<PAGE>   1
                                    FORM 10-Q
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

(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, 1997

                                       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 0-26964


                              CARNEGIE GROUP, INC.
--------------------------------------------------------------------------------

           DELAWARE                                    25-1435252
--------------------------------------------------------------------------------
(State or other Jurisdiction of          (I.R.S Employer Identification Number)
Incorporation or Organization)



     FIVE PPG PLACE, PITTSBURGH, PENNSYLVANIA                   15222
--------------------------------------------------------------------------------
     (Address of principal executive offices)                (Zip Code)



                                 (412) 642-6900
--------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)


     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 such shorter period that the registrant
was required to files such reports), and (2) has been subject to such filing
requirements for the past 90 days.


                                    Yes   X     No
                                        -----      -----

Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock as of the latest practicable date:

             CLASS                         OUTSTANDING AT OCTOBER 31, 1997
             -----                         -------------------------------
 Common Stock, $.01 par value                         6,465,255


                                     - 1 -
<PAGE>   2



                                    FORM 10-Q

                              CARNEGIE GROUP, INC.

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>

                                                                                                              PAGE NUMBER
                                                                                                              -----------
<S>           <C>                                                                                               <C> 

PART 1  FINANCIAL INFORMATION

     Item 1.  Financial Statements
              Carnegie Group, Inc. and Subsidiaries                                                               3
              Consolidated Statements of Operations for
              the three months and nine months ended
              September 30, 1997 and 1996

              Carnegie Group, Inc. and Subsidiaries                                                               4
              Consolidated Balance Sheets

              Carnegie Group, Inc. and Subsidiaries                                                               5
              Consolidated Statements of Cash Flows

              Notes to Unaudited Consolidated Financial Statements                                                6

     Item 2.  Management's Discussion and Analysis of                                                             7
              Financial Condition and Results of Operations

     Item 3.  Quantitative and Qualitative Disclosures about                                                     15
              Market Risks

PART 2  OTHER INFORMATION

     Item 6.  Exhibits and Reports on Form 8-K                                                                   16

     Signatures                                                                                                  17

     Exhibit Index                                                                                               18
</TABLE>


                                     - 2 -
<PAGE>   3


                         PART I - FINANCIAL INFORMATION

ITEM 1.       FINANCIAL STATEMENTS

                      CARNEGIE GROUP, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

<TABLE>
<CAPTION>

                                                                    THREE MONTHS ENDED            NINE MONTHS ENDED
                                                              ----------------------------  -----------------------------
                                                              SEPTEMBER 30,  SEPTEMBER 30,  SEPTEMBER 30,   SEPTEMBER 30,
                                                                  1997            1996           1997            1996
                                                                  ----            ----           ----            ----
<S>                                                          <C>              <C>           <C>             <C> 
Revenue
         Software services--Unrelated parties                $ 5,657,403      $ 5,317,571   $ 17,235,707    $18,396,585
         Software services--Related parties                    2,163,790          793,347      4,851,972      2,038,273
                                                              ----------       ----------     ----------     ----------

                  Total software services                      7,821,193        6,110,918     22,087,679     20,434,858
         Software licenses                                       122,518          398,351        845,957      1,061,112
                                                             -----------       ----------     ----------   ------------

                  Total revenue                                7,943,711        6,509,269     22,933,636     21,495,970
                                                              ----------       ----------     ----------     ----------

Costs and expenses:
         Cost of revenue - Unrelated parties                   3,669,785        3,454,845     11,292,810     12,064,410
         Cost of revenue - Related parties                     1,308,871          507,078      2,815,565      1,282,354
                                                            ------------       ----------     ----------   ------------

                  Total cost of revenue                        4,978,656        3,961,923     14,108,375     13,346,764
         Research and development                                505,140          346,868      1,255,686        814,158
         Selling, general and administrative                   2,108,397        1,671,435      6,046,420      5,822,321
                                                              ----------       ----------     ----------     ----------

                  Total costs and expenses                     7,592,193        5,980,226     21,410,481     19,983,243
                                                              ----------       ----------     ----------     ----------

Income from operations                                           351,518          529,043      1,523,155      1,512,727
Other income (expense):
         Interest income                                         179,743          153,011        512,619        451,701
         Other income                                              6,749            7,931         19,347         20,729
         Interest expense                                         (3,242)          (4,262)       (10,295)       (13,683)
                                                              ----------       ----------    -----------    -----------

         Total other income (expense)                            183,250          156,680        521,671        458,747
                                                              ----------       ----------     ----------     ----------

Income before income taxes                                       534,768          685,723      2,044,826      1,971,474
Income tax provision                                            (212,678)        (276,215)      (812,980)      (757,958)
                                                              ----------      -----------     ----------     ----------

         Net income                                           $  322,090       $  409,508   $  1,231,846   $  1,213,516
                                                              ----------       ----------   ------------   ------------

Earnings per share of common stock                            $     0.05      $     0.06      $    0.18      $     0.17
                                                              ==========      ==========      =========      ==========

