<PAGE>   1

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                                 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, 1999

                                       OR

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

                         COMMISSION FILE NUMBER 0-26776

                                  CLARIFY INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S>                                            <C>
                  DELAWARE                                      77-0259235
       (STATE OR OTHER JURISDICTION OF                         (IRS EMPLOYER
       INCORPORATION OR ORGANIZATION)                     IDENTIFICATION NUMBER)
</TABLE>

                              2560 ORCHARD PARKWAY
                           SAN JOSE, CALIFORNIA 95131
         (ADDRESS, INCLUDING ZIP CODE, OF PRINCIPAL EXECUTIVE OFFICES)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 965-7000

     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 [ ]

     As of October 22, 1999 there were 23,713,180 shares of the Registrant's
Common Stock outstanding.

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<PAGE>   2

                                  CLARIFY INC.

                                   FORM 10-Q
                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                        PAGE
                                                                        ----
<S>       <C>                                                           <C>
PART I.   FINANCIAL INFORMATION
Item 1.   Condensed Consolidated Financial Statements:
          Condensed Consolidated Balance Sheets as of September 30,
          1999 and December 31, 1998..................................    3
          Condensed Consolidated Statements of Income for the three
          and nine months ended September 30, 1999 and 1998...........    4
          Condensed Consolidated Statements of Cash Flows for the nine
          months ended September 30, 1999 and 1998....................    5
          Notes to Condensed Consolidated Financial Statements........    6
Item 2.   Management's Discussion and Analysis of Financial Condition
          and Results of Operations...................................    8
Item 3.   Quantitative and Qualitative Disclosures about Market
          Risk........................................................   12

PART II.  OTHER INFORMATION
Item 6.   Exhibits and Reports on Form 8-K............................   22
SIGNATURE.............................................................   23
</TABLE>

                                        2
<PAGE>   3

                                  CLARIFY INC.

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)

                                     ASSETS

<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,    DECEMBER 31,
                                                                  1999             1998
                                                              -------------    ------------
                                                               (UNAUDITED)
<S>                                                           <C>              <C>
Current assets:
  Cash and cash equivalents.................................    $ 37,860         $ 31,271
  Short-term investments....................................      30,908           25,917
  Accounts receivable, net of allowances of $5,286 in 1999
     and $2,757 in 1998.....................................      63,094           45,224
  Prepaid expenses and other current assets.................       4,362            2,604
  Deferred tax assets.......................................       4,934            4,934
                                                                --------         --------
          Total current assets..............................     141,158          109,950

Property and equipment, net.................................      14,721            8,437
Long-term investments.......................................       9,387              516
Non-current deferred tax assets.............................       1,860            1,860
Other non-current assets....................................       1,558            1,837
                                                                --------         --------
          TOTAL ASSETS......................................    $168,684         $122,600
                                                                ========         ========
                           LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................    $ 12,565         $  5,826
  Payroll related accruals..................................      13,921            9,589
  Other accrued liabilities.................................       9,864            8,800
  Income taxes payable......................................       1,987            1,980
  Deferred revenue..........................................      31,921           25,086
                                                                --------         --------
          Total current liabilities.........................      70,258           51,281
                                                                --------         --------

Stockholders' equity:
  Preferred stock, $.0001 par value, 5,000 shares
     authorized; none outstanding...........................
  Common stock, $.0001 par value, 55,000 shares authorized;
     shares issued and outstanding: 23,378 in 1999 and
     22,168 in 1998.........................................           2                2
  Additional paid-in-capital................................      74,553           59,127
  Accumulated other comprehensive deficit...................        (952)            (602)
  Deferred compensation.....................................          --              (18)
  Retained earnings.........................................      24,823           12,810
                                                                --------         --------
          Total stockholders' equity........................      98,426           71,319
                                                                --------         --------
          TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........    $168,684         $122,600
                                                                ========         ========
</TABLE>

  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
                                        3
<PAGE>   4

                                  CLARIFY INC.

                  CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                (IN THOUSANDS, EXCEPT PER SHARE DATA, UNAUDITED)

