<PAGE>   1

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

                                    FORM 10-Q

(Mark One)

[X]      Quarterly report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934

For the quarterly period ended September 30, 1998 or

[]       Transition report pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934

For the transition period from ______________ to ______________

Commission file number     0-18090

                                CAERE CORPORATION
                                -----------------
             (Exact name of registrant as specified in its charter)

DELAWARE                                                    94-2250509
--------                                                    ----------
(State or other jurisdiction of                             (I.R.S. Employer
incorporation or organization)                              Identification No.)

                 100 COOPER COURT, LOS GATOS, CALIFORNIA, 95032
                 ----------------------------------------------
                    (Address of principal executive offices)

                                 (408) 395-7000
                                 --------------
              (Registrant's telephone number, including area code)

--------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                                  Yes X  No_____

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of
common stock.

<TABLE>
<CAPTION>
                                                          Outstanding
           Class                                       November 10, 1998
           -----                                       -----------------
<S>                                                    <C>
           Common Stock
           $.001 par value                                12,299,728
</TABLE>

                           This is page 1 of 20 pages


<PAGE>   2


                                CAERE CORPORATION
                                      INDEX

                          PART I. FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                                                         Page
                                                                                                         ----
<S>               <C>                                                                                    <C>
ITEM 1.           Financial Statements

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

                  Condensed Consolidated Statements of Earnings -- Three Months
                      and Nine Months Ended September 30, 1998 and 1997                                     4

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

                  Notes to Condensed Consolidated Financial Statements                                    6-9

ITEM 2.           Management's Discussion and Analysis of Financial
                      Condition and Results of Operations                                               10-18

ITEM 3.           Quantitative and Qualitative Disclosures about Market Risk                               19


                                      PART II. OTHER INFORMATION

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

SIGNATURES                                                                                                 19

EXHIBIT INDEX                                                                                              20
    
</TABLE>



                                       2
<PAGE>   3

                          PART I. FINANCIAL INFORMATION

                          ITEM 1. FINANCIAL STATEMENTS

                                CAERE CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                        (IN THOUSANDS, EXCEPT SHARE DATA)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                 September 30,    December 31,
                                                                     1998           1997
                                                                   -------         -------
<S>                                                              <C>             <C>    

                                      ASSETS

Cash and cash equivalents                                          $ 4,471         $16,417
Short-term investments                                              43,315          33,156
Receivables, net                                                     5,835           5,263
Inventories (Note B)                                                 1,434           1,917
Deferred income taxes                                                3,241           3,241
Other current assets                                                   692             990
                                                                   -------         -------
         Total current assets                                       58,988          60,984

Property and equipment, net                                          4,068           4,781
Other assets                                                         2,029           1,535
                                                                   -------         -------

         Total assets                                              $65,085         $67,300
                                                                   =======         =======

                 LIABILITIES AND STOCKHOLDERS' EQUITY

Accrued expenses and other payables                                $ 6,992         $ 6,091

Stockholders' equity:
Preferred stock, $.001 par value:  authorized 2,000,000
  shares; none issued or outstanding                                    --              --
Common stock, $.001 par value:  authorized 30,000,000
  shares; issued and outstanding 12,588,910 and 13,107,235
  Shares, respectively                                                  13              13
Additional paid-in capital                                          47,787          57,720
Retained earnings                                                   10,293           3,476
                                                                   -------         -------

         Total stockholders' equity                                 58,093          61,209
                                                                   -------         -------

         Total liabilities and stockholders' equity                $65,085         $67,300
                                                                   =======         =======
</TABLE>


The accompanying notes are an integral part of the condensed consolidated
financial statements.



                                       3
<PAGE>   4


                                CAERE CORPORATION
                  CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                        Three Months Ended          Nine Months Ended
                                                          September 30,              September 30,
                                                       --------------------      ---------------------
                                                         1998         1997         1998         1997
                                                       --------     --------     --------     --------
<S>                                                    <C>          <C>          <C>          <C>     
Net revenues                                           $ 15,707     $ 14,069     $ 47,534     $ 39,392

Cost of revenues                                          3,556        3,448       10,866       10,517
                                                       --------     --------     --------     --------

                                                         12,151       10,621       36,668       28,875
                                                       --------     --------     --------     --------
Operating expenses:
  Research and development                                3,059        2,592        8,992        6,798
  Selling, general and administrative                     6,817        6,605       20,730       19,600
  In-process research and development                        --           --           --        2,935
                                                       --------     --------     --------     --------

                                                          9,876        9,197       29,722       29,333
                                                       --------     --------     --------     --------

  Operating earnings (loss)                               2,275        1,424        6,946         (458)

Interest income                                             635          692        1,965        1,867
                                                       --------     --------     --------     --------

  Earnings before income taxes                            2,910        2,116        8,911        1,409

Income tax expense                                          731          264        2,094          486
                                                       --------     --------     --------     --------

  Net earnings                                         $  2,179     $  1,852     $  6,817     $    923
                                                       ========     ========     ========     ========

Basic earnings per share                               $   0.17     $   0.14     $   0.53     $   0.07
                                                       ========     ========     ========     ========
Diluted earnings per share                             $   0.17     $   0.14     $   0.51     $   0.07
                                                       ========     ========     ========     ========

Weighted average shares used in basic earnings per
share calculation                                        12,591       13,310       12,869       13,093
                                                       ========     ========     ========     ========
Weighted average shares used in diluted earnings
per share calculation                                    13,159       13,524       13,482       13,261
                                                       ========     ========     ========     ========
</TABLE>

The accompanying notes are an integral part of the condensed consolidated
financial statements.