Weighted average number of common shares and                   7,053,755        6,971,076      6,969,017      7,120,084
equivalents outstanding                                       ==========       ==========     ==========     ==========
</TABLE>



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


                                     - 3 -
<PAGE>   4


                      CARNEGIE GROUP, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>

                                                   (UNAUDITED)
                                                   SEPTEMBER 30,    DECEMBER 31,
                                                       1997             1996
                                                       ----             ----
                      ASSETS
<S>                                                <C>             <C> 
CURRENT ASSETS:
Cash and cash equivalents                           $ 13,841,553    $ 14,691,765
Accounts receivable                                    5,394,024       2,751,316
Accounts receivable from related parties               1,021,148         769,223
Accounts receivable--unbilled                          2,012,664       3,660,765
Accounts receivable related parties--unbilled            968,649         188,302
Deferred income taxes                                  1,957,139       2,179,426
Other current assets                                     732,271         403,508
                                                    ------------    ------------

         Total current assets                         25,927,448      24,644,305
                                                    ------------    ------------

Property and equipment, net of accumulated
         depreciation and amortization                 2,726,594       2,046,415
Deferred income taxes                                  1,283,514       1,775,480
Long term notes receivable--from officer                 325,000               0
Other assets                                              16,135          23,055
                                                    ------------    ------------

         Total assets                               $ 30,278,691    $ 28,489,255
                                                    ============    ============

         LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Trade accounts payable                              $  1,094,907    $    614,458
Payables to related parties                              292,352       1,034,608
Accrued compensation                                     707,764         706,965
Advance billings and deferred revenue                  2,091,210       1,101,221
Accrued rent                                             361,518         538,641
Other accrued liabilities                                629,930         821,752
Obligations under capital leases--current
          portion                                            167          33,242
                                                    ------------    ------------

         Total liabilities                             5,177,848       4,850,887
                                                    ------------    ------------

STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 20,000,000
         shares authorized, 6,689,970 and
         6,512,038 shares issued at
         September 30, 1997 and December 31, 1996
         respectively                                     66,900          65,120
Capital in excess of par value                        31,612,929      31,384,080
Accumulated deficit                                   (6,103,986)     (7,335,832)
Treasury stock, 190,000 shares                          (475,000)       (475,000)
                                                    ------------    ------------

         Total stockholders' equity                   25,100,843      23,638,368
                                                    ------------    ------------

         Total liabilities and stockholders'
            equity                                  $ 30,278,691    $ 28,489,255
                                                    ============    ============
</TABLE>


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


                                     - 4 -
<PAGE>   5


                      CARNEGIE GROUP, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                     NINE MONTHS ENDED
                                                                 SEPTEMBER 30,     SEPTEMBER 30,
                                                                     1997               1996
                                                                     ----               ----
<S>                                                             <C>               <C>   
Cash flows from operating activities:
         Net income                                             $  1,231,846       $  1,213,516
         Adjustments to reconcile net income
         to net cash (used in) provided
         by operating activities:
                  Depreciation and amortization                      937,908            698,989
                  (Gain) loss on sale of fixed assets                    503                  0
                  Deferred income taxes                              714,253            661,952
                  Changes in working capital component:
                  Accounts receivable                               (994,607)         1,531,603
                  Accounts receivable - Related parties           (1,032,272)          (993,120)
                  Other assets                                      (321,843)           144,153
                  Trade accounts payable                             480,449           (568,524)
                  Payables to related parties                       (742,256)           (37,772)
                  Accrued compensation                                   799           (211,810)
                  Accrued rent                                      (177,123)           (52,855)
                  Long term notes receivable--from officer          (325,000)                 0
                  Other accrued liabilities                         (125,058)            68,927
                  Advance billings and deferred revenue              989,989             75,981
                                                                ------------       ------------
                       Net cash (used in) provided by
                             operating activities                    637,588          2,531,040

Cash flows from investing activities:
         Proceeds from the sale of fixed assets, net                   1,000                 --
         Capital expenditures                                     (1,619,592)          (940,464)
                                                                ------------       ------------

                  Net cash used in investing
                       activities                                 (1,618,592)          (940,464)
                                                                ------------       ------------
         Cash flows from financing activities:
                  Borrowings on line of credit                            --                 --
                  Repayments on line of credit                            --                 --
                  Principal payments under capital
                      lease obligations                              (33,075)           (40,909)
                  Proceeds from sales of common stock, net           163,867            251,617
                                                                ------------       ------------

                       Net cash (used in) provided by
                            financing activities                     130,792            210,708
                                                                ------------       ------------

Net change in cash and cash equivalents                             (850,212)         1,801,284
Cash and cash equivalents:
         Beginning of period                                      14,691,765         12,394,588
         End of period                                          $ 13,841,553       $ 14,195,872
                                                                ============       ============
</TABLE>



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


                                     - 5 -
<PAGE>   6


              NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

BASIS OF PRESENTATION

     In the opinion of the management of Carnegie Group, Inc. (the "Company"),
these unaudited interim consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, considered
necessary for a fair presentation of operating results for the three month and
nine month periods ended September 30, 1997. Results for the interim periods are
not necessarily indicative of results for the full year. The accompanying
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and pursuant to the rules and
regulations of the Securities and Exchange Commission and therefore do not
include all information and footnotes required by generally accepted accounting
principles for complete financial statements. Accordingly, the information
contained in this Form 10-Q should be read in conjunction with the financial
statements and notes thereto contained in the Company's Form 10-K for the year
ended December 31, 1996 as filed with the Securities and Exchange Commission.

