<PAGE> 1

EXHIBIT 13.01

[PAGES 16-36]
            
SELECTED CONSOLIDATED FINANCIAL DATA (US FORMAT)

The following selected financial data should be read in conjunction with, and is
qualified in its entirety by reference  to, the  financial  statements  of Micro
Focus, expressed in U.S. dollars, set forth on pages 23 to 36 of this report.

<TABLE>
<CAPTION>
 .......................................................................................................................
(In thousands of U.S. dollars -
except per share and ADS data, percentages and employees)

Years ended January 31,                                       1998          1997        1996          1995         1994
-----------------------------------------------------------------------------------------------------------------------
<S>                                                           <C>            <C>         <C>           <C>         <C>
Results of Operations:
Net revenue                                                 167,309      123,227      134,784       151,012      137,164
Non-recurring items (note 2 below)                                -       (8,670)      (9,469)      (18,265)           -
Income (loss) before income taxes                            21,841      (13,972)     (11,245)        3,757       35,801
Net income (loss)                                            14,633      (14,690)     (11,156)      (3,507)       24,015
Net income (loss) per share:
   Basic                                                     $0.19       ($0.19)      ($0.14)       ($0.05)       $0.33
   Diluted                                                   $0.18       ($0.19)      ($0.14)       ($0.05)        $0.32
   Basic - per ADS (note 3 below)                            $0.93       ($0.95)      ($0.72)       ($0.23)        $1.65
   Diluted - per ADS: (note 3 below)                         $0.89       ($0.94)      ($0.72)       ($0.23)        $1.61
Weighted average number of shares outstanding, in thousands
   Basic                                                     78,735       77,675       77,395        75,420       72,830
   Diluted                                                   82,635       78,060       77,395        75,420       74,565
   Basic - ADS equivalent                                    15,747       15,535       15,479        15,084       14,566
   Diluted - ADS equivalent                                  16,527       15,612       15,479        15,084       14,913

Financial Position at January 31:
Cash and short-term investments                              84,490       75,696       63,857        94,511       92,732
Total assets                                                200,397      161,870      161,606       197,713      176,335
Long-term obligations                                            20           24          100           307          605
Shareholders' equity                                        114,834       92,744      107,275       124,831      120,602

Financial Condition:
Working capital                                              59,256       44,374       45,761        61,034       75,591
Current ratio                                                 1.78         1.74         1.77          1.96         2.61
Return on net revenue: excluding non-recurring items           8.7%         n/a          n/a           n/a         17.5%
Return on average equity: excluding non-recurring items       14.1%         n/a          n/a           n/a         19.9%

Employee Information:
Average number of employees                                     805          786          858           871          764
Number of employees at year-end                                 827          712          831           908          795
Net revenue per employee                                        208          157          157           173          180
 .........................................................................................................................

Notes:

1. Data for all periods  presented  has been  restated to reflect the pooling of
interest accounting in connection with the Company's acquisition of XDB Systems,
Inc. on January 20, 1998 (see note 2 to the consolidated financial statements on
page 30).

2. Details of the non-recurring  items are set out in note 5 to the consolidated
financial statements on page 31. 

3. Share and  per-share  data for all  periods  presented  has been  restated to
reflect the 5-for-1  stock split  which  occurred  effective  as of the close of
business on March 13, 1998 (see note 12 to the consolidated financial statements
on page 35). The Company's  American  Depository  Shares ("ADSs") did not split,
although the  conversion  rights of such ADSs have been  adjusted such that each
ADS represents  five ordinary  shares.  Per share earnings are also shown in the
U.S.format on an ADS equivalent basis, consistent with pre-split reporting.

</TABLE>

                                       16

<PAGE> 2

MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION (US FORMAT) 

The  following  discussion  should  be read in  conjunction  with the  financial
statements of Micro Focus Group Plc and its subsidiaries  ("Micro Focus" or "the
Company") in U.S. dollars, on pages 23 to 36.

The Company has previously referred to its current fiscal yearending January 31,
1998 as "fiscal  year 1997." In the  future,  the Company  will  designate  each
fiscal year by  reference  to the  calendar  year in which the last month of the
fiscal  year  occurs.  Accordingly,  the  Company's  current  fiscal year ending
January 31, 1998 is referred to as "fiscal year 1998",  "fiscal 1998" and "1998"
in this report, and prior fiscal years are referenced accordingly.

Results of Operations

On January  20,  1998,  the  Company  acquired  XDB  Systems,  Inc.("XDB").  The
transaction  was  accounted  for using  the  pooling  of  interests  method  and
accordingly the Company's financialstatements for all periods have been restated
to include the results of XDB. For further  information on the XDB  acquisition,
see the sections entitled "Business combinations" on pages 20 and 30.

Micro Focus  reported  net income for fiscal 1998 of $14.6  million or $0.18 per
share  diluted as compared to a net loss of $14.7  million or $0.19 per share in
1997 and a net loss of $11.2 million or $0.14 per share in 1996. Results for the
prior years  include  non-recurring  charges of $8.7 million and $9.5 million in
1997 and 1996, respectively.

The table below sets forth  results of operations as a percentage of net revenue
for the three fiscal years ended January 31, 1998, 1997 and 1996.

<TABLE>
<CAPTION>
                                                                                                        
 ........................................................................................................................
                                                                                                            Year to year            
                                                                  Percentage of net revenue            percentage change
                                                                                                       
                                                                  Years ended January 31               1997         1996    
                                                              1998         1997          1996       to 1998      to 1997
------------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>          <C>          <C>           <C>           <C>    
Net revenue
   Product revenue                                               62           58           58            46           (9)
   Service revenue                                               38           42           42            21           (9)
-------------------------------------------------------------------------------------------------------------------------
Total net revenue                                                100         100          100            36           (9)
-------------------------------------------------------------------------------------------------------------------------
Costs and expenses
   Cost of product revenue                                        6            7            9            28          (35)
   Cost of service revenue                                       16           16           15            36           (5)
-------------------------------------------------------------------------------------------------------------------------
Total cost of revenue                                            22           23           24            33          (16)
-------------------------------------------------------------------------------------------------------------------------
Gross profit                                                     78           77           76            36           (6)
-------------------------------------------------------------------------------------------------------------------------
Operating expenses
   Research and development                                      21           31           29            (9)         -
   Sales and marketing                                           38           43           43            16           (7)
   General and administrative                                     9           10            8            32            6
   Non-recurring items                                            0            7            7           n/a           (8)
-------------------------------------------------------------------------------------------------------------------------
Total operating expenses                                         68           91           87            -            (3)
-------------------------------------------------------------------------------------------------------------------------
Income (loss) from operations                                    10          (14)         (11)          n/a           14
Interest income                                                   3            3            3            41          (18)
Interest expense                                                  -            -           -             70          (38)
 .........................................................................................................................
Income (loss) before income taxes                                13          (11)          (8)          n/a          (24)
Income taxes                                                     (4)          (1)          -            n/a          n/a
-------------------------------------------------------------------------------------------------------------------------
Net income (loss)                                                 9          (12)          (8)          n/a          (32)
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

Net revenue

Micro Focus  derives its net revenue  from the license of software  products and
related support, maintenance and consulting services ("direct revenue") and from
the licensing of distribution  rights to software products to original equipment
manufacturers ("OEM revenue"). Direct revenue represents  approximately 90% of
total net revenue.

Net revenue is analyzed between product revenue, which consists of the licensing
of software  product to end-users and OEMs, and service  revenue,  consisting of
maintenance and other support services, including training and consulting.

                                       17
<PAGE> 3

Total net revenue  increased by $44.1 million or 36% to $167.3 million in fiscal
1998,  having  previously  decreased by $11.6 million or 9% to $123.2 million in
fiscal  1997.  The increase in 1998  reflected  initial  worldwide  sales of the
Company's SoftFactory/2000 and NetExpress products, increased UNIX product sales
and revenue  from  consulting  services.  The decrease in revenue in fiscal 1997
arose during the first two quarters with  relatively flat sales in comparison to
the third and fourth quarters.  Factors contributing to the decline in the first
two quarters of 1997 included slow  conversion of theMicro Focus  installed base
to 32-bit  products and continuing  uncertainties  arising from the  fundamental
changes caused by the Internet.  The improved  performance in the second half of
1997 reflected increased sales of products to address the "Year 2000" problem.

Product  revenue  increased by $32.9 million or 46% to $104.0  million in fiscal
1998,  having  previously  decreased by $6.6  million or 9% to $71.1  million in
fiscal 1997. The increase in product  licensing revenue in 1998 reflected higher
sales of Year 2000 products, UNIX products, NetExpress and other product lines.

Service  revenue  increased by $11.2  million or 21% to $63.3  million in fiscal
1998,  having  previously  decreased by $4.9  million or 9% to $52.1  million in
fiscal 1997.  The increase in service  revenue in 1998 resulted  from  increased
software maintenance revenue and from consulting revenue.

Net revenue by customer location was contributed as follows:

--------------------------------------------------------------------------------
Fiscal years:                   1998       1997       1996
--------------------------------------------------------------------------------
United States                   51%         54%        57%
United Kingdom                  12%         10%        10%
Other                           37%         36%        33%
--------------------------------------------------------------------------------
                               100%        100%       100%
--------------------------------------------------------------------------------

In fiscal 1998, U.S. revenue increased by 38% over 1997. Revenue from non-U.S.
territories increased by 34% over 1997.

In fiscal 1997, U.S. revenue decreased by 7%, while non-U.S.  territories showed
a 3%  increase,  with  growth in the  United  Kingdom,  France  and Japan  being
partially  offset by decreased sales to certain  distributors,  notably in Italy
and
Brazil.

There can be no assurance  that the market for the Company's  products will grow
in future periods at its historical rate of growth,  that certain  segments will
not decline, or that the Company will be able to increase or maintain its market
share in the future or achieve its historical revenue growth rates.

Cost of product revenue

Cost of  product  revenue  is  comprised  principally  of the  cost  of  product
materials  (including  the  purchase  of  disks  and  CDs,  transfer  of data to
electronic  media, and printing of manuals),  packaging and distribution  costs,
and royalties to third party  software  developers  for the licensing of certain
add-on softwarE products.

Such costs  increased  by $2.2  million or 28% to $10.3  million in fiscal 1998,
having previously  decreased by $4.3 million in fiscal 1997 and represented 10%,
11% and 16% of product revenue in 1998, 1997 and 1996,  respectively.  Decreases
in product  costs as a  percentage  of  product  revenue  principally  reflected
savings in product materials  arising from the  documentation  being supplied on
CD-ROM.

Cost of service revenue

Cost of service revenue is comprised  principally of compensation  for technical
support personnel, plus the costs associated with training and consulting.

Such costs  increased  by $7.0  million or 36% to $26.6  million in fiscal 1998,
having previously  decreased by $1.1 million in fiscal 1997 and represented 42%,
38% and 36% of  service  revenue  in 1998,  1997  and  1996,  respectively.  The
increase in such costs in 1998 arose mainly from the expansion of the consulting
organization, including the acquisition of Millennium UK Limited ("Millennium").
For further information on the Millennium acquisition, see the sections entitled
"Business combinations" on pages 20 and 30.

The decrease in 1997  reflected  reductions  taken to better align expenses with
revenue.

Gross profit

Gross profit represented 78%, 77% and 76% of net revenue in 1998, 1997 and 1996,
respectively. The improvement primarily reflected proportionately higher product
sales which carry higher margins and savings attributable to the
replacement of printed software documentation with electronic versions.

The  Company's  gross  margin can be affected by a number of factors,  including
changes in product or  distribution  channel mix, the mix of product and service
revenue, and competitive pressures on pricing. Gross margin is also dependent on
discounts selectively provided to customers in competitive sales situations.  In
addition,  gross margin may be adversely  affected by expansion of the Company's
consulting  organization  and the to deploy its  capacity to revenue  generating
projects.  As a result of the  above  factors,  gross  margin  fluctuations  are
difficult  to predict,  and gross  margins may decline  from  current  levels in
future periods.

                                       18
<PAGE> 4

Research and development

Research and development costs consist  principally of compensation for software
developers  and related costs  incurred,  after  adjusting for the proportion of
such costs  capitalized  (in accordance  with Statement of Financial  Accounting
Standard No. 86) and the amortization of previously  capitalized software costs.
Research and  development  spending  supports the development and enhancement of
new and  existing  products and is  consistent  with the  Company's  strategy of
investing heavily to improve and expand its product lines.

Research  and  development  spending  in fiscal  1998 was  directed  principally
towards further development of SoftFactory/2000  products which address the Year
2000  problem;  NetExpress,  a  complete  set of tools for  developing  business
applications  targeted  at  graphical  PC  workstations,   distributed  computer
environments  and the  Internet;  and tools to  enhance  the  functionality  and
capability of the COBOL Workbench  product line for  workstation  development of
IBM mainframe applications.

Research  and  development  spending  in 1997  and  1996  was  directed  towards
SoftFactory/2000  and NetExpress,  development of new 32-bit  products;  further
development of client/server solutions; object oriented programming in COBOL;
and tools for downsizing from IBM mainframes.

Expenditure   on   internal   software   research   and   development,    before
capitalization, decreased by $2.5 million or 7% to $31.6 million in fiscal 1998,
and by $6.2 million or 15% to $34.1 million in 1997 and represented 19%, 28% and
30% of net revenue in fiscal 1998, 1997 and 1996, respectively.  The decrease in
research  and  development  costs  reflects  a  lower  relative  cost  structure
following last year's restructuring of operations.

In fiscal 1998,  1997 and 1996,  $9.3 million,  $8.3 million and $15.6  million,
representing 29%, 24% and 39%, respectively, of these costs, were capitalized as
software product assets.  Provisions for amortization in those years,  excluding
non-recurring items, amounted to $12.7 million, $12.7 million and $13.9 million,
resulting  in a net charge to income in 1998 of $3.4  million,  compared to $4.4
million in fiscal 1997 and a net credit of $1.7 million in 1996.

The Company  believes that ongoing  development  of new products and features is
required to maintain and enhance its competitive  position.  Accordingly,  while
the  Company  will  continue to control  expenses  where  possible,  the Company
anticipates that aggregate research and development  expenses will increase over
time, and may not be directly related to the level of revenue realized in future
quarters.

Sales and marketing

Sales and marketing  costs include  compensation,  travel and facility costs for
sales,   pre-sales  and  marketing  personnel,   and  publicity  costs  such  as
advertising and trade shows.

Such costs  increased  by $8.7  million or 16% to $62.2  million in fiscal 1998,
having  previously  decreased by $4.0  million or 7% to $53.5  million in fiscal
1997,  and  represented  38%,  43% and 43% of  revenue  in 1998,  1997 and 1996,
respectively.  The increase in sales and marketing  costs  reflected sales force
expansion,  higher  commissions and higher  advertising and marketing  expenses,
including  those  associated with new product  launches.  The decrease in fiscal
1997 reflected the worldwide cost reduction initiatives implemented in the first
quarter of that year.

The Company believes that continued  investments in sales,  marketing,  customer
support and promotional  activities are essential to maintaining its competitive
position.   The  Company  is  expanding  its  sales  and  support   staffs  and,
accordingly,  anticipates  that aggregate  sales and marketing  expenses will be
higher in future periods, but as a function of revenue will remain about the 
same.

General and administrative

General and  administrative  costs  include the corporate  management,  finance,
legal and human resources operations of Micro Focus.

Such costs increased by $3.7 million or 32% to $15.6 million in fiscal 1998, and
by $0.7 million or 6% to $11.8  million in fiscal 1997 and  represented  9%, 10%
and 8% of revenue in 1998, 1997 and 1996,  respectively.  The increase in fiscal
1998 reflected  higher bonus accruals,  staff additions and related  recruitment
expenses,  goodwill  amortization  arising from the acquisition of Millennium UK
Limited and costs  incurred in connection  with the  acquisition of XDB Systems,
Inc. The increase in 1997 resulted  principally  from the  strengthening  of the
Micro Focus management team.

The Company is investing to strengthen its  infrastructure  and anticipates that
aggregate general and administrative  expenses will increase in future quarters,
but decrease as a percentage of revenue.

Non-recurring items

No non-recurring items were separately reported in fiscal 1998.

In fiscal 1997,  Micro Focus  incurred  restructuring  charges of $8.7  million.
These  charges  consisted  of  the  costs  associated  with a  reduction  in the
Company's   workforce  of  approximately  95  people,   facility   closures  and
consolidations, and asset write-downs.

Non-recurring  items recorded in 1996 consisted of a charge of $10.5 million for
restructuring and a credit of $1.0 million in respect of an employer loan to the
Micro Focus Group  Employee  Benefit  Trust  1994.  Restructuring  costs of $5.0
million  incurred in the first quarter of 1996  principally  related to employee
terminations  (including salary, benefit continuation and outplacement costs for
approximately  75  employees),   closure  of  surplus  office  facilities,   and
write-downs  of related  fixed  assets.  An  additional  charge of $5.5 million,
booked in the fourth  quarter of 1996,  reflected  a reduction  in the  carrying
values of software product assets in line with future revenue  expectations from
certain products.

                                       19

<PAGE> 5

Interest income

Interest earned on cash and short-term  investments increased by $1.3 million or
41% to $4.4 million in fiscal 1998, having previously  decreased by $0.7 million
or 18% to $3.1 million in fiscal 1997 and  represented 3% of net revenue in each
of the last three years.  The increase in fiscal 1998  reflected  higher average
cash balances and higher  investment  yields  resulting  from the  investment of
funds in money market instruments  instead of bank certificates of deposit.  The
decrease in 1997 reflected  lower average cash balances and, to a lesser degree,
lower interest rates.

Income taxes

The Company's tax rate in fiscal 1998 was 33%,  which  compares to the statutory
U.K. rate applicable to the Company of 31.3%.  The excess  principally  reflects
the impact of  permanent  differences  between  accounting  profits  and taxable
profits, primarily the amortization of goodwill.

The  tax  rate  in  both  1997  and  1996  was  significantly  affected  by  the
distribution of taxable profits and losses among the tax  jurisdictions in which
the Company  operates and by  restructuring  charges,  certain of which were not
deductible for tax purposes.

An analysis of the charge for income taxes, including an analysis of differences
between the effective rate and the U.K.  statutory  rates, is given in note 9 to
the consolidated financial statements pages 32 and 33.

Business combinations

During fiscal 1998, Micro Focus completed two acquisitions.

On  April  30,  1997,  the  Company  acquired  all of the  outstanding  stock of
Millennium  UK Limited  ("Millennium"),  a  privately-held  consulting  firm, in
exchange for 745,710  ordinary  shares in the Company and a cash payment of $3.2
million.  Millennium provided consulting and project management services and had
specialized  expertise in the  estimating,  planning and management of Year 2000
compliance projects for large scale systems, as well as development expertise in
Web-based  applications.  Effective  January 31, 1998,  Millennium's  consulting
services  were  integrated  with the  professional  services  operations  of the
Company.

The transaction has been accounted for as a purchase. Accordingly, the excess of
the purchase price over the estimated fair value of the net tangible  assets has
been  allocated to  goodwill,  and the net assets and results of  operations  of
Millennium have been combined with those of Micro Focus as of April 30, 1997 and
for the  nine-month  period  subsequent to April 30, 1997,  respectively.  Where
appropriate  the accounting  policies of Millennium have been amended to conform
with those of Micro Focus. The effects of the resulting changes to the financial
statements were not material.  The goodwill,  which amounted to $6.7 million, is
being  amortized  primarily  over three years.  On January 20, 1998, the Company
acquired XDB Systems,  Inc ("XDB") in exchange for 1,891,975  ordinary shares in
the Company.  XDB, a  privately-held  corporation  based in Maryland,  USA, is a
provider of DB2 database development, maintenance and connectivity solutions.

The combination has been accounted for using the pooling of interests method and
accordingly all financial data presented herein has been restated to include the
results of XDB.  Where  appropriate,  the  accounting  policies of XDB have been
amended  to conform  with those of Micro  Focus.  The  effects of the  resulting
changes to the financial
statements were not material.

In 1996,  Micro Focus completed the  acquisition of Burl Software  Laboratories,
Inc. The transaction was accounted for as a purchase.

Further information on these transactions is given in note 2 to the consolidated
financial statements on page 30.

Risk factors that may influence future operating results

Micro Focus operates in a rapidly changing environment that involves a number of
risks,  some of which are  beyond the  Company's  control.  This  section of the
discussion highlights some of these risks and the possible impact of
these factors on future results from operations.

The factors set forth below as well as statements  made elsewhere in this Report
contain certain forward-looking  statements that are based on the beliefs of the
Company's management,  as well as assumptions made by, and information currently
available  to,  the  Company's   management.   The  Company's   actual  results,
performance or  achievements  in fiscal 1999 and beyond could differ  materially
from those  expressed  in, or implied by, any such  forward-looking  statements.
Factors that could cause or contribute to such material differences include, but
are not limited to,  those  discussed in this  section,  as well as those in the
Letter to Shareholders and those discussed  elsewhere in this Annual Report. The
Company undertakes no obligation to release publicly any updates or revisions to
any  such  forward-looking   statements  may  reflect  events  or  circumstances
occurring after the date of this Annual Report.  For more information  regarding
forward-looking  statements, see "Further Information for Shareholders - Special
Note on Forward-Looking Statements"on page 13.

The  Company's  future  operating  results are subject to  quarterly  and annual
fluctuations  due to a variety of factors,  including  demand for the  Company's
products,  the size and timing of customer  orders,  product  life  cycles,  the
ability  of the  Company to  develop,  introduce  and  market  new and  enhanced
versions of the  Company's  products on a timely  basis,  the  introduction  and
acceptance  of new  products  and  product  enhancements  by the  Company or its
competitors,  customer order  deferrals in  anticipation  of enhancements or new
products,  changes  in the  mix  of  distribution  channels  through  which  the
Company's  products  are  offered,   purchasing  patterns  of  distributors  and

                                       20

<PAGE> 6

retailers,  quality  control  of  products  sold,  price and  other  competitive
conditions  in  the  industry,  changes  in the  Company's  level  of  operating
expenses,  changes in the Company's sales incentive  plans,  budgeting cycles of
its  customers,  the  cancellation  of  licenses  during  the  warranty  period,
nonrenewal  of  maintenance  agreements,  economic  conditions  generally  or in
various geographic areas, and other factors discussed in this section.  