                                       4
<PAGE>   5


                                CAERE CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                     Nine Months Ended
                                                                       September 30,
                                                                  ----------------------
                                                                    1998          1997
                                                                  --------      --------
<S>                                                               <C>           <C>     
Cash flows from operating activities:
  Net earnings                                                    $  6,817      $    923
  Adjustments to reconcile net earnings to net cash provided
  by operating activities:
    Depreciation and amortization                                    2,230         2,265
    In-process research and development                                 --         2,935
    Amortization of capitalized software development costs             489           373
    Tax benefit associated with exercise of stock options               30            --
    Changes in operating assets and liabilities:
         Receivables, net                                             (572)         (835)
         Inventories                                                   483           779
         Other current assets                                          298          (418)
         Accrued expenses and other payables                           901        (1,379)
                                                                  --------      --------
         Net cash provided by operating activities                  10,676         4,643
                                                                  --------      --------
Cash flows from investing activities:
    Short-term investments, net                                    (10,159)      (11,953)
    Capital expenditures                                            (1,157)       (2,085)
    Capitalized software development costs                            (215)         (708)
    Other assets                                                    (1,128)            3
                                                                  --------      --------
         Net cash used for investing activities                    (12,659)      (14,743)
                                                                  --------      --------
Cash flows from financing activities:
  Proceeds from issuance of common stock                             3,233           866
  Repurchase of stock                                              (13,196)           --
                                                                  --------      --------
         Net cash provided by (used for) financing activities       (9,963)          866
                                                                  --------      --------
Net change in cash and cash equivalents                            (11,946)       (9,234)

Cash and cash equivalents at beginning of period                    16,417        11,663
                                                                  --------      --------
Cash and cash equivalents at end of period                        $  4,471      $  2,429
                                                                  ========      ========
Supplemental disclosures:
  Cash paid for income taxes                                      $  2,412      $  1,117
                                                                  ========      ========
  Common stock issued for business acquisition                    $     --      $  3,105
                                                                  ========      ========
</TABLE>

The accompanying notes are an integral part of the condensed consolidated
financial statements.



                                       5
<PAGE>   6


                                CAERE CORPORATION

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

A)       Basis of Presentation

         The accompanying unaudited condensed consolidated balance sheets,
statements of earnings, and statements of cash flows reflect all adjustments
(consisting of only normal recurring adjustments) which are, in the opinion of
management, necessary to present the financial position of the Company as of
September 30, 1998, and its results of operations and cash flows for the periods
indicated.

         The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions for Form 10-Q, and,
therefore, certain information and footnote disclosures normally contained in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. The Company filed audited financial
statements with the Securities and Exchange Commission which included all
information and footnotes necessary for a complete presentation of the Company's
financial position, results of operations and cash flows for the years ended
December 31, 1997, 1996 and 1995, in its report on Form 10-K, as amended, for
the year ended December 31, 1997 (the "Form 10-K"). These condensed consolidated
financial statements should be read in conjunction with the financial statements
contained in the Company's Form 10-K. The results of operations for the interim
period ended September 30, 1998, are not necessarily indicative of the results
to be expected for the full year.


<TABLE>
<CAPTION>
B)       Inventories                                September 30, 1998           December 31, 1997
         -----------                                ------------------           -----------------
                                                                   (In thousands)
          A summary of inventories follows:
<S>                                                      <C>                        <C>     
               Raw materials                             $    625                   $    738
               Work in process                                207                        226
               Finished goods                                 602                        953
                                                         --------                   --------
                                                         $  1,434                   $  1,917
                                                         ========                   ========

</TABLE>



                                       6
<PAGE>   7


C)       Earnings Per Share

         In 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 128, Earnings Per Share. SFAS No. 128 changes the
standards for computing earnings per share ("EPS") by replacing the presentation
of primary EPS with basic EPS for all periods presented. Basic EPS excludes
dilution and is computed by dividing net earnings available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS is computed similarly to fully diluted EPS pursuant to
Accounting Principles Board ("APB") Opinion No. 15. The shares used in computing
dilutive EPS include all dilutive common equivalent shares. All prior period
share and per share amounts have been restated to comply with SFAS No. 128.

