems  Incorporated  stock option  plan.  Special
compensation expense was $118,000, or less than 1% of revenue, in the first nine
months of 1998 and $259,000, or 1% of revenue, in the first nine months of 1997.

Income (Loss) from Operations

The Company  recorded a loss from  operations  of $3.4 million in the first nine
months of 1998,  down from $3.7 million of income from  operations  in the first
nine months of 1997.  Due  primarily  from the  decrease  in revenue,  loss from
operations was 11% of revenue in the first nine months of 1998, down from income
from operations of 11% of revenue in the first nine months of 1997.

Income Taxes

From commencement  through June 5, 1997 the Company had elected to be treated as
an S  Corporation  under  Subchapter S of the Internal  Revenue Code of 1986, as
amended.  As such,  federal income taxes  attributable to income through June 5,
1997  were the  responsibility  of the  individual  stockholders.  The pro forma
disclosures  on the  statements  of  operations  reflect  adjustments  to record
provisions for income taxes as if the Company had not been an S Corporation. 

                                       12
<PAGE>


The pro forma  provision  for income  taxes of $1.4  million for the nine months
ended  September 30, 1997 is computed  using an estimated  annual  effective tax
rate of 36%, which differs form the federal  statutory rate of 34% primarily due
to state taxes.
                                    
The  historical  benefit  for income  taxes of $1.2  million for the nine months
ended  September 30, 1998 is computed  using an estimated  annual  effective tax
rate of 43%, which differs from the federal statutory rate of 34% as a result of
state taxes and the  relationship  of tax-exempt  interest  income to the pretax
loss.

During the third quarter, the Company revised its estimated annual effective tax
rate for  1998  from  19% to 43% due to  changes  in  management's  estimate  of
tax-exempt income relative to projected levels of operating income.

Net Loss and Pro Forma Net Income

Net loss was $1.6  million  in the first  nine  months of 1998 and pro forma net
income was $2.4  million in the first  nine  months of 1997.  Net loss was 5% of
revenue  in the first  nine  months of 1998 and pro forma net  income  was 7% of
revenue in the first nine months of 1997.

Liquidity and Capital Resources

At September 30, 1998, the Company had cash and short term investments  totaling
$19.3 million, a decrease from $23.3 million at December 31, 1997 as a result of
funding operating and investing activities.

The Company  maintains a Credit Facility with a bank providing for borrowings of
up to $10 million, subject to a borrowing base requirement.  The Credit Facility
expires on May 1, 1999. Available borrowings under the Credit Facility are based
upon a percentage of the Company's  eligible accounts  receivable.  At September
30, 1998, no amount was outstanding  under the Credit Facility and the available
borrowing amount was $7.5 million.

The Company  anticipates  that its existing capital  resources  described above,
together with cash provided by operating activities will be adequate to fund the
Company's  operations for at least the next 12 months. There can be no assurance
that  changes  will not occur that would  consume  available  capital  resources
before such time. The Company's capital requirements depend on numerous factors,
including  potential  acquisitions,  the  timing  of  the  receipt  of  accounts
receivable,  employee  growth and the  percentage  of projects  performed at the
Company's  facilities.  There can be no assurance that  additional  funding,  if
necessary, will be available on favorable terms, if at all.


Year 2000 Compliance

Many older computer systems and software products  currently in use are coded to
accept  only two digit  entries in the date code  field.  These date code fields
will need to accept four digit  entries to  distinguish  21st century dates from
20th century dates. As a result, in less than 15 months, computer systems and/or
software  used by many  companies  will need to be  upgraded to comply with such
"Year 2000" requirements.

All of the  services  currently  offered by the Company are  designed to be Year
2000 compliant.  However, the Company's services are often integrated or used in
conjunction with third-party software;  such software may not be compatible with
Company's  services  or Year 2000  compliant.  The  Company may in the future be
subject  to claims  based on Year 2000  problems  in  other's  products,  custom
scripts  created by third parties to interface  with the  Company's  services or
issues arising from the  integration of multiple  products and systems within an
overall system. The costs of defending and resolving Year 2000-related disputes,
and any  liability  of the  Company  for Year  2000-related  damages,  including
consequential  damages,  could have a material  adverse  effect on the Company's
business, operating results and financial condition.