RECENT ACCOUNTING PRONOUNCEMENTS

     In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128 "Earnings per Share." SFAS No.
128 establishes new standards for computing and presenting earnings per share.
The Company is required to adopt the provisions of SFAS No. 128 for its
consolidated financial statements for the year ended December 31, 1997 and
subsequent interim periods. Upon adoption, the standard also requires the
restatement of all prior period earnings per share information presented.

     In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components. The Company is required to
adopt the provisions of SFAS No. 130 beginning with its consolidated financial
statements for the three months ending March 31, 1998. SFAS No. 131 requires
certain disclosures about segment information in interim and annual financial
statements and related information about products and services, geographic areas
and major customers. The Company must adopt the provisions of SFAS No. 131 for
its consolidated financial statements for the year ending December 31, 1998.

     The adoptions of SFAS No. 128, SFAS No. 130 and SFAS No. 131 are not
expected to have a material effect on the measurement of the Company's financial
position, results of operations or cash flows; the Company is reviewing possible
changes in disclosures that may be called for.


                                     - 6 -
<PAGE>   7


ITEM 2

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

GENERAL

     Carnegie Group, Inc. ("Carnegie Group" or the "Company") provides
client/server software development services that integrate advanced
user-centered, intelligent software technologies with clients' existing
computing infrastructures to automate and enhance complex business processes.
The Company performs business and technical consulting, custom software
development, and systems integration services to improve clients' productivity
and market position in two business areas: customer interaction; and logistics,
planning and scheduling. Within these areas, the Company targets its services to
clients in the financial services, government, manufacturing and
telecommunications industries.

     The Company's expertise encompasses a wide range of advanced software
technologies, including knowledge-based systems, object-oriented technology,
advanced graphical user interfaces, constraint-directed search and distributed
computing. The Company captures certain aspects of its business area experience
and advanced technology expertise in a portfolio of reusable software templates
that can be used as building blocks to create software solutions quickly and
effectively. In addition, Carnegie Group employs an iterative or "spiral"
approach to software design that begins with the construction of a prototype and
continues through testing of successive versions of the software against project
requirements. This iterative design facilitates rapid software development,
encourages client feedback and leads to greater congruence with client needs and
expectations.

     Since inception, Carnegie Group has emphasized relationships with leading
corporations in its targeted industries. These relationships have provided the
Company with opportunities for growth through the provision of additional
services to existing clients and through references to other companies within
the Company's targeted industries. Carnegie Group's clients include the United
States Transportation Command, U S WEST Communications, Inc., BellSouth
Telecommunications, Inc., U.S. Army, Caterpillar, Inc., First USA Bank, Highmark
Blue Cross Blue Shield and Philips Medical Systems.

     The Company only includes in backlog signed contracts that either have
milestones yet to be attained or for which the Company can make a reasonable
estimate of work yet to be performed. The Company's backlog at September 30,
1997 was $7.2 million, compared to $11.6 million at September 30, 1996 and $9.6
million at December 31, 1996. As most of the contracts in backlog are terminable
by the Company or the client upon short notice, there can be no assurance that
contracts reflected in backlog are a reliable measure of future revenue.

                                     - 7 -
<PAGE>   8


COMPARISON OF QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30,
1996.

     Revenue. Total revenue for the quarter ended September 30, 1997 was $7.9
million compared to $6.5 million for the quarter ended September 30, 1996, an
increase of $1.4 million or 22%. For the nine months ended September 30, 1997
revenue was $22.9 million compared to $21.5 million for the nine months ended
September 30, 1996, an increase of $1.4 million or 7%.

     Total software services revenue for the quarter ended September 30, 1997
was $7.8 million compared to $6.1 million for the quarter ended September 30,
1996, an increase of $1.7 million or 28%. For the nine months ended September
30, 1997 software services revenue was $22.1 million compared to $20.4 million
for the nine months ended September 30, 1996, an increase of $1.7 million or 8%.
Revenue from software services-related parties was $4.8 million for the nine
months ended September 30, 1997 compared to $2.0 million for the nine months
ended September 30, 1996, an increase of $2.8 million or 140%. This increase was
primarily due to an increase in customer contact engagements for a
telecommunications industry client.