A high  percentage  of Micro Focus'  operating  expenses is fixed over the short
term and if  anticipated  revenue  does not occur or is delayed,  the  operating
results  for  that  quarter  will be  immediately  and  adversely  affected.  In
addition,  a substantial  portion of the Company's  revenue for most quarters is
booked and shipped in the last month of the quarter  such that the  magnitude of
the quarterly  fluctuations  may not become evident until late in or even at the
end of the particular quarter. Furthermore, the Company's customers tend to make
product purchase decisions in the fourth quarter of the Company's fiscal year as
a result of purchase  cycles related to expiration of budgetary  authorizations.
As a result,  the Company has  historically  experienced  lower  revenue for the
first  quarter of a fiscal year than in the fourth  quarter of the prior  fiscal
year.

The Company's revenue is also affected by seasonal  fluctuations  resulting from
lower sales that  typically  occur during the summer  months in Europe and other
parts of the world. Due to all of the foregoing factors,  it is possible that in
some  future  quarters  the  Company's  operating  results  will  be  below  the
expectations  of stock market  analysts and  investors  and that the share price
would likely be materially adversely affected.

Micro Focus is in a market that is subject to rapid  technological  change.  The
Company  must  continually  adapt to that change by  improving  its products and
introducing new products and technologies.  The growth and financial performance
of Micro  Focus will  depend upon its  ability,  on a timely and  cost-effective
basis,  to develop  and  introduce  enhancements  of existing  products  and new
products  that  accommodate  the latest  technological  advances and  standards,
customer  requirements and market  conditions.  The Company's ability to develop
and market  enhancements of existing  products and new products depends upon its
ability to attract and retain qualified employees.  In the past, Micro Focus has
experienced  delays and  increased  expenses in  developing  new  products.  Any
failure  by the  Company  to  anticipate  or  respond  adequately  to changes in
technology and market conditions,  to complete product development and introduce
new  products on a timely  basis or to attract and retain  qualified  employees,
could materially  adversely affect the Companys business,  results of operations
and financial condition.

Substantially  all of the  Company's  revenue is  currently,  and is expected to
continue in the future to be,  derived from  products  and  services  related to
applications  development  in the COBOL  language.  As a result,  the  Company's
future  operating  results depend upon market  acceptance of the COBOL language.
Any  decline in the demand for or market  acceptance  of the COBOL  language  or
mainframe  computers  where  COBOL  is  a  dominant  language  as  a  result  of
competition, technological change or other factors would have a material adverse
effect on Micro Focus' business, financial condition and results of operations.

The  markets  in  which  the  Company   competes  are   characterized  by  rapid
technological change and aggressive  competition.  The Company believes that the
principal  competitive  factors in the Company's markets are product performance
and  reliability,   functionality,  product  quality,  application  portability,
product  enhancement,  price,  training,  support  and the  quality  of  service
offerings.  The  Company  expects  competition  to  increase  in the future from
existing  competitors  and from  other  companies  that may enter the  Company's
existing  or future  markets  with  similar or  substitute  solutions  including
database  vendors  of tools and  other  programming  languages  that may be less
costly or provide  better  performance or  functionality.  Some of the Company's
current and  prospective  competitors in the products and services  markets have
greater financial,  marketing or technical resources than Micro Focus and may be
able to adapt more quickly to new or emerging  technologies,  or devote  greater
resources  to the  promotion  and sale of their  products  than can Micro Focus.
There can be no  assurance  that other  companies  will not develop  competitive
products in the future.  In  addition,  the software  industry is  characterized
generally  by low  barriers  to  entry,  as a result  of which  new  competitors
possessing  technological,  marketing or other competitive advantages may emerge
and rapidly  acquire market share.  Furthermore,  there can be no assurance that
the  Company  will  be  able  to  compete  effectively  in  the  future  in  the
professional  services  market  and,  particularly,  the Year 2000  professional
services market.

The market price of the Company's  securities has experienced  significant price
volatility and such  volatility may occur in the future.  Factors such as actual
or anticipated fluctuations in the Company's operating results, announcements of
technological  innovations,  new products or new contracts by the Company or its
competitors,  conditions  and  trends  in  the  software  and  other  technology
industries,   adoption  of  new  accounting  standards  affecting  the  software
industry,  general  market  conditions  and other factors may have a significant
impact on the market price of the Company's securities.  Furthermore,  the stock
market has experienced  extreme  volatility that has  particularly  affected the
market prices of equity  securities  of many high  technology  companies.  These
market  fluctuations,   as  well  as  general  economic,  political  and  market
conditions, may adversely affect the market price of the Company's securities.

Micro Focus is subject to the general  economic  climate in the various areas of
the  world  in  which  it  does  business.  The  risks  inherent  in  conducting
international  business generally include exposure to exchange rate fluctuations
(see  "Exchange  rate  fluctuations"  below),  longer  payment  cycles,  greater
difficulties in accounts receivable collection and enforcing agreements, tariffs
and other restrictions on foreign trade, U.S. export requirements,  economic and
political instability,  withholding and other tax consequences,  restrictions on
repatriation  of earnings  and the burdens of  complying  with a wide variety of
foreign laws.

                                       21

<PAGE> 7

There can be no  assurance  that the  factors  described  above will not have an
adverse effect on the Company's future international revenue and expenses.

The Company  markets  certain of its  products  and  services to  customers  for
managing  development  and  maintenance of  mission-critical  computer  software
systems. In addition, an increasing portion of the Company's business is devoted
to  addressing  the  Year  2000  problem  which  affects  the   performance  and
reliability of many mission-critical  systems. The Company's agreements with its
customers  typically contain provisions designed to limit the Company's exposure
to potential product and service liability claims. It is possible, however, that
the  limitation  of liability  provisions  contained in the  Company's  customer
agreements  may not be  effective  as a result of  existing  or future  federal,
state,  local or foreign laws or ordinances or unfavorable  judicial  decisions.
Although the Company has not experienced any product or service liability claims
to date,  the sale and support of its  products and services may entail the risk
of such claims,  particularly in the Year 2000 market.  A successful  product or
service  liability  claim  brought  against  the  Company  could have a material
adverse  effect upon the  Company's  business,  operating  results and financial
condition.  Furthermore,  the Company  anticipates  that demand in the Year 2000
market will decline, perhaps rapidly, following the year 2000 and the demand for
the Company's Year 2000  solutions,  products and services may also decline as a
result of new  technologies,  competition or other  factors.  If this decline in
demand were to occur, the Company's  license revenues and professional  services
fees could be materially and adversely affected.

Micro Focus is in the process of reviewing all of its major  internal  corporate
systems for any potential Year 2000 compliance  issues and will take appropriate
corrective  action based on the results of such review. In doing so, Micro Focus
does  not  anticipate  that it will  incur  material  operating  expenses  or be
required to invest heavily in internal  system  improvements as a result of Year
2000  compliance  issues.  In addition,  Micro Focus  believes  that the current
versions of its software products are Year 2000 compliant.  Notwithstanding  the
foregoing, there can be no assurance that the Year 2000 problem will not have an
adverse  effect on the  Company's  business,  financial  condition or results of
operations,  due to external factors relating to the Year 2000 problem which are
not controlled by Micro Focus, but on which Micro Focus may rely with respect to
its business and operations.

Micro Focus completed two significant business  combinations during fiscal 1998,
as previously noted. The Company is in the process of integrating the operations
acquired in these  transactions with its own. There can be no assurance that the
anticipated  benefits  of  recently  concluded  business  combinations  will  be
realized. In addition,  these acquisitions could require significant  additional
management  attention.  The  Company  expects to continue  growing its  business
through acquisitions. If Micro Focus is unsuccessful in integrating and managing
the  recently  acquired  businesses  or other  businesses  it may acquire in the
future, the Company's  business,  results of operations and financial  condition
could be adversely affected in future periods.

Exchange rate fluctuations

Micro Focus prepares separate  consolidated  financial  statements  expressed in
U.S. dollars and G.B. pounds.  Revenue, costs and expenses arising in currencies
other than the reporting  currency are translated  using average exchange rates.
Assets and  liabilities  denominated  in  currencies  other  than the  reporting
currency are translated at exchange rates in effect at the balance sheet date.

The majority of the Company's net revenue arises in U.S. dollars  (approximately
two-thirds  in 1998),  whereas its costs are incurred  approximately  equally in
U.S. dollars and other  currencies,  predominately  G.B.  pounds.  Consequently,
fluctuations  in exchange  rates,  particularly  between the U.S. dollar and the
G.B. pound, may have a significant  impact on the Company's  operating  results,
notably when expressed in G.B. pounds.

In 1998 and 1997,  fluctuations  between the U.S. dollar and the G.B. pound have
not been  significant,  and net  exchange  rate  gains or losses on  operational
transactions have been immaterial.

Liquidity and capital resources

Micro Focus continues to fund its activities  through cash from  operations.  In
1998,  cash  provided by operating  activities  was $31.1 million  (1997:  $22.8
million).

In 1998,  Micro Focus invested  $13.8 million (1997:  $4.2 million) in property,
plant and equipment and $9.3 million  (1997:  $8.3 million) in software  product
assets.  Investment  in 1998  included  $4.3  million  in  connection  with  the
relocation of the Company to new U.S.  facilities in Mountain  View,  California
and Wayne,  Pennsylvania,  and $5.1 million for  communications  and  enterprise
systems.  In 1998, the Company also paid $3.2 million in cash in connection with
the acquisition of Millennium.

Net of these  expenditures,  cash and short-term  investments  increased by $8.8
million to $84.5 million (1997: increased by $10.4 million to $75.7 million).

The  Company  has in place a line of credit  under the terms of which  unsecured
financing of up to $8.0 million is available  until January 2001. At January 31,
1998,  borrowings  totalling  $1.7  million had been made  against  this line of
credit (1997: $0).

Micro  Focus  believes  it is  important  to  maintain  a  conservative  capital
structure and a strong cash position. Cash is primarily invested in liquid money
market investments. The Company's investment policy is designed to minimize risk
while  maximizing  return  on  cash  given  such  levels  of  risk,  and to keep
uninvested cash at a minimum. Cash management is centralized, although some cash
is held at various subsidiaries around the world to meet local operating
requirements.

The Company believes that existing cash balances, in combination with internally
generated  funds  and its  available  bank  lines of  credit,  will be more than
sufficient to meet cash requirements in fiscal 1999.

                                       22

<PAGE> 8

CONSOLIDATED STATEMENTS OF INCOME (US FORMAT) 

<TABLE>
<CAPTION>

 .................................................................................................................
(In thousands of U.S. dollars -
except share and per share data) 

                            Years ended January 31,           1998          1997       1996
------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>            <C>        <C>  
Net revenue
   Product revenue                                          $104,041      $71,115      $77,725
   Service revenue                                            63,268       52,112       57,059
------------------------------------------------------------------------------------------------------------------
Total net revenue                                            167,309      123,227      134,784
------------------------------------------------------------------------------------------------------------------
Cost of revenue
   Cost of product revenue                                    10,309        8,075       12,416
   Cost of service revenue                                    26,593       19,586       20,642
-------------------------------------------------------------------------------------------------------------------
Total cost of revenue                                         36,902       27,661       33,058
-------------------------------------------------------------------------------------------------------------------
Gross profit                                                 130,407       95,566      101,726
-------------------------------------------------------------------------------------------------------------------
Operating expenses
   Research and development (note 4)                          35,040       38,556       38,573
   Sales and marketing                                        62,214       53,519       57,494
   General and administrative                                 15,559       11,814       11,102
   Non recurring items (note 5)                                   -         8,670        9,469
-------------------------------------------------------------------------------------------------------------------
Total operating expenses                                     112,813      112,559      116,638
-------------------------------------------------------------------------------------------------------------------
Income (loss) from operations                                17,594      (16,993)     (14,912)
Interest income                                               4,370        3,094        3,784
Interest expense                                              (123)         (73)        (117)
-------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes                             21,841      (13,972)     (11,245)
Income taxes (note 9)                                         (7,208)        (718)          89
-------------------------------------------------------------------------------------------------------------------
Net income (loss)                                            $14,633     ($14,690)    ($11,156)
-------------------------------------------------------------------------------------------------------------------

Net income (loss) per share - basic (note below)              $0.19       ($0.19)       ($0.14)
Net income (loss) per ADS - basic                             $0.93       ($0.95)       ($0.72)
 ..................................................................................................................
Weighted average number of shares outstanding - 
basic (thousands)                                             78,735       77,675       77,395
Shares converted to ADS equivalent                            15,747       15,535       15,479
-------------------------------------------------------------------------------------------------------------------

Net income (loss) per share - diluted (note below)            $0.18       ($0.19)      ($0.14)
Net income (loss) per ADS - diluted                           $0.89       ($0.94)      ($0.72)
 ...................................................................................................................
Weighted average number of shares outstanding - 
diluted (thousands)                                          82,635       78,060       77,395
Shares converted to ADS equivalent                           16,473       15,612       15,479
-------------------------------------------------------------------------------------------------------------------

Note:
Shares and per share data for all periods presented has been restated to reflect
the 5-for-1 stock split of the Company's ordinary shares, which was effective as
of the  close of  business  on March 13,  1998 (see note 12 to the  consolidated
financial  statements  on page 35). The  Company's  American  Depository  Shares
("ADSs") did not split,  although the  conversion  rights of such ADSs have been
adjusted such that each ADS represents five ordinary shares.  Per share earnings
are also shown sin the U.S.format on an ADS equivalent  basis,  consistent  with
pre-split reporting.

See accompanying notes to consolidated financial statements on pages 27 to 36.

</TABLE>

                                       23

<PAGE> 9

CONSOLIDATED BALANCE SHEETS (US FORMAT)

<TABLE>
<CAPTION>

 ..................................................................................................................
(In thousands of U.S. dollars - 
except per share data                                                               January 31,  January 31,
                                                                                           1998         1997
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                       <C>        <C>     
Current assets:
   Cash and cash equivalents                                                           $48,174      $73,119
   Short-term investments                                                               36,316        2,577
   Accounts receivable, net of allowances for doubtful accounts 
   of $2,499 ($1,731 in 1997)                                                           47,798       22,390
   Inventories                                                                             519          774
   Prepaid expenses and other assets                                                     2,833        5,870
-------------------------------------------------------------------------------------------------------------------
Total current assets                                                                   135,640      104,730
-------------------------------------------------------------------------------------------------------------------
Fixed assets:
Property, plant and equipment, net (note 6)                                             39,083       33,796
Goodwill, net of accumulated amortization of $1,391 ($nil in 1997)                       5,346            0
Software product assets, net of accumulated amortization of $108,871 ($95,402 in 1997)  20,328       23,344
-------------------------------------------------------------------------------------------------------------------
Total assets                                                                          $200,397     $161,870
-------------------------------------------------------------------------------------------------------------------
Liabilities and shareholders' equity 
Current liabilities:
   Bank loan                                                                           $1,652        $1,500
   Accounts payable                                                                     6,957         5,732
   Product and royalties payable                                                        1,386           963
   Accrued employee compensation and commissions                                       12,383         5,811
   Accrued payroll taxes                                                                1,142           838
   Income taxes payable                                                                10,459         4,142
   Deferred revenue                                                                    32,848        31,155
   Other current liabilities                                                            9,557        10,215
-------------------------------------------------------------------------------------------------------------------
Total current liabilities                                                               76,384       60,356
-------------------------------------------------------------------------------------------------------------------
Long term debt and other liabilities                                                        20           24
Deferred income taxes (note 9)                                                           9,159        8,746
-------------------------------------------------------------------------------------------------------------------
Total liabilities                                                                       85,563       69,126
-------------------------------------------------------------------------------------------------------------------
Commitments (note 8)
Shareholders' equity:
   Ordinary shares: 2 pence (G.B.) par value 112,500,000 shares authorized, 
   79,417,000 shares issued and outstanding (75,840,000 in 1997)                       $2,508        $2,452
   Additional paid-in capital                                                          33,362        27,468
   Unrealised gain (loss) on available-for-sale securities, net of tax                     44        (90)
   Treasury stock                                                                      (7,769)       (8,959)
   Retained earnings                                                                    89,019       74,386
Currency translation adjustment                                                         (2,330)      (2,513)
-------------------------------------------------------------------------------------------------------------------
Total shareholders' equity                                                              114,834       92,744
-------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity                                             $200,397     $161,870
-------------------------------------------------------------------------------------------------------------------

Note:  Share data for all  periods  presented  has been  restated to reflect the
5-for-1 stock split of the Company's ordinary shares,  which was effective as of
the  close of  business  on March  13,  1998  (see  note 12 to the  consolidated
financial  statements  on page 35). The  Company's  American  Depository  Shares
(""ADSs"") did not split,  although the conversion rights of such ADSs have been
adjusted such that each ADS represents five ordinary shares.

See accompanying notes to consolidated financial statements on pages 27 to 36.

</TABLE>


                                       24

<PAGE> 10

CONSOLIDATED STATEMENTS OF CASH FLOW (US FORMAT)

<TABLE>
<CAPTION>
 .......................................................................................................................
(In thousands of U.S. dollars)         Years ended January 31,                          1998           1997       1996
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>            <C>         <C>    
Operating activities
     Net income (loss)                                                                $14,633     ($14,690)    ($11,156)
     Adjustments to reconcile net income (loss) to cash provided by operations
          Depreciation of fixed assets                                                  7,706         9,410       10,290
          Amortization of software product assets                                      12,716        12,690       19,862
          Amortization of goodwill                                                      1,391             0            0
          Loss on sale of fixed assets                                                    207           504          237
          Deferred income taxes                                                         1,846        (1,622)
     Changes in operating assets and liabilities:
          (Increase) decrease in accounts receivable                                   (26,506)       13,691        4,339
          Decrease  in inventories                                                        247         1,895          185
          (Increase) decrease in prepaid expenses and other assets                      2,955         1,011          149
          Increase (decrease) in accounts payable                                       1,607        (2,560)       1,002
          Increase (decrease) in product royalties payable                              1,034           (18)         312
          Increase (decrease) in accrued employee compensation                          6,581          (890)        (908)
          Increase (decrease) in accrued payroll taxes                                    381           158         (105)
          Increase  (decrease) in income taxes payable                                  6,219        (2,204)      (4,786)
          Increase (decrease) in deferred revenue                                       2,000        (1,481)      (3,709)
          (Decrease)increase in other current liabilities                                 (49)        3,413       (1,117)
-------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities                                              31,122        22,775       12,973
-------------------------------------------------------------------------------------------------------------------------
Investing activities
   Purchases of property, plant and equipment, net of capital lease                   (13,782)       (4,235)     (14,065)
   obligations incurred
   Software product assets                                                             (9,321)       (8,261)     (15,989)
   Own shares                                                                           1,190             0       (7,954)
   Acquisition of subsidiary, net of cash balances acquired                            (3,437)            0            0
   Settlement of deferred purchase consideration                                            0             0       (6,252)
   Disposals of property, plant and equipment                                             570           916          478
   Short-term investments                                                             (33,639)        1,654        1,056
-------------------------------------------------------------------------------------------------------------------------
Net cash (used) by investing activities                                               (58,419)       (9,926)     (42,726)
-------------------------------------------------------------------------------------------------------------------------
Financing activities
   Issuance of ordinary shares, net of expenses                                         2,439           215          446
   Borrowings                                                                             152         1,500           0
   Repayment of capital leases                                                            (73)         (233)        (467)
-------------------------------------------------------------------------------------------------------------------------
Net cash (used) by financing activities                                                 2,518         1,482          (21)
-------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash                                                  (166)         (687)        (117)
(Decrease) increase in cash                                                           (24,945)       13,644      (29,891)
Cash at beginning of year                                                              73,119        59,475       89,366
-------------------------------------------------------------------------------------------------------------------------
Cash at end of year                                                                   $48,174       $73,119      $59,475
-------------------------------------------------------------------------------------------------------------------------

Supplemental disclosure of cash flow information:
   Income taxes paid during the year                                                    $817        $1,022       $6,460
   Interest paid during the year                                                          87            72          172

See accompanying notes to consolidated financial statements on pages 27 to 36.

</TABLE>
                                       25
<PAGE> 11

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (US FORMAT) 

<TABLE>
<CAPTION>

 ....................................................................................................................................
                                                               Unrealized
                                        Ordinary  Additional      gain on                Deferred                Currency
(In thousands)                  Number    shares     pain-in   marketable  Treasury       purchase  Retained  translation          
                             of shares    amount     capital   securities     stock  consideration  earnings   adjustment   Total
------------------------------------------------------------------------------------------------------------------------------------
<S>                               <C>       <C>      <C>         <C>         <C>         <C>           <C>         <C>       <C>
BALANCE, JANUARY 31, 1995       73,710    $2,323   $19,549      ($311)        -         $5,311       $100,232    ($2,412) $124,692
Share options exercised            575        19       474          -         -         -              -           -           493
Agreed acquisition of Burl       3,325       107     7,234          -         -         (5,311)        -           -         2,030
Unrealized gain on marketable
     securities, net of taxes        -         -        -         313         -         -              313         -            -
Treasury stock                       -         -        -           -      (8,959)      -              -           -        (8,959)
Net loss                             -         -        -           -         -         -            (11,156)      -       (11,156)
Currency translation adjustment      -         -         -          -         -         -              -          (1,370)   (1,370)
 ....................................................................................................................................
BALANCE, JANUARY 31, 1996       77,610     2,449    27,257          2     8,959)        -             89,076      (3,782)   106,043
Share options exercised            120         3       211          -         -         -              -           -            214
Unrealized loss on marketable
   securities, net of taxes          -         -         -         -        (92)        -              -           -           (92)
Net loss                             -         -         -         -          -         -             (14,690)     -       (14,690)
Currency translation adjustment      -         -         -          -         -         -                -         1,269      1,269
 ....................................................................................................................................
BALANCE, JANUARY 31, 1997       77,730     2,452    27,468        (90)   (8,959)       -              74,386      (2,513)    92,744
Share options exercised            941        31     2,408          -     1,190         -                -          -         3,629
Issued for acquisitions            746        25     3,486          -         -         -                -          -         3,511
Unrealized gain on marketable
securities, net of taxes             -         -         -        134         -         -                -          -           134
Net income                           -         -         -          -         -                        14,633       -        14,633
Currency translation adjustment      -         -         -          -         -         -                -         183          183
------------------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 31, 1998       79,417    $2,508   $33,362        $44   ($7,769)       $-             $89,019    ($2,330)  $114,834
------------------------------------------------------------------------------------------------------------------------------------

Note:  Share data for all  periods  presented  has been  restated to reflect the
5-for-1 stock split of the Company's ordinary shares,  which was effective as of
the  close  of  business  on  March  13,1998  (see  note 12 to the  consolidated
financial  statements  on page 35). The  Company's  American  Depository  Shares
("ADSs") did not split,  although the  conversion  rights of such ADSs have been
adjusted such that each ADS represents five ordinary shares.