<TABLE>
<CAPTION>
                                                     THREE MONTHS ENDED     NINE MONTHS ENDED
                                                       SEPTEMBER 30,          SEPTEMBER 30,
                                                     ------------------    -------------------
                                                      1999       1998        1999       1998
                                                     -------    -------    --------    -------
<S>                                                  <C>        <C>        <C>         <C>
Revenues:
  License fees.....................................  $36,940    $22,480    $ 89,780    $58,236
  Services.........................................   26,392     11,977      69,304     30,946
                                                     -------    -------    --------    -------
Total revenues.....................................   63,332     34,457     159,084     89,182
                                                     -------    -------    --------    -------
Cost of revenues:
  License fees.....................................      848        477       2,598      1,592
  Services.........................................   13,786      6,974      38,044     18,392
                                                     -------    -------    --------    -------
Total cost of revenues.............................   14,634      7,451      40,642     19,984
                                                     -------    -------    --------    -------
Gross margin.......................................   48,698     27,006     118,442     69,198
Operating expenses:
  Product development and engineering..............    7,814      4,987      20,287     14,691
  Sales and marketing..............................   27,959     16,827      70,049     42,348
  General and administrative.......................    4,023      2,413      10,415      7,149
                                                     -------    -------    --------    -------
  Total operating expenses.........................   39,796     24,227     100,751     64,188
                                                     -------    -------    --------    -------
Operating income...................................    8,902      2,779      17,691      5,010
Interest and other income (expense), net...........      769        409       2,002      1,036
                                                     -------    -------    --------    -------
Income before income taxes.........................    9,671      3,188      19,693      6,046
Provision for income taxes.........................    3,772      1,180       7,680      2,237
                                                     -------    -------    --------    -------
Net income.........................................  $ 5,899    $ 2,008    $ 12,013    $ 3,809
                                                     =======    =======    ========    =======
Basic net income per share.........................  $  0.25    $  0.09    $   0.53    $  0.18
                                                     =======    =======    ========    =======
Shares used in per share computation -- basic......   23,197     21,739      22,769     21,574
                                                     =======    =======    ========    =======
Diluted net income per share.......................  $  0.23    $  0.09    $   0.47    $  0.17
                                                     =======    =======    ========    =======
Shares used in per share computation -- diluted....   26,120     22,108      25,303    $22,147
                                                     =======    =======    ========    =======
</TABLE>

  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
                                        4
<PAGE>   5

                                  CLARIFY INC.

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                           (IN THOUSANDS, UNAUDITED)

<TABLE>
<CAPTION>
                                                                NINE MONTHS ENDED
                                                                  SEPTEMBER 30,
                                                              ---------------------
                                                                1999         1998
                                                              ---------    --------
<S>                                                           <C>          <C>
Cash flows from operating activities:
  Net income................................................  $  12,013    $  3,809
  Adjustments to reconcile net income to net cash provided
     by operating activities:
     Depreciation and amortization..........................      4,568       4,041
     Provision for doubtful accounts........................        801       1,520
     Other..................................................         --          71
     Changes in assets and liabilities:
       Accounts receivable..................................    (22,025)     (4,589)
       Prepaid expenses and other current assets............     (1,417)       (128)
       Accounts payable.....................................      6,555        (340)
       Payroll related accruals.............................      4,660       2,121
       Other accrued liabilities............................      1,146       2,301
       Deferred revenue.....................................      9,928       5,519
                                                              ---------    --------
     Net cash provided by operating activities..............     16,229      14,325
                                                              ---------    --------
Cash flows from investing activities:
  Purchase of property and equipment........................    (10,883)     (4,395)
  Purchase of investments...................................   (121,578)    (11,170)
  Sale and maturities of investments........................    107,717      17,290
  Other assets..............................................          2        (970)
                                                              ---------    --------
     Net cash (used for) provided by investing activities...    (24,742)        755
                                                              ---------    --------
Cash flows from financing activities --
  Proceeds from issuance of common stock, net...............     15,428       2,440
                                                              ---------    --------
     Net cash provided by financing activities..............     15,428       2,440
                                                              ---------    --------
Effect of foreign exchange rate changes on cash.............       (326)         (5)
                                                              ---------    --------
Net increase in cash and cash equivalents...................      6,589      17,515
Cash and cash equivalents, beginning of period..............     31,271      20,744
                                                              ---------    --------
  Cash and cash equivalents, end of period..................  $  37,860    $ 38,259
                                                              =========    ========
Supplemental disclosure of cash flow information:
  Cash paid for interest....................................  $      21    $      6
                                                              =========    ========
  Cash paid for taxes.......................................  $   3,903    $  1,731
                                                              =========    ========
Supplemental disclosure of noncash investing and financing
  activities:
Change in unrealized net holding gain on investments........  $     (39)   $     (1)
                                                              =========    ========
</TABLE>

  The accompanying notes are an integral part of these condensed consolidated
                              financial statements
                                        5
<PAGE>   6

                                  CLARIFY INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 1. BASIS OF PRESENTATION

     The accompanying unaudited condensed consolidated balance sheets of Clarify
Inc. and its subsidiaries ("Clarify" or the "Company") as of September 30, 1999
and December 31, 1998, the related unaudited condensed consolidated statements
of income for the three and nine months ended September 30, 1999 and 1998, and
the related unaudited condensed consolidated statements of cash flows for the
nine months ended September 30, 1999 and 1998, have been prepared on
substantially the same basis as are the annual consolidated financial
statements. The December 31, 1998 balance sheet was derived from audited
financial statements, but does not include all disclosures required by generally
accepted accounting principles. The results of operations for the three and nine
months ended September 30, 1999 are not necessarily indicative of results to be
expected for the entire year.