     Revenue from software licenses was $123,000 for the three month period
ended September 30, 1997, compared to $398,000 for the same three month period
in 1996, a decrease of $275,000 or 69%. The decrease in software licenses in the
third quarter of 1997 when compared to 1996 was attributable to the failure to
close a certain major template license during the third quarter of 1997. Revenue
from software licenses was $846,000 for the nine months ended September 30, 1997
compared to $1,061,000 for the nine months ended September 30, 1996, a decrease
of $215,000 or 20%.

     Cost of Revenue. Cost of revenue consists primarily of salaries and related
benefits for personnel, and also includes an allocated portion of rent, building
services and expenses. For the third quarter of 1997, total cost of revenue was
$5.0 million compared to $4.0 million for the third quarter of 1996, an increase
of $1.0 million or 25%. For the nine months ended September 30, 1997, total cost
of revenue was $14.1 million compared to $13.3 million for the nine months ended
September 30, 1996, an increase of $.8 million or 6%. The nine month increase
was primarily attributable to an increase in the number of software engineers
deployed on customer contact engagements. Cost of revenue-related parties was
$2.8 million for the nine months ended September 30, 1997 compared to $1.3
million for the nine months ended September 30, 1996, an increase of $1.5
million or 115%. This increase was primarily attributable to an increase in
customer contact engagements for a telecommunications industry client.

     Research and Development. Research and development expenses for the quarter
ended September 30, 1997 were $505,000 compared to $347,000 for the third
quarter of 1996, an increase of $158,000 or 46%. For the nine months ended
September 30, 1997 research and development expenses were $1.2 million compared
to $.8 million for the nine months ended September 30, 1996, an increase of $.4
million or 50%. These increases were primarily attributable to continued
investment in template and methodology development.

     Selling, General and Administrative. Selling, general and administrative
expenses include costs of proposal development and proposal writing, marketing
communications and advertising, sales and management staff, and corporate
services functions including accounting, human resources and legal services,
along with corporate executive staff. Selling, general and administrative
expenses were $6.0 million for the nine months ended September 30, 1997 compared
to $5.8 million for the nine months ended September 30, 1996, an increase of $.2
million or 3%.

     Other Income (Expense). Total other income for the third quarter of 1997
was $183,000 compared to total other income of $157,000 in 1996, an increase of
$26,000 or 17%. For the nine months ended September 30, 1997, total other income
was $522,000 compared to total other income of $459,000 for the same period in
1996, an increase of $63,000 or 14%. This income is primarily interest income
earned on the net 

                                     - 8 -
<PAGE>   9


proceeds received in December 1995 from the Company's initial public offering,
which were invested in an interest-bearing account.

     Income Tax Provision. An income tax provision of $213,000 was recorded for
the third quarter of 1997 and $813,000 for the nine months ended September 30,
1997 based on the Company's estimate of the effective tax rate for the year.

     SFAS No. 109, "Accounting for Income Taxes," requires a valuation allowance
when it is "more likely than not that some portion or all of the deferred tax
assets will not be realized." It further states that "forming a conclusion that
a valuation allowance is not needed is difficult when there is negative evidence
such as cumulative losses in recent years." The ultimate realization of its
deferred income tax asset depends on the Company's ability to generate
sufficient taxable income in the future. The Company has weighed the positive
evidence of sustained profitability over the last three years and future income
expectations within the Company's three year strategic planning horizon against
the negative evidence of dependence upon a limited number of customers and other
uncertainties and has concluded that retaining a valuation allowance related to
net operating losses is no longer necessary.

     In estimating the amount of its realizable deferred tax asset, the Company
gives substantial weight to recent historical results. Significant changes in
circumstances or in enacted tax laws which affect the valuation allowance are
recorded when they occur. The Company's annual strategic business planning
process takes place in the fourth quarter of the year, and the valuation
allowance is adjusted for future years' income expectations resulting from that
process. When preparing subsequent interim and annual financial statements, the
Company reevaluates whether there has been any significant change in the
assumptions underlying its plan and adjusts the valuation allowance as
necessary.

     Net Income. Net income for the quarter ended September 30, 1997 was
$322,000 compared to $410,000 for the quarter ended September 30, 1996. This
decrease of $88,000 was due to the aforementioned decrease in software licenses
sold in the third quarter of 1997 when compared to 1996 which was attributed to
the failure to close a certain major template license.

LIQUIDITY AND CAPITAL RESOURCES

     The Company has funded its operations in recent years primarily through
cash generated from operations and the use of cash reserves, and in part by
borrowing under available lines of credit. The Company has also funded its
operations through the net proceeds of the initial public offering of its Common
Stock consummated in December 1995.

     During the first nine months of 1997 the Company generated $637,000 in
positive cash flow from operating activities, although overall, the Company had
a net use of cash amounting to $850,000. This negative cash flow was the result
of a substantial nine month investment of $1.6 million in capital expenditures.
In comparison, capital equipment spending for the nine months ended September
30, 1996 was $940,000.