See accompanying notes to consolidated financial statements on pages 27 to 36.

</TABLE>

                                       26
<PAGE> 12

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (US FORMAT)

The statutory financial  statements of Micro Focus Group Plc, within the meaning
of section 240 of the  Companies Act 1985 of Great  Britain,  for the year ended
January 31, 1998 are contained on pages 51 to 67.

The Company has  previously  referred to its current  fiscal year ending January
31, 1998 as "fiscal year 1997." In the future,  the Company will  designate each
fiscal year by  reference  to the  calendar  year in which the last month of the
fiscal  year  occurs.  Accordingly,  the  Company's  current  fiscal year ending
January 31, 1998 is referred to as "fiscal year 1998",  "fiscal 1998" and "1998"
in this report, and prior fiscal years are also referenced accordingly.

Note 1 Significant accounting policies

To enable the reader to see immediately any information  provided in addition to
the common policy statements, the text of this note and the corresponding note 1
to the U.K. format financial  statements on page 57 is italicised where the text
is identical.

Nature of operations

Micro Focus designs and develops computer software  products.  Approximately 90%
of its revenue is derived from the sale of software product licenses and related
support and  maintenance  to end users.  The  remaining  10% is derived from the
licensing  of  distribution  rights to software  products to original  equipment
manufacturers.

Product licenses are sold and supported in more than 60 countries. The principal
market is the United States,  which accounts for  approximately  50% of revenue.
Approximately   30%  of  revenue  is  derived  from   customers  in  Europe  and
approximately 20% is earned in the rest of the world.

Principles of consolidation

The  consolidated  financial  statements are those of the Company and all of its
subsidiaries.  They have been prepared under the historical  cost convention and
in accordance  with U.S.  generally  accepted  accounting  principles  ("GAAP"),
which, as applied by Micro Focus, do not differ in any significant  respect from
U.K. GAAP,  except with regard to the treatment of acquisitions and goodwill and
the presentation of certain items in the financial statements.

As more fully described in Note 2, on January 20, 1998, the Company acquired XDB
Systems,  Inc.  ("XDB").  The transaction was accounted for using the pooling of
interests  method and accordingly  all financial data presented  herein includes
the results of XDB. All significant inter-company balances and transactions have
been eliminated on consolidation.

The Company has revised the  presentation of its income  statement to show gross
profit by  segregating  direct  costs of  revenue  from  operating  costs.  This
revision does not affect the results of operations of the Company.

The  preparation of financial  statements in accordance  with U.S. GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial  statements and  accompanying  notes.  Actual results could differ
from those estimates.

Revenue recognition

Net revenue  represents  the amounts  derived  from the  provision  of goods and
services  which fall within the  Company's  ordinary  activities,  stated net of
applicable sales taxes.

Revenue from licensing  software packaged products to end users and resellers is
recognized on delivery,  provided that no significant  vendor  obligations exist
and collection of the resulting receivable is deemed probable.

Revenue  from  sales  to  original  equipment   manufacturers   ("OEM's")  under
non-cancelable  license  agreements  generally  provide for development fees and
initial license fees, which are recognized at the later of: (a) the date product
is delivered to the OEM; (b) the date payment  becomes due within twelve months;
and (c) the date of  receipt of monies if  collection  cannot be  assessed  with
reasonable  assurance.  When  sales by the OEM exceed the  initial  license  fee
commitment, revenue is recognized as unit shipments are reported by the OEM.

Revenue from maintenance  agreements is recognized pro-rata over the life of the
agreement corresponding to notional delivery of the service.

Software product assets (capitalized software development costs)

Costs  related to the initial  development  and design of new software  products
prior to the  establishment  of  technological  feasibility  are  written off as
research  and  development  costs.  Once  technological   feasibility  has  been
reasonably  established,  either by the completion  and successful  testing of a
detailed program design,  or by the creation and testing of an operative working
model,  further  development  costs incurred are capitalized as software product
assets,  in compliance with Statement of Financial  Accounting  Standards No. 86
("SFAS 86") "Accounting for the Cost of Computer  Software to be Sold, Leased or
Otherwise Marketed".

                                       27
<PAGE> 13

Software  licensed  for  inclusion  in the Micro Focus  product  set,  including
software   acquired  through   acquisitions   which  meets  the  provisions  for
capitalization under SFAS 86, is also included in software product assets.

During the years  ended  January  31,  1998,  1997 and 1996  purchased  software
totaling  $0,  $0 and  $350,000,  respectively,  was added to  software  product
assets.

Software  product  assets are amortized  using the straight line method over the
estimated  economic life of the  products,  which in most cases is assumed to be
four years.  Where a shortfall in future revenue from a product is  anticipated,
amortization is accelerated.

Amortization of software  product assets is included in research and development
costs.

Goodwill

Goodwill  represents  the  excess of the  amount  paid on the  acquisition  of a
business  over the  aggregate  fair value of the net assets  acquired.  Goodwill
arising on a purchase is capitalized as an intangible  fixed asset and amortized
over its estimated useful life.

The estimated  lives will depend on the length of the future period  expected to
benefit from the  purchase.  Where there is a potential  impairment of goodwill,
based on cash flow  projections  of the  businesses  acquired,  amortization  is
accelerated.

Property, plant and equipment

Property,  plant and equipment is stated at cost less  accumulated  depreciation
and   amortization.   Depreciation   and  amortization  is  computed  using  the
straight-line  method over  estimated  economic lives from the time the asset is
put into use. Present estimated economic lives are as follows:

Office buildings           40 years
Leasehold improvements     over the lease term
Computer equipment         3 - 5 years
Office equipment           7 years
Transportation equipment   3 - 4 years

Leasing

Leases which transfer  substantially  all the benefits and risks of ownership of
an asset to Micro Focus are capitalised as fixed assets.  The amount capitalised
is that sum for which the leased  asset could be  purchased  at the start of the
lease, this sum also being treated as a liability.

Depreciation on such leased assets is provided at rates  calculated to write off
the capitalized cost over the shorter of the lease term and the asset's economic
life.  Lease payments are apportioned  between finance charges  (computed on the
basis of implicit interest rates) and a reduction in the original liability.

Rentals paid under  operating  leases are expensed on a straight line basis over
the term of the lease.

Income taxes

The  provision  for income  taxes  includes  U.S.,  U.K.  and other income taxes
currently  payable and those deferred because of temporary  differences  between
financial and tax reporting.

Inventories

Inventories,  consisting  principally  of diskettes and technical  manuals,  are
stated at the lower of cost or market,  using the  first-in,  first-out  method.
Contracts  in  progress,   representing   engineering   costs   associated  with
non-cancelable license agreements prior to delivery, are included in inventories
and expensed when the related revenue is recognized.

Cash and short-term investments

Cash  and cash  equivalents  include  cash  placed  on  short-term  deposit  and
short-term money market instruments where the
maturity date is less than three months from the initial date of deposit.

In accordance  with SFAS 115  "Accounting  for Certain  Investments  in Debt and
Equity  Securities,"  the  appropriate  classification  of  debt  securities  is
determined at the time of purchase and  re-evaluated at each balance sheet date.
Debt  securities  that the  Company has the intent and the ability to hold until
maturity are classified as  held-to-maturity,  and all other debt securities are
classified as available-for-sale.

                                       28
<PAGE> 14

Short-term investments represents cash placed on deposit where the maturity date
exceeds three months from the initial date of deposit.

Other financial instruments

The Company enters into forward foreign currency contracts to hedge the value of
assets and liabilities recorded in
foreign currencies against fluctuations in exchange rates.

Translation of foreign currencies

Micro  Focus'  policy on  foreign  currency  translation  complies  with SFAS 52
"Foreign Currency Translation".

Assets and  liabilities  denominated in currencies  other than U.S.  dollars are
translated at exchange  rates in effect at the balance sheet date.  Closing U.S.
dollar to G.B.  pound  rates at January  31,  1998,  1997 and 1996 were $1 = GBP
0.610,  $1 = GBP  0.625 and $1 = GBP  0.662,  respectively.  Revenue,  costs and
expenses are translated using average rates. Monthly average U.S. dollar to G.B.
pound  rates used during  fiscal 1998 range  between $1 = GBP 0.599 and $1 = GBP
0.625,  and average $1 = GBP 0.611,  $1 = GBP 0.633 and $1 = GBP 0.634 in fiscal
1998, 1997 and 1996,  respectively.  Translation  adjustments resulting from the
process of translating financial statements denominated in currencies other than
U.S. dollars are dealt with separately in shareholders' equity.

Net income (loss)/per share

Net income  (loss) per share is computed in  accordance  with SFAS 128 "Earnings
per Share" which is required to be adopted in financial  statements  for periods
ending on or after December 15, 1997.  Accordingly,  net income (loss) per share
is disclosed in accordance with SFAS 128 for all periods presented.

Basic net  income  (loss)  per share is based on net  income  (loss)  and on the
weighted average number of ordinary shares outstanding during the period.

Diluted net income per share is based on net income and on the weighted  average
number of ordinary shares outstanding during the period,  including common share
equivalents,  represented by shares issuable upon exercise of share options. The
computation  assumes the proceeds from the exercise of share options are used to
repurchase  the Company's  ordinary  shares at their average market price during
each period.  In 1996 and 1997,  common stock  equivalents were antidilutive and
therefore excluded from the computation.

Shares and per share data for all periods presented has been restated to reflect
the  5-for-1  Stock  Split  (see note 12 on page  35).  The  Company's  American
Depository Shares ("ADSs") did not split, although the conversion rights of such
ADSs have been adjusted such that each ADS represents five ordinary shares.  Per
share  earnings are also shown in the  U.S.format  on an ADS  equivalent  basis,
consistent with pre-split reporting.

Pro-forma net income (loss) per share calculated on the fair-value-based  method
is  disclosed  in  accordance   with  SFAS  123   "Accounting  for  Stock  Based
Compensation" (see "Stock based compensation" below).

Concentration of credit risk

Financial instruments which potentially subject the Company to concentrations of
credit risk consist  principally  of short-term  investments,  foreign  exchange
contracts and trade receivables.

Micro Focus places its  short-term  investments  only in financial  high quality
instruments and, by policy, limits the amounts invested with any one issuer. The
counterparties  to the  agreements  relating to the Company's  foreign  exchange
contracts are financial institutions of high credit standing.  Concentrations of
credit  risk with  respect to trade  receivables  are  limited due to the large,
widespread  customer  base  which  encompasses  many  different  industries  and
countries.  No single customer  represented more than 5% of Micro Focus' revenue
in 1998, 1997 and 1996.

Other risks and uncertainties

The Company amortizes  capitalized  software using the straight-line method over
the  remaining  estimated  economic  life of the product.  In the event that the
remaining  estimated  economic  life  of a  product  is  judged  to  be  reduced
significantly,  the carrying  amount of the  capitalized  software  costs may be
reduced.

Stock based compensation

The Company adopted SFAS 123 "Accounting for Stock-Based Compensation" in fiscal
1997.  As permitted by SFAS 123, the Company  continues to measure  compensation
expense for its  stock-based  employee  compensation  plans using the  intrinsic
value method  prescribed  by APB Opinion No. 25  "Accounting  for Stock  Options
Issued to  Employees",  and  accordingly,  since all options are granted with an
exercise  price  equal to the fair  value of the  shares  at the date of  grant,
recognizes no compensation expense for share option grants.

Pro-forma  disclosures  of net income  (loss)  and net  income  (loss) per share
computed  as if the  fair-value-based  method  prescribed  by SFAS  123 had been
applied are provided in Note 11.

Advertising costs

Advertising costs are charged to operations when incurred.  Advertising expense,
which includes media, agency and promotional  expenses,  amounted to $2,086,000,
$5,897,000 and $7,097,000 in fiscal 1998, 1997 and 1996, respectively.

                                       29
<PAGE> 15

Other recent pronouncements

In  June  1997,  the  Financial  Accounting  Standards  Board  issued  SFAS  130
"Reporting  Comprehensive Income" and SFAS 131 "Disclosures About Segments of an
Enterprise and Related Information".  In October 1997, the American Institute of
Certified Public Accountants issued Statement of Position 97-2 "Software Revenue
Recognition".  All of these  statements are effective for fiscal years beginning
after December 15, 1997. The Company will comply with the  requirements of these
statements  in fiscal  1999.  The future  adoption  of these  statements  is not
expected to have a material  effect on the Company's  results from operations or
financial position.

Note 2  Business combinations

During fiscal 1998, Micro Focus completed two acquisitions.

On  April  30,  1997,  the  Company  acquired  all of the  outstanding  stock of
Millennium UK Limited  ("Millennium"),  a privately-held  consulting firm, for a
total consideration of $6,400,000, satisfied by a cash payment of $3,200,000 and
the issuance of 149,142  ordinary  shares of the Company  (equivalent to 745,710
ordinary shares following the Stock Split - see note 12 on page 35).  Millennium
provided specialised consulting and project management services.

The transaction has been accounted for as a purchase. Accordingly, the excess of
the purchase price over the estimated fair value of the net tangible  assets has
been  allocated to  goodwill,  and the net assets and results of  operations  of
Millennium have been combined with those of Micro Focus as of April 30, 1997 and
for the  nine-month  period  subsequent to April 30, 1997,  respectively.  Where
appropriate,  the accounting policies of Millennium have been amended to conform
with those of Micro Focus. The effects of the resulting changes to the financial
statements  were not material.  The goodwill,  which amounted to $6,737,000,  is
being amortised primarily over three years.

The following table presents pro forma information on the results of operations
as though the acquisition had occurred at the beginning of the periods shown:

--------------------------------------------------------------------------------
(in thousands)                           1998         1997
--------------------------------------------------------------------------------
Net revenue                           $168,462    $124,885
Income (loss) before income taxes       21,795     (14,334)
Net income (loss)                       14,602     (15,052)
Net income per share (diluted)          $0.19      ($0.19)
Net income per share (basic)            $0.18      ($0.19)
--------------------------------------------------------------------------------

On January 20, 1998, the Company  acquired all of the  outstanding  stock of XDB
Systems,  Inc.  ("XDB") in exchange for 378,395  ordinary  shares of the Company
(equivalent  to  1,891,975  ordinary  shares  following  the Stock  Split) which
represented a value of $14,243,000 on the date the merger was completed.  XDB, a
privately-held corporation based in Maryland, USA, is a provider of DB2 database
development, maintenance and connectivity solutions.

The Company incurred charges in the fourth quarter of 1998 of approximately $1.6
million  in  connection  with  activities  to  complete  this  acquisition.  The
combination  has been  accounted  for using the pooling of interests  method and
accordingly all financial data presented herein has been restated to include the
results of XDB. The following  table sets forth the  composition of combined net
revenue and net income (loss) for the periods  indicated.  Information  for 1998
with  respect to XDB  reflects  the period from  February 1, 1997 to January 20,
1998, the date XDB was acquired.

--------------------------------------------------------------------------------
(In thousands)               1998        1997         1996
--------------------------------------------------------------------------------
Net revenue:
Micro Focus               $159,033    $115,409    $121,956
XDB                          9,477      10,042      14,241
Elimination                 (1,201)     (2,224)    (1,413)

--------------------------------------------------------------------------------
As restated               $167,309    $123,227    $134,784
--------------------------------------------------------------------------------
Net income (loss):
Micro Focus                $15,731    ($10,508)   ($10,436)
XDB                         (1,098)     (4,182)       (720)
--------------------------------------------------------------------------------
As restated                $14,633    ($14,690)   ($11,156)
--------------------------------------------------------------------------------

Where appropriate,  the accounting  policies of XDB have been amended to conform
with those of Micro Focus. The effects of the resulting changes to the financial
statements were not material.

In  fiscal  1996,  Micro  Focus  completed  the  acquisition  of  Burl  Software
Laboratories, Inc. for a total of $13,500,000 which was satisfied by the payment
of $6,251,000 in cash and the issuance of 664,979 ordinary shares of the Company
(equivalent  to  3,324,895  ordinary  shares  following  the Stock  Split).  The
acquisition was accounted for as a purchase.

                                       30
<PAGE> 16

Note 3  Financial instruments

The Company  invests its excess cash in  accordance  with an  investment  policy
approved by the Board of Directors  and  implemented  as of the beginning of the
current  fiscal  year.  This policy  authorizes  investment  in U.S.  government
securities, municipal bonds, certificates of deposit with highly-rated financial
institutions and other specified money market  instruments of similar  liquidity
and credit quality.

The Company  has  determined  that all of its  investment  securities  are to be
classified as  available-for-sale.  Such  securities are stated at amounts which
approximate fair value, based on quoted market prices, with the unrealized gains
and  losses  reported  as  a  separate   component  of   shareholders'   equity.
Available-for-sale securities with original maturities of less than three months
are classified as cash equivalents.

Estimated  fair  values of  financial  instruments  are  based on quoted  market
prices.  The  carrying  amounts  and  fair  value  of  the  Company's  financial
instruments are as follows:

--------------------------------------------------------------------------------
(In thousands)                           1998         1997
--------------------------------------------------------------------------------
Cash                                   $24,773     $73,119
Available for sale securities           59,717       2,577
Forward foreign currency contracts          -           -
--------------------------------------------------------------------------------

Available-for-sale securities are analysed as follows:
 ................................................................................
                                         Gross
                                         unrealized    Estimated
(In thousands)                Cost       gains(losses) fair value
--------------------------------------------------------------------------------
At January 31, 1998:
Money market funds            $815      $   -           $815
Commercial paper            20,722          10        20,732
Certificates of deposit      7,971          10         7,981
Agency                       3,870           5         3,875
Auction rate securities      3,319          -          3,319
Corporates                  22,953          42        22,995
--------------------------------------------------------------------------------
                           $59,650         $67       $59,717
--------------------------------------------------------------------------------
At January 31, 1997:
Mutual funds                $1,912       ($152)        1,760
Bonds                          683           3           686
Other                          131           -           131
--------------------------------------------------------------------------------
                            $2,726       ($149)       $2,577
--------------------------------------------------------------------------------

The  cost  and  estimated  fair  values  of  available-for-sale   securities  by
contractual maturity are as follows:
 ................................................................................
                                        Estimated
(In thousands)                Cost      fair value
--------------------------------------------------------------------------------
At January 31, 1998:
Less than three months     $24,498      $23,501
Between 3 - 12 months       25,551       25,558
Over 12 months              10,601       10,658
--------------------------------------------------------------------------------
                           $59,650      $59,717
--------------------------------------------------------------------------------

The notional amounts of foreign  currency  contracts were $4,800,000 and $nil at
January 31, 1998 and January 31, 1997,  respectively,  and were predominantly to
exchange  U.S.  dollars  for G.B.  pounds  sterling.  Substantially  all forward
foreign  currency  contracts  entered into by the Company have  maturities of 60
days or less.

Note 4  Research and development costs

--------------------------------------------------------------------------------
(In thousands)               1998        1997        1996
--------------------------------------------------------------------------------
Research and
   development costs,
   before capitalization   $31,645     $34,138     $40,295
Costs capitalized as software
   product assets           (9,321)     (8,272)    (15,639)
Amortization of
   capitalized costs        12,716      12,690      13,917
--------------------------------------------------------------------------------
                           $35,040     $38,556     $38,573
--------------------------------------------------------------------------------

Note 5  Non-recurring items

The Company has reported no non-recurring items in 1998.

Non-recurring   items   recorded   in  fiscal  1997   represented   charges  for
restructuring. The charges consisted of the costs associated with a reduction in
the  Company's  workforce  of  approximately  95 people,  facility  closures and
consolidations,  and asset  write-downs.  All outstanding  amounts due under the
restructuring were settled prior to January 31, 1998.

Non-recurring items recorded in fiscal 1996 consisted of a charge of $10,502,000
for  restructuring  and a credit of $1,033,000 in respect of an employer loan to
the Micro Focus  Group  Employee  Benefit  Trust  1994.  Restructuring  costs of
$5,031,000   incurred  in  the  first   quarter  of  1996  related  to  employee
terminations, closure of surplus office facilities, and fixed asset write-downs.
Additional asset  write-downs of $5,471,000 booked in the fourth quarter of 1996
were  primarily  the  result of a review  into the  carrying  value of  software
product assets.
                                       31
<PAGE> 17

Note 6  Property, plant and equipment

--------------------------------------------------------------------------------
(In thousands)                           1998         1997
--------------------------------------------------------------------------------
Land and buildings                     $22,679     $21,690
Leasehold improvements                   4,228       1,390
Computer and communications
   equipment & software                 47,239      40,236
Office equipment                         8,374       8,346
Transportation equipment                   268         727
--------------------------------------------------------------------------------
Property, plant and equipment - at cost 82,788      72,389
Less: accumulated depreciation
   and amortization                    (43,705)    (38,593)
--------------------------------------------------------------------------------
Property, plant and equipment - net    $39,083     $33,796
--------------------------------------------------------------------------------

The above figures include assets under capital leases as follows:

--------------------------------------------------------------------------------
(In thousands)                            1998        1997
--------------------------------------------------------------------------------
Cost                                       $47        $200
Less: accumulated depreciation
   and amortization                        (33)       (105)
--------------------------------------------------------------------------------
                                           $14         $95
--------------------------------------------------------------------------------
During the years ended January 31, 1998,  1997 and 1996,  depreciation  expense,
including  depreciation on leased assets,  totalled  $7,706,000,  $9,410,000 and
$10,290,000, respectively.