                                       13
<PAGE>

Over the past three years,  the Company has made Year 2000 compliance a priority
in IT purchasing and installation decisions.  The Company's internal information
technology  group has  adopted  a Year 2000  compliance  program  to assess  and
address any Year 2000 issues which remain  related to the  Company's IT systems.
The program consists of the following phases:  identifying Year 2000 application
issues,  updating  applications,  identifying  Year 2000  systems and  operating
systems issues (such phases are complete),  collecting manufacturer's compliance
statements,  verifying  solutions to Year 2000 issues,  updating and/or patching
operating systems,  updating firmware and phasing out unsupported hardware (such
phases are in process and  scheduled  to be  completed  in the first  quarter of
fiscal 1999). As of October 1, 1998, the Company has spent approximately $15,000
of the currently estimated $30,000 total cost of the program. Costs incurred and
expected  to be  incurred  consist  primarily  of the cost of Company  personnel
involved  in  updating  applications  and  operating  systems  and the  costs of
software updates and patches (many of which are provided free of charge from the
vendors). Funds for the Year 2000 compliance program are expected to be provided
from available working capital.  The Company has utilized the Company's internal
technical personnel,  and intends to continue to use such personnel,  to address
Year 2000 issues, rather than contract with third-party consultants.

Although the Company has not completed its survey of third parties with which it
has a  material  relationship,  the  majority  of the  Company's  customers  are
sophisticated IT vendors and users who are addressing their own Year 2000 issues
and the Company  relies  primarily on its  technical  personnel  and internal IT
systems,  rather  than  third  party  suppliers.  As  the  Company's  Year  2000
compliance program is on schedule to be completed in the first quarter of fiscal
year 1999,  the Company has not formulated a most  reasonably  likely worst case
scenario  or  formulated  a  contingency  plan  should  the  program  fail to be
completed by such date.

Significant  uncertainty still exists as to the global  implications of the Year
2000 issue. The Company  believes that the purchasing  patterns of customers and
potential  customers  may be  affected by Year 2000 issues in a variety of ways.
Many companies  (including  customers of the Company, and customers or potential
customers of the Company's  customers)  are expending  significant  resources to
correct or patch  their  current  hardware  and  software  systems for Year 2000
compliance.  Such  expenditures  may result in reduced  funds  available for the
Company's  customers  to  pursue  product  development  programs  or IT  systems
enhancements for which the Company's  services would otherwise be utilized.  Any
of the foregoing,  including costs of defending and resolving Year  2000-related
disputes,  reductions  in  development  programs or IT systems  enhancements  by
customers  and their  customers  or the  failure of the  Company  to  adequately
resolve internal Year 2000 compliance  issues could result in a material adverse
effect on the Company's business, operating results and financial condition.

Certain Factors That May Affect Future Results, Financial Condition
   and Market Price of Securities

Numerous  factors may affect the Company's  business and results of  operations.
These  factors  include,  but are not limited  to,  industry  concentration  and
dependence on large  projects,  fixed price  contracts and other project  risks,
ability to manage growth,  variability of quarterly  operating results,  need to
attract and retain professional staff, rapid technological  advances and risk of
targeting emerging  technologies,  dependence on key personnel,  risks of system
interruption  and  security  risks,  and  uncertainty  related  to the Year 2000
Compliance issues.  The discussion below addresses some of these factors.  For a
more  thorough  discussion  of these  and  other  factors  that may  affect  the
Company's  future results,  see the "Item 1 - Business" of the Company's  Annual
Report of Form  10-K for the year  ended  December  31,  1997 and the  Company's
Registration Statement of From S-1 (File No. 333-21565).