     The Company's net accounts receivable increased by $2.0 million for the
nine months ended September 30, 1997 which reflects increases in revenue.
Invoicing of amounts to clients generally occurs within 45 days of time and
materials cost incurrence, unless a specific schedule is agreed upon, and
payment follows invoicing in accordance with customary terms. The Company has
not experienced any significant write-downs of receivables, nor does the Company
expect that payments are doubtful; accordingly, the Company has not made any
allowance for doubtful accounts.

     Advance billings and deferred revenue increased $1.0 million for the nine
months ended September 30, 1997. Advanced billings and deferred revenue balances
will normally change from period to period. Any increase reflects billings in
advance of revenue earned, but which were billed in accordance with established
or agreed billings schedules. These amounts are recorded as deferred revenue
until earned. The 


                                     - 9 -
<PAGE>   10


timing and magnitude of such advance billings vary from contract to contract and
from client to client.

     The Company currently has a committed line of credit agreement in the
amount of $3.5 million in place with PNC Bank, N.A. (the "Bank"). Borrowings
under this agreement are collateralized by accounts receivable. The line of
credit bears interest at the Bank's prime interest rate and the Bank charges a
0.15% fee per annum on the unused portion of that line of credit. The Bank's
prime interest rate was 8.50% at September 30, 1997 compared to 8.25% at
December 31, 1996. This agreement was amended on July 1, 1997 by extending the
expiration date to June 30, 1998. No borrowings were outstanding against the
line of credit at September 30, 1997 or December 31, 1996.

     The Company believes that the current cash balances, together with cash
generated from operations and borrowing available under its line of credit, will
satisfy the Company's working capital and capital expenditure requirements
during fiscal year 1997 and the foreseeable period thereafter. In the longer
term, the Company may require additional sources of liquidity to fund future
growth. Such sources of liquidity may include additional equity offerings or
debt financings. Capital expenditures are typically made for computing
equipment, software, physical plant, and furniture and fixtures in order to seek
enhancements in the productivity of the Company's employees and to support
growth.

RECENT ACCOUNTING PRONOUNCEMENTS

     In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128 "Earnings per Share." SFAS No.
128 establishes new standards for computing and presenting earnings per share.
The Company is required to adopt the provisions of SFAS No. 128 for its
consolidated financial statements for the year ended December 31, 1997 and
subsequent interim periods. Upon adoption, the standard also requires the
restatement of all prior period earnings per share information presented.

     In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components. The Company is required to
adopt the provisions of SFAS No. 130 beginning with its consolidated financial
statements for the three months ending March 31, 1998. SFAS No. 131 requires
certain disclosures about segment information in interim and annual financial
statements and related information about products and services, geographic areas
and major customers. The Company must adopt the provisions of SFAS No. 131 for
its consolidated financial statements for the year ending December 31, 1998.

     The adoptions of SFAS No. 128, SFAS No. 130 and SFAS No. 131 are not
expected to have a material effect on the measurement of the Company's financial
position, results of operations or cash flows; the Company is reviewing possible
changes in disclosures that may be called for.

MATERIAL FACTORS AFFECTING THE COMPANY'S BUSINESS

     The Company's business is subject to a number of risks and uncertainties
that could materially affect future results. To the extent that any of the
statements made in this report on Form 10-Q (including, without limitation,
statements with respect to growth in the Company's business and client
engagements) may be deemed to be forward-looking statements, or to the extent
that the Company or its representatives may in the future be deemed to make oral
forward-looking statements, the following is a list of important factors, among
others, that could cause actual results to differ materially from those
expressed in any such forward-looking statements:

     Dependence Upon Limited Number of Clients. The Company has derived in the
past, and expects to derive in the future, a significant portion of its revenue
from a 


                                     - 10 -
<PAGE>   11


relatively limited number of major clients. For example, approximately 83%, 87%
and 80% of total software services revenue in the years ended December 31, 1996,
1995 and 1994, respectively, was derived from the Company's five largest clients
in each such period. In 1996, revenue from billings to each of the United States
Transportation Command, BellSouth Telecommunications, Inc. and Caterpillar Inc.
accounted for more than 10% of the Company's total revenue. In 1995, revenue
from billings to each of such customers and U S WEST Communications, Inc.
accounted for more than 10% of the Company's total revenue. The Company's
business depends in large part upon its ability to establish and maintain
relationships with a limited number of large clients. The loss of, or any
significant reduction in the services provided to, any existing major clients,
or the failure of the Company to establish and maintain relationships with new
major clients, would have a material adverse effect on the Company's business,
financial position and results of operations.

     Project Risks. Many of the Company's engagements involve projects which are
critical to the operations of its clients' businesses and which provide benefits
that may be difficult to quantify. Moreover, many of these engagements are
significant to the Company, in that each may represent a significant portion of
the Company's total revenue. For example, the Company's ten largest engagements
accounted for approximately 76%, 68%, and 56% of total software services revenue
in the years ended December 31, 1996, 1995 and 1994, respectively. The Company's
failure or inability to meet a client's expectations in the performance of an
engagement could have a material adverse effect on the Company's business,
financial position and results of operations, including damage to the Company's
reputation that could adversely affect its ability to attract new business. In
addition, the Company's engagements generally are terminable by clients on short
or no notice. An unanticipated termination of a major engagement could require
the Company either to maintain under-utilized employees, resulting in a higher
than expected number of unassigned persons and concomitant lower utilization
rate, or to terminate such employees, resulting in higher severance expenses.
The Company must maintain a sufficient number of senior professionals to oversee
existing client engagements and to participate with the Company's sales force in
securing new client engagements; thus, professional staff expenses are
relatively fixed. Although the majority of the Company's contracts are performed
on a time-and-materials basis, some contracts are performed on a fixed-price
basis, exposing the Company to the risks of cost overruns and inflation.