<TABLE>
<CAPTION>
                                                         Three Months Ended                Nine Months Ended
                                                            September 30,                    September 30,
                                                      ---------------------------     ------------------------------
                                                         1998            1997            1998               1997
                                                      -----------     -----------     -----------     --------------
<S>                                                   <C>             <C>             <C>             <C>           
Net earnings                                          $ 2,179,000     $ 1,852,000     $ 6,817,000     $      923,000
                                                      ===========     ===========     ===========     ==============

Shares used to compute basic earnings per share
(weighted average common shares outstanding)
                                                       12,591,506      13,309,577      12,869,003         13,092,852

Dilutive common equivalent shares - stock options
                                                          567,209         214,866         612,718            168,091
                                                      -----------     -----------     -----------     --------------

Shares used to compute diluted earnings per share
                                                       13,158,715      13,524,443      13,481,721         13,260,943
                                                      ===========     ===========     ===========     ==============

Basic earnings per share                              $       .17     $       .14     $       .53     $          .07
                                                      ===========     ===========     ===========     ==============

Diluted earnings per share                            $       .17     $       .14     $       .51     $          .07
                                                      ===========     ===========     ===========     ==============
</TABLE>


           There were no reconciling items in the numerators between the basic
and diluted earnings per share computations. Options excluded from the
computation of earnings per share because their effect on earnings per share was
antidilutive, but which could dilute basic earnings per share in future periods,
were as follows:

<TABLE>
<CAPTION>
                                    Three Months Ended         Nine Months Ended
                                        September 30,            September 30,
                                    -------------------     ----------------------
                                      1998        1997        1998        1997
                                    -------     -------     -------    -----------
<S>                                 <C>         <C>         <C>        <C>        

Options excluded                    229,750     406,930      88,121        461,245

Weighted average exercise price     $ 13.97     $  9.77     $ 13.97    $      9.77

</TABLE>

                                       7
<PAGE>   8



D)         Business Acquisition

           On March 31, 1997, the Company acquired Formonix, Inc. ("Formonix"),
a software developer located in Colorado. The total value of the acquisition was
approximately $3,188,000. The Company issued 550,000 shares of Common Stock in
exchange for all of the capital stock of Formonix. Using the closing price of
the Company's Common Stock on the closing date of the acquisition, the valuation
of the shares issued was approximately $3,105,000. Acquisition costs associated
with the transaction totaled approximately $83,000 and consisted mainly of
professional fees. The business combination was accounted for under the purchase
method of accounting. Accordingly, the consolidated financial statements of the
Company do not include Formonix until after the date of the acquisition.

           Acquired technology was valued using a risk-adjusted cash flow model,
under which future expected cash flows were discounted taking into account risks
related to existing markets, the technology's life expectancy, future target
markets and potential changes thereto, and the competitive outlook for the
technology. The analysis resulted in an allocation of approximately $253,000 to
purchased software and the balance of approximately $2,935,000 to in-process
technology, which had not yet reached technological feasibility and had no
alternative future use, and accordingly, was charged to expense.

           The following summarized, pro forma results of operations assume the
acquisition took place at the beginning of the period and excludes the
$2,935,000 charge for acquired in-process technology.

<TABLE>
<CAPTION>
                                                                 Nine Months Ended
                                                                 September 30, 1997
          (In thousands, except per share amounts)
<S>                                                                   <C>    
          Net revenues                                                $39,392
          Net earnings                                                  3,715
          Diluted earnings per share                                  $   .27
</TABLE>

E)       Revenue Recognition

         The Company recognizes revenue in accordance with Statement of Position
("SOP") No. 97-2, Software Revenue Recognition, which supersedes SOP No. 91-1.
SOP No. 97-2 generally requires revenue earned on software arrangements
involving multiple elements such as software products, upgrades, enhancements,
post-contract customer support, installation, and training to be allocated to
each element based on the relative fair values of the elements. The fair value
of an element must be based on evidence that is specific to the vendor. If a
vendor does not have evidence of the fair value for the elements in a
multiple-element arrangement, all revenue from the arrangement generally is
deferred until such evidence exists or until all elements are delivered.



                                       8
<PAGE>   9


F)       Comprehensive Income

         In June 1997, SFAS No. 130, Reporting Comprehensive Income ("SFAS No.
130"), was issued and established standards for reporting and displaying
comprehensive income and its components in the financial statements. It does
not, however, require a specific format for the disclosure but requires the
Company to display an amount representing total comprehensive income for the
period in its financial statements. The Company has not determined the manner in
which it will present the information required by SFAS No. 130 in its annual
financial statements for the year ending December 31, 1998. The Company's total
comprehensive income for all periods presented herein would not have differed
significantly from those amounts reported as net earnings in the condensed
consolidated statements of operations.

G)       Segment Reporting

         In June 1997, SFAS No. 131, Disclosure About Segments of an Enterprise
and Related Information ("SFAS No. 131"), was issued and established standards
for the manner in which public companies report information about operating
segments in annual and interim financial statements issued to shareholders. The
Company has not yet determined the manner in which it will present the
information required by SFAS No. 131.