         Industry  Concentration;  Dependence on Large Projects. The Company has
derived and  believes it will  continue to derive a  significant  portion of its
revenue  from  the  technology  vendor  industry.  As a  result,  the  Company's
business,  financial  condition  and results of  operations  are  influenced  by
economic  and  other  conditions  affecting  such  industry,  such  as  economic
downturns  which could lead to a reduction in spending on IT projects,  which in
turn could lead to fewer new research and development outsourcing projects being
undertaken. Further, several of the Company's client contracts limit its ability
to provide  services to competitors  of such clients,  thereby  restricting  the
field of  potential  future  clients.  In  addition,  as a result of the dynamic
nature  of the IT vendor  industry,  the  Company  may lose  clients  due to the
acquisition, merger or consolidation of existing clients with entities which are
not current clients of the Company. The occurrence of any of the foregoing could
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.

                                       14
<PAGE>

         Fixed-Price  Contracts  and Other  Project  Risks.  During 1997 and the
first  nine  months of 1998,  approximately  20% and 13%,  respectively,  of the
Company's  revenue  was  generated  on a  fixed  price,  fixed-delivery-schedule
("fixed price") basis, rather than on a time-and-materials  basis. The Company's
failure to accurately  estimate the resources required for a fixed price project
or its  failure to  complete  its  contractual  obligations  in a timely  manner
consistent  with the project  plan upon which its fixed price  contract is based
could  have a  material  adverse  effect on the  Company's  business,  financial
condition  and  results of  operations.  In the past,  the  Company has found it
necessary to revise project plans after  commencement  of the project and commit
unanticipated  additional  resources to complete  certain  projects,  which have
negatively  affected  the  profitability  of  such  projects.  The  Company  may
experience similar situations in the future, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, the Company may establish contract prices before the project design
specifications are finalized, which could result in a fixed price that proves to
be too low and therefore  adversely  affects the Company's  business,  financial
condition and results of operations.

         Many of the Company's  engagements  involve projects which are critical
to the operations of its clients' businesses and which provide benefits that may
be difficult to quantify.  The Company's failure to meet a client's expectations
in the  performance  of its services  could damage the Company's  reputation and
adversely  affect its ability to attract new  business,  and may have a material
adverse effect upon its business, financial condition and results of operations.
The Company has undertaken,  and may in the future undertake,  projects in which
the Company guarantees  performance based upon defined operating  specifications
or guaranteed  delivery dates. The Company has also undertaken projects in which
a material  portion  of total  revenue is earned  based upon  meeting  specified
delivery  dates.  Unsatisfactory  performance or  unanticipated  difficulties or
delays in completing  such projects may result in client  dissatisfaction  and a
reduction  in payment  to, or payment of damages by, the  Company,  any of which
could  have a  material  adverse  effect on the  Company's  business,  financial
condition and results of operations.  There can be no assurance that the Company
will be able to limit its liability to clients, including liability arising from
the  Company's  failure to meet  clients'  expectations  in the  performance  of
services, through contractual provisions, insurance or otherwise.

         Management  of Growth.  The  Company's  growth  has placed  significant
demands on its management and other resources.  For example, the Company's staff
increased  from 167  full-time  employees at December 31, 1994 to 442  full-time
employees at September 30, 1998. In order to manage its growth effectively,  the
Company will need to continue to develop and improve its operational,  financial
and other internal systems,  as well as its business  development  capabilities,
and to continue to attract, train, retain, motivate and manage its employees. In
addition,  the Company's future success will depend in large part on its ability
to continue to maintain high rates of employee utilization, set fixed price fees
accurately, maintain project quality and meet delivery dates, all as the Company
seeks to increase the number of projects in which it is engaged.  If the Company
is unable to manage its growth and projects  effectively,  such inability  would
have a material  adverse  effect on the quality of the Company's  services,  its
ability  to retain key  personnel  and its  business,  financial  condition  and
results of operations.  No assurance can be given that the Company's growth will
continue to be achieved, or if achieved,  will be maintained or that the Company
will be successful in managing any such growth.