     In the opinion of management, these interim financial statements reflect
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of the financial position, operating results and cash flows
for those periods presented. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
These unaudited condensed consolidated financial statements should be read in
conjunction with the Company's 1998 Annual Report on Form 10-K.

 2. COMPREHENSIVE INCOME

     The components of total comprehensive income, net of tax, are as follows
(in thousands):

<TABLE>
<CAPTION>
                                                     THREE MONTHS       NINE MONTHS
                                                         ENDED             ENDED
                                                     SEPTEMBER 30,     SEPTEMBER 30,
                                                    ---------------   ----------------
                                                     1999     1998     1999      1998
                                                    ------   ------   -------   ------
<S>                                                 <C>      <C>      <C>       <C>
Net income.......................................   $5,899   $2,008   $12,013   $3,809
Unrealized net holding (loss) gain on
  investments....................................      (10)       4       (39)      (1)
Translation adjustment...........................     (606)    (246)     (311)      (2)
                                                    ------   ------   -------   ------
          Total comprehensive income.............   $5,283   $1,766   $11,663   $3,806
                                                    ======   ======   =======   ======
</TABLE>

     The components of accumulated other comprehensive deficit are as follows
(in thousands):

<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,   DECEMBER 31,
                                                                  1999            1998
                                                              -------------   ------------
<S>                                                           <C>             <C>
Unrealized net holding (loss) gain on investments...........      $ (29)         $  10
Cumulative translation adjustment...........................       (923)          (612)
                                                                  -----          -----
Accumulated other comprehensive deficit.....................      $(952)         $(602)
                                                                  =====          =====
</TABLE>

 3. EARNINGS PER SHARE

     Basic earnings per share is computed based on the weighted average number
of shares outstanding during the period. Diluted earnings per share is computed
based on the weighted average number of shares outstanding during the period
increased by the effect of dilutive stock options and stock purchase contracts,
using the treasury stock method.

                                        6
<PAGE>   7
                                  CLARIFY INC.

        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     The following table presents information necessary to calculate basic and
diluted earnings per common and common equivalent share (in thousands):

<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED    NINE MONTHS ENDED
                                                SEPTEMBER 30,         SEPTEMBER 30,
                                              ------------------    ------------------
                                               1999       1998       1999       1998
                                              -------    -------    -------    -------
<S>                                           <C>        <C>        <C>        <C>
Weighted average shares
  outstanding -- basic......................   23,197     21,739     22,769     21,574
Dilutive common stock equivalents...........    2,923        369      2,534        573
                                              -------    -------    -------    -------
Weighted average shares and equivalents --
  diluted...................................   26,120     22,108     25,303     22,147
                                              =======    =======    =======    =======
Net income for basic and diluted earnings
  per share computation.....................  $ 5,899    $ 2,008    $12,013    $ 3,809
                                              =======    =======    =======    =======
</TABLE>

 4. HEDGING

     In the normal course of business, the Company has exposure to foreign
currency fluctuations arising from foreign currency sales and purchases and
intercompany transactions, among other things. The Company uses foreign exchange
forward contracts to limit its exposure to foreign exchange losses arising from
foreign currency payables and receivables. The Company evaluates its net
exposure therefrom and enters into forward contracts to hedge the net exposure
over a specified amount. These contracts are executed with credit-worthy
financial institutions and are denominated in currencies of major industrial
nations. Gains and losses on these contracts serve as hedges in that they offset
fluctuations that would otherwise impact the Company's financial results. Costs
associated with entering into such contracts are generally amortized over the
life of the instruments and are not material to the Company's financial results.

     At September 30, 1999, the Company had foreign currency forward contracts
outstanding to hedge foreign currency intercompany accounts receivable and
accounts payable. These contracts typically have 30 day maturities and are
intended to reduce exposure to foreign currency exchange risk. The total
aggregate fair value of and the net unrealized loss on foreign exchange
contracts were $16.3 million and $266,000, respectively.

 5. RECENTLY ISSUED ACCOUNTING STANDARDS

     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities. It requires that an
entity recognizes all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
Management has not yet evaluated the effects of this change on its operations.
SFAS No. 133 will be effective for the Company's fiscal year 2001. Management
believes that this statement will not have a significant impact on the Company.