     Variability of Quarterly Operating Results; Future Operating Results
Uncertain. The Company has experienced significant quarterly and other
variations in revenue and operating results. Because the Company's business is
characterized by significant client concentration and relatively large projects,
the timing of performance for each client engagement can result in significant
variability in the Company's revenue and cost of revenue from quarter to
quarter. In addition, variations in the Company's revenue and operating results
occur as a result of a number of other factors, such as employee hiring and
utilization rates and the number of working days in a quarter. The timing of
revenue is difficult to forecast because the Company's sales cycle is relatively
long and may depend on factors such as the size and scope of assignments and
general economic conditions. Because a high percentage of the Company's
expenses, particularly employee compensation, are relatively fixed, a variation
in the timing of the initiation or completion of client engagements, especially
at or near the end of any quarter, can cause significant variations in operating
results from quarter to quarter and could result in quarterly losses. Future
revenue and operating results may vary as a result of these and other factors,
including the demand for the Company's services and solutions and the
competitive conditions in the industry. Moreover, much of the Company's revenue
from software licenses is realized upon the licensing of individual copies of
software, rather than in the course of a specific services engagement.
Accordingly, the timing of software license revenue can be difficult to predict
and may vary significantly from quarter to quarter. Many of the factors that
could result in quarterly variations are not within the Company's control. The
Company believes that quarter-to-quarter comparisons of its financial results
are not necessarily meaningful and should not be relied upon as an indication of
future performance.


                                     - 11 -
<PAGE>   12


     In addition, quarterly variations, together with the Company's dependence
upon a limited number of clients and the Company's experience of adverse
operating results in years prior to 1994, make it difficult for management to
engage in strategic planning that contemplates a horizon of more than three
years. Thus, income expectations beyond three years are viewed by management as
very uncertain, and management's past assessments of its ability to realize its
deferred tax asset through future taxable income have reflected this. Prior to
December 31, 1996, the Company's interim and annual financial statements
included a valuation allowance that was intended to reflect management's
estimation, in light of these and other risk factors, of the realizability of
its deferred tax asset. In determining the amount of any valuation allowance and
the possible need to adjust that amount, the Company weighs the negative
evidence of its dependence upon a limited number of clients and the other risks
described herein, on the one hand, against the positive evidence of recent
results and future expectations over its three-year planning horizon, on the
other hand. The Company then adjusts the valuation allowance, if any, to reflect
the portion of the deferred tax asset that the Company believes it will, more
likely than not, be unable to realize. Any valuation allowance that may be shown
on the Company's financial statements would reflect that the Company does not
believe that it is more likely than not to realize certain deferred tax assets.

     Dependence on Key Management Personnel. The Company's success depends in
significant part upon the retention of key senior management and technical
personnel. The Company does not have employment agreements with any of its
personnel other than Dennis Yablonsky, its President and Chief Executive
Officer, nor does it maintain key man life insurance on any of its personnel.
The loss of one or more of its key management employees or the inability to
attract and retain other qualified management employees could have a material
adverse effect on the Company's business, financial position and results of
operations.

     Attraction and Retention of Employees. Carnegie Group's business involves
the delivery of software development services and is labor-intensive. The
Company's success depends in large part upon its ability to attract, retain and
motivate highly skilled employees, particularly project managers, sales and
marketing personnel, engineers and other senior personnel. Qualified project
managers and engineers are in particularly great demand and are likely to remain
a limited resource in the foreseeable future. Although the Company expects to
continue to attract sufficient numbers of highly skilled employees and to retain
existing project managers, sales and marketing personnel, engineers and other
senior personnel for the foreseeable future, there can be no assurance that the
Company will be able to do so. The Company, like others in the information
technology services industry, is subject to a relatively high annual rate of
turnover in personnel. The loss of project managers, sales and marketing
personnel, engineers and other senior personnel could have a material adverse
effect on the Company's business, financial position and results of operations,
including its ability to secure and complete engagements. No project managers,
sales and marketing personnel, engineers or other senior personnel have entered
into employment agreements, other than Dennis Yablonsky, the Company's President
and Chief Executive Officer.