                                       15
<PAGE>

         Recent  Organization;  Limited  Operating  History  as  an  Independent
Business;  Limited  Relevance  of  Historical  Financial  Information.  Prior to
October 1996, the Company  conducted its business and operations as the software
division of Pencom Systems Incorporated ("Pencom"). Accordingly, the Company has
only a limited  independent  operating  history upon which an  evaluation of the
Company and its prospects can be based.  Prior to October 1996, the Company also
had limited  accounting  capability and depended upon Pencom for most accounting
functions.  By October 1, 1996, the Company had assumed  responsibility for most
internal accounting  functions,  but continued to depend upon Pencom for limited
accounting  support in connection with the Company's 1996 year-end audit.  There
can be no assurance  that the Company will be  successful  in taking  control of
these functions from Pencom. The Company has also relied upon, and will continue
to rely upon,  Pencom for certain legal services and recruiting  functions.  The
Company's  management  has only limited  experience  operating  the Company as a
stand-alone company, separate and apart from Pencom. Pencom has no obligation to
provide financial or management assistance to the Company and has no plans to do
so.  The  inability  of  the  Company  to  operate  successfully  as  an  entity
independent  from Pencom would have a material  adverse  effect on the Company's
business, financial condition and results of operations.

         Variability of Quarterly  Operating  Results.  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. Such
quarterly  fluctuations are based on a number of factors,  including the number,
size and scope of  projects in which the  Company is  engaged,  the  contractual
terms and  degree  of  completion  of such  projects,  any  delays  incurred  in
connection  with a project,  the Company's  success in earning  bonuses or other
contingent  payments,  employee  hiring and utilization  rates,  the adequacy of
provisions  for losses,  the  accuracy of  estimates  of  resources  required to
complete ongoing projects and general economic  conditions.  Other factors which
may effect  operating  results  include  customer  budget  cycles  and  customer
spending priorities such as the Year 2000 compliance issue. A high percentage of
the Company's operating expenses,  particularly personnel and rent, are fixed in
advance of any particular quarter. For example, while the number of professional
staff the  Company  employs may be adjusted  to reflect  active  projects,  such
adjustments  take time and the  Company  must  maintain a  sufficient  number of
senior  professionals  to oversee  existing  client  engagements and to focus on
securing new client engagements.  As a result,  unanticipated  variations in the
number or progress  toward  completion of the Company's  projects or in employee
utilization rates may cause  significant  variations in operating results in any
particular  quarter  and  could  result  in  adverse  changes  to the  Company's
business,  financial condition and results of operations. In the last quarter of
1998,  revenues may be adversely  impacted by the Company's lengthy sales cycle,
among other matters,  which may cause the Company's  revenues and earnings to be
below the  expectations  of  securities  analysts.  Any  shortfall in revenue or
earnings  from  expected  levels  or  other  failures  to meet  expectations  of
securities  analysts or the market in general  regarding  results of  operations
could have an immediate and material  adverse  effect on the market price of the
Company's Common Stock. Given the possibility of such quarterly  fluctuations in
revenue or earnings,  the Company  believes  that  comparisons  of its quarterly
results of operations are not  necessarily  meaningful and that such results for
one quarter should not be relied upon as an indication of future performance.

         Need to Attract and Retain  Professional  Staff. The Company's  success
depends in large part upon its ability to attract,  train, retain,  motivate and
manage highly skilled employees,  particularly project managers and other senior
technical  personnel.  Significant  competition  exists for  employees  with the
skills required to perform the services offered by the Company,  and the Company
requires that a significant  number of such employees  travel to client sites to
perform services on its behalf,  which may make a position with the Company less
attractive  to  potential  employees.   Qualified  project  managers,   software
architects  and senior  technical  and  professional  staff are in great  demand
worldwide  and are  likely  to  remain a limited  resource  for the  foreseeable
future.  Furthermore,  there is a high rate of attrition  among such  personnel.
There can be no assurance that a sufficient  number of highly skilled  employees
will continue to be available to the Company,  that potential  employees will be
willing to travel to client  sites,  or that the Company will be  successful  in
training,  retaining and motivating  current or future employees.  The Company's
inability  to  attract,  train and retain  skilled  employees  or the  Company's
employees'  inability to achieve expected levels of performance could impair the
Company's  ability to adequately  manage and staff its existing  projects and to
bid for or obtain new  projects,  which in turn  would  have a material  adverse
effect on the Company's business, financial condition and results of operations.