 6. SUBSEQUENT EVENTS

     On October 1, 1999, the Company acquired all of the outstanding stock and
assumed all of the outstanding options of Newtonian Software, Inc. ("Newtonian")
in exchange for Clarify Common Stock and cash. The aggregate purchase price for
Newtonian was approximately $17 million, consisting of approximately $6 million
in cash and approximately $11 million of Clarify Common Stock. The acquisition
will be accounted for under the purchase method of accounting.

     On October 18, 1999, the Company announced the acquisition of the Company
by Nortel Networks Corporation ("Nortel"). Upon completion of the acquisition,
Clarify stockholders will receive 1.3 shares of Nortel Common Shares for each
Clarify share they own. Completion of Nortel's acquisition of the Company is
subject to certain regulatory approvals and the approval of a majority of the
outstanding shares of Clarify Common Stock.

                                        7
<PAGE>   8

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

     In addition to historical information, this report on Form 10-Q contains
forward-looking statements that involve risks and uncertainties that could cause
actual results to differ materially from those projected. Factors that might
cause or contribute to such differences include, but are not limited to, those
discussed in the section entitled "Management's Discussion and Analysis of
Consolidated Financial Condition and Results of Operations" and "Certain Factors
That May Affect Future Results of Operations" in the Company's 1998 Annual
Report on Form 10-K. Readers should carefully review the risks described in
other documents the Company files from time to time with the Securities and
Exchange Commission, including the annual report on Form 10-K and the quarterly
reports on Form 10-Q. Readers are cautioned not to place undue reliance on the
forward-looking statements, including statements regarding the Company's
expectations, beliefs, intentions or strategies regarding the future, which
speak only as of the date of this Form 10-Q. The Company undertakes no
obligation to release publicly any updates to the forward-looking statements
included herein after the date of this document.

OVERVIEW

     Clarify Inc. ("Clarify" or the "Company"), founded in August 1990, is a
leading developer and provider of enterprise-scale, Internet-ready front office
applications software for high-quality management of customer relationships over
their lifetime. Clarify's software helps companies build service into every
customer interaction across a variety of media with integrated solutions that
automate call center, sales and marketing, technical support, field service and
logistics, quality assurance, and help desk processes. By uniting the entire
virtual enterprise around the customer, including suppliers and partners who
help meet customer needs, Clarify helps companies attract, acquire and retain
customers at significantly reduced costs.

     Clarify markets its software and services primarily through its direct
sales organization. Clarify maintains sales and support offices throughout North
America, Europe, and the Asia/Pacific region. A variety of industries employ
Clarify's solutions, including telecommunications, high technology, financial
services, healthcare, consumer products, and travel and entertainment. Clarify's
customers include Automatic Data Processing, Inc., BP Amoco, British
Telecommunications, Compaq, General Electric Company, Georgia Pacific, The
Gillette Company, Hewlett-Packard Company, Microsoft Corporation, and Sprint
PCS. Clarify maintains its executive offices at 2560 Orchard Parkway, San Jose,
California 95131.

                                        8
<PAGE>   9

                           PERCENT OF TOTAL REVENUES

     The following table sets forth the percentage of total revenues for certain
items in the Company's Condensed Consolidated Statements of Income data for the
three and nine months ended September 30, 1999 and 1998.

<TABLE>
<CAPTION>
                                                THREE MONTHS ENDED      NINE MONTHS ENDED
                                                  SEPTEMBER 30,           SEPTEMBER 30,
                                                ------------------      ------------------
                                                 1999        1998        1999        1998
                                                ------      ------      ------      ------
<S>                                             <C>         <C>         <C>         <C>
Revenues:
  License fees................................   58.3%       65.2%       56.4%       65.3%
  Services....................................   41.7        34.8        43.6        34.7
                                                -----       -----       -----       -----
          Total revenues......................  100.0       100.0       100.0       100.0
Cost of revenues:
  License fees................................    1.3         1.4         1.6         1.8
  Services....................................   21.8        20.2        23.9        20.6
                                                -----       -----       -----       -----
          Total cost of revenues..............   23.1        21.6        25.5        22.4
                                                -----       -----       -----       -----
Gross margin..................................   76.9        78.4        74.5        77.6
Operating expenses:
  Product development and engineering.........   12.3        14.5        12.8        16.5
  Sales and marketing.........................   44.1        48.8        44.0        47.5
  General and administrative..................    6.4         7.0         6.6         8.0
                                                -----       -----       -----       -----
          Total operating expenses............   62.8        70.3        63.4        72.0
                                                -----       -----       -----       -----
  Operating income............................   14.1         8.1        11.1         5.6
Interest and other income (expense), net......    1.2         1.2         1.3         1.2
                                                -----       -----       -----       -----
Income before income taxes....................   15.3         9.3        12.4         6.8
Provision for income taxes....................    6.0         3.4         4.8         2.5
                                                -----       -----       -----       -----
Net income....................................    9.3%        5.9%        7.6%        4.3%
                                                =====       =====       =====       =====
</TABLE>