     Management of Growth. Carnegie Group is currently experiencing a period of
growth which has placed, and could continue to place, a strain on the Company's
financial and other resources. The Company was founded in 1983 by computer
scientists at Carnegie Mellon University in Pittsburgh, Pennsylvania. The
Company was initially funded through equity investments and technology alliances
with Digital Equipment Corporation, Generale de Service Informatique, The Boeing
Company, Texas Instruments Incorporated, Ford Motor Company and U S WEST, Inc.
From January 1, 1994 through December 31, 1996, the size of the Company's staff
increased from 124 to 238 employees and independent contractors. In addition,
the Company has opened offices in Atlanta, Georgia and Fairview Heights,
Illinois since January 1, 1995. In order to manage any further growth in its
staff and facilities, the Company must continue to improve its operational,
financial and other internal systems, and to attract, train, motivate and manage
its personnel. If the Company is unable to manage growth effectively and new
personnel are unable to achieve anticipated performance levels, 


                                     - 12 -
<PAGE>   13


the Company's business, financial position and results of operations would be
adversely affected.

     Competition. The information technology services market includes a large
number of participants, is subject to rapid change and is highly competitive.
The Company competes with and faces potential competition for client assignments
and experienced personnel from a number of companies that have significantly
greater financial, technical and marketing resources and greater name
recognition. Primary competitors include: the consulting practices of the "Big
Six" accounting firms; systems consulting and integration firms such as American
Management Systems, Inc. and Cambridge Technology Partners, Inc.; and the
professional services groups of large companies, such as International Business
Machines Corporation, Digital Equipment Corporation and AT&T Corporation. In
addition, clients may elect to use their internal information systems resources
to satisfy their needs for software development, systems integration and
technical consulting services, rather than using those services offered by the
Company. The Company also faces competition from organizations providing
outsourcing services to the information systems departments of existing and
potential clients. In addition, the information technology services market is
highly fragmented and is served by numerous firms; some of these firms compete
nationally and internationally, while others serve only their respective local
markets. While the Company has not experienced competition from foreign
providers of information technology services, there can be no assurance that the
Company will not experience such competition in the future. Carnegie Group has
targeted, and expects to continue to target, industries that are characterized
by business areas (such as customer interaction, and logistics, planning and
scheduling) to which the Company's services and technology are particularly
well-suited, and by participants who possess the financial resources and scale
of operations necessary to support the engagement of service providers such as
the Company. A growing number of professional services firms are seeking
engagements from that same client group. The Company believes that the principal
competitive factors in the information technology services industry include the
nature of the service offering, quality of service, timeliness, responsiveness
to client needs, experience with the client's industry and competitive
environment, technical expertise, access to replicable technology, such as
software templates, and price. The Company believes that its ability to compete
also depends in part upon a number of competitive factors outside its control,
including: the ability of its competitors to hire, retain and motivate project
managers, sales and marketing personnel and engineers; competitors' ownership of
or access to software and technology used by potential clients; the development
by others of software that is competitive with the Company's solutions and
services; the price at which others offer comparable services; and the extent of
competitors' responsiveness to customer needs.

     While the information technology services market remains highly fragmented
and continues to be served by numerous firms, the Company notes that this market
has been subject to recent consolidation. Accordingly, the Company from time to
time considers possible acquisitions, consolidations and other strategic
alternatives. In addition, business combinations among the Company's
competitors may result in the creation of additional large information
technology service providers with greater financial, marketing and other
resources, than those of the Company.

     Developing Market; Technological Advances. The market for client/server
software development services is continuing to develop. The Company's success is
dependent in part upon the acceptance of information processing systems
utilizing client/server architectures. While the Company believes that
corporations and government agencies will continue to accept the use of
client/server architectures, a decline in this trend could have a material
adverse effect on the Company's business, financial position and results of
operations. The Company's success will also depend in part on its ability to
develop software solutions that incorporate and keep pace with continuing
changes in advanced software technologies, evolving industry standards and
changing client preferences. There can be no assurance that the Company will be
successful in adequately addressing these developments on a timely basis or
that, if these developments are addressed, the Company will be successful in the
marketplace. The Company's failure to address these developments could have a
material adverse effect on the Company's business, financial position and
results of


                                     - 13 -
<PAGE>   14


operations. In addition, there can be no assurance that products or
technologies developed by others will not render the Company's services
uncompetitive or obsolete.

     Intellectual Property Rights. The Company's success is dependent in part
upon reusable software templates and other intellectual property. The Company's
business includes the development of custom software solutions in connection
with specific client engagements. Ownership of certain custom components of such
software is generally assigned to the client. The Company has licensed through
December 1997 certain custom software components developed in the course of an
engagement for a client. In addition, the Company also develops core software
technology and reusable software templates, often in the course of engagements
for clients, as well as object-oriented software components and certain software
"tools," which can be reused in software application development and which
generally remain the property of the Company.

     The Company relies upon a combination of patent, trade secret,
non-disclosure and other contractual arrangements, and patent, copyright and
trademark laws, to protect its proprietary rights and the proprietary rights of
third parties from whom the Company licenses intellectual property. The Company
enters into confidentiality agreements with its employees, consultants, clients
and potential clients and limits access to and distribution of proprietary
information. There can be no assurance that the steps taken by the Company in
this regard will be adequate to deter misappropriation of proprietary
information or that the Company will be able to detect unauthorized use and take
appropriate steps to enforce its intellectual property rights.