                                       16
<PAGE>


         Rapid Technological Advances; Risk of Targeting  Emerging Technologies.
The Company has derived,  and will continue to derive, a substantial  portion of
its revenue from projects  based on  client/server  systems.  The  client/server
systems  market is continuing  to develop and is subject to rapid  technological
change.  The Company's future success will also depend in part on its ability to
develop IT  solutions  which keep pace with  continuing  changes in  information
processing   technology,   evolving  industry   standards  and  changing  client
preferences.  There can be no assurance  that the Company will be  successful in
addressing  these  developments  in a timely manner or that,  if addressed,  the
Company will be successful in the marketplace. The Company's delay or failure to
address these developments could have a material adverse effect on the Company's
business,  financial condition and results of operations. In addition, there can
be no assurance that products or technologies developed, or services offered, by
third parties will not render the Company's services noncompetitive or obsolete.
The  Company's  Software   Technology  Unit  also  seeks  to  identify  emerging
technologies  which it believes  will develop into  critical  technologies  with
broad  application  and  longevity.  Once  identified,  the  Company  may commit
substantial   resources  to  provide   services  to  the   developers   of  such
technologies.  No assurance can be given that the technologies identified by the
Company will develop  into  critical  technologies  with broad  application  and
longevity.  The  failure  of the  Company  to align  itself  with such  critical
emerging  technologies  would have a material  adverse  affect on its  business,
financial condition and results of operations.

         Changes in Senior  Management.  On August 31, 1998, the Company's Board
of Directors named Timothy D. Webb as president and Chief  Executive  Officer of
the Company.  Webb  succeeds Dr. W. Frank King who will continue to serve on PSW
Technologies,  Inc. Board of Directors and as an advisor to the Company. In May,
1998,  Patrick D. Motola resigned as Chief Financial Officer and was replaced by
Keith D.  Thatcher  (who had been  serving  as Vice  President  of  Finance  and
Treasurer of the  Company).  In  addition,  Brian E.  Baisley,  who had held the
position of Senior Vice  President of Client  Services,  resigned in  September,
1998.  Baisley's  position was not replaced and as a result,  the business  unit
vice presidents will report directly to the Chief Exectutive Officer.  There can
be no assurances that such changes in the senior  management of the Company will
not adversely affect the Company's results of operations or financial condition,
that the new  members of the  management  team will  succeed in their roles in a
timely or efficient manner or that they will be satisfactorily  assimilated,  or
that new and additional management responsibilities can be allocated effectively
among such executives.  Failure by the Company to assimilate new executives,  or
the failure of any such executive to perform effectively,  could have a material
adverse  effect on the Company's  business,  financial  condition and results of
operations.

         Dependence on Key Personnel.  The Company's  future success will depend
in part upon the  continued  services of a number of key  management  employees,
particularly  Timothy D. Webb,  Keith D. Thatcher,  James T. Kelsey,  Michael V.
Jaggers,  Brent R. Terry and  William C.  Cason,  and a number of key  technical
employees.  The loss of the services of any of the Company's key personnel could
have a material adverse effect on the Company's  business,  financial  condition
and results of operations.  In addition, the Company's credit facility prohibits
material  changes in management.  The Company does not maintain  key-person life
insurance on any of its employees.  In addition, if one or more of the Company's
key  employees  resigns  from  the  Company  to join a  competitor  or to form a
competing  company,  any resulting loss of existing or potential  clients to any
such competitor could have a material adverse effect on the Company's  business,
financial  condition and results of operations.  In the event of the loss of any
such  personnel,  there can be no  assurance  that the Company  would be able to
prevent the unauthorized disclosure or use of its technical knowledge, practices
or procedures by such personnel.