Note 7 Lines of credit

Micro Focus has an unsecured revolving  multi-currency loan facility,  under the
terms of which financing of up to GBP 5,000,000 ($8,200,000 at January 31, 1998)
or its  equivalent  in such other  currency  as the Company  may  determine,  is
available  until January 2001.  Borrowings  under this facility bear interest at
0.75% above the London  Interbank  Offered Rate ("LIBOR").  Amounts  outstanding
against this credit line at January 31, 1998 were the  equivalent  of $1,652,000
(1997: $nil), drawn in French Francs, and incurring interest at 3.6% per annum.

A second line of credit,  negotiated by XDB, expired on June 30, 1997. Under the
terms of the credit  line,  up to  $1,500,000  was  available,  secured by XDB's
short-term  investments.  The amount  outstanding  against  this  credit line at
January  31, 1997 was  $1,500,000;  the amount was repaid in full on February 1,
1997.

Note 8  Commitments

The Company  leases  certain of its  facilities  and equipment  under  operating
leases  expiring at various dates through 2007. In most cases, it is anticipated
that these  leases  will be renewed or  replaced  by other  leases in the normal
course of  business.  The Company  also leases  transportation  equipment  under
capital leases. Minimum lease commitments as of January 31, 1998 are as follows:

 ................................................................................
(In thousands)                           Capital     Operating
Years ended January 31                    Leases        Leases
--------------------------------------------------------------------------------
1999                                        $60         $6,245
2000                                         11          3,249
2001                                         23          2,271
2002                                          -          2,049
2003                                          -          2,037
Thereafter                                    -            769
--------------------------------------------------------------------------------
Total minimum lease payments                 94         16,620
Less: amount representing interest           (3)           -
Present value of net minimum lease payments  $91           -
--------------------------------------------------------------------------------

During the years ended January 31, 1998,  1997 and 1996,  rent expense  totalled
$4,650,000, $4,594,000 and $5,309,000, respectively.

Note 9 Income taxes

--------------------------------------------------------------------------------
(In thousands)               1998         1997        1996
--------------------------------------------------------------------------------
Current:    U.K.            $5,048        $380        $237
            U.S. federal       273      (1,635)        484
            U.S. state         209        (242)         58
            Other            1,568         369        (230)
--------------------------------------------------------------------------------
                             7,098      (1,128)        549
--------------------------------------------------------------------------------
Deferred:   U.K.               110       1,489        (235)
            U.S. federal         -         280        (344)
            U.S. state          -           77         (59)
                               110       1,846        (638)
Total:                      $7,208        $718        ($89)
--------------------------------------------------------------------------------

                                       32
<PAGE> 18

Deferred taxes result from timing  differences in the recognition of revenue and
expenses  for tax  and  financial  statement  purposes.  The  sources  of  these
differences and the tax effect of each were as follows:

--------------------------------------------------------------------------------
(In thousands)                1998        1997         1996
--------------------------------------------------------------------------------
Software development costs
   and other                  $249      $2,043       ($884)
Depreciation and amortization (139)       (197)        246
--------------------------------------------------------------------------------
                              $110      $1,846        (638)
--------------------------------------------------------------------------------

The following table analyses the differences between the U.K. statutory tax 
rate and the effective tax rate:

--------------------------------------------------------------------------------
                             1998        1997         1996
--------------------------------------------------------------------------------
U.K. statutory tax rate      31.3%       33.0%       33.0%
Tax effect of earnings of
   foreign subsidiaries     (1.8)%     (22.4)%        6.7%
Permanent differences
   and other                  3.5%     (15.7)%     (38.9)%
--------------------------------------------------------------------------------
Effective tax rate           33.0%      (5.1)%        0.8%
--------------------------------------------------------------------------------

Deferred income taxes, all of which are non-current, are as follows:

--------------------------------------------------------------------------------
(In thousands)                           1998         1997
--------------------------------------------------------------------------------
Software development costs
   and other                            $9,017      $8,475
Depreciation and amortization              142         271
--------------------------------------------------------------------------------
                                        $9,159      $8,746
--------------------------------------------------------------------------------

Deferred tax relative to the different tax jurisdictions is as follows:

--------------------------------------------------------------------------------
(In thousands)                           1998         1997
--------------------------------------------------------------------------------
U.K.                                   $10,111      $9,983

U.S.                                      (952)     (1,237)
--------------------------------------------------------------------------------
                                        $9,159      $8,746
--------------------------------------------------------------------------------

The  corporate  income  tax  returns  of  certain  U.S.  subsidiaries  are under
examination  by  the  Internal  Revenue  Service,  which  has  proposed  certain
adjustments.  The Company  believes that the outcome of the examination will not
give rise to any material adjustment to the financial statements.

Note 10 Business segment information

Micro Focus operates in one business  segment - the development and marketing of
computer software  products and related  services.  The following table analyses
worldwide  operations by  geographical  segment,  based on the location of Micro
Focus facilities.

--------------------------------------------------------------------------------
(In thousands)               1998        1997       1996
--------------------------------------------------------------------------------
Revenue:
   United States          $100,699     $75,203     $89,839
   United Kingdom           72,562      55,701      56,158
   Europe (excluding U.K.)  39,612      33,849      32,734
   Other                    12,869       3,205       2,251
--------------------------------------------------------------------------------
                           225,742    $167,958     180,982
--------------------------------------------------------------------------------
Inter-segment revenue:
   United States            (8,612)     (8,288)     (9,647)
   United Kingdom          (34,567)    (25,265)    (26,372)
   Europe (excluding U.K.) (14,904)    (10,331)     (8,715)
   Other                      (350)       (847)     (1,464)
--------------------------------------------------------------------------------
Total net revenue          167,309     123,227     134,784
--------------------------------------------------------------------------------
Income (loss) from operations:
   United States              (671)    (12,374)     (7,229)
   United Kingdom            7,957      (4,704)      1,606
   Europe (excluding U.K.)   1,577        (580)     (8,568)
   Other                     8,731         665        (721)
--------------------------------------------------------------------------------
                            17,594     (16,993)    (14,912)
--------------------------------------------------------------------------------
Total assets:
   United States            48,855      26,622      45,674
   United Kingdom           69,574      71,578      61,694
   Europe (excluding U.K.)  70,331      62,969      63,915
   Other                    11,637         701         798
--------------------------------------------------------------------------------
                          $200,397    $161,870    $172,081
--------------------------------------------------------------------------------

Inter-segment  revenue  principally  represents  license fees and sub-contracted
development charges between locations.

                                       33
<PAGE> 19

Note 11  Employee share and retirement plans
Share option plans

All references to shares and options within this note have been adjusted for the
Stock Split - see note 12 below.

The  Company's  share option  plans  provide for the grant of options to acquire
shares to persons who devote substantially all their working time to Micro Focus
and such other eligible  persons as the Board may determine.  The exercise price
of options issued under these plans is 100% of the fair market value at the time
such  options are  granted.  Options  are  generally  exercisable  in five equal
cumulative  annual  installments  commencing  one year  after the date of grant.
Unexercised  options lapse when the optionholder  ceases to be employed by Micro
Focus or at a  predetermined  expiry  date (of up to ten years  from the date of
grant), whichever occurs first.

The 1996  Share  Option  Plan was  approved  by  shareholders  in June  1996 and
authorised  the  Company to grant  options up to a maximum of  3,786,845  shares
(representing 5% of the issued share capital of the Company at that time);  such
authority  will  expire  on June 18,  1999.  Prior to 1996,  authority  to grant
options under  similar terms had been granted  pursuant to the 1991 Share Option
Plan and the 1983-1984 Share Option Plan. Such  authorities  expired in 1996 and
1991, respectively. At January 31, 1998, 8,437,900 option shares were issued and
outstanding under the plans, and a further 1,596,265 which had been approved for
grant by shareholders under the 1996 Share Option Plan were currently unissued.

In 1994,  the Micro Focus Group  Employee  Benefit  Trust 1994 ("the Trust") was
established to further the Company's  policy of encouraging  share  ownership by
its  employees.  Under the terms of the  Trust,  Micro  Focus  Trustees  Limited
("MFTL") is  permitted  to acquire  ordinary  shares in the Company and to issue
options for those shares to directors and employees.  At January 31, 1998,  MFTL
owned 3,968,565 shares,  and options granted by MFTL to purchase up to 3,171,225
of  these  shares  were  outstanding.  Options  which  had been  granted  for an
additional  110,000  shares  prior to their  acquisition  by MFTL also  remained
outstanding.  The  remaining  526,100  option  shares were  available for future
grant.  The shares held by the Trust are shown in the balance  sheet as treasury
stock within shareholders' equity.

Pursuant to the  agreement to acquire XDB  Systems,  Inc.  ("XDB"),  the Company
assumed  XDB's 1992 Share  Option  Plan and 1996 Share  Option  Plan.  Under the
agreement,  holders of XDB options are  entitled  to exercise  their  options in
return for ordinary shares in the Company.  At January 20, 1998, the date of the
merger,  XDB option  holders held 200,210 option shares in the Company at prices
between $1.59 and $7.41 and  denominated in U.S.  dollars.  At January 31, 1998,
150,280 of these option shares remained outstanding.

Share option activity under the plans was as follows:

--------------------------------------------------------------------------------
                                   Number           Option price per
                                of shares       share in G.B.POUNDS
--------------------------------------------------------------------------------
Outstanding, January 31, 1995   8,644,370         GBP 0.44-GBP 5.77
Options granted                 3,018,975         GBP 1.08-GBP 1.64
Options exercised                (574,325)        GBP 0.44-GBP 1.08
Options cancelled                (795,175)        GBP 0.44-GBP 5.77
--------------------------------------------------------------------------------
Outstanding, January 31, 1996  10,293,845         GBP 1.08-GBP 5.77
Options granted                11,504,150         GBP 1.17-GBP 1.94
Options exercised                (120,780)        GBP 1.08-GBP 1.93
Options cancelled              (9,202,055)        GBP 1.08-GBP 5.77
--------------------------------------------------------------------------------
Outstanding, January 31, 1997  12,475,160         GBP 1.08-GBP 4.32
Options granted                 6,622,725         GBP 0.97-GBP 4.52
Options exercised              (1,553,705)        GBP 1.08-GBP 3.70

Options cancelled              (5,674,775)        GBP 0.97-GBP 4.52
--------------------------------------------------------------------------------
Outstanding, January 31, 1998  11,869,405         GBP 0.97-GBP 4.52
--------------------------------------------------------------------------------

The total of  11,869,405  option  shares  outstanding  at  January  31,  1998 is
represented  by 8,588,180  unissued  shares  (8,437,900  granted under the Micro
Focus plans and 150,280  pursuant to the XDB plans) and 3,281,225  issued shares
held by MFTL.

The following tables summarize  information  about share options  outstanding at
January 31, 1998:

Options outstanding:
--------------------------------------------------------------------------------
                                                      Weighted       Weighted
                                        Number         average        average
                                outstanding at     contractual  exercise price
Ranges of exercise prices     January 31, 1998    life (months)    (G.B.POUNDS)
--------------------------------------------------------------------------------
GBP 0.97-GBP 1.50                     4,069,680         97          GBP 1.37
GBP 1.51-GBP 2.00                       696,800        102          GBP 1.73
GBP 2.00-GBP 4.52                     7,102,925        108          GBP 3.43
--------------------------------------------------------------------------------
                                     11,869,405        104          GBP 2.62
--------------------------------------------------------------------------------


                                       34

<PAGE> 20

Options exercisable:
--------------------------------------------------------------------------------
                                                                 Weighted
                                             Number               average
                                     exercisable at        exercise price
Ranges of exercise prices          January 31, 1998           (G.B.POUNDS)
--------------------------------------------------------------------------------
GBP 0.97-GBP 1.50                      968,915                 GBP 1.33
GBP 1.51-GBP 2.00                      158,770                 GBP 1.72
GBP 2.00-GBP 4.52                      555,380                 GBP 3.17
--------------------------------------------------------------------------------
                                      1,683,065                GBP 1.97
--------------------------------------------------------------------------------

As stated in note 1, the  Company  has  elected  to  follow  APB 25 and  related
Interpretations  in  accounting  for its  employee  share  options  because,  as
discussed below,  the alternative fair value accounting  provided for under SFAS
123 requires the use of option  valuation models that were not developed for use
in valuing  employee share options.  Under APB 25, because the exercise price of
the Company's  options equals the market price of the  underlying  shares on the
date of grant, no compensation expense is recognized.

Pro forma  information  regarding  net income  (loss) and net income  (loss) per
share is required  by SFAS 123,  and has been  determined  as if the Company had
accounted for employee  share  options  granted since January 31, 1995 under the
fair  value  method of that  statement.  The fair  value for these  options  was
estimated at the date of grant using a  Black-Scholes  option pricing model with
the following weighted-average assumptions for 1998 and 1997: risk-free interest
rate based on Treasury  Strip,  No  Principal  from the Wall Street  Journal for
maturity  of six  years,  based on the date of  grant;  dividend  yields  of 0%;
volatility  factors  of the  expected  market  price of  0.378;  and an  average
expected life of the option of six years.

The  Black-Scholes  valuation model was developed for use in estimating the fair
value of  traded  options  which  have no  vesting  restrictions  and are  fully
transferable.  In addition,  the option  valuation  models  require the input of
highly  subjective  assumptions  including the expected share price  volatility.
Because the Company's options have characteristics  significantly different from
those of traded options and because changes in the subjective input  assumptions
can materially  affect the fair value  estimate,  in management's  opinion,  the
existing models do not necessarily provide a reliable single measure of the fair
value of its options.

For purposes of pro forma  disclosures,  the estimated fair value of the options
is amortized to expense over the options'  vesting  period.  The  Company's  pro
forma net income and  diluted net income per share in 1998 was  $12,525,000  and
$0.19,  respectively,  pro  forma  net loss  and net loss per  share in 1997 was
$15,961,000  and  $0.20,  respectively,  and pro forma net loss and net loss per
share in 1996 was $11,359,000 and $0.14, respectively.  The effects on pro forma
disclosures  of applying  SFAS 123 are not likely to be  representative  of such
effects in future  years since SFAS 123 is  applicable  only to options  granted
since January 31, 1995. The effect will not be fully  reflected in the pro forma
disclosures until 2001.

Retirement plans

Micro Focus has entered into  arrangements to provide pensions for its employees
on  a  defined  contribution  basis.  Contributions,   which  are  independently
administered  by  insurance  companies  and other  financial  institutions,  are
expensed in the year in which they become payable.

In the United States,  Micro Focus' plan  qualifies  under Section 401(k) of the
Internal Revenue Code. Under the plan, Micro Focus matches contributions made by
participating employees up to certain predetermined thresholds. Arrangements for
employees in other countries have been established on similar bases,  subject to
local conditions and practices in the countries concerned.

In the years ended  January 31,  1998,  1997 and 1996,  contributions  totalling
$755,000, $779,000 and $1,020,000, respectively, have been expensed.

Note 12  Subsequent event - stock split

On March 12, 1998, shareholders approved a 5-for-1 sub-division of the Company's
ordinary shares.  The sub-division  became effective as of the close of business
on Friday,  March 13, 1998, and unless otherwise  stated,  all data presented in
these financial  statements has been restated to reflect the  sub-division.  The
Company's  American  Depository Shares ("ADSs"),  which are traded on the Nasdaq
Stock Market in the United States, did not split, although the conversion rights
of such ADSs have been  adjusted  such that each ADS now  represents  5 ordinary
shares.

                                       35
<PAGE> 21

Note 13  Quarterly financial information (unaudited)

Quarterly  financial  information for the two years ended January 31, 1998 is as
follows:

<TABLE>
<CAPTION>

----------------------------------------------------------------------------------------------------------------------
(In thousands - except per share and ADS data)                                  
                                               First Quarter   Second Quarter   Third Quarter   Fourth Quarter    Year
----------------------------------------------------------------------------------------------------------------------
<S>                                                <C>            <C>                <C>             <C>          <C>    
YEAR ENDED JANUARY 31, 1998:
Net revenue                                       32,533         39,178            43,612           51,986      167,309
Operating income                                   2,531          2,807             5,303            6,953       17,594
Net income                                         2,375          2,548             4,371            5,339       14,633
Net income per share: diluted                      $0.03          $0.03             $0.05            $0.06        $0.18
Net income per share: basic                        $0.03          $0.03             $0.06            $0.07        $0.19
Net income per ADS: basic                          $0.15          $0.16             $0.28            $0.34        $0.93
Net income per ADS: diluted                        $0.15          $0.15             $0.26            $0.32        $0.89
------------------------------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31, 1997:
Net revenue                                       25,820         29,755            30,158           37,494      123,227
Non-recurring items                               (8,670)           -                 -               -         (8,670)
Operating income (loss)                          (15,576)        (3,661)               83            2,161     (16,993)
Net income (loss)                                (14,432)        (2,437)              405            1,774     (14,690)
Net income (loss) per share: basic                ($0.19)        ($0.03)            $0.01            $0.02      ($0.19)
Net income (loss) per share: diluted              ($0.19)        ($0.03)            $0.01            $0.02      ($0.19)
Net income (loss) per ADS: basic                  ($0.93)        ($0.16)            $0.03            $0.11      ($0.94)
Net income (loss) per ADS: diluted                ($0.93)        ($0.16)            $0.03            $0.11      ($0.95)
------------------------------------------------------------------------------------------------------------------------

Notes:
Data for all  periods  presented  has been  restated  to reflect  the pooling of
interest accounting in connection with the Company's acquisition of XDB Systems,
Inc. on January 20, 1998 (see note 2 to the consolidated financial statements on
page 28). 

Share and per-share data for all periods  presented has been restated to reflect
the 5-for-1 stock split which occurred  effective as of the close of business on
March 13, 1998 (see note 12 to the  consolidated  financial  statements  on page
35). The Company's American  Depository Shares ("ADSs") did not split,  although
the  conversion  rights  of such  ADSs  have  been  adjusted  such that each ADS
represents  five  ordinary  shares.  Per share  earnings  are also  shown in the
U.S.format on an ADS equivalent basis, consistent with pre-split reporting.

</TABLE>

REPORT OF THE INDEPENDENT AUDITORS (US FORMAT)


To the Board of Directors and Shareholders
of Micro Focus Group Plc

We have audited the  consolidated  balance sheets of Micro Focus Group Plc as of
January 31, 1998 and 1997,  and the related  consolidated  statements of income,
shareholders'  equity and cash  flows for each of the three  years in the period
ended  January 31, 1998 on pages 23 to 35. These  financial  statements  are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on the financial statements based on our audits.

We conducted our audits in accordance  with United  Kingdom  auditing  standards
which do not differ in any significant  respect from those generally accepted in
the United States. Those standards require that we plan and perform the audit to
obtain reasonable  assurance about whether the financial  statements are free of
material  misstatement.  An audit includes examining,  on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We believe  that our audits  provide a  reasonable  basis for our
opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the consolidated financial position of Micro Focus Group
Plc at January 31, 1998 and 1997 and the consolidated  results of its operations
and its consolidated  cash flows for each of the three years in the period ended
January 31, 1998 in conformity with United States generally accepted  accounting
principles.



Ernst & Young
Chartered Accountants
Registered Auditor
Reading, England
May 1, 1998

                                       36
<PAGE> 22

[PAGE 41]

EXECUTIVE REMUNERATION COMMITTEE'S REPORT (UK FORMAT)

The Micro Focus  Executive  Remuneration  Committee was  established in December
1993. At present the Committee members are J. Michael Gullard, Harold Hughes and
J. Sidney Webb.

The remuneration of the executive directors is determined by the Committee.  The
Committee ensures that remuneration is appropriate to each executive  director's
responsibilities,  taking into  consideration the overall financial and business
position of the Company, the highly competitive industry of which Micro Focus is
part,  and  the  importance  of  recruiting  and  retaining  management  of  the
appropriate  calibre.  The  Company  has  complied  with  Section  A of the Best
Practice Provisions annexed to the Listing Rules of the London Stock Exchange.

Directors' Remuneration Policy

In framing its remuneration  policy,  the Committee has given full consideration
to Section B of the Best Practice Provisions annexed to the Listing Rules of the
London Stock Exchange. The chief components of remuneration are as follows:

Basic  salary:  Salary  rates for the  executive  directors  are  determined  by
reference  to relevant  market  data for the  countries  in which the  directors
perform their duties,  and are normally reviewed on an annual basis. In general,
the  Committee's  philosophy  is to have base  salary  rates lower than those of
others in the market, with higher rates of pay for performance.

Fees:  Non-executive  directors  receive an annual  retainer and earn additional
fees  for   attendance   at  Board   meetings   and  for  time  spent  on  other
company-related  business.  Such fees are determined in advance by the executive
directors and not by the Committee.

Performance-related   pay:   Executive   directors   are   eligible  for  annual
performance-related  bonuses,  which  are  calculated  based on  fixed  formulae
measuring Micro Focus' performance  against targets set at the beginning of each
year.  Such bonuses are earned on a pro-rata basis in proportion to the level of
achievement  relative to the performance targets set, subject to certain minimum
thresholds.

The philosophy is to offer greater than market  opportunities  in terms of bonus
compensation,  scaling  upwards if the  performance  of Micro Focus  exceeds the
targets set out at the beginning of the year.

In the current  year such bonuses  were based on targets  measuring  achievement
against performance, measured in terms of audited earnings per share.

Compensation  for loss of  office:  The  Company  provides  nominal  amounts  of
compensation to its non-executive officers for loss of office.  Compensation for
loss of office for  executive  officers  may exceed  such  nominal  amounts as a
result  of  the  Company  needing  to  provide  such  executive  directors  with
competitive packages in accordance with the criteria described elsewhere in this
"Directors' Remuneration Policy" section.

Pension  contributions:  The Company  does not operate a pension  scheme for its
directors,  but does make  contributions to a director's own personal pension in
lieu of salary entitlement.

Other: Other emoluments relate to an amount received by Mr. Waters in respect of
acceptance of office, and benefits  principally  related to the use of corporate
communications  facilities  by,  and  personal  travel  provided  to,  a  former
director.