H)       Recently Issued Accounting Pronouncements

         In June 1998, SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities ("SFAS No. 133") was issued. SFAS No. 133 addresses the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts. Under SFAS No. 133, entities are required to carry
all derivative instruments in the balance sheet at fair value. The accounting
for changes in the fair value (i.e., gains or losses) of a derivative instrument
depends on whether it has been designated and qualifies as part of a hedging
relationship and, if so, the reason for holding it. The Company must adopt SFAS
No. 133 by October 1, 1999. The Company has not determined the impact that SFAS
No. 133 will have on its financial statements.



                                       9
<PAGE>   10

                 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

         The Company notes that, except for the historical information contained
herein, the matters discussed below contain forward-looking statements subject
to risks and uncertainties that may cause the Company's actual results to differ
materially. Readers are cautioned not to place undue reliance on the
forward-looking statements, which speak only as of the date of this Form 10-Q.
The Company expressly disclaims any obligation to update this information or
publicly release any revisions or reflect events or circumstances after the date
of this report. Such risks and uncertainties include, but are not limited to,
various important competitive and technological factors, such as pricing
pressures; success of the "bundle and upgrade" business model, including the
maintenance of the Company's relationships with scanner manufacturers, as well
as customers opting to upgrade to newer or more fully featured products; the
timely completion of additional product capabilities and software updates;
changes in customer order patterns, the maintenance of relationships with retail
distributors and dealers; manufacturing considerations, including the
maintenance of margins in a declining-price environment, as well as risk of
inventory obsolescence due to shifts in market demand and new product
introductions; and other risk factors described below or listed from time to
time in the Company's reports filed with the Securities and Exchange Commission,
including, but not limited to, the report on Form 10-K, as amended, for the year
ended December 31, 1997.

RESULTS OF OPERATIONS

         The following chart summarizes net revenues, cost of revenues, and
gross margins for the Company's products categorized between hardware and
software. Software products consist of the OmniPage, WordScan, OmniForm,
PageKeeper, and Recognita lines of products. Hardware products consist of
transaction processing optical character recognition ("OCR") and bar code
products, and the M/Series line of production OCR products.

BUSINESS LINE ANALYSIS


<TABLE>
<CAPTION>
THREE MONTHS ENDING:                        SEPTEMBER 30,                                 SEPTEMBER 30,
                                               1998                                          1997
                             SOFTWARE        HARDWARE                       SOFTWARE       HARDWARE
                             PRODUCTS        PRODUCTS        COMBINED       PRODUCTS       PRODUCTS        COMBINED
                             --------        --------        --------       --------       --------        --------
<S>                          <C>            <C>             <C>            <C>            <C>              <C>    
Net revenues                  $13,508          $2,199         $15,707       $11,458          $2,611          $14,069
Cost of revenues                2,522           1,034           3,556         2,343           1,105            3,448
                             --------        --------        --------       --------       --------         --------
                              $10,986          $1,165         $12,151        $9,115          $1,506          $10,621
Gross margin %                  81.3%           53.0%           77.4%         79.6%           57.7%            75.5%
</TABLE>


<TABLE>
<CAPTION>
NINE MONTHS ENDING:                         SEPTEMBER 30,                                SEPTEMBER 30,
                                               1998                                          1997
                             SOFTWARE        HARDWARE                       SOFTWARE       HARDWARE
                             PRODUCTS        PRODUCTS        COMBINED       PRODUCTS       PRODUCTS        COMBINED
                             --------        --------        --------       --------       --------        --------
<S>                          <C>            <C>             <C>            <C>           <C>               <C>    
Net revenues                  $40,869          $6,665         $47,534       $33,674          $5,718          $39,392
Cost of revenues                7,568           3,298          10,866         7,605           2,912           10,517
                             --------        --------        --------       --------       --------         --------
                              $33,301          $3,367         $36,668       $26,069          $2,806          $28,875
Gross margin %                  81.5%           50.5%           77.1%         77.4%           49.1%            73.3%

</TABLE>



                                       10
<PAGE>   11

         Net revenues for software products increased 18 percent during the
third quarter of 1998 to $13,508,000 from $11,458,000 in the same period of
1997, due primarily to increased shipments of OmniForm 3.0, which began shipping
late in the first quarter of 1998. Also contributing to the increase in revenues
for software products was increased royalty revenue along with revenues from
PageKeeper Standard, the first of the Company's new generation of document
management products, which began shipping in the second quarter of 1998. On a
sequential basis, software product revenues were down one percent in the third
quarter of 1998, from $13,618,000 during the second quarter of 1998. The primary
reason for the decline was a decrease in sales of PageKeeper Standard following
the initial shipments of the new product in the second quarter of this year. For
the nine months ended September 30, 1998, net revenues for software products
increased 21 percent to $40,869,000 from $33,674,000 during the same period of
1997, due primarily to increased shipments of OmniForm, the introduction of
PageKeeper Standard, and increased royalties related to bundled OCR and document
management products.

         The marketplace for OCR software has been changing rapidly as a result
of significant declines in scanner prices. To gain greater leverage in this
expanding market the Company reduced the price of its OmniPage Pro upgrade
product to $99 from $129 in April 1998. The Company expects that the reduced
price will generate sufficient increases in consumer demand to provide for
continuing increases in quarterly software revenues. However, there can be no
assurance that volume increases will result or will be adequate to increase
revenues or that more consumers will purchase the software at the lower price
point.