         System  Interruption and Security Risks.  The Company's  operations are
dependent on its ability to protect its  intranet  from  interruption  by damage
from  telecommunications  failure,  fire, earthquake,  power loss,  unauthorized
entry or other  events  beyond  the  Company's  control.  Most of the  Company's
computer equipment,  including its processing equipment, is currently located at
a single site.  There can be no assurance that  unanticipated  problems will not
cause any significant  system outage or data loss. Despite the implementation of
security  measures,  the  Company's  infrastructure  may also be  vulnerable  to
computer  viruses,  hackers or similar  disruptive  problems  caused by Internet
users.  Persistent problems continue to affect public and private data networks.
For example,  it is common for Internet service  providers to experience  system
interruptions which cause the Company to lose access to the Internet,  the means
by which the Company posts  internal  information  and provides  e-mail and time
sheet query and entry.  Any damage or failure that causes  interruptions  in the
Company's  operations  could have a  material  adverse  effect on the  Company's
business, financial condition and results of operations.

                                       17
<PAGE>

         Potential  Volatility  of Stock  Price.  The market for  securities  of
early-stage and small capital stock companies has been highly volatile in recent
years as a result of factors  often  unrelated  to a  company's  operations.  In
addition, the Company believes factors such as quarterly variations in operating
results,  announcements of technological innovations or new products or services
by the Company or its competitors,  general conditions in the IT industry or the
industries  in which the  Company's  clients  compete  and  changes in  earnings
estimates by securities  analysts,  could  contribute  to the  volatility of the
price of the Company's Common Stock. These factors,  as well as general economic
conditions  such as recessions  or changes in interest  rates,  could  adversely
affect the market price of the Company's Common Stock. Furthermore, in the past,
following  periods of volatility in the market price of a company's  securities,
securities  class action claims have been brought  against the issuing  company.
There can be no assurance that such litigation will not occur in the future with
respect to the Company.  Such litigation could result in substantial costs and a
diversion of management's attention and resources, and any adverse determination
in such  litigation  could also subject the Company to significant  liabilities,
all of which could have a material  adverse  effect on the  Company's  business,
financial condition and results of operations.

         Effect of  Certain  Antitakeover  Provisions.  The  Company's  Board of
Directors has the authority to issue shares of Preferred  Stock and to determine
the designations,  preferences and rights and the qualifications or restrictions
of those  shares  without any further  vote or action by the  stockholders.  The
rights of the holders of Common  Stock will be subject to, and may be  adversely
affected by, the rights of the holders of any Preferred Stock that may be issued
in the future.  The issuance of Preferred  Stock could have the effect of making
it more  difficult  for a third party to acquire a majority  of the  outstanding
voting  stock of the  Company.  In  addition,  the  Company  is  subject  to the
antitakeover  provisions of Section 203 of the Delaware General  Corporation Law
(the  "DGCL").  In general,  this  statute  prohibits a publicly  held  Delaware
corporation  from  engaging  in a  "business  combination"  with an  "interested
stockholder"  for a period of three years after the date of the  transaction  in
which  the  person  became  an  interested  stockholder,   unless  the  business
combination  is approved in a  prescribed  manner.  Furthermore,  certain  other
provisions of the Company's  Amended and Restated  Certificate of  Incorporation
and Amended and Restated Bylaws may have the effect of discouraging, delaying or
preventing a merger, tender offer or proxy contest, which could adversely affect
the market price of the Company's Common Stock.

         Uncertainty  Related  to the Year 2000  Compliance  Issues.  Many older
computer systems and software products currently in use are coded to accept only
two digit  entries in the date code  field.  These date code fields will need to
accept four digit  entries to  distinguish  21st century dates from 20th century
dates.  As a result,  in less than 15 months,  computer  systems and/or software
used by many  companies will need to be upgraded to comply with such "Year 2000"
requirements. Significant uncertainty still exists as to the global implications
of the Year 2000 issue.  The Company  believes that the  purchasing  patterns of
customers  and  potential  customers  may be  affected  by Year 2000 issues in a
variety  of ways.  Many  companies  (including  customers  of the  Company,  and
customers  or potential  customers of the  Company's  customers)  are  expending
significant  resources to correct or patch their  current  hardware and software
systems for Year 2000 compliance.  Such expenditures may result in reduced funds
available for the Company's customers to pursue product development  programs or
IT systems  enhancements  for which the Company's  services  would  otherwise be
utilized. Any of the foregoing,  including costs of defending and resolving Year
2000-related  disputes,   reductions  in  development  programs  or  IT  systems
enhancements  by customers and their  customers or the failure of the Company to
adequately  resolve  internal  Year 2000  compliance  issues  could  result in a
material  adverse  effect  on the  Company's  business,  operating  results  and
financial condition.