Share  options:  All of the directors are eligible to  participate  in the Micro
Focus  share  option  plans,  details  of  which  are  set out in note 21 to the
financial  statements  on page 66. The grant of share  options to  directors  is
designed to ensure that an element of their  remuneration is directly related to
long-term growth in shareholder value.

Long-term incentives: None of the directors is eligible for any long-term 
incentive payments.

Service  agreements:  Except as noted below, none of the directors has a service
contract  with a notice  period in excess of one  year,  or with  provision  for
predetermined  compensation  on termination of an amount which equals or exceeds
one year's salary and benefits.

In the event of a change of control of the Company, Mr. Waters would be entitled
to  predetermined  compensation  on  termination  of his employment of an amount
which  exceeds one year's salary and  benefits,  provided  that the  termination
occurs within one year from the effective date of the change of control.

                                      41
<PAGE> 23

[PAGE 42]

Directors' Remuneration

The following table analyses the remuneration earned by each director in each of
the last two years.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                           Performance       Pension        Compensation
                                       Salary        Fees  related pay contributions  for loss of office     Other        TOTAL
Years ended January 31                GBP'000     GBP'000      GBP'000       GBP'000             GBP'000   GBP'000      GBP'000
------------------------------------------------------------------------------------------------------------------------------------
          <S>                           <C>          <C>        <C>          <C>            <C>               <C>          <C>
1998:    J. Michael Gullard              -           50          -            -               -                -            50
         Harold Hughes                   -           18          -            -               -                -            18
         J. Sidney Webb
            (appointed December 2 1997)  -            5          -            -               -                -             5
         Martin Waters
            (appointed June 21 1997)    105           -         201           -               -               183           489
         Paul Adams                      85           -         125           -               -                -            210
         Ron Forbes                      82           -          76           6               -                -            164
         Marcelo Gumucio
            (resigned June 21 1997)      53           -          31           -              545               -            629
------------------------------------------------------------------------------------------------------------------------------------
                                        325          73         433           6              545              183         1,565
------------------------------------------------------------------------------------------------------------------------------------
1997:    J. Michael Gullard              -           63          -            -               -                -             63
         Harold Hughes                   -           20          -            -               -                -             20
         Marcelo Gumucio                101           1         129           -               -                -            231
         Paul Adams                      79           -          50           -               -                -            129
         Ron Forbes                      79           -          16           6               -                -            101
         Brian Reynolds
            (resigned March 24 1996)     -            -          -            -               -               29             29
         Paul O'Grady
            (resigned April 1 1996)      24           -          -            -               30               -             54
------------------------------------------------------------------------------------------------------------------------------------
                                        283          84         195           6               30              29            627
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Upon the resignation of Marcelo  Gumucio,  the Company entered into a settlement
agreement and release with Mr. Gumucio, pursuant to which Mr.Gumucio was paid an
amount of $225,000  (GBP  136,000)  for loss of office,  Mr.  Gumucio  agreed to
provide six months of  consulting  services  to the  Company in  exchange  for a
payment of $200,000  (GBP 120,00) and vesting for 138,440  option shares held by
Mr. Gumucio was accelerated and the exercise period extended.  As expected,  the
services that were intended to be performed  under the agreement  were performed
during fiscal 1998.

The  following  additional  information  is  provided  in  accordance  with  the
requirements of the Companies Act.
--------------------------------------------------------------------------------
                                            1998       1997
                                         GBP'000    GBP'000
--------------------------------------------------------------------------------
All directors:
Aggregate emoluments                     1,559         621
Pension contributions                        6           6
Gain on exercise of share options          889           -
--------------------------------------------------------------------------------
                                         2,454         627
--------------------------------------------------------------------------------
Highest paid director:
Aggregate emoluments                       629         231
Gain on exercise of share options          889           -
--------------------------------------------------------------------------------
                                         1,518         231
--------------------------------------------------------------------------------

Gains on exercise of share  options  are  calculated  as at the date of exercise
although the shares may have been retained.

                                       42
<PAGE> 24

[PAGES 44-67]

SELECTED CONSOLIDATED FINANCIAL DATA (UK FORMAT)

The following selected financial data should be read in conjunction with, and is
qualified in its entirety by reference  to, the  financial  statements  of Micro
Focus, expressed in G.B. POUNDS, set out on pages 51 to 67 of this report.

<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------------------------
(In thousands of G.B. POUNDS - except per share data,
percentages and employee information)  

                    Years ended January 31                    1998         1997         1996          1995         1994
---------------------------------------------------------------------------------------------------------------------------
<S>                                                           <C>          <C>          <C>            <C>         <C>
Operating results for the year:
Revenue                                                      97,015       73,089       77,258        89,885       83,842
Profit/(loss) before taxation and exceptional items*         15,217         (614)        (541)       12,871       21,761
Exceptional items*                                               -        (5,195)      (6,001)       (4,148)         -
Profit/(loss) before taxation                                15,217       (5,809)      (6,542)        8,723       21,761
Retained profit/(loss) for the year                          10,426       (7,281)      (6,470)        4,590       14,747
Earnings/(loss) per share: basic                              67.8p       (48.0p)      (43.6p)        32.0p       104.3p
Earnings/(loss) per share: diluted                            65.0p       (48.0p)      (43.6p)        32.0p       101.2p
Average number of shares in issue (thousands)                15,373       15,156       14,843        14,336       14,138

Financial position at end of year:
Cash and bank deposits                                       51,518       44,725       38,972        55,823       57,544
Total assets      123,824                                   100,204      111,828      124,302       109,915
Creditors: amounts falling due after more than one year          12           15           66           193          404
Total shareholders funds                                     70,892       61,124       70,187        72,856       75,100

Financial condition:
Working capital                                              36,195       26,611       27,306        36,554        48,686
Current ratio                                                  1.78         1.81         1.76          1.80          2.38
Return on revenue: excluding exceptional items*                 11%          n/a         n/a            10%          18%
Return on average equity: excluding exceptional items*          16%          n/a         n/a            12%          28%

Employee information:
Average number of employees                                     719          646          735           751          667
Year end number of employees                                    847          626          708           788          698
Revenue per employee                                            135          113          105           120          126
Profit/(loss) after taxation per employee:
   excluding exceptional items *                                 14           (3)          (2)           12           22
---------------------------------------------------------------------------------------------------------------------------

*  Details  of the  exceptional  items  are set  out in note 8 to the  financial
statements on page 62.

</TABLE>
                                       44

<PAGE> 25

MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION (UK FORMAT)

This discussion has been prepared in accordance with U.S. reporting practice and
is presented here so that readers of the U.K. format  financial  statements have
the same  information as readers of the U.S.  format  financial  statements.  It
should be read in conjunction with the financial statements of Micro Focus Group
Plc and its subsidiary  undertakings ("Micro Focus") in G.B. pounds, on pages 51
to 67.

The Company has previously referred to its current financial year ending January
31 1998 as "financial year 1997." In the future, the Company will designate each
financial  year by reference to the calendar year in which the last month of the
financial year occurs. Accordingly, the Company's current year ending January 31
1998 is referred to as "financial year 1998" or "1998" in this report, and prior
financial years are also referenced accordingly.

Results of Operations

Micro Focus has  reported a profit for the year of GBP 10.4m  compared to a loss
of GBP 7.3m in 1997. Results for the prior year included  non-recurring  charges
of GBP 5.2m.

The table below sets forth operating results as a percentage of revenue for each
of last three years and the percentage changes relative to the previous year for
each of the last two years.

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
                                                                                                                 Year to year
                                                                    Percentage of net revenue               percentage change
                                                                       Years ended January 31          1997              1996
                                                              1998         1997          1996       to 1998           to 1997
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                             <C>          <C>          <C>            <C>          <C>    
Revenue
   Product revenue                                               62           57           57            44           (4)
   Service revenue                                               38           43           43            18           (7)
--------------------------------------------------------------------------------------------------------------------------------
Total revenue                                                   100          100          100            33           (5)
--------------------------------------------------------------------------------------------------------------------------------
Costs and expenses
   Cost of product revenue                                        7            9           11             9          (28)
   Cost of service revenue                                       17           16           16            33           (4)
--------------------------------------------------------------------------------------------------------------------------------
Total cost of revenue                                            24           25           27            25          (14)
--------------------------------------------------------------------------------------------------------------------------------
Operating expenses
   Research and development                                      20           33           35           (19)         (10)
   Sales and marketing                                           36           41           43            17           (8)
   General and administrative                                     7           11            6           (18)          58
--------------------------------------------------------------------------------------------------------------------------------
Total operating expenses                                         63           85           84            (2)          (4)
--------------------------------------------------------------------------------------------------------------------------------
Operating profit (loss)                                          13          (10)         (11)          n/a           13
Interest income                                                   3            2            3            48          (21)
Interest expense                                                  -            -           -            238          (72)
 ................................................................................................................................
Profit/(loss) before taxation                                    16           (8)          (8)          n/a          (11)
Taxation                                                         (5)          (2)          -            227          n/a
--------------------------------------------------------------------------------------------------------------------------------
Retained profit/(loss) for the year                              11          (10)          (8)          n/a           13
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Revenue

Micro  Focus  derives its revenue  from the  licence of  software  products  and
related  support,  maintenance  and consulting  ("direct  revenue") and from the
licencing  of  distribution  rights to software  products to original  equipment
manufacturers  ("OEM revenue").  Direct revenue represents  approximately 90% of
total revenue.

Net revenue is analysed between product revenue, which consists of the licensing
of software  product to end-users and OEMs, and service  revenue,  consisting of
maintenance and other support services, including training and consulting.

Revenue  increased by GBP 23.9m or 33% to GBP 97.0m in 1998 having  decreased by
GBP 4.2m or 5% to GBP 73.1m in 1997.  The  increase  in 1998  reflected  initial
worldwide  sales of the  Company's  SoftFactory/2000  and  NetExpress  products,
increased UNIX product sales and revenue from consulting services.  The decrease
in revenue in 1997 arose  during the first two  quarters  with  relatively  flat
sales in comparison to the third and fourth  quarters.  Factors  contributing to
the decline in the first two quarters of 1997 included slow conversion to 32-bit
products of Micro Focus installed base and continuing uncertainties arising from
the fundamental changes caused by the Internet.  The improved performance in the
second half of 1997 reflected  increased  sales of products to address the "Year
2000" problem.

                                       45
<PAGE> 26

Product  revenue  increased  by GBP  18.5m or 44% to GBP  60.5m in 1998,  having
previously  decreased  by GBP 2.0m or 4% to GBP 42.0m in 1997.  The  increase in
product  licencing revenue in 1998 reflected higher sales of Year 2000 products,
UNIX products, NetExpress and other product lines.

Service  revenue  increased  by GBP 5.5m or 18% to GBP  36.5m  in  1998,  having
previously  decreased  by GBP 2.2m or 7% to GBP 31.1m in 1997.  The  increase in
service revenue resulted from increased  software  maintenance  revenue and from
consulting revenue.

Revenue by customer  location is analysed in note 2 to the financial  statements
on page 59. In 1998 United Kingdom revenue grew by 74%, United States revenue by
27% and revenue from other countries by 31%.

In 1997 U.S. revenue  decreased by 10%, while non-U.S.  territories  showed a 1%
increase,  with growth in the United  Kingdom,  France and Japan being offset by
decreased sales to certain distributors, notably in Italy and Brazil.

There can be no assurance  that the market for the Company's  products will grow
in future periods at its historical rate of growth,  that certain  segments will
not decline, or that the Company will be able to increase or maintain its market
share in the future or achieve its historical revenue growth rates.

Cost of product revenue

Cost of  product  revenue  is  comprised  principally  of the  cost  of  product
materials  (including  the  purchase  of  disks  and  CDs,  transfer  of data to
electronic  media, and printing of manuals),  packaging and distribution  costs,
and royalties to third party
software developers for the licensing of certain add-on software products.

Such costs  increased by GBP 0.6m or 9% to GBP 7.0m in 1998,  having  previously
decreased by $2.4m in 1997 and  represented  12% of product revenue in 1998 (15%
in  1997).  Decreases  in  product  costs as a  percentage  of  product  revenue
principally   reflected   savings  in  product   materials   arising   from  the
documentation being supplied on CD-ROM.

Cost of service revenue

Cost of service revenue is comprised  principally of compensation  for technical
support personnel, plus the costs associated with training and consulting.

Such costs increased by GBP 4.0m or 33% to GBP 15.8m in 1998,  having previously
decreased by $0.5m in 1997 and  represented  43% of service revenue in 1998 (38%
in 1997).  The increase in such costs in 1998 arose mainly from the expansion of
the consulting organization, including the acquisition of Millennium UK Limited.
The decrease in 1997  reflected  cost  reductions  taken to align  expenses with
anticipated revenue.

Gross profit

Gross  profit  represented  76% of net  revenue  (1997:  75%).  The  improvement
primarily  reflected  proportionately  higher  product  sales which carry higher
margins  and  savings  attributable  to  the  replacement  of  printed  software
documentation with
electronic versions.

The  Company's  gross  margin can be affected by a number of factors,  including
changes in product or  distribution  channel mix, the mix of product and service
revenue, and competitive pressures on pricing. Gross margin is also dependent on
discounts selectively provided to customers in competitive sales situations.  In
addition,  gross margin may be adversely  affected by expansion of the Company's
consulting  organization  and the  ability  to deploy  its  capacity  to revenue
generating projects. As a result of the above factors, gross margin fluctuations
are difficult to predict,  and gross margins may decline from current  levels in
future periods.

Research and development

Research and development costs consist  principally of compensation for software
developers and related costs expended,  less the development costs  capitalised,
plus  amortisation  of previously  capitalised  costs.  Research and development
spending  supports the development and enhancement of new and existing  products
and is consistent with the Company's strategy of
investing heavily to improve and expand its product lines.

Research  and  development  spending in 1998 was  directed  principally  towards
further  development  of  SoftFactory/2000  products which address the Year 2000
problem;   NetExpress,   a  complete  set  of  tools  for  developing   business
applications  targeted  at  graphical  PC  workstations,   distributed  computer
environments  and the  Internet;  and tools to  enhance  the  functionality  and
capability of the COBOL Workbench  product line for  workstation  development of
IBM mainframe applications.

Research  and  development  spending  in 1997  and  1996  was  directed  towards
SoftFactory/2000  and NetExpress,  development of new 32-bit  products;  further
development of client/server  solutions;  object oriented  programming in COBOL;
and tools for downsizing from IBM mainframes.

Expenditure on internal software research and development before capitalisation,
decreased  by GBP 1.6m to GBP 17.6m in 1998 and by GBP 4.2m to GBP 19.2m in 1997
and represented 18% of net revenue in 1998 (1997:  26%; 1996: 30%). The decrease
in research and  development  costs  reflects a lower  relative  cost  structure
following last year's restructuring of operations.

                                       46
<PAGE> 27

In 1998 GBP 5.7m,  representing  32% of these  costs  were  capitalised  as
software  product assets (1997:  27%, 1996:  42%).  Provisions for  amortisation
amounted to GBP 7.8m (1997:  GBP 8.1m; 1996: GBP 8.8m) resulting in a net charge
to profit and loss in 1998 of GBP 2.1m (1997:  charge of GBP 2.7m; 1996:  credit
of GBP 1.1m).

The Company  believes that ongoing  development  of new products and features is
required to maintain and enhance its competitive  position.  Accordingly,  while
the  Company  will  continue to control  expenses  where  possible,  the Company
anticipates that aggregate research and development  expenses will increase over
time, and may not be directly related to the level of revenue realized in future
quarters.

Sales and marketing

Sales and marketing  costs include  compensation,  travel and facility costs for
sales,   pre-sales  and  marketing  personnel,   and  publicity  costs  such  as
advertising and trade shows.

Such costs increased by GBP 5.1m or 17% to GBP 35.3m in 1998,  having  decreased
by GBP 2.7m or 8% to GBP 30.1m in 1997 and  represented  36% of net  revenue  in
1998 (1997: 41%; 1996: 43%). The increase in sales and marketing costs reflected
sales force expansion,  higher  commissions and higher advertising and marketing
expenses,  including those associated with new product launches. The decrease in
fiscal 1997 reflected the worldwide cost  reduction  initiatives  implemented in
the first quarter of that year.

The Company believes that continued  investments in sales,  marketing,  customer
support and promotional  activities are essential to maintaining its competitive
position.   The  Company  is  expanding  its  sales  and  support   staffs  and,
accordingly,  anticipates  that aggregate  sales and marketing  expenses will be
higher in future  periods,  but as a function of revenue  will remain  about the
same.

General and administrative

General and  administrative  costs  include the corporate  management,  finance,
legal and human resources operations of Micro Focus.

Such costs decreased by GBP 1.4m or 18% to GBP 6.5m in 1998, having increased by
GBP 2.9m or 58% to GBP 7.9m in 1997 and  represented  7% of net  revenue in 1998
(1997:  11%;  1996:  6%). The total for 1997 included GBP 1.9m of  restructuring
costs  (see  "Non-recurring  items"  below).  The  underlying  increase  in 1998
reflected  higher bonus  accruals and staff  additions  and related  recruitment
expenses.  The increase in 1997 resulted  principally from the  strengthening of
the Micro Focus management team.

The Company is investing to strengthen its  infrastructure  and anticipates that
aggregate general and administrative  expenses will increase in future quarters,
but decrease as a percentage of revenue.

Non-recurring items

No non-recurring items were separately reported in 1998.

In 1997 Micro  Focus  incurred a  restructuring  charge of GBP 5.2m.  The charge
consisted of the costs associated with a reduction in the Company's workforce of
approximately  65  people,  facility  closures  and  consolidations,  and  asset
write-downs.

Non-recurring  items  recorded  in 1996  consisted  of a charge  of GBP 6.7m for
restructuring  and a credit of GBP 0.7m in  respect of an  employer  loan to the
Micro Focus Group Employee Benefit Trust 1994.  Restructuring  costs of GBP 3.1m
incurred  in  the  first  quarter  of  1996  principally   related  to  employee
terminations  (including salary, benefit continuation and outplacement costs for
approximately  75  employees),   closure  of  surplus  office  facilities,   and
write-downs of related fixed assets. An additional charge of GBP 3.6m, booked in
the fourth  quarter of 1996,  reflected a reduction  in the  carrying  values of
software  product assets in line with future revenue  expectations  from certain
products.

Interest income

Interest earned on cash and short-term  investments  increased by GBP0.8m or 48%
to GBP 2.6m in 1998,  having  decreased  by GBP 0.4m or 21% to GBP 1.7m in 1997,
and represented 3% of revenue in 1998 (1997: 2%; 1996: 3%). The increase in 1998
reflected  higher average cash balances and higher  investment  yields resulting
from  the  investment  of  funds in money  market  instruments  instead  of bank
certificates  of deposit.  The  decrease in 1997  reflected  lower  average cash
balances and, to a lesser degree, lower interest rates.

Taxation

The Company's tax rate in 1998 was 31.5%,  which  compares to the statutory U.K.
rate applicable to the Company of 31.3%.

The  tax  rate  in  both  1997  and  1996  was  significantly  affected  by  the
distribution of taxable profits and losses among the tax  jurisdictions in which
the Company  operates and by  restructuring  charges,  certain of which were not
deductible for tax
purposes.

An  analysis  of  the  charge  for  income  taxes  is  given  in  note  9 to the
consolidated financial statements on page 63.

                                       47
<PAGE> 28

Acquisitions

During the current year Micro Focus completed two acquisitions.

On April 30 1997 the Company  acquired all of the share capital of Millennium UK
Limited ("Millennium"), a privately-held consulting firm, for a consideration of
GBP4.0m  paid in a  combination  of  GBP2.0m  in cash and the  issue of  149,142
ordinary   shares  in  the   Company.   Millennium   provided   consulting   and
projectmanagement  services and had  specialized  expertise  in the  estimating,
planning  and  management  of Year 2000  compliance  projects  for  large  scale
systems, as well as development expertise in Web-based applications. With effect
from January 31 1998 Millennium's  consulting  services were integrated with the
professional services operations of the Company.

On January 20 1998 the Company acquired all of the share capital of XDB Systems,
Inc  ("XDB") in exchange  for  378,395  ordinary  shares in the  Company,  which
represented  a  value  of  GBP8.7m  on the  date  of  the  acquisition.  XDB,  a
privately-held corporation based in Maryland, USA, is a provider of DB2 database
development, maintenance and connectivity solutions.

Both  transactions  have been accounted for as  acquisitions.  Accordingly,  the
excess of the purchase  price over the estimated  fair value of the net tangible
assets has been allocated to goodwill, and the results of the acquired companies
have been  combined  with those of Micro Focus with effect from the  acquisition
dates. Goodwill has been written off directly to reserves. Where appropriate the
accounting  policies of  Millennium  and XDB have been  amended to conform  with
those of Micro Focus.  The effects of the  resulting  changes are  summarised in
note 3 to the financial statements on page 60.

Risk factors that may influence future operating results

Micro Focus operates in a rapidly changing environment that involves a number of
risks,  some of which are  beyond the  Company's  control.  This  section of the
discussion  highlights  some of these  risks  and the  possible  impact of these
factors on future results from operations.

The  following  comments are  included in both the U.S.  and U.K.  format of the
Management's  Discussion  and Analysis in this Annual Report in accordance  with
the Private Securities Litigation Reform Act 1995, which became effective in the
U.S. on January 1 1996. For more information on U.S.  Securities Law Matters see
page 13.

The factors set forth below as well as statements  made elsewhere in this Report
contain certain forward-looking  statements that are based on the beliefs of the
Company's management,  as well as assumptions made by, and information currently
available  to,  the  Company's   management.   The  Company's   actual  results,
performance  or  achievements  in  financial  year 1999 and beyond  could differ
materially  from those  expressed  in, or implied  by, any such  forward-looking
statements.  Factors that could cause or contribute to such material differences
include,  but are not limited to,  those  discussed  in this  section as well as
those in the Letter to Shareholders and those discussed elsewhere in this Annual
Report.  The Company undertakes no obligation to release publicly any updates or
revisions  to any such  forward-looking  statements  that may reflect  events or
circumstances  occurring  after  the  date  of  this  Annual  Report.  For  more
information regarding forward-looking  statements,  see "Further Information for
Shareholders - Special Note on Forward-Looking Statements" on page 13.