         Net revenues for hardware products decreased 14 percent to $2,199,000
in the third quarter of 1998, compared to $2,611,000 during the same period in
1997. The primary reason for this decline was decreased shipments of transaction
processing barcode products as well as M/Series hardware products. It is common
in this line of business for the Company to receive large, one-time product
orders periodically. This ordering pattern has historically resulted in
significant fluctuations in quarterly hardware revenues. This trend is expected
to continue. On a sequential basis, revenues from hardware products decreased 14
percent from $2,550,000 in the second quarter of 1998, due primarily to a
decline in shipments of transaction processing OCR and barcode products. For the
nine months ended September 30, 1998, net revenues for hardware products
increased 17 percent to $6,665,000 from $5,718,000 during the same period of
1997, due primarily to increased shipments of transaction processing OCR
products.

         International sales increased 23 percent in the third quarter of 1998,
compared to the third quarter of 1997, and accounted for approximately 29
percent of total sales during the third quarter of 1998, compared to 27 percent
in the third quarter of 1997. The increase in international sales was primarily
attributable to increased shipments of OmniPage Pro 8.0 as well as OmniForm 3.0
in Europe. For the nine months ended September 30, 1998, international sales
increased 25 percent compared to the same period of 1997, and accounted for
approximately 33 percent of total sales in 1998, compared to 32 percent in 1997.
This increase was primarily attributable to increased shipments of OmniPage Pro
8.0 as well as the introduction of OmniForm 3.0.



                                       11
<PAGE>   12


GROSS MARGINS

         Gross margins for software products improved from 79.6 percent in the
third quarter of 1997 to 81.3 percent in the third quarter of 1998. The primary
reason for the improvement in margins was the increase in overall sales volume
during the quarter, allowing fixed manufacturing costs to be spread over a
higher level of production. For the nine months ended September 30, 1998, gross
margins for software products improved to 81.5 percent, from 77.4 percent during
the same period of 1997. This improvement was primarily attributable to the same
factors, as well as an increase in royalty revenues between the two periods.

         There will be downward pressure on gross margins for software products
in the future as a result of the Company's decision to reduce the price of its
OmniPage Pro upgrade products in the second quarter of 1998. This decrease is
expected to be somewhat offset by volume increases that shall lead to improved
economies of scale. However, there can be no assurance that production volumes
will rise sufficiently or that the Company will be successful in securing more
favorable pricing from key suppliers.

         Gross margins for hardware products declined to 53.0 percent in the
third quarter of 1998 from 57.7 percent in the same period of 1997, due
primarily to lower overall factory volume as a result of lower unit sales of
transaction processing barcode and M/Series hardware products. Also contributing
to the decline in margin on hardware products was the fixed nature of a majority
of the Company's hardware manufacturing overhead. As hardware product volumes
increase or decrease, the level of manufacturing overhead does not necessarily
change in the same proportion. For the nine months ended September 30, 1998,
gross margins for hardware products improved to 50.5 percent from 49.1 percent
during the same period of 1997. This improvement was due primarily to higher
overall factory volume between the two periods and the fixed nature of hardware
manufacturing overhead.

         The primary factor affecting gross margins in the future is likely to
be shifts in product mix between fully priced retail software, bundled software,
and upgrade products, as well as overall shifts in product mix between software
and hardware products. The microcomputer software market has been subject to
rapid changes, including significant price competition, which can be expected to
continue. Future technology or market changes may cause certain products to
become obsolete rapidly, necessitating increased inventory write-offs or
reserves and a corresponding decrease in gross margins.

OPERATING EXPENSES

         Research and development (R&D) expense increased 18 percent to
$3,059,000 in the third quarter of 1998, from $2,592,000 during the same period
of 1997. The increase in spending related primarily to additional staffing
associated with ongoing software development projects. As a percentage of
revenue, R&D expense increased to 19 percent of revenue in the third quarter of
1998, compared to 18 percent in the third quarter of 1997. This increase was
attributable to the Company's commitment to developing new and improved products
on a more timely and frequent basis. For the nine months ended September 30,
1998, R&D expense increased 32 percent to $8,992,000, from $6,798,000 in the
same period of 1997. As a percentage of revenue, 



                                       12
<PAGE>   13

R&D expense increased to 19 percent of revenue in the first nine months of 1998,
from 17 percent in the same period of 1997. These increases were primarily
attributable to the same factors noted above.

         The Company is committed to providing continuing enhancements to
current products, as well as developing new technologies for the future. This
commitment will result in the Company continuing to invest heavily in R&D during
the reminder of 1998 and in 1999. In accordance with Statement of Financial
Accounting Standards No. 86, the Company capitalized $65,000 of software
development costs during the third quarter of 1998, compared to $150,000 in the
same period of 1997. Amortization of capitalized software development costs was
$171,000 in the third quarter of 1998, versus $130,000 for the comparable period
in 1997. For the nine months ended September 30, 1998, capitalized software
development costs totaled $215,000, compared to $455,000 during the same period
of 1997. In addition to the capitalization of internal R&D expenses in 1997, in
connection with the acquisition of Formonix in March 1997, the Company also
capitalized approximately $253,000 of the acquisition cost. The costs
capitalized related to the portion of the Formonix acquisition valuation that
was allocated to existing products acquired. For the nine-month period,
amortization of capitalized software development costs was $489,000 in 1998,
versus $373,000 in the comparable period of 1997.