  Revenues

     Total revenues increased $28.9 million (84%) to $63.3 million in the third
quarter of 1999 from $34.5 million in the same period one year ago. Total
revenues increased $69.9 million (78%) to $159.1 million in the first nine
months of 1999 from $89.2 million in the same period one year ago. Revenue from
the Americas increased $21.1 million (75%) and $48.2 million (67%) for the third
quarter and nine months ended September 30, 1999, respectively, compared to the
same periods one year ago. Other international revenue increased $7.8 million
(123%) and $21.7 million (128%) for the three and nine months ended September
30, 1999, respectively, compared to the corresponding prior year periods. Other
international revenue accounted for approximately 22% and 24% of total revenue
in the third quarter and first nine months of 1999, respectively, compared to
18% and 19%, respectively, in the third quarter and first nine months of 1998.
The absolute increase in total revenues is a result of growth in both license
fees and service revenues. The Company does not believe that the percentage
increases in revenues achieved in any one period should necessarily be
anticipated in future periods. The Company's revenues are derived primarily from
license fees and charges for services, including maintenance, consulting and
training. License fees revenue consists of revenue from initial licenses for the
Company's products, sales of licenses to existing customers for additional users
of the Company's products, product documentation, and fees from sublicensing
third-party software products. Services revenue consists primarily of
maintenance, consulting, and training revenues. Consulting services consist
primarily of implementation services related to the installation of the
Company's software and do not include significant customization to or
development of the underlying software code.

     License Fees. License fees revenue increased $14.5 million (64%) to $36.9
million in the third quarter of 1999 from $22.5 million in the same period a
year ago. License fees revenue increased $31.5 million (54%) to

                                        9
<PAGE>   10

$89.8 million in the first nine months of 1999 from $58.2 million in the same
period a year ago. License fees revenue from the Americas increased $10.4
million (58%) and $19.4 million (43%) for the third quarter and nine months
ended September 30, 1999, respectively, compared to the same three and nine
month periods a year ago. Other international license fees revenue increased
$4.1 million (88%) and $12.1 million (95%), during the third quarter and first
nine months of 1999, respectively, compared to the same periods a year ago.
Other international license fees revenue accounted for approximately 24% and 28%
of total license fees revenue in the third quarter and first nine months of 1999
compared to 21% and 22%, respectively, for the same prior year periods. The
increase in license fees revenue was due to further market acceptance of the
Company's existing products, continued enhancement of such products and
increased breadth of the Company's product offerings. The growth was also
attributable to increased follow-on sales to existing customers. The Company
expects that license fees revenue will fluctuate as a percentage of total
revenue in the future depending on the timing of new product introductions,
customer buying patterns, the Company's pricing actions, competition, and other
factors. Further, the Company does not believe that license fee revenues in any
one period are indicative of license fee revenues in any future period.

     Services. Revenue from services increased $14.4 million (120%) to $26.4
million in the third quarter of 1999 from $12.0 million in the same period one
year ago. Revenue from services increased $38.4 million (124%) to $69.3 million
in the first nine months of 1999 from $31.0 million in the same period one year
ago. Services revenue from the Americas increased $10.7 million (104%) in the
current quarter and increased $28.8 million (108%) in the first nine months of
1999, compared to the same periods last year. Other international services
revenue increased $3.7 million (220%) and $9.6 million (225%) for the third
quarter and first nine months of 1999, respectively, compared to the same
periods one year ago. Other international services revenue accounted for
approximately 20% of total services revenue in both the third quarter and first
nine months of 1999 compared to 14% for both of the corresponding prior year
periods. The growth in services revenue in absolute dollars was due to an
increase in maintenance and maintenance renewals, and consulting and training
services associated with increased sales of the Company's applications. The
Company expects that revenue from services will fluctuate as a percentage of
total revenue in the future depending on the volume of product implementations
as well as customer maintenance renewals. Further, the Company does not believe
that revenue from services in any one period is indicative of revenue from
services in any future period.

  Costs of Revenues

     Cost of License Fees. Cost of license fees increased to $0.8 million and
$2.6 million in the third quarter and first nine months of 1999, respectively,
from $0.5 million and $1.6 million, respectively, in the same periods in 1998.
Cost of license fees represented 2% and 3% of the related license fee revenues
for the third quarter and first nine months of 1999. Cost of license fees as a
percentage of license fees revenue may fluctuate from period to period due to
the increased or decreased sale of royalty bearing software products and related
negotiations for such royalty agreements. Costs related to research, design and
development of products are charged to product development and engineering
expense as incurred.