The  Company's  future  operating  results are subject to  quarterly  and annual
fluctuations  due to a variety of factors,  including  demand for the  Company's
products,  the size and timing of customer  orders,  product  life  cycles,  the
ability  of the  Company to  develop,  introduce  and  market  new and  enhanced
versions  of the  Companys  products on a timely  basis,  the  introduction  and
acceptance  of new  products  and  product  enhancements  by the  Company or its
competitors,  customer order  deferrals in  anticipation  of enhancements or new
products,  changes  in the  mix  of  distribution  channels  through  which  the
Company's  products  are  offered,   purchasing  patterns  of  distributors  and
retailers,  quality  control  of  products  sold,  price and  other  competitive
conditions  in  the  industry,  changes  in the  Company's  level  of  operating
expenses,  changes in the Company's sales incentive  plans,  budgeting cycles of
its  customers,  the  cancellation  of  licenses  during  the  warranty  period,
nonrenewal  of  maintenance  agreements,  economic  conditions  generally  or in
various geographic areas, and other factors discussed in this section.

A high  percentage  of Micro Focus'  operating  expenses is fixed over the short
term and if  anticipated  revenue  does not occur or is delayed,  the  operating
results  for  that  quarter  will be  immediately  and  adversely  affected.  In
addition,  a substantial  portion of the Company's  revenue for most quarters is
booked and shipped in the last month of the quarter  such that the  magnitude of
the quarterly  fluctuations  may not become evident until late in or even at the
end of the particular quarter. Furthermore, the Company's customers tend to make
product  purchase  decisions in the fourth  quarter of the  Company's  year as a
result of purchase cycles related to expiration of budgetary authorizations.  As
a result,  the Company has historically  experienced lower revenue for the first
quarter of a financial year than in the fourth quarter of the prior year.

The Company's revenue is also affected by seasonal  fluctuations  resulting from
lower sales that  typically  occur during the summer  months in Europe and other
parts of the world. Due to all of the foregoing factors,  it is possible that in
some  future  quarters  the  Company's  operating  results  will  be  below  the
expectations  of stock market  analysts and  investors  and that the share price
could be materially adversely affected.
                                
Micro Focus is in a market that is subject to rapid  technological  change.  The
Company  must  continually  adapt to that change by  improving  its products and
introducing new products and technologies.  The growth and financial performance

                                       48
<PAGE> 29

of Micro  Focus will  depend upon its  ability,  on a timely and  cost-effective
basis,  to develop  and  introduce  enhancements  of existing  products  and new
products  that  accommodate  the latest  technological  advances and  standards,
customer  requirements and market  conditions.  The Company's ability to develop
and market  enhancements of existing  products and new products depends upon its
ability to attract and retain qualified employees.  In the past, Micro Focus has
experienced  delays and  increased  expenses in  developing  new  products.  Any
failure  by the  Company  to  anticipate  or  respond  adequately  to changes in
technology and market conditions,  to complete product development and introduce
new  products on a timely  basis or to attract and retain  qualified  employees,
could materially  adversely affect the Companys business,  results of operations
and financial condition.

Substantially  all of the  Company's  revenue is  currently,  and is expected to
continue in the future to be,  derived from  products  and  services  related to
applications  development  in the COBOL  language.  As a result,  the  Company's
future  operating  results depend upon market  acceptance of the COBOL language.
Any  decline in the demand for or market  acceptance  of the COBOL  language  or
mainframe  computers  where  COBOL  is  a  dominant  language  as  a  result  of
competition, technological change or other factors would have a material adverse
effect on Micro Focus' business, financial condition and results of operations.

The  markets  in  which  the  Company   competes  are   characterized  by  rapid
technological change and aggressive  competition.  The Company believes that the
principal  competitive  factors in the Company's markets are product performance
and  reliability,   functionality,  product  quality,  application  portability,
product  enhancement,  price,  training,  support  and the  quality  of  service
offerings.  The  Company  expects  competition  to  increase  in the future from
existing  competitors  and from  other  companies  that may enter the  Company's
existing  or future  markets  with  similar or  substitute  solutions  including
database  vendors  of tools and  other  programming  languages  that may be less
costly or provide  better  performance or  functionality.  Some of the Company's
current and  prospective  competitors in the products and services  markets have
greater financial,  marketing or technical resources than Micro Focus and may be
able to adapt more quickly to new or emerging  technologies,  or devote  greater
resources  to the  promotion  and sale of their  products  than can Micro Focus.
There can be no  assurance  that other  companies  will not develop  competitive
products in the future.  In  addition,  the software  industry is  characterized
generally  by low  barriers  to  entry,  as a result  of which  new  competitors
possessing  technological,  marketing or other competitive advantages may emerge
and rapidly  acquire market share.  Furthermore,  there can be no assurance that
the  Company  will  be  able  to  compete  effectively  in  the  future  in  the
professional  services  market  and,  particularly,  the Year 2000  professional
services market.

The market price of the Company's  securities has experienced  significant price
volatility and such  volatility may occur in the future.  Factors such as actual
or anticipated fluctuations in the Company's operating results, announcements of
technological  innovations,  new products or new contracts by the Company or its
competitors,  conditions  and  trends  in  the  software  and  other  technology
industries,   adoption  of  new  accounting  standards  affecting  the  software
industry,  general  market  conditions  and other factors may have a significant
impact on the market price of the Company's securities.  Furthermore,  the stock
market has experienced  extreme  volatility that has  particularly  affected the
market prices of equity  securities  of many high  technology  companies.  These
market  fluctuations,   as  well  as  general  economic,  political  and  market
conditions, may adversely affect the market price of the Company's securities.

Micro Focus is subject to the general  economic  climate in the various areas of
the  world  in  which  it  does  business.  The  risks  inherent  in  conducting
international  business generally include exposure to exchange rate fluctuations
(see  "Exchange  rate  fluctuations"  below),  longer  payment  cycles,  greater
difficulties in accounts receivable collection and enforcing agreements, tariffs
and other  restrictions  on foreign  trade,  export  requirements,  economic and
political instability,  withholding and other tax consequences,  restrictions on
repatriation  of earnings  and the burdens of  complying  with a wide variety of
foreign laws.  There can be no assurance that the factors  described  above will
not have an adverse  effect on the Company's  future  international  revenue and
expenses.
                                       
The Company  markets  certain of its  products  and  services to  customers  for
managing  development  and  maintenance of  mission-critical  computer  software
systems. In addition, an increasing portion of the Company's business is devoted
to  addressing  the  Year  2000  problem  which  affects  the   performance  and
reliability of many mission-critical  systems. The Company's agreements with its
customers  typically contain provisions designed to limit the Company's exposure
to potential product and service liability claims. It is possible, however, that
the  limitation  of liability  provisions  contained in the  Company's  customer
agreements  may not be effective  as a result of existing or future  domestic or
foreign laws or  ordinances or  unfavourable  judicial  decisions.  Although the
Company has not experienced any product or service liability claims to date, the
sale and  support  of its  products  and  services  may  entail the risk of such
claims,  particularly in the Year 2000 market.  A successful  product or service
liability claim brought against the Company could have a material adverse effect
upon  the  Company's  business,   operating  results  and  financial  condition.
Furthermore,  the Company  anticipates  that demand in the Year 2000 market will
decline,  perhaps  rapidly,  following  the  year  2000 and the  demand  for the
Company's  Year 2000  solutions,  products  and  services  may also decline as a
result of new  technologies,  competition or other  factors.  If this decline in
demand were to occur, the Company's  license revenues and professional  services
fees could be materially and adversely affected.

                                       49
<PAGE> 30

Micro Focus is in the process of reviewing its major internal  corporate systems
for  potential  Year 2000  compliance  issues and  intends  to take  appropriate
corrective  action  based on the  results of such  review.  Micro Focus does not
currently  anticipate  that it will  incur  material  operating  expenses  or be
required to invest heavily in internal  system  improvements as a result of Year
2000  compliance  issues.  In addition,  Micro Focus  believes  that the current
versions of its software products are Year 2000 compliant.  Notwithstanding  the
foregoing, there can be no assurance that the Year 2000 problem will not have an
adverse  effect on the  Company's  business,  financial  condition or results of
operations,  due to external factors relating to the Year 2000 problem which are
not controlled by Micro Focus, but on which Micro Focus may rely with respect to
its business and operations.

Micro Focus  completed two  significant  corporate  acquisitions  in the current
year,  as  noted  above.  The  Company  is in the  process  of  integrating  the
operations  acquired  in  these  transactions  with  its  own.  There  can be no
assurance  that  the  anticipated   benefits  of  recently   concluded  business
combinations will be realised.  In addition,  these  acquisitions  could require
significant  additional  management  attention.  The Company expects to continue
growing its business  through  acquisitions.  If Micro Focus is  unsuccessful in
integrating and managing the recently acquired businesses or other businesses it
may acquire in the future,  the Company's  business,  results of operations  and
financial condition could be adversely affected in future periods.

Exchange rate fluctuations

Micro Focus prepares separate  consolidated  financial  statements  expressed in
U.S. dollars and G.B. pounds.  Revenue, costs and expenses arising in currencies
other than the reporting  currency are translated  using average exchange rates.
Assets and  liabilities  denominated  in  currencies  other  than the  reporting
currency are translated at exchange rates in effect at the balance sheet date.

The majority of the  Company's  revenue  arises in U.S.  dollars  (approximately
two-thirds  in 1998),  whereas its costs are incurred  approximately  equally in
U.S. dollars and other  currencies,  predominately  G.B.  pounds.  Consequently,
fluctuations  in exchange  rates,  particularly  between the U.S. dollar and the
G.B. pound, may have a significant  impact on the Company's  operating  results,
notably when expressed in G.B. pounds.  In 1998 and 1997,  fluctuations  between
the U.S. dollar and the G.B. pounds have not been significant,  and net exchange
rate gains or losses on operational transactions have been immaterial.

Liquidity and capital resources

Micro  Focus  continues  to fund its  activities  through  cash  from  operating
activities.  In 1998 cash provided by operating  activities was GBP 17.8m (1997:
GBP 12.1m).

In 1998 Micro Focus  invested GBP 8.3m (1997:  GBP 2.5m) in property,  plant and
equipment and GBP 5.7m (1997: GBP 5.3m) in software  product assets.  Investment
in 1998 included  $2.7m in connection  with the relocation of the Company to new
U.S. facilities in Mountain View, California and Wayne, Pennsylvania,  and $3.2m
for  communications  and enterprise  systems.  In 1998 the Company also paid GBP
2.0m in cash in connection with the acquisition of Millennium.

Net of these expenditures, cash and short-term investments increased by GBP 6.8m
to GBP 51.5m (1997: increased by GBP 5.8m toGBP 44.7m).

The  Company  has in place a line of credit  under the terms of which  unsecured
financing of up to GBP 5.0m is available  until January 2001. At January 31 1998
borrowings  totalling  GBP1.0m had been made against this line of credit  (1997:
GBPnil).

Micro  Focus  believes  it is  important  to  maintain  a  conservative  capital
structure and a strong cash position. Cash is primarily invested in liquid money
market investments. The Company's investment policy is designed to minimize risk
while  maximizing  return  on  cash  given  such  levels  of  risk,  and to keep
uninvested cash at a minimum. Cash management is centralized, although some cash
is held at  various  subsidiaries  around  the  world  to meet  local  operating
requirements.

The Company  believes that existing cash balances in combination with internally
generated  funds  and its  available  bank  lines of  credit  will be more  than
sufficient to meet cash requirements in its 1999 financial year.

                                       50
<PAGE> 31

CONSOLIDATED PROFIT AND LOSS ACCOUNT (UK FORMAT)

<TABLE>
<CAPTION>

--------------------------------------------------------------------------------------------------------------------------
                                                          Continuing  Acquisitions  Year ended   Year ended   Year ended
                                                          operations      (note 3)  January 31   January 31   January 31
                                                                                          1998         1997         1996
                                                  Notes      GBP'000       GBP'000     GBP'000      GBP'000      GBP'000
---------------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>           <C>        <C>          <C>          <C>    
Revenue
   Product revenue                                           60,323         157        60,480       42,020       43,991
   Service revenue                                           34,274        2,261       36,535       31,069       33,267
---------------------------------------------------------------------------------------------------------------------------
Total revenue                                        2        94,597        2,418       97,015       73,089       77,258
---------------------------------------------------------------------------------------------------------------------------
Costs and expenses
   Cost of product revenue                                    6,987            3        6,990        6,406        8,855
   Cost of service revenue                                   13,742        2,103       15,845       11,892       12,343
---------------------------------------------------------------------------------------------------------------------------
Total cost of revenue                                         20,729        2,106       22,835       18,298       21,198
---------------------------------------------------------------------------------------------------------------------------
Gross profit                                                  73,868          312       74,180       54,791       56,060
---------------------------------------------------------------------------------------------------------------------------
Operating expenses
    Research and development                         4        19,625           54       19,679       24,299       26,851
    Sales and marketing                                       35,222           67       35,289       30,146       32,857
    General and adminisive                                     6,091          385        6,476        7,854        4,986
--------------------------------------------------------------------------------------------------------------------------
Total operating expenses                                      60,938          506       61,444       62,299       64,694
--------------------------------------------------------------------------------------------------------------------------
Operating profit/(loss)                              5        12,930         (194)      12,736       (7,508)      (8,634)
---------------------------------------------------------------------------------------------------------------------------
Interest income                                                             2,551        1,720        2,166
Interest expense                                                              (70)         (21)         (74)
 ...........................................................................................................................
Profit/(loss) before taxation                                                           15,217       (5,809)      (6,542)
Taxation                                             9                                  (4,791)      (1,472)          72
---------------------------------------------------------------------------------------------------------------------------
Retained profit/(loss) for the year                                                     10,426       (7,281)      (6,470)
---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: basic                    10                                  67.8p       (48.0p)     (43.6p)
---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: diluted                  10                                  65.0p       (48.0p)     (43.6p)
---------------------------------------------------------------------------------------------------------------------------

Earnings  per share  after  5-for-1  stock  split (see note 22 to the  financial
statements on page 67):

---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: basic                                                        13.6p        (9.6p)      (8.7p)
---------------------------------------------------------------------------------------------------------------------------
Earnings/(loss) per share: diluted                                                      13.0p        (9.6p)      (8.7p)
---------------------------------------------------------------------------------------------------------------------------

The notes on pages 57 to 67 form part of these financial statements.

</TABLE>

                                       51
<PAGE> 32

CONSOLIDATED BALANCE SHEET (UK FORMAT)

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                                                 January 31   January 31
                                                                                                       1998         1997
                                                                                         Notes  GBP'000  GBP'000
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                        <C>       <C>            <C>    
Fixed assets
   Intangible fixed assets                                                                  11      12,394        14,590
   Tangible fixed assets                                                                    12       23,836       20,543
   Investments                                                                              13        4,886        5,634
---------------------------------------------------------------------------------------------------------------------------
Total fixed assets                                                                                   41,116       40,767
---------------------------------------------------------------------------------------------------------------------------
Current assets
   Stocks                                                                                   14         317          484
   Debtors                                                                                  15       30,873       14,228
   Cash and bank deposits                                                               51,518       44,725
---------------------------------------------------------------------------------------------------------------------------
Total current assets                                                                                 82,708       59,437
---------------------------------------------------------------------------------------------------------------------------
Creditors: amounts falling due within one year                                              16       26,483       16,180
Deferred revenue                                                                        20,030       16,646
Net current assets                                                                                   36,195       26,611
Total assets less current liabilities                                                                77,311       67,378
Creditors: amounts falling due after more than one year                                     17          12           15
Provisions for liabilities and charges:
    Deferred taxation                                                                       20        6,407        6,239
---------------------------------------------------------------------------------------------------------------------------
Net assets                                                                                           70,892       61,124
---------------------------------------------------------------------------------------------------------------------------
Capital and reserves
   Called up share capital                                                                           1,588         1,517
   Share premium account                                                                            30,196        18,071
   Profit and loss account                                                                          39,108        41,536
---------------------------------------------------------------------------------------------------------------------------
Total shareholders' funds                                                                            70,892       61,124
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
                                  
The  financial  statements  on  pages  51 to 67 were  approved  by the  Board of
Directors on May 1 1998

/s/ Martin Waters                                           /s/ Ron Forbes 

Martin Waters                                               Ron Forbes
Director                                                    Director

The notes on pages 51 to 67 form part of these financial statements.

                                       52

<PAGE> 33

CONSOLIDATED CASH FLOW STATEMENT (UK FORMAT)

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                                                                    January 31   January 31   January 31
                                                                                          1998         1997         1996
                                                                                     GBP'000    GBP'000    GBP'000
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                       <C>         <C>          <C>    
Net cash inflow from operating activities                                               17,767       12,135        9,725
---------------------------------------------------------------------------------------------------------------------------
Returns on investments and servicing of finance
   Interest received                                                                    2,519        1,803        2,082
   Interest paid                                                                         (70)         (21)         (74)
---------------------------------------------------------------------------------------------------------------------------
Net cash inflow from returns on investments and servicing of finance                     2,449        1,782        2,008
---------------------------------------------------------------------------------------------------------------------------
Taxation
   U.K. corporation tax (paid)                                                           (599)         (88)      (1,562)
   Overseas tax refunded/(paid)                                                          (262)          70       (1,362)
---------------------------------------------------------------------------------------------------------------------------
Tax paid                                                                                 (861)         (18)      (2,924)
---------------------------------------------------------------------------------------------------------------------------
Capital expenditure and financial investment
   Purchase of tangible fixed assets                                                   (8,263)      (2,500)      (8,643)
   Purchase of software product assets                                                     -            -          (226)
   Capitalised software product assets                                                  (5,688)      (5,258)      (9,882)
   Purchase of own shares                                                                   -           -         (5,002)
   Disposal of own shares                                                                 748           -            -
   Disposal of tangible fixed assets                                                      447          546          298
---------------------------------------------------------------------------------------------------------------------------
Net cash outflow from capital expenditure and financial investment                     (12,756)      (7,212)     (23,455)
---------------------------------------------------------------------------------------------------------------------------
Acquisitions and disposals
   Purchase of subsidiary undertaking                                                   (2,000)         -         (3,892)
   Net cash acquired with subsidiary undertakings                                          961          -            -
---------------------------------------------------------------------------------------------------------------------------
Net cash outflow from acquisitions and disposals                                        (1,039)         -         (3,892)
---------------------------------------------------------------------------------------------------------------------------
Cash inflow/(outflow) before financing                                                  (6,546)       6,687      (18,538)
---------------------------------------------------------------------------------------------------------------------------
Financing
   Issue of ordinary shares, net of expenses                                             1,517          138          278
   Capital element of finance lease obligations                                            (65)        (131)        (295)
   Bank loan                                                                             1,007           -             -
---------------------------------------------------------------------------------------------------------------------------
Net cash inflow/(outflow) from financing                                                 2,459           -           (17)
---------------------------------------------------------------------------------------------------------------------------
Increase/(decrease) in cash                                                              8,019        6,694      (18,555)
---------------------------------------------------------------------------------------------------------------------------

The notes on pages 57 to 67 form part of these financial statements.

</TABLE>
                                       53

<PAGE> 34

NOTES TO CONSOLIDATED CASH FLOW STATEMENT (UK FORMAT)

<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------------------------
                                                                                    Year ended   Year ended   Year ended
                                                                                    January 31   January 31   January 31
                                                                                          1998         1997         1996
                                                                                       GBP'000      GBP'000      GBP'000
---------------------------------------------------------------------------------------------------------------------------
(i)  Reconciliation of operating profit to "Net cash inflow from operating activities"
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                      <C>          <C>          <C>    
Operating profit/(loss)                                                                 12,736       (7,508)      (8,634)
Depreciation charges                                                                     4,534        5,655        6,186
Amortisation charges                                                                     7,765        8,067       12,639
Loss on sale of tangible fixed assets                                                       72          221           70
Decrease in stocks                                                                         154        1,171          117
(Increase)/decrease in debtors                                                         (14,460)       8,012        2,174
Increase/(decrease) in creditors                                                         3,942         (790)        (690)
Increase/(decrease) in deferred revenue                                                  3,024       (2,693)      (2,137)
---------------------------------------------------------------------------------------------------------------------------
Net cash inflow from operating activities                                               17,767       12,135        9,725
---------------------------------------------------------------------------------------------------------------------------

(ii) Reconciliation of net cash flow to movement in net funds
---------------------------------------------------------------------------------------------------------------------------
Increase/(decrease) in cash                                                              8,019        6,694      (18,555)

Net cash inflow/(outflow) from financing                                                  (942)         131          295
                                                                                         7,077        6,825      (18,260)
Translation difference                                                                  (1,226)        (941)       1,704
---------------------------------------------------------------------------------------------------------------------------
                                                                                         5,851        5,884      (16,556)
Net debt, beginning of year                                                             44,642       38,758       55,314
---------------------------------------------------------------------------------------------------------------------------
Net debt, end of year                                                                   50,493       44,642       38,758
---------------------------------------------------------------------------------------------------------------------------

(iii)  Analysis of net funds

---------------------------------------------------------------------------------------------------------------------------
                                                                      Balances at                            Balances at
                                                                       January 31                  Exchange   January 31
                                                                             1997   Cash flow   differences         1998
                                                                          GBP'000     GBP'000       GBP'000      GBP'000
--------------------------------------------------------------------------------------------------------------------------
Cash                                                                       44,725        8,019       (1,226)      51,518
Short term loans                                                              -         (1,007)           -       (1,007)
Finance lease obligations                                                     (83)          65            -          (18)
---------------------------------------------------------------------------------------------------------------------------
Balance, end of year                                                       44,642        7,077       (1,226)      50,493
---------------------------------------------------------------------------------------------------------------------------

The notes on pages 57 to 67 form part of these financial statements.