         Selling, general and administrative (S,G&A) expenses increased three
percent in the third quarter of 1998 to $6,817,000, from $6,605,000 during the
same period of 1997. The primary factor for the increase was sales and support
expenses associated with the Company's growing customer base resulting from the
high-volume business generated by the "bundle and upgrade" model. As a
percentage of revenue, S,G&A expense decreased to 43 percent of total revenue in
the third quarter of 1998, from 47 percent during the same period in 1997. This
decrease was primarily attributable to higher net revenues between the
comparable periods. For the nine months ended September 30, 1998, S,G&A expense
increased six percent to $20,730,000, or 44 percent of revenue, from
$19,600,000, or 50 percent of revenue, during the first nine months of 1997.
These changes were due to the same factors noted above. The Company is
attempting to control the level of S,G&A expenditures while it invests heavily
in vital R&D projects. Nonetheless, the Company believes that S,G&A expense may
increase in dollar terms in 1998 as necessary efforts to expand sales and
marketing activities continue in the OCR, forms, and desktop document management
areas.

         In the first nine months of 1997, a $2,935,000 one-time charge for
in-process R&D was taken related to the Company's acquisition of Formonix in
March 1997. This charge related to the portion of the Formonix acquisition
valuation represented by the present value of estimated cash flows expected to
be generated by Formonix-related technology which, at the acquisition date, had
not yet reached the point of technological feasibility and did not have an
alternative future use.

INTEREST INCOME

         Interest income was $635,000 in the third quarter of 1998, compared to
$692,000 in the same period of 1997. The decrease in interest income was
primarily attributable to lower average cash and short-term investment balances
between the comparable periods. For the nine months ended September 30, 1998,
interest income increased to $1,965,000, compared to 



                                       13
<PAGE>   14

$1,867,000 in the first nine months of 1997, due primarily to an increase in
average cash and short-term investment balances between the comparable periods.

INCOME TAXES

         The Company's effective income tax rate in 1998 is expected to be
between 23 percent and 28 percent, which is less than statutory rates, primarily
due to the use of the Company's foreign sales corporation and increased
utilization of net operating loss carryforwards assumed in its 1994 acquisition
of Calera Recognition Systems, Inc. ("Calera"). In the first nine months of
1997, the effective income tax rate was 11 percent (excluding the Formonix
in-process R&D charge due to its non-deductibility for tax purposes), primarily
due to the use of the Company's foreign sales corporation and to the utilization
of Calera net operating loss carryforwards in the 1997 fiscal year.

NET EARNINGS AND EARNINGS PER SHARE

         Net earnings for the third quarter of 1998 were $2,179,000, compared to
$1,852,000 during the same period in 1997. Diluted earnings per share were $.17
in the third quarter of 1998, versus $.14 in the comparable period of 1997. For
the nine months ended September 30, 1998, net earnings were $6,817,000, or $.51
per share, compared to $923,000, or $.07 per share, in the first nine months of
1997. Earnings in 1997 were reduced by the one-time $2,935,000 in-process R&D
charge related to the Formonix acquisition. Excluding this one-time charge, net
earnings for the first nine months of 1997 would have been $3,858,000, or $.29
per share.

CERTAIN TRENDS AND RISKS

         The Company's future operating results may be affected by various
uncertain trends and factors which are beyond the Company's control. These
include, but are not limited to, adverse changes in general economic conditions,
rising costs, or the occasional unavailability of needed components. In
addition, the industry is characterized by rapid changes in the technologies
affecting optical character recognition, forms technology, and document
management technology. The industry has also become increasingly competitive,
and, accordingly, the Company's results may also be adversely affected by the
actions of existing or future competitors, including the development of new
technologies, the introduction of new products, and the reduction of prices by
such competitors to gain or retain market share.

         Bundled products incorporating OmniPage and WordScan began shipping in
significant quantities in the fourth quarter of 1994. Because of the lower
per-unit revenue to the Company that results from the combined sale of a bundled
product plus an upgrade, compared to the retail sale of a fully featured version
of the software, the success of the "bundle and upgrade" program depends on
increasing unit sales of upgrades. There can be no assurance that the Company's
transition to the "bundle and upgrade" business model will be successful and
provide a sufficient increase in unit volume in the future to offset reduced
per-unit revenue. In addition, customers using the bundled product may defer or
forego purchase of the Company's more fully featured versions of OmniPage and
WordScan products if they find that the bundled products satisfy their
recognition needs.



                                       14
<PAGE>   15

         A significant portion of the Company's net revenues is attributable to
sales through the distribution channel. The Company's future operating results
are dependent to a certain extent on its ability to maintain its existing
relationships with such distributors. There can be no assurance that the Company
will be able to maintain such relationships.