     Cost of Services. Cost of services increased to $13.8 million and $38.0
million in the third quarter and first nine months of 1999, respectively, from
$7.0 million and $18.4 million, respectively, in the same periods in 1998. Cost
of services represented 52% and 55% of the related service revenues for the
third quarter and first nine months of 1999, respectively. Cost of services
consists primarily of costs incurred in providing telephone support, consulting
services, shipment of product upgrades and training of customers. The absolute
dollar increases are due primarily to the increase in the number of customer
support and training personnel and related overhead costs necessary to support a
larger installed customer base. The Company expects to make continued
investments in its service organization in order to support the Company's
customer installed base and anticipates that cost of services will increase in
absolute dollars in future periods.

  Operating Expenses

     Product Development and Engineering. Product development and engineering
expenses increased $2.8 million (57%) and $5.6 million (38%) in the third
quarter and first nine months of 1999, respectively,
                                       10
<PAGE>   11

compared to the same periods one year ago. As a percentage of total revenue,
product development and engineering expense decreased to 12% and 13% in the
third quarter and nine months of 1999 from 15% and 17%, respectively, for the
same periods one year ago. Product development and engineering expenses include
expenses associated with the development of new products, enhancements of
existing products and quality assurance activities. These expenses consist
primarily of employee salaries, benefits, consulting expenses and the cost of
software development tools. Costs related to research, design and development of
products are charged to product development and engineering expenses as
incurred. The increase in absolute dollars was primarily attributable to an
increase in personnel and related overhead costs as well as consulting expenses.
The Company currently anticipates that product development and engineering
expenses will increase in absolute dollars as the Company continues to commit
substantial resources to product development and engineering in future periods.

     Sales and Marketing. Sales and marketing expenses increased $11.1 million
(66%) and $27.7 million (65%) in the third quarter and first nine months of
1999, respectively, compared to the same periods one year ago. As a percentage
of total revenue, sales and marketing expense decreased to 44% in both the third
quarter and nine months of 1999 from 49% and 48% for the same periods one year
ago. Sales and marketing expenses consist primarily of employee salaries, sales
commissions, travel and promotional expenses. The increase in dollar amount was
primarily due to the further expansion of the Company's worldwide sales
organization, higher sales commissions associated primarily with increased
revenue, and increased marketing activities. The Company intends to continue to
invest substantial resources in expanding its other distribution channels and
conducting marketing programs to support existing and new product offerings.
Accordingly, sales and marketing expenses are expected to increase in absolute
dollars in future periods.

     General and Administrative. General and administrative expenses increased
$1.6 million (67%) and $3.3 million (46%) in the third quarter and first nine
months of 1999, respectively, compared to the same periods one year ago. As a
percentage of total revenue, general and administrative expense decreased to 6%
and 7% in the third quarter and first nine months of 1999 from 7% and 8%,
respectively, for the same periods one year ago. General and administrative
expenses consist primarily of salaries and benefits, and related overhead costs
for the finance, human resources, and executive and administrative personnel of
the Company. The increase in dollar amount was due primarily to increases in
personnel, related overhead costs and expenses related to the Company's
infrastructure expansion. The Company currently expects general and
administrative expenses to increase in absolute dollars in the future as the
Company continues to expand its infrastructure.

     Interest and Other Income (Expense), Net. Interest and other income
(expense), net represents interest income earned on the Company's cash, cash
equivalents and investments, and other items including foreign exchange gains
and losses. Interest and other income (expense), net increased to $0.8 million
in the third quarter of 1999 from $0.4 million in the third quarter of 1998 due
to higher investment income and higher foreign exchange gains.

     Provision for Income Taxes. The Company's effective tax rate for the third
quarter and first nine months of 1999 and 1998 was 39% and 37%, respectively.

LIQUIDITY AND CAPITAL RESOURCES

     The Company's cash, cash equivalents and investments totaled $78.2 million
at September 30, 1999 representing about 46% of total assets compared to $57.7
million at December 31, 1998, representing about 47% of total assets. The
Company has invested its cash in excess of current operating requirements in a
portfolio of both taxable and tax-exempt investment grade securities. The
investments have variable and fixed interest rates and short and long term
maturities. In accordance with Financial Accounting Standards Board Statement
No. 115, "Accounting for Certain Investments in Debt and Equity Securities" such
investments are classified as "available for sale".