</TABLE>

                                       54

<PAGE> 35

COMPANY BALANCE SHEET (UK FORMAT)

<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------------------------------------
                                                                                                 January 31  January 31
                                                                                                       1998        1997
                                                                                         Notes      GBP'000     GBP'000
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                       <C>          <C>         <C>    
Fixed assets
   Tangible fixed assets                                                                    12        2,971       2,992
   Investments                                                                              13       45,086      32,809
---------------------------------------------------------------------------------------------------------------------------
Total fixed assets                                                                                   48,057      35,801
---------------------------------------------------------------------------------------------------------------------------
Current assets
   Amounts owed by subsidiary undertakings                                                            8,989      11,214
   Other debtors                                                                          40             2
   Cash and bank deposits                                                                               738          18
---------------------------------------------------------------------------------------------------------------------------
Total current assets                                                                                  9,767      11,234
---------------------------------------------------------------------------------------------------------------------------
Creditors: amounts falling due within one year
   Amounts owed to subsidiary undertakings                                                            9,153      11,469
   Trade creditors                                                                         69            9
   Corporation tax                                                                         63           178
   Accrued expenses                                                                                     206          47
---------------------------------------------------------------------------------------------------------------------------
Net current assets/(liabilities)                                                                        276        (469)
---------------------------------------------------------------------------------------------------------------------------
Total assets less current liabilities                                                                48,333      35,332
Provisions for liabilities and charges:
   Deferred taxation                                                                      20             19          19
---------------------------------------------------------------------------------------------------------------------------
Net assets                                                                                           48,314      35,313
---------------------------------------------------------------------------------------------------------------------------
Capital and reserves
   Called up share capital                                                                            1,588       1,517
   Share premium account                                                                             30,196      18,071
   Profit and loss account                                                                           16,530      15,725
---------------------------------------------------------------------------------------------------------------------------
Total shareholders' funds                                                                            48,314      35,313
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

The  financial  statements  on  pages  51 to 67 were  approved  by the  Board of
Directors on May 1 1998.


/s/Martin Waters                                               /s/Ronald Forbes 

Martin Waters                                                  Ron Forbes
Director                                                       Director

This is the balance  sheet of Micro Focus Group Plc, the holding  company of the
Micro Focus group of companies,  which is presented in  accordance  with section
226 of the  Companies  Act 1985 of Great  Britain.  No profit or loss account is
presented  for Micro Focus Group Plc as provided by section 230 of the same Act.
The notes on pages 51 to 67 form part of these financial statements.

                                       55

<PAGE> 36

STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES/MOVEMENT IN SHAREHOLDERS' FUNDS 
(UK FORMAT)  

STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES 

<TABLE>
<CAPTION>

--------------------------------------------------------------------------------------------------------------------------
                                                                                    Year ended   Year ended   Year ended
                                                                                    January 31   January 31   January 31
                                                                                          1998         1997         1996
                                                                                       GBP'000      GBP'000      GBP'000
--------------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>           <C>          <C>   
Profit/(loss) for the year                                                              10,426       (7,281)      (6,470)
Currency translation adjustment                                                         (1,122)      (1,920)       2,275
---------------------------------------------------------------------------------------------------------------------------
Total recognised gains and losses for the year                                           9,304       (9,201)      (4,195)
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


MOVEMENT IN SHAREHOLDERS' FUNDS

<TABLE>
<CAPTION>

 ....................................................................................................................................
                                                   Ordinary shares of 10p each:
                                                                                     Share       Deferred      Retained
                                                  Authorised   Issued      Amount   premium  consideration     earnings      Total
                                                        '000     '000     GBP'000   GBP'000        GBP'000      GBP'000    GBP'000
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>         <C>       <C>       <C>          <C>              <C>       <C>
BALANCE, JANUARY 31 1995                            16,500      14,364    1,437    13,147         3,340           54,932    72,856
Share options exercised                                -          115       11       297           -             -          308
Shares issued to complete Burl acquisition             -          665       66      4,492       (3,340)          -          1,218
(Loss) for the year                                    -           -        -         -            -             6,470)    (6,470)
Currency translation adjustment                        -           -        -         -            -             2,275      2,275
------------------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 31 1996                            16,500      15,144    1,514    17,936          -             50,737    70,187
Increase in authorised share capital                 6,000         -        -         -            -              -         -
Share options exercised                                -           24        3       135           -              -         138
(Loss) for the year                                    -           -        -         -            -             (7,281)   (7,281)
Currency translation adjustment                        -           -        -         -            -             (1,920)   (1,920)
------------------------------------------------------------------------------------------------------------------------------------
BALANCE, JANUARY 31 1997                            22,500      15,168    1,517    18,071          -             41,536    61,124
Issued on acquisitions                                 -          527        52    10,627          -               -       10,679
Goodwill arising on acquisitions                       -           -        -           -          -            (11,732)  (11,732)
Share options exercised                                -          188        19     1,498          -               -        1,517
Profit for the year                                    -           -        -         -            -             10,426    10,426
Currency translation adjustment                        -           -        -         -            -             (1,122)   (1,122)
BALANCE, JANUARY 31 1998                            22,500     15,883    1,588    30,196           -             39,108    70,892
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The issued ordinary shares are allotted, called up and fully paid (see also note
22 on page 67).

Micro  Focus  Group  Plc has  been  authorised  by its  members  to make  market
purchases  of its own  shares  (within  the  meaning  of  section  163(3) of the
Companies  Act  1985).   The  cumulative   value  of  goodwill  written  off  on
acquisitions  between  December 23 1989 and  January 31 1998 was GBP  11,732,000
(January 31 1997: GBPnil).


The notes on pages 57 to 67 form part of these financial statements.

                                       56
<PAGE> 37

NOTES TO THE FINANCIAL STATEMENTS (UK FORMAT)

The statutory financial statements of Micro Focus, within the meaning of section
240 of the  Companies Act 1985 of Great  Britain,  for the year ended January 31
1998 are contained on pages 43 to 59.

The Company has previously referred to its current financial year ending January
31 1998 as "1997." In the future, the Company will designate each financial year
as the  calendar  year in which the last  month of the  financial  year  occurs.
Accordingly, the Company's current year ending January 31 1998 is referred to as
"financial  year 1998" and "1998" in this report,  and prior financial years are
referenced accordingly.

Note 1  Significant accounting policies

To enable the reader to see immediately any information  provided in addition to
the common policy statements, the text of this note and the corresponding note 1
to the financial  statements in U.S.  format on page 19 is italicised  where the
text is identical.

Basis of preparation

The financial statements have been prepared under the historical cost convention
and in accordance with applicable U.K. Accounting Standards which, as applied by
Micro Focus, do not differ in any significant respect from US generally accepted
accounting  principles  ("GAAP") except with regard to acquisitions and goodwill
and the presentation of certain items in the financial  statements.  In order to
comply  with the  provisions  of FRS 1  (Revised)  the  Consolidated  Cash  Flow
Statement  has been  restated for the years ended January 31 1997 and January 31
1996.

Basis of consolidation

The consolidated  financial  statements are those of Micro Focus Group Plc ("the
Company") and all of its subsidiary  undertakings  ("Micro  Focus") for the year
ended January 31 1998. All significant  inter-company  balances and transactions
have been eliminated on consolidation.

The  presentation  of data  presented  in the profit and loss  account  has been
revised  in order to  segregate  costs of  revenue  from  operating  costs.  The
presentation  of prior year numbers has been  similarly  revised to conform with
the  current  presentation.  The  results of  operations  of the Company are not
affected by this changed presentation.

Acquisitions  are  accounted  for using the  acquisition  method of  accounting.
Accordingly the Consolidated  Profit and Loss Account and Consolidated Cash Flow
Statement  include the results and cash flows for the period of  ownership.  The
cost of acquisition  represents the cash value of the  consideration  and/or the
market value of the shares  issued on the date the offer  became  unconditional,
plus expenses. The purchase consideration is allocated to assets and liabilities
on the basis of fair value at the date of acquisition.

Revenue recognition

Revenue  represents the amounts derived from the provision of goods and services
which fall within Micro Focus'  ordinary  activities,  stated net of  applicable
sales taxes.

Revenue from licencing  software packaged products to end users and resellers is
recognised on delivery,  provided that no significant  vendor  obligations exist
and collection of the resulting debt is deemed probable.

Revenue  from  sales  to  original  equipment   manufacturers   ("OEM's")  under
non-cancellable  licence  agreements  generally provide for development fees and
initial licence fees, which are recognised at the later of: (a) the date product
is delivered to the OEM; (b) the date payment  becomes due within twelve months;
and (c) the date of  receipt of monies if  collection  cannot be  assessed  with
reasonable  assurance.  When  sales by the OEM exceed the  initial  licence  fee
commitment, revenue is recognised as unit shipments are reported by the OEM.

Revenue from maintenance  agreements is recognised pro-rata over the life of the
agreement corresponding to notional delivery of the service.

Software product assets - development costs

Costs  related to the initial  development  and design of new software  products
prior to the  establishment  of  technological  feasibility  are  written off as
research  and  development  costs.  Once  technological   feasibility  has  been
reasonably  established,  either by the completion  and successful  testing of a
detailed program design,  or by the creation and testing of an operative working
model,  further  development  costs incurred are capitalised as software product
assets.

Software  licenced  for  inclusion  in the Micro Focus  product  set,  including
software  acquired  through  acquisitions,  is also included in software product
assets.

Software  product  assets are amortised  using the straight line method over the
estimated  economic life of the  products,  which in most cases is assumed to be
four years.  Where a shortfall in future revenue from a product is  anticipated,
amortisation is accelerated.

Amortisation of software  product assets is included in research and development
costs.

                                       57
<PAGE> 38

Goodwill

Goodwill  represents  the  excess of the  amount  paid on the  acquisition  of a
business over the aggregate fair value of the net assets acquired.  Such amounts
are set off against reserves as incurred.

Tangible fixed assets

Tangible  fixed  assets are  stated at cost less  accumulated  depreciation  and
amortisation.  Depreciation and amortisation is computed using the straight-line
method over  estimated  economic  lives from the time the asset is put into use.
Present estimated economic lives are as follows:

Freehold office buildings  40 years
Leasehold improvements     over the lease term
Computer equipment         3 - 5 years
Office equipment           7 years
Transportation equipment   3 - 4 years

Leasing

Leases which transfer  substantially  all the benefits and risks of ownership of
an asset to Micro Focus are capitalised as fixed assets.  The amount capitalised
is that sum for which the leased  asset could be  purchased  at the start of the
lease, this sum also being treated as a liability.

Depreciation on such leased assets is provided at rates  calculated to write off
the capitalised cost over the shorter of the lease term and the asset's economic
life.  Lease payments are apportioned  between finance charges  (computed on the
basis of implicit interest rates) and a reduction in the original liability.

Rentals  paid under  operating  leases are charged to income on a  straight-line
basis over the lease term.

Deferred taxation

Deferred taxation is provided on the liability method on all timing  differences
to the extent  that they are  expected  to reverse in the future  without  being
replaced,  calculated  at  the  rate  at  which  it is  anticipated  the  timing
differences will reverse.

Stocks

Stocks, consisting principally of diskettes and technical manuals, are stated at
the  lower of cost and net  realisable  value,  using  the  first-in,  first-out
method.  Contracts in progress,  representing  engineering costs associated with
non-cancellable licence agreements prior to delivery, are included in stocks and
charged to income when the related revenue is recognised.

Cash and bank deposits

Cash and bank  deposits  includes cash placed on deposit where the maturity date
is between  three and twelve  months from the initial date of deposit.  All such
cash  balances are  repayable on demand and can be withdrawn at any time without
notice or penalty.

Investments

Investments are recorded at cost less any provision for permanent  diminution in
value.

Translation of foreign currencies

Micro Focus' policy on foreign currency translation complies with U.K. Statement
of Standard Accounting Practice No. 20 "Foreign Currency Translation".

Assets and  liabilities  denominated  in currencies  other than G.B.  pounds are
translated at exchange  rates in effect at the balance sheet date.  Closing G.B.
pounds  to U.S.  dollar  rates at  January  31 1998,  1997 and 1996 were GBP 1 =
$1.64, GBP 1 = $1.60 and GBP 1 = $1.51 respectively. Revenue, costs and expenses
are translated  using average rates.  Monthly average G.B. pounds to U.S. dollar
rates  used  during  1998  range  between  GBP 1 = $1.60 and GBP 1 = $1.67,  and
average  GBP 1 = $1.64,  GBP 1 = $1.58 and GBP 1 = $1.58 in 1998,  1997 and 1996
respectively.  Translation adjustments resulting from the process of translating
financial statements  denominated in currencies other than G.B. pounds are dealt
with through reserves.  All other differences are charged through the profit and
loss account.

Earnings/(loss) per share

Earnings/(loss)  per  share are based on the  profit/(loss)  for the year  after
taxation,  and on the weighted  average  number of ordinary  shares  outstanding
during the period.

Fully  diluted  earnings  per share are based on the  profit  for the year after
taxation,  and on the weighted  average  number of ordinary  shares  outstanding
during the  period as  adjusted  for  shares  issuable  upon  exercise  of share
options. The computation assumes the proceeds from the exercise of share options
are invested in 2.5% Consolidated Stock.

                                       58
<PAGE> 39

Pensions

Micro  Focus  has  entered  into  arrangements  under  which  it  makes  defined
contributions   to  personal   pension   schemes   operated  by  its  employees.
Contributions,  which are independently  administered by insurance companies and
other  financial  institutions,  are charged to income in the year in which they
become payable.

Related party transactions

The Company is exempt  under the  provisions  of FRS 8 from  disclosing  related
party transactions which are eliminated on consolidation.

New accounting standards

Financial Reporting Standards No. 9  - Associates and Joint Ventures and No. 10 
- Goodwill and Intangible Assets, were issued by the Accounting Standards Board 
in 1997, and will apply to the Company in 1999.

Note 2  Segmental information

Micro Focus operates in one business  segment - the development and marketing of
computer software  products and related  services.  The following table analyses
revenue by geographical area, based on customer location:

                              1998        1997        1996
--------------------------------------------------------------------------------
                           GBP'000     GBP'000     GBP'000
--------------------------------------------------------------------------------
United Kingdom              11,864       6,811       7,178
United States               49,037      38,640      42,824
Europe (excluding U.K.)     18,498      19,297      19,400
Japan                        3,964       3,519       2,720
Other                       13,652       4,822       5,136
--------------------------------------------------------------------------------
                            97,015      73,089      77,258
--------------------------------------------------------------------------------

The following table analyses worldwide operations by geographical area, based on
the location of Micro Focus facilities.

                             1998        1997       1996
--------------------------------------------------------------------------------
                           GBP'000     GBP'000     GBP'000
--------------------------------------------------------------------------------
Revenue:
   United Kingdom           43,249      33,974      33,988
   United States            56,846      42,856      49,503
   Europe (excluding U.K.)  23,554      20,588      20,196
   Other                     7,859       1,910       1,300
--------------------------------------------------------------------------------
                           131,507      99,328     104,987
--------------------------------------------------------------------------------
Inter-segment revenue:
   United Kingdom          (21,003)    (15,900)    (16,728)
   United States            (4,199)     (3,501)     (4,790)
   Europe (excluding U.K.)  (9,077)     (6,381)     (5,362)
   Other                      (213)       (457)       (849)
--------------------------------------------------------------------------------
                            97,015      73,089      77,258
--------------------------------------------------------------------------------
Operating profit/(loss):
   United Kingdom            5,498      (2,960)      1,350
   United States             1,041      (4,699)     (4,429)
   Europe (excluding U.K.)     896        (220)     (5,097)
   Other                     5,301         371        (458)
--------------------------------------------------------------------------------
                            12,736      (7,508)     (8,634)
--------------------------------------------------------------------------------
Net operating assets/(liabilities):
   United States            14,174      16,075      20,264
   United Kingdom            2,930      (8,199)     (3,087)
   Europe (excluding U.K.)  (4,122)      2,988       9,176
   Other                     2,521         (16)       (558)
--------------------------------------------------------------------------------
                            15,513      10,848      25,795
--------------------------------------------------------------------------------


Inter-segment  revenue  principally  represents  licence  fees and  charges  for
research and development  between locations.  Operating  profit/(loss)  excludes
interest    income   and   expense   and,    correspondingly,    net   operating
assets/(liabilities)   exclude   interest-bearing  assets  and  liabilities.   A
reconciliation of the net operating  assets/(liabilities)  as shown above to net
assets as shown in the balance sheet is as follows:

                             1998        1997       1996
--------------------------------------------------------------------------------
                            GBP'000     GBP'000    GBP'000
--------------------------------------------------------------------------------
Net operating assets        15,513      10,848      25,795
Cash and bank loans         50,511      44,725      38,972
Investment in own shares     4,886       5,634       5,634
Finance lease obligations      (18)        (83)       (214)
--------------------------------------------------------------------------------
Net assets                  70,892      61,124      70,187
--------------------------------------------------------------------------------

                                       59
<PAGE> 40

Note 3  Acquisitions


In  the  current  year  Micro  Focus  completed  two  acquisitions  for a  total
consideration of GBP 12,679,000 in cash and shares.

On April 30 1997 the Company  acquired all of the share capital of Millennium UK
Limited  ("Millennium"),   a  provider  of  consulting  and  project  management
services,  for a  consideration  of GBP 4,000,000  paid in a combination  of GBP
2,000,000  in cash and the issuance of 149,142  ordinary  shares in the Company.
The transaction has been accounted for as an acquisition and,  accordingly,  the
results of operations and cash flows of Millennium have been combined with those
of Micro Focus for the nine-month period subsequent to April 30 1997.

The acquisition cost has been allocated between the identifiable tangible assets
and liabilities of Millennium  based on their  respective  fair values,  and the
excess has been allocated to goodwill, as shown in the following table.

--------------------------------------------------------------------------------
                        Net assets   Fair value Fair values on
                          acquired  adjustments    acquisition
                           GBP'000      GBP'000        GBP'000
--------------------------------------------------------------------------------
Cash                           (31)         -          (31)
Accounts receivable            379          -          379
Other current assets            45          -           45
Tangible fixed assets           20          -           20
Current liabilities           (570)         -         (570)
--------------------------------------------------------------------------------
Total net assets              (157)         -         (157)
--------------------------------------------------------------------------------
Goodwill arising                                     4,157
--------------------------------------------------------------------------------
                                                     4,000
--------------------------------------------------------------------------------
Purchase consideration payable to vendors            4,000
--------------------------------------------------------------------------------

Goodwill arising on the acquisition has been charged to reserves.

Millennium  reported a loss after  taxation of GBP 229,000 in its financial year
ended  December 31 1996.  In the  subsequent  four month period to April 30 1997
Millennium  recorded a profit after taxation of GBP 19,000.  In the period since
acquisition, Millennium contributed GBP 48,000 to the group's net operating cash
flows and utilised GBP 44,000 for capital expenditure.

Subsequent to the acquisition, costs amounting to GBP 200,000 have been incurred
in connection with a reorganisation  of the business of Millennium.  These costs
are included in general and administrative costs in the current year.

On January 20 1998 the Company  completed the  acquisition  of XDB Systems,  Inc
("XDB"). XDB was acquired in exchange for 378,395 ordinary shares in the Company
and the exchange of XDB stock options for Micro Focus options, which represented
a total value of GBP 8,679,000 on the date the acquisition was completed. XDB, a
privately-held corporation based in Maryland, USA, is a provider of DB2 database
development,  maintenance and connectivity  solutions.  The transaction has been
accounted for as an acquisition. Accordingly, the results of operations and cash
flows of XDB have  been  combined  with  those of  Micro  Focus  for the  period
subsequent to January 20 1998.

The acquisition cost has been allocated between the identifiable tangible assets
and liabilities of XDB based on their respective fair values, and the excess has
been allocated to goodwill, as shown in the following table.

--------------------------------------------------------------------------------
                            Fair value adjustments
--------------------------------------------------------------------------------
                               Accounting
                  Net assets       policy         Fair values on
                    acquired      changes            acquisition
                     GBP'000      GBP'000   Other        GBP'000
--------------------------------------------------------------------------------
Cash                     992         -        -           992
Accounts receivable    2,442      (707)       -         1,735
Other current assets     116         -        -           116
Tangible fixed assets    276         -        -           276
Current liabilities   (2,093)        -       78       (2,015)
Deferred taxation        754         -     (754)           -
--------------------------------------------------------------------------------
Total net assets       2,487      (707)    (676)        1,104
--------------------------------------------------------------------------------
Goodwill arising                                        7,575
--------------------------------------------------------------------------------
                                                        8,679
--------------------------------------------------------------------------------
Purchase consideration payable to vendors               8,679
--------------------------------------------------------------------------------

The fair value  adjustments  relate to: - the deferral of previously  recognised
revenue totalling GBP 707,000 to reflect  compliance with the Company's existing
revenue recognition policy - reductions of GBP 78,000 to accruals established by
XDB to provide for costs  incurred  during 1998 - the  elimination of a deferred
tax asset amounting to GBP 754,000 which had been established in accordance with
U.S. accounting principles.

The  acquisition  of XDB was  completed  shortly  before the end of the  current
financial year and  consequently  fair values on acquisition have been estimated
based on information  currently  available.  Any additional  adjustments to fair
values  arising on final  review will be disclosed  in the  Company's  financial
statements for the year ended January 31 1999.

                                       60
<PAGE> 41

In addition to the above adjustments,  provisions  amounting to GBP 122,000 have
been recorded for the estimated costs of  rationalisation  and reorganisation of
the acquired business,  and charged to general and  administrative  costs in the
profit and loss account.

Goodwill arising on the acquisition has been charged to reserves.

XDB's loss after  taxation in its  financial  year ended January 31 1997 was GBP
2,642,000.  In the  subsequent  pre-acquisition  period from  February 1 1997 to
January 20 1998 XDB recorded a loss after  taxation of GBP  671,000.  XDB's cash
flows for the period of ownership were not material.