         The Company's future earnings and stock price could be subject to
significant volatility, particularly on a quarterly basis. The Company's
revenues and earnings are unpredictable until the end of each quarter due to the
Company's shipment patterns. As is common in the software industry, the
Company's experience has been that a disproportionately large percentage of
shipments has occurred in the third month of each fiscal quarter, and shipments
tend to be concentrated in the latter half of that month. Because the Company's
backlog early in a quarter is not generally large enough to assure that it will
meet its revenue targets for any particular quarter, quarterly results are
difficult to predict until the end of the quarter. A shortfall in shipments at
the end of any particular quarter may cause the results for that quarter to fall
significantly short of anticipated levels. Due to analysts' expectations of
continued growth, any such shortfall in earnings could have a very significant
adverse effect on the trading price of the Company's common stock in any given
period.

         Like many other companies, the Year 2000 computer issues create certain
risks for the Company. If the Company's internal management information systems
or products sold to customers do not correctly recognize and process date
information beyond the year 1999, there could be an adverse impact on the
Company's operations. Based on currently available information, the Company does
not believe that the Year 2000 issues related to internal systems or products
sold to customers will have a material adverse impact on its financial condition
or overall trends in results of operations; however, it is still uncertain to
what extent the Company may be affected by such matters. In addition, customers
may delay purchase decisions because of uncertainty about Year 2000 issues.
There also can be no assurance that the failure to ensure Year 2000 compliance
by a supplier or another third party would not have a material adverse effect on
the Company.

         As a result of the foregoing factors and other factors which may arise
in the future, the market price of the Company's common stock may be subject to
significant fluctuations over a short period of time. These fluctuations may be
due to factors specific to the Company, to changes in analysts' earnings
estimates, or to factors affecting the computer industry or the securities
markets in general.

LIQUIDITY AND CAPITAL RESOURCES

         The Company's financial position remains strong at September 30, 1998.
Working capital decreased five percent to $51,996,000, from $54,893,000 at
December 31, 1997. The Company has no long-term debt. The Company's cash and
short-term investments totaled $47,786,000 at September 30, 1998. The Company
believes that current cash balances and internally generated funds will be
sufficient to meet its cash requirements through 1998.

         The Company generated cash from operating activities of $10,676,000
during the nine months ended September 30, 1998. Uses of cash included
$10,159,000 to purchase additional short-term investments, net of maturities,
and $13,196,000 to repurchase 961,000 shares of the 



                                       15
<PAGE>   16

Company's common stock, in addition to $1,157,000 for investments in capital
equipment. During the first nine months of 1997, the Company generated cash from
operating activities of $4,643,000. Uses of cash during that period included
$11,953,000 to purchase short-term investments, net of maturities, and
$2,085,000 for capital equipment acquisitions.

         The Company offers credit terms to qualifying customers and also sells
on a prepaid, credit card and cash-on-delivery basis. With respect to credit
sales, the Company attempts to control its bad debt exposure through monitoring
of customers' creditworthiness and, where practicable, through participation in
credit associations that provide credit rating information about its customers.
The Company has also purchased credit insurance for certain key accounts to
reduce the potential for catastrophic losses.

YEAR 2000 ISSUES AND POTENTIAL CONSEQUENCES

         Like many other companies, the year 2000 computer issues create certain
risks for the Company. Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. This is frequently referred to as
the "Year 2000 Problem." If the Company's internal management information
systems and products do not correctly recognize and process date information
beyond the year 1999, there could be an adverse impact on the Company's
operations. In mid-1997, the Company initiated a company-wide Year 2000 Project
to address this issue. A Year 2000 Committee was established and was mandated
with defining, assessing and converting, or replacing, various programs,
hardware and instrumentation systems to make them Year 2000 compatible.

         1.       STATUS OF READINESS

         To address the Year 2000 issues with its internal information
technology ("IT") systems, the Company has initiated a program to evaluate these
systems, including manufacturing, sales, and financial systems. The Company has
completed the assessment phase and the renovation and testing phases are
proceeding in parallel. The Company's assessment indicated that certain internal
systems should be upgraded or replaced as part of a solution to the Year 2000
problem. All of the hardware and most of the software for the Company's internal
IT systems come from third-party suppliers and are being remediated by them.

         Although the majority of the Company's non-IT systems do not in many
cases directly impact the Company's core business, they remain an important part
of the Company's Year 2000 efforts. All mission-critical non-IT systems and
products have the same target dates for remediation and interoperability testing
as their network element and information system counterparts. The Company is
currently evaluating the Year 2000 readiness of its non-IT systems with a
comprehensive inventory of monitoring and control devices for premises, safety
systems and other similar operating installations. The Company has communicated
with all mission critical suppliers and service providers about their plans for
Year 2000 compliance. Plans detailing the tasks and resources required to ensure
Year 2000 readiness of non-IT systems by the end of June 1999 are expected to be
in place by March 31, 1999.