     The Company believes that cash generated from operations and its existing
cash, cash equivalents and investment balances will satisfy the Company's
projected working capital and other cash requirements for at least the next
twelve months. Although operating activities may provide cash in certain
periods, to the extent

                                       11
<PAGE>   12

the Company grows in the future, its operating and investing activities may use
cash. In the event that cash generated from operating activities may not be
sufficient to meet future cash requirements, there can be no assurance that
additional financing will be available to the Company on commercially reasonable
terms, or at all.

CHANGES IN FINANCIAL CONDITION

     Cash and cash equivalents at September 30, 1999 totaled $37.9 million
representing an increase of 21% from December 31, 1998. Operating activities
provided $16.2 million. The effect of foreign exchange rate changes generated a
decrease of $0.3 million. Investing activities used $24.7 million including a
net increase in investments of $13.9 million, and $11.0 million was used to
acquire property and equipment (net of proceeds from disposition of property and
equipment). Financing activities consisting of sales of shares under employee
benefit plans generated $15.4 million.

     Net cash provided by operating activities was $16.2 million in the first
nine months of 1999 compared to $14.3 million in the first nine months of 1998.
In 1999, net cash provided by operating activities was comprised primarily of
net income, increases in accounts payable and payroll related accruals, and
depreciation and amortization. In 1998, net cash provided by operating
activities was primarily attributable to net income and an increase in other
accrued liabilities, deferred revenue and accrued payroll and related accruals,
offset primarily by an increase in accounts receivable, after adjustment for the
provision of doubtful accounts, depreciation and amortization expense.

     Net cash used in investing activities was $24.7 million in the first nine
months of 1999 compared to $0.8 million provided by investing activities in the
same period one year ago. In 1999, net cash used resulted from net purchases of
investments and net purchases of property and equipment. Purchases of property
and equipment primarily related to purchases made in connection with the
Company's relocation of its headquarters in May 1999. In 1998 net cash provided
by investing activities consisted primarily of net sales of investments
partially offset by purchases of property and equipment.

     Net cash provided by financing activities was $15.4 million in the first
nine months of 1999 compared to $2.4 million in the first nine months of 1998.
The net cash provided for both periods resulted primarily from sales of shares
under employee benefit plans.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The following discussion about the Company's risk-management activities
includes "forward looking statements" that involve risks and uncertainties.
Actual results could differ materially from those projected in the
forward-looking statements.

     The following tables summarize the financial instruments and derivative
commodity instruments held by the Company at September 30, 1999, which are
sensitive to changes in interest rates and foreign exchange rates. The Company
uses forward foreign exchange contracts to manage these primary market exposures
associated with underlying assets, liabilities and anticipated transactions. The
Company uses these instruments to reduce risk by essentially creating offsetting
market exposures. The instruments held by the Company are not leveraged and are
held for purposes other than trading.

     In the normal course of business, the Company also faces risks that are
either nonfinancial or nonquantifiable. Such risks principally included country
risk, credit risk, and legal risk, and are not represented in the following
tables.

                                       12
<PAGE>   13

INTEREST RATE SENSITIVITY

     This table presents descriptions of the maturity dates of the financial
instruments that were held by the Company at September 30, 1999 and which are
sensitive to changes in interest rates (in thousands except percentages):

<TABLE>
<CAPTION>
                                                  SEPTEMBER 30,
                                           ---------------------------
                                            2000       2001      2002     TOTAL FAIR VALUE
                                           -------    ------    ------    ----------------
<S>                                        <C>        <C>       <C>       <C>
State and municipal securities...........  $12,461    $4,779    $4,608        $21,848
US Government Agency securities..........    5,147        --        --          5,147
Corporate debt securities................   13,300        --        --         13,300
                                           -------    ------    ------        -------
Total....................................  $30,908    $4,779    $4,608        $40,295
                                           =======    ======    ======        =======
Average interest rate....................     4.44%     3.93%     3.88%
</TABLE>

FOREIGN CURRENCY EXCHANGE RISK

     The Company has international subsidiaries through which the Company's
products are sold in various global markets. As a result, the Company's earnings
and cash flows are exposed to fluctuations in foreign currency exchange rates.
The Company attempts to limit these exposures through operational strategies and
financial market instruments. The Company utilizes hedge instruments, primarily
forward contracts with maturities of approximately 30 days, to manage its
exposure associated with firm intercompany positions denominated in
nonfunctional currencies. The Company does not use derivative financial
instruments for trading purposes.

     The Company had $16.3 million of short-term forward exchange contracts,
denominated in major foreign currencies, which approximated the fair value of
such contracts and their underlying transactions at September 30, 1999. Gains
and losses related to these instruments at September 30, 1999 were not material.
The Company does not anticipate any material adverse effect on its consolidated
financial position, results of operations, or cash flows resulting from the use
of these instruments. There can be no assurance that these strategies will be
effective or that transaction losses can be minimized or forecasted accurately.