Note 4  Research and development costs

--------------------------------------------------------------------------------
                              1998        1997        1996
                           GBP'000     GBP'000     GBP'000
--------------------------------------------------------------------------------
Research and
   development costs,
   before capitalization    17,602      19,235      23,423
Costs capitalized as 
   software product assets (5,688)     (5,258)     (9,882)
Amortisation of
   capitalized costs         7,765       8,067       8,805
 ................................................................................
                            19,679      22,044      22,346
Exceptional items (note 8): 17,602      19,235      23,423
Restructuring costs:
   - accelerated amortisation    -           -       3,834
   - other costs                 -       2,255         671
--------------------------------------------------------------------------------
                            19,679      24,299      26,851
--------------------------------------------------------------------------------

Note 5  Operating profit/(loss)

Operating profit/(loss) is stated after charging:
--------------------------------------------------------------------------------
                              1998        1997         1996
                           GBP'000     GBP'000      GBP'000
--------------------------------------------------------------------------------
Auditors' remuneration:
   audit services: U.K.        117         105          96
   audit services: overseas    110          93         100
   non-audit services: U.K.    230         181         141
   non-audit services: overseas289         218         179
Operating lease rentals
   equipment                   756         743         903
   land and buildings        1,780       1,811       2,137
Depreciation to leased assets   39          39         118
Other depreciation and
   amortisation              4,534       5,616       6,068
--------------------------------------------------------------------------------

The profit  attributable to the ordinary  shareholders of Micro Focus Group Plc,
dealt with in the financial statements of Micro Focus, is GBP 805,000 (1997: GBP
716,000;  1996: GBP 1,449,000).  There were no other movements on reserves other
than the movement on share premium shown on page 56.

Note 6  Directors and employees

An  analysis  of the  directors'  remuneration  pension  entitlements  and share
options is set out in the Executive Remuneration  Committee's Report on pages 42
and 43.

The average weekly number of staff employed by Micro Focus during the year was:
--------------------------------------------------------------------------------
                              1998        1997        1996
                            number      number      number
--------------------------------------------------------------------------------
U.K.                           252         255         302
U.S.                           355         310         355
Other                          112          81          78
--------------------------------------------------------------------------------
                               719         646         735
--------------------------------------------------------------------------------

Staff costs, which include salaries, bonus and commissions, amounted to:

--------------------------------------------------------------------------------
                              1998        1997        1996
                           GBP'000     GBP'000     GBP'000
--------------------------------------------------------------------------------
U.K.                        10,324       9,173      10,167
U.S.                        22,803      16,758      17,801
Other                        5,184       3,554       3,856
--------------------------------------------------------------------------------
                            38,311      29,485      31,824
Social security costs        2,979       2,797       2,884
Other pension costs            432         437         596
--------------------------------------------------------------------------------
                            41,722      32,719      35,304
--------------------------------------------------------------------------------

Other  pension  costs  principally  represent  amounts  paid by  Micro  Focus to
personal pension schemes operated by its employees. In the United Kingdom, Micro
Focus   matches   contributions   made   by   participating   employees   up  to
certainpredetermined  thresholds.  Arrangements for employees in other countries
have been  established  on  similar  bases,  subject  to local  regulations  and
practices in the countries concerned.

Note 7 Interest expense

--------------------------------------------------------------------------------
                               1998        1997        1996
                            GBP'000     GBP'000     GBP'000
--------------------------------------------------------------------------------
Finance charges payable under
   finance leases                5          18          74
On bank loans and overdrafts    65           3           -
--------------------------------------------------------------------------------
                                70          21          74
--------------------------------------------------------------------------------

                                       61
<PAGE> 42

Note 8  Exceptional items

Exceptional  items  recorded  in the year ended  January 31 1997  represented  a
charge of GBP  5,195,000  for  restructuring.  The charge  consists of the costs
associated  with a reduction  in the  Company's  workforce of  approximately  65
people,  facility  closures  and  consolidations,  and  asset  write-downs.  All
outstanding amounts due under the restructuring were settled prior to January 31
1998.

Exceptional  items  recorded in the year ended  January 31 1996  consisted  of a
charge of GBP 6,667,000 for  restructuring and a credit of GBP 666,000 resulting
from the adoption of Abstract 13  "Accounting  for ESOP Trusts" which was issued
by the Urgent Issues Task Force of the Accounting  Standards Board in June 1995.
Restructuring  costs of GBP 3,125,000  announced in May 1995 related to employee
terminations, closure of surplus office facilities, and fixed asset write-downs.
Additional  asset  write-downs  of GBP  3,542,000  booked in  January  1996 were
primarily  the result of a review into the  carrying  value of software  product
assets.

Note 9   Taxation

The taxation charge for the year consists of the following:

--------------------------------------------------------------------------------
                              1998         1997        1996
                           GBP'000      GBP'000     GBP'000
--------------------------------------------------------------------------------
U.K. corporation tax         3,244         237         133
Deferred taxation              (71)        870        (458)
Double taxation relief        (162)       (174)        105
Overseas taxation:
   U.S. federal                542           4           5
   U.S. state                  128           1           -
   Other                       958         276        (118)
 ................................................................................
                             4,639       1,214        (543)
Taxation underprovided/
   (overprovided)
   in previous years
Corporation tax                  -         258           -
Deferred taxation              152           -         202
Overseas taxation:
   U.S. federal                  -           -         193
   U.S. state                    -           -          (2)
   Other                         -           -          78
--------------------------------------------------------------------------------
                             4,791       1,472         (72)
--------------------------------------------------------------------------------

The effective tax rate in 1998 is 31.5%,  which compares to the applicable  U.K.
corporate tax rate of 31.3%.

In prior years the effective tax rate was significantly  distorted,  principally
as a result of losses  incurred  in the United  States  which can only be offset
against  profits  arising  in future  periods,  and the  impact of  disallowable
exceptional  items.  The  corporation  tax  returns of certain  U.S.  subsidiary
undertakings are under examination by the U.S.  Internal Revenue Service,  which
has proposed certain  adjustments.  The Company believes that the outcome of the
examination  will not give  rise to any  material  adjustment  to the  financial
statements.

Note 10  Earnings/(loss) per share

Earnings/(loss) per share is computed on the bases set out in note 1.

--------------------------------------------------------------------------------
                                   1998        1997       1996
--------------------------------------------------------------------------------
Basic earnings per share:
   Profit/(loss) after taxation    10,426    (7,281)     (6,470)
   Ordinary shares
      (weighted average)           15,373    15,156      14,843
Diluted earnings per share:
   Adjusted profit/(loss)
      after taxation               11,180    (7,281)     (6,470)
   Ordinary shares
      (weighted average)           17,199    15,156      14,843


Pro-forma  earnings per share data,  based on ordinary shares in issue following
the 5-for-1  sub-division of the Company's ordinary shares on March 13 1998 (see
note 22 to the financial statements on page 67) are also shown on the profit and
loss account.

Note 11  Intangible fixed assets

Intangible fixed assets consist of software product assets, as follows:

------------------------------------------------------------------------------- 
                                                         Net book          
                              Cost     Amortisation         value
                           GBP'000          GBP'000       GBP'000
--------------------------------------------------------------------------------
At January 31 1997          74,216           59,626         14,590
Currency fluctuations         (755)          (636)          (119)
Additions                     5,688            -            5,688
Amortisation for the year        -           7,765          (7,765)
--------------------------------------------------------------------------------
At January 31 1998          79,149           66,755         12,394
--------------------------------------------------------------------------------

                                       62

<PAGE> 43

Note 12   Tangible fixed assets

<TABLE>
<CAPTION>

(a) Micro Focus:
-------------------------------------------------------------------------------------------------------------------------------
                                                                                   Computer and
                                            Freehold                             communications
                                            land and     Leasehold        Office      equipment  Transportation
                                           buildings  Improvements     equipment   and software       equipment     Total
                                             GBP'000       GBP'000       GBP'000        GBP'000         GBP'000   GBP'000
-------------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>         <C>            <C>          <C>            <C>           <C>
Cost:
At January 31 1997                             13,556       840           4,690        23,954          292         43,332
Currency fluctuations                             -        (60)           (101)         (457)          (2)          (600)
Additions                                        272      1,795           1,308         5,157          27           8,560
Disposals                                         -         -           (1,246)         (834)        (191)        (2,271)
---------------------------------------------------------------------------------------------------------------------------
At January 31 1998                             13,828     2,575           4,651        27,820         126          49,021
---------------------------------------------------------------------------------------------------------------------------
Depreciation:
At January 31 1997                              436       760            3,312         18,118         163          22,789
Currency fluctuations                            -       (28)             (52)          (347)         (2)           (415)
Provision for the year                          223       85               403          3,810          9            4,534
Disposals                                        -        -              (965)          (659)        (100)        (1,724)
At January 31 1998                              659       817            2,698         20,922         70           25,184
Net book values:
At January 31 1997                           13,120       80             1,378          5,836         129          20,543
At January 31 1998                           13,169      1,758           1,955          6,898         56           23,837
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

Freehold  land and  buildings  includes  capitalised  interest  of GBP  385,000.
Transportation equipment includes assets held under finance leases as follows:
                                                
--------------------------------------------------------------------------------
                                              Cost   Netbook
                                      depreciation     value
                            GBP'000        GBP'000   GBP'000
--------------------------------------------------------------------------------
At January 31 1997             125          66          59
Provision for the year           -           -           -
Disposals                        -           -           -
--------------------------------------------------------------------------------
At January 31 1998             125          66          59
--------------------------------------------------------------------------------

(b) Company:

The Company's  tangible  fixed assets  consist of freehold  land and  buildings,
valued at cost which includes capitalised interest of GBP 385,000.

--------------------------------------------------------------------------------
                                             Cost       Netbook
                                     depreciation         value
                            GBP'000       GBP'000       GBP'000
--------------------------------------------------------------------------------
At January 31 1997           3,088          96           2,992
Provision for the year           -          21           (21)
--------------------------------------------------------------------------------
At January 31 1998           3,088         117           2,971
--------------------------------------------------------------------------------

                                       63
<PAGE> 44

Note 13  Investments

(a)  Micro Focus:

Investment in own shares  represents the Company's  ordinary  shares acquired by
Micro Focus Trustees Limited on behalf of the Micro Focus Group Employee Benefit
Trust 1994 ("the Trust"), at cost:

--------------------------------------------------------------------------------
                                           1998        1997
                                        GBP'000     GBP'000
--------------------------------------------------------------------------------
Beginning of year                        5,634       5,634
Sold on exercise of options               (748)          -
--------------------------------------------------------------------------------
End of year                              4,886       5,634
--------------------------------------------------------------------------------

As at January 31 1998 the Trust owned 757,369 shares with a nominal value of GBP
75,737,  and options have been granted to employees to purchase up to 634,245 of
such shares (see note 21 to the  financial  statements  on page 66).  The market
value of these shares was GBP 20,729,000  (January 31 1997: GBP  9,656,000);  if
they had been sold at this value a liability to corporation tax of approximately
GBP 4,500,000  (January 31 1997: GBP 1,100,000) would have arisen. The Trust has
not waived its right to dividends in respect of this shareholding.The assets and
liabilities of the Trust, as well as its operating  costs, are included in Micro
Focus' consolidated financial statements.

(b) Company:
--------------------------------------------------------------------------------
                                           1998       1997
                                        GBP'000    GBP'000
--------------------------------------------------------------------------------
Investments in subsidiary undertakings:
Beginning of year                       27,175     27, 685
Acquisitions (note 3):                  12,679           -
Additions                                  309           -
Effect of exchange rate changes             37        (510)
--------------------------------------------------------------------------------
End of year                             40,200      27,175

Investment in own shares (see (a) above):
End of year                              4,886       5,634
--------------------------------------------------------------------------------
                                        45,086     32, 809
--------------------------------------------------------------------------------

The principal subsidiary undertakings, all of which are wholly-owned, are:

--------------------------------------------------------------------------------
                                         Country of incorporation
--------------------------------------------------------------------------------
Micro Focus Limited                               U.K. (1)
Micro Focus International Limited                 U.K. (2)
Micro Focus Holdings Limited                      U.K. (1)
Micro Focus Incorporated                        U.S.A. (2)
XDB Systems, Inc.                               U.S.A. (1)
Micro Focus Japan                                Japan (2)
Micro Focus GmbH                               Germany (2)
Micro Focus SARL                                France (2)
Micro Focus SA                                   Spain (2)
Micro Focus Investments Limited                 Jersey (3)
System Focus BV                            Netherlands (2)
Micro Focus Technology NV         Netherlands Antilles (2)
--------------------------------------------------------------------------------

(1) Held directly by the Company
(2) Held by a subsidiary undertaking
(3) Held  directly  by  the  Company,  operating  as  a  financing  company. The
    activities of the other subsidiary  undertakings are described in the 
    Directors' Report.

Note 14  Stocks

The  replacement  value of stocks is not  considered to be materially  different
from their balance sheet values.

Note 15  Debtors

--------------------------------------------------------------------------------
                                          1998        1997
                                       GBP'000     GBP'000
--------------------------------------------------------------------------------
Trade debtors                           29,145      12,672
Other debtors and prepaid expenses       1,728       1,556
--------------------------------------------------------------------------------
                                        30,873      14,228
--------------------------------------------------------------------------------

Trade debtors include GBPnil (1997: GBP 1,693,000) which is due more than twelve
months from the balance sheet date.  Other debtors and prepaid  expenses include
loans to an officer of Micro Focus  totalling  GBP nil (1997:  GBP 57,000),  and
amounts due more than twelve  months from the balance  sheet date  totalling GBP
74,000 (1997: GBP 164,000).

                                       64
<PAGE> 45

Note 16  Creditors: amounts falling due within one year

--------------------------------------------------------------------------------
                                               1998       1997
                                            GBP'000    GBP'000
--------------------------------------------------------------------------------
Bank loans                                   1,007           -
Obligations under finance leases (note 18)       6          68
Trade creditors                              4,241       3,054
Current corporation tax                      6,428       2,590
Other taxes and social security costs        1,725       1,129
Product royalties and purchases                845         602
Accrued employees compensation
   and commissions                           7,481       3,632
   Accrued expenses                          4,750       1,556
--------------------------------------------------------------------------------
                                            26,483      16,180
--------------------------------------------------------------------------------

The  bank  loan   represents   borrowings   against   an   unsecured   revolving
multi-currency  loan  facility,  under  the  terms of which  financing  of up to
GBP 5,000,000,  or its  equivalent in such other  currency as the Company may
determine,  is available until January 2001. Borrowings under this facility bear
interest at 0.75% above the London Interbank Offered Rate ("LIBOR").  The amount
outstanding  against  this  credit  line at  January 31 1998 was drawn in French
Francs, and was incurring interest at 3.6% per annum.

Accrued  expenses  includes  GBP 116,000  (1997:  GBP  123,000) in respect of an
unfunded  defined benefit scheme operated by a foreign  subsidiary  undertaking,
and other  outstanding  contributions  payable by Micro Focus in connection with
employees' pension arrangements.

Note 17  Creditors: amounts falling due after more than one year

Creditors  due  after  more  than one year  represent  obligations  under  lease
commitments (see note 18).

Note 18  Lease commitments

Financial  commitments  for future  periods under lease  agreements  existing at
January 31 1998 are as follows:

Finance leases:
--------------------------------------------------------------------------------
                                              1998       1997
                                           GBP'000    GBP'000
--------------------------------------------------------------------------------
Amounts payable within one year                 6          71
Amounts payable from one to two years          15          15
--------------------------------------------------------------------------------
                                               21          86
Less finance charges allocated to
   future periods                               -          (3)
--------------------------------------------------------------------------------
                                               21          83
--------------------------------------------------------------------------------
Finance leases are shown as:
Amounts due within one years (note 16)          6          68
Amounts due after more than one year           12          15
--------------------------------------------------------------------------------
                                               18          83
--------------------------------------------------------------------------------
Operating leases:
--------------------------------------------------------------------------------
                                  Land and buildings                     Other
                                   1998         1997         1998         1997
                                GBP'000      GBP'000      GBP'000      GBP'000
--------------------------------------------------------------------------------
Annual commitment 
under leases which expire:
   within one year                 263       1,117             4         114
   in the second to fifth
      years inclusive            1,576         648           541         462
   thereafter                      469         168             -           -
--------------------------------------------------------------------------------
                                 2,308       1,933           545         576
--------------------------------------------------------------------------------

Note 19  Capital commitments

At January 31 1998 and  January 31 1997  Micro  Focus had no  material  capital
expenditure commitments.

                                       65
<PAGE> 46

Note 20  Deferred taxation

Deferred taxation has been fully provided as follows:

(a)  Micro Focus:

--------------------------------------------------------------------------------
                                          1998         1997
                                       GBP'000     GBP'000
--------------------------------------------------------------------------------
Capital allowances in advance
   of depreciation and amortisation         89         169
Other timing differences                 6,318       6,070
--------------------------------------------------------------------------------
                                         6,407       6,239
--------------------------------------------------------------------------------


The movement of deferred taxation during the year is as follows:

--------------------------------------------------------------------------------
                                          1998        1997
                                       GBP'000     GBP'000
--------------------------------------------------------------------------------
Balances, beginning of year              6,239       5,454
Movement on captital allowances
   in advance of depreciation
   and amortisation                        (80)       (140)
Movement in other timing differences       248         925
--------------------------------------------------------------------------------
Balances, end of year                    6,407       6,239
--------------------------------------------------------------------------------

(b)  Company:
--------------------------------------------------------------------------------
                                         1998         1997
                                      GBP'000      GBP'000
--------------------------------------------------------------------------------
Capital allowances in advance
   of depreciation and amortisation         19          19
--------------------------------------------------------------------------------
                                            19          19
--------------------------------------------------------------------------------

Note 21  Share option plans

The  Company's  share option  plans  provide for the grant of options to acquire
shares to persons who devote substantially all their working time to Micro Focus
and such other eligible  persons as the Board may determine.  The exercise price
of options issued under these plans is 100% of the fair market value at the time
such  options are  granted.  Options  are  generally  exercisable  in five equal
cumulative  annual  installments  commencing  one year  after the date of grant.
Unexercised  options lapse when the optionholder  ceases to be employed by Micro
Focus or at a  predetermined  expiry  date (of up to ten years  from the date of
grant), whichever occurs first.

The 1996  Share  Option  Plan was  approved  by  shareholders  in June  1996 and
authorised  the Company to grant  options for up to a maximum of 757,369  shares
(representing 5% of the issued share capital of the Company at that time);  such
authority will expire on June 18 1999. Prior to 1996, authority to issue options
under similar terms had been granted  pursuant to the 1991 Share Option Plan and
the  1983-1984  Share  Option Plan.  Such  authorities  expired  in1996 and 1991
respectively.  At January 31 1998 1,687,580  options were issued and outstanding
under the plans,  and a further  319,253  which had been  approved  for grant by
shareholders under the 1996 Share Option Plan were currently unissued.

In 1994 the Micro  Focus Group  Employee  Benefit  Trust 1994 ("the  Trust") was
established to further the Company's  policy of encouraging  share  ownership by
its  employees.  Under the terms of the  Trust,  Micro  Focus  Trustees  Limited
("MFTL") is  permitted  to acquire  ordinary  shares in the Company and to issue
options for those shares to  directors  and  employees.  At January 31 1998 MFTL
owned 793,713 shares,  and options granted by MFTL to purchase  634,245 of these
shares were outstanding. Options which had been granted for an additional 22,000
shares  prior  to their  acquisition  by MFTL  also  remained  outstanding.  The
remaining 105,220 option shares were available for future grant. The shares held
by the  Trust  are  included  in  Investments  (see  note  13 to  the  financial
statements on page 64).

Pursuant to the  agreement to acquire XDB  Systems,  Inc.  ("XDB"),  the Company
assumed  XDB's 1992 Share  Option  Plan and 1996 Share  Option  Plan.  Under the
agreement,  holders of XDB options are entitled to exercise  their option shares
in return for ordinary  shares in the Company.  At January 20 1998,  the date of
the merger,  XDB option  holders  held  40,042  options in the Company at prices
between $7.95 and $37.06 and  denominated  in U.S.  dollars.  At January 31 1998
30,056 of these option shares remained outstanding.

                                       66
<PAGE> 47

Share option activity under the plans was as follows:

--------------------------------------------------------------------------------
                                   Number           Option price
                                of shares              per share
--------------------------------------------------------------------------------
Outstanding, January 31, 1995   1,728,874         GBP 2.20-GBP 28.83
Options granted                   603,795         GBP 5.42-GBP 8.20
Options exercised                (114,865)        GBP 2.20-GBP 5.42
Options cancelled                (159,035)        GBP 2.20-GBP 28.83
--------------------------------------------------------------------------------
Outstanding, January 31, 1996   2,058,769         GBP 5.42-GBP 28.83
Options granted                 2,300,830         GBP 5.83-GBP 9.70
Options exercised                 (24,156)        GBP 5.42-GBP 9.66
Options cancelled              (1,840,411)        GBP 5.42-GBP 28.83
--------------------------------------------------------------------------------
Outstanding, January 31, 1997   2,495,032         GBP 5.42-GBP 21.61
Options granted                 1,324,545         GBP 4.85-GBP 22.60
Options exercised                (310,741)        GBP 5.42-GBP 18.52
Options cancelled              (1,134,955)        GBP 4.85-GBP 22.60
--------------------------------------------------------------------------------
Outstanding, January 31, 1998   2,373,881         GBP 4.85-GBP 22.60
--------------------------------------------------------------------------------

The total of 2,373,881 options  outstanding at January 31 1998 is represented by
1,717,636  unissued  shares  (1,687,580  issued  under the Micro Focus plans and
30,056 pursuant to the XDB plans) and 656,245 issued shares held by MFTL.

The outstanding  options are exercisable  between 1998 and 2007; the proceeds on
exercise  at  January  31 1998  would be GBP  21,579,000  (January  31  1997:GBP
19,790,000).

At January 31 1998 options for 254,000 shares (January  311997:  168,000 shares)
were  currently  exercisable  at prices  per share of  between  GBP 5.42 and GBP
22.60;  the proceeds on exercise of such options at January 31 1998 would be GBP
2,586,000 (January 31 1997: GBP 2,095,000).
                                 
Note 22  Post-balance sheet event

On March 12 1998 shareholders  approved a 5-for-1  sub-division of the Company's
ordinary shares ("the Stock Split".) The sub-division became effective as of the
close of business on Friday,  March 13 1998. The Company's  American  Depository
Shares  ("ADSs"),  which are  traded on the  Nasdaq  Stock  Market in the United
States,  did not split,  although the  conversion  rights of such ADSs have been
adjusted such that each ADS now represents 5 ordinary shares.

                                       67