                                       18
<PAGE>



                          PART II -- OTHER INFORMATION

Item 2.   Use of Proceeds

On June 5, 1997 (the "Effective Date"), the Company's  Registration Statement on
Form S-1 (Registration  No.  333-21565)  relating to its initial public offering
(the "IPO") was declared effective by the Securities and Exchange Commission and
the offering of up to 3,277,500  shares of the Company's Common Stock covered by
such Registration  Statement commenced.  The IPO, which has been completed,  was
managed  by  Alex,  Brown & Sons  Incorporated  and J.P.  Morgan  & Co.,  as the
representatives of the several underwriters (the "Underwriters") of the IPO. All
of the  securities  registered  were sold for the  account of the  Company at an
aggregate offering price of $29.5 million. Of the shares of Common Stock sold by
the  Company,  2,850,000  shares were sold on June 5, 1997,  and 427,500  shares
(which were  subject to an  overallotment  option  granted by the Company to the
Underwriters) were sold on July 2, 1997.

In connection  with the IPO, total expenses of  approximately  $3.8 million were
incurred  by  the  Company,  which  expenses  consisted  of:  (i)  $2.1  million
representing  underwriting  discounts and commissions paid to the  Underwriters;
and (ii) other offering expenses, including without limitation, attorney's fees,
accountants' fees, printing costs and filing fees of approximately $1.7 million.
Of the other  offering  expenses,  $101,000 were direct or indirect  payments to
directors or officers of the Company or their  associates  or to persons  owning
ten percent (10%) or more of any class of equity securities of the Company or to
affiliates  of the  Company.  The net offering  proceeds of such  shares,  after
deducting such total expenses,  was approximately  $25.7 million,  of which $3.0
million was used to repay  indebtedness  of the  Company,  $654,000  was used to
satisfy certain federal income tax obligations of the Company,  $1.4 million was
used to pay a dividend to the Company's stockholders of record just prior to the
IPO in respect of the estimated tax that such  stockholders  are required to pay
on the estimated 1997 taxable income  allocated to them.  During the nine months
ended  September  30,  1998,  the Company  used $1.4  million of the proceeds to
acquire  property  and  equipment  and  $2.2  million  to fund  working  capital
requirements.  The remaining  $17.1 million is invested in short-term,  interest
bearing  municipal  obligations,  corporate  securities,  and money market funds
pending application of such proceeds by the Company. Other than the amounts paid
as a dividend to the  stockholders of record just prior to the IPO, no other net
proceeds  were paid  directly or  indirectly to any directors or officers of the
Company or their  associates  or to persons  owning ten percent (10%) or more of
any class of equity securities of the Company or to affiliates of the Company.


Item 6.   Exhibits and Reports on Form 8-K

          (a)Exhibits

Number   Description

 10.1    Employment Agreement dated August 28, 1998 between  the  Registrant and
         Timothy  D. Webb.
 27.1    Financial Data Schedule
---------


          (b) Reports on Form 8-K

                None.



                                       19
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                                   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.



                                       PSW TECHNOLOGIES, INC.
                                       (Registrant)



Date:  November 13, 1998               /s/ Timothy Webb              
                                       -----------------------
                                       Timothy Webb
                                       President and Chief Executive Officer
                                       (Principal Executive Officer)





Date:  November 13, 1998               /s/ Keith Thatcher
                                       -------------------------
                                       Keith D. Thatcher
                                       Vice President of Finance, Treasurer and
                                       Chief Financial Officer
                                       (Principal Financial Officer)



Date:  November 13, 1998               /s/ Kasaundra Smith
                                       -------------------------
                                       Kasaundra L. Smith
                                       Financial Reporting and Budgeting Manager
                                       (Principal Accounting Officer)



                                       20
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