                                       16
<PAGE>   17

         The Company's Year 2000 Project for internal systems is scheduled to be
completed by mid-1999. The chart below shows the overall status of the Company's
five-phase Year 2000 project in the following areas:

<TABLE>
<CAPTION>
                 AWARENESS       ASSESSMENT      RENOVATION              TESTING                  IMPLEMENTATION
--------------  ------------    ------------    ----------------------   ---------------------    ---------------------
<S>             <C>             <C>             <C>                      <C>                      <C>
IT SYSTEMS       Completed       Completed       Underway with           Underway with            Planning and
                                                 approximately 20%       approximately 20%        scheduling underway.
                                                 completed.  Mission     completed.  Mission      Scheduled to be
                                                 critical elements       critical elements        completed by mid-1999.
                                                 scheduled to be         scheduled to be
                                                 completed by mid-1999.  completed by mid-1999.

NON-IT SYSTEMS   Completed       Completed       Underway with           Underway with            Planning and
                                                 approximately 20%       approximately 20%        scheduling underway.
                                                 completed.  Mission     completed.  Mission      Scheduled to be
                                                 critical elements       critical elements        completed by mid-1999.
                                                 scheduled to be         scheduled to be
                                                 completed by mid-1999.  completed by mid-1999.
</TABLE>


         The Company is in the process of identifying and prioritizing critical
third parties and customers, and will follow up with them concerning their plans
and progress in addressing the Year 2000 problem. The Company is also working
with key suppliers of products and services to determine that their operations
and products are Year 2000 Compliant or to monitor their progress toward Year
2000 compliance, as appropriate.

         In the Company's standard license agreements, the Company warrants to
licensees that its software routines and programs are Year 2000 Compliant. If
any of the Company's licensees experience Year 2000 problems, such licensee
could assert claims for damages against the Company. Any such litigation could
result in substantial costs and diversion of the Company's resources even if
ultimately decided in favor of the Company.

         The Company believes that all products currently shipping and supported
by the Company are "Year 2000 Compliant." It is likely that some older products
in use by end users may not be Year 2000 Compliant. As used by the Company,
"Year 2000 Compliant" means that when used properly and in conformity with the
product information provided by the Company, and when used with "Year 2000
Compliant" computer systems, the product will accurately store, display,
process, provide, and/or receive data from, into, and between the twentieth and
twenty-first centuries, including leap year calculations, provided that all
other technology used in combination with the Company's product properly
exchanges date data with the Company's product. There can be no assurance that
(i) third party technologies used in combination with the Company's products
will be Year 2000 Compliant and (ii) the Company's products will not be
adversely affected when used with such third party technologies, nor can the
Company represent that any modifications to its products made by a party other
than the Company will be Year 2000 Compliant.



                                       17
<PAGE>   18

         2.       COSTS ASSOCIATED WITH THE YEAR 2000 PROJECT

         Costs associated with certain system upgrades are included in existing
operating budgets. In some instances (such as the Company's financial
administrative system), the installation schedule of new software and hardware
in the normal course of business is being accelerated to also afford a solution
to Year 2000 compliance issues. Certain of the costs related to upgrades of
hardware and software systems are covered by ongoing maintenance agreements.
Additional costs of purchasing, installing, modifying and testing the internal
systems are not expected to exceed $800,000. The total cost associated with
required modifications to become Year 2000 Compliant is estimated not to exceed
$1,000,000.

         The total cost estimate is based on the current assessment of the
projects and is subject to change as the project progresses. Based on currently
available information, the Company does not believe that the Year 2000 matters
discussed above related to internal systems or products sold to customers will
have a material adverse impact on its financial condition or overall trends in
results of operations; however, it is still uncertain to what extent the Company
may be affected by such matters. In addition, customers may delay purchase
decisions because of uncertainty about Year 2000 issues. There also can be no
assurance that the failure to ensure Year 2000 compliance by a supplier or
another third party would not have a material adverse effect on the Company.

         The Company has begun internal discussions concerning contingency
planning to address potential problem areas with internal systems and with
suppliers and other third parties. It is expected that remediation and
contingency planning activities will be on-going throughout calendar year 1998
and 1999 with the goal of appropriately resolving all material internal systems
and third party issues.



                                       18
<PAGE>   19



                                     ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   Not applicable.


                           PART II. OTHER INFORMATION


                                     ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

(a)      Exhibits

                  Exhibit 27 - Financial Data Schedule

(b)      Reports on Form 8-K

                  No reports on Form 8-K were filed by the Company during the
period covered by this report.




SIGNATURES

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

                                     CAERE CORPORATION

Date:  November 12, 1998

                                     /S/  Blanche M. Sutter
                                     -------------------------------------------
                                     Blanche M. Sutter, Executive Vice President
                                     and Chief Financial Officer
                                     (Principal Financial and Accounting Officer
                                     and Duly Authorized Officer)


                                       19
<PAGE>   20

                               INDEX TO EXHIBITS


<TABLE>
<CAPTION>
Exhibit 
Number           Description
------           -----------
<S>              <C>

27               Financial Data Schedule

</TABLE>