     Although the Company believes that its services and solutions (including
its reusable software templates) do not infringe on the intellectual property
rights of others and that it has all rights necessary to utilize the
intellectual property employed in its business, the Company is subject to the
risk of litigation alleging infringement of third party intellectual property
rights. There can be no assurance that third parties (including the parties for
whom the Company has been engaged to develop solutions, from which its reusable
software templates have been derived) will not assert infringement claims
against the Company in the future with respect to intellectual property utilized
by the Company now or in the future. Any such claims could require the Company
to expend significant sums in litigation, pay damages, develop non-infringing
intellectual property or acquire licenses to the intellectual property which is
the subject of asserted infringement.


                                     - 14 -
<PAGE>   15



ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable


                                     - 15 -
<PAGE>   16


                          PART II - OTHER INFORMATION

ITEM 6   EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS                   DESCRIPTION
                                          
    10.01       Loan Agreement, dated as of September 11,
                1997, between Dennis Yablonsky and
                Carnegie Group, Inc.

    10.02       Agreement No. 9700050785, effective as of 
                July 1, 1997, between U S WEST Business 
                Resources, Inc., as agent for various 
                U S WEST Companies, and Carnegie Group, 
                Inc. (confidential treatment with respect 
                to certain information in this exhibit has 
                been requested of the Commission pursuant 
                to Rule 24b-2 under the Securities Exchange 
                Act of 1934, as amended).

    10.03       Schedule Number 230397, effective as of 
                July 21, 1997, to Agreement No. 9700050785 
                between U S WEST Business Resources, Inc., 
                as agent for various U S WEST Companies, and 
                Carnegie Group, Inc. (confidential treatment 
                with respect to certain information in this 
                exhibit has been requested of the Commission 
                pursuant to Rule 24b-2 under the Securities 
                Exchange Act of 1934, as amended).
 
    10.04       Schedule Number 230597, effective as of 
                August 18, 1997, to Agreement No. 9700050785 
                between U S WEST Business Resources, Inc., 
                as agent for various U S WEST Companies, and 
                Carnegie Group, Inc. (confidential treatment 
                with respect to certain information in this 
                exhibit has been requested of the Commission 
                pursuant to Rule 24b-2 under the Securities 
                Exchange Act of 1934, as amended).

    11.1        Statement regarding computation of per share earnings

    27.         Financial Data Schedule

(b) Reports on Form 8-K
         The registrant did not file any reports on Form 8-K during the quarter
         ended September 30, 1997.


                                     - 16 -
<PAGE>   17


                                   SIGNATURES

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

Date: November 14, 1997                            CARNEGIE GROUP, INC.

                                                   /s/ DENNIS YABLONSKY
                                                   --------------------------
                                                   Dennis Yablonsky
                                                   President, and
                                                   Chief Executive Officer

                                                   /s/ JOHN W. MANZETTI
                                                   --------------------------
                                                   John W. Manzetti
                                                   Executive Vice President,
                                                   Chief Financial Officer
                                                   and Treasurer


                                     - 17 -
<PAGE>   18


                                  EXHIBIT INDEX
<TABLE>
<CAPTION>
                                                                SEQUENTIAL
EXHIBIT NO.               DESCRIPTION                          PAGE NUMBER
-----------               -----------                          -----------
<S>             <C>                                            <C>   
10.01           Loan Agreement, dated as of September 11,
                1997, between Dennis Yablonsky and
                Carnegie Group, Inc.

10.02           Agreement No. 9700050785, effective as of 
                July 1, 1997, between U S WEST Business 
                Resources, Inc., as agent for various 
                U S WEST Companies, and Carnegie Group, 
                Inc. (confidential treatment with respect 
                to certain information in this exhibit has 
                been requested of the Commission pursuant 
                to Rule 24b-2 under the Securities Exchange 
                Act of 1934, as amended).

10.03           Schedule Number 230397, effective as of 
                July 21, 1997, to Agreement No. 9700050785 
                between U S WEST Business Resources, Inc., 
                as agent for various U S WEST Companies, and 
                Carnegie Group, Inc. (confidential treatment 
                with respect to certain information in this 
                exhibit has been requested of the Commission 
                pursuant to Rule 24b-2 under the Securities 
                Exchange Act of 1934, as amended).
 
10.04           Schedule Number 230597, effective as of 
                August 18, 1997, to Agreement No. 9700050785 
                between U S WEST Business Resources, Inc., 
                as agent for various U S WEST Companies, and 
                Carnegie Group, Inc. (confidential treatment 
                with respect to certain information in this 
                exhibit has been requested of the Commission 
                pursuant to Rule 24b-2 under the Securities 
                Exchange Act of 1934, as amended).
                     
11.1            Statement Regarding Computation
                of Per Share Earnings

27              Financial Data Schedule
</TABLE>


                                     - 18 -