     The following table provides information about the Company's foreign
exchange forward contracts at September 30, 1999. The table presents the value
of the contracts in U.S. dollars at the contract exchange rate as of the
contract maturity date. Due to the short-term nature of these contracts, the
fair value approximates the weighted average contractual foreign currency
exchange rate value of the contracts at September 30, 1999.

     Forward contracts to sell foreign currencies for U.S. dollars:

<TABLE>
<CAPTION>
                                                  AVERAGE            U.S.
                                               CONTRACT RATE    NOTIONAL AMOUNT    FAIR VALUE
                                               -------------    ---------------    ----------
                                                   (IN THOUSANDS, EXCEPT CONTRACT RATES)
<S>                                            <C>              <C>                <C>
Japanese Yen.................................    109.8500           $5,426           $5,638
German Mark..................................      1.8382            3,998            3,932
British Pound Sterling.......................      1.6047            4,333            4,442
Australian Dollar............................      0.6454            1,614            1,631
Singapore Dollar.............................      1.6859              652              645
</TABLE>

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

     The Company operates in a rapidly changing environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks. Other risks are presented elsewhere
in this report and in the Company's periodic filings with the Securities and
Exchange Commission.

                                       13
<PAGE>   14

  Limited and Variable Profitability

     The Company was founded in August 1990 and began shipping products in
September 1992. The Company has experienced substantial revenue growth in recent
years, but its profitability, as a percentage of net revenues, has varied widely
on a quarterly and annual basis, including net operating losses in each fiscal
year from inception through 1994. Due to the Company's limited operating history
on a significant international scale, the rate of growth of the Company's
business and the variability of operating results in past periods, there can be
no assurance that the Company's revenues will continue at the current level or
will grow, or that the Company will be able to sustain profitability on a
quarterly or annual basis.

  Variability of Quarterly Operating Results

     The Company's net revenues and operating results can vary, sometimes
substantially, from quarter to quarter. In general, the Company's revenues, and,
in particular, license fees, are relatively difficult to forecast for a number
of reasons, including (i) the size and timing of individual license
transactions, (ii) the level of price and product competition, (iii) demand for
the Company's products, (iv) the potential for deferral or delay of customer
implementations of the Company's software, (v) the timing of the introduction of
new products or product enhancements by the Company or its competitors, (vi)
changes in customer budgets, (vii) changes in pricing policies by the Company or
its competitors, and (viii) seasonality of technology purchases and other
general economic conditions.

     The Company's software products generally are shipped as orders are
received. Furthermore, the Company has often recognized a substantial portion of
its revenues in the last month of a quarter, with a concentration of these
revenues in the last half of that month. As a result, license fees in any
quarter are substantially dependent on orders booked and shipped in that
quarter. In addition, there has been and continues to be a trend toward larger
enterprise license transactions, which often require approval by a customer's
upper management. The timing of these transactions are typically difficult to
manage and predict. Failure to close any individually significant anticipated
transaction could cause the Company's revenues and operating results in a period
to fall short of the expectations of securities analysts and investors, and
could result in revenue losses. In addition, revenues in any one quarter are not
indicative of revenues in any future period.

     The Company believes the purchase of its products generally involves a
significant commitment of capital. Customers have tended to implement the
Company's products on a large scale and must establish certain minimum hardware
capabilities. As a result, in the event of any downturn in any existing or
potential customer's business or the economy in general, purchases of the
Company's products may be deferred or canceled, which could have a material
adverse effect on the Company's business, operating results and financial
condition.

     The Company's business has experienced and is expected to continue to
experience seasonality, in part due to customer buying patterns.

     The foregoing factors make estimating quarterly revenues and operating
results prior to the end of a quarter uncertain. The Company's expense levels
are based, in significant part, on the Company's expectations as to future
revenues and are therefore relatively fixed in the short term. If revenue levels
are below expectations, the Company's business, operating results and financial
condition are likely to be adversely affected. Net income may be
disproportionately adversely affected by a reduction in revenues because
substantial portions of the Company's expenses are relatively fixed in any given
quarter. As a result, the Company believes that period-to-period comparisons of
its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. There can be no assurance that
the Company will be able to achieve or maintain profitability on a quarterly or
annual basis in the future. The Company plans to increase expenditures to fund
continued expansion of international operations, a larger worldwide direct and
indirect sales and marketing staff and related marketing expenditures,
development of new distribution and resale channels, greater levels of research
and development, and broader customer service and support capability, although
annual expenditures will depend upon ongoing operating results and evolving
business needs. To the extent such expenses precede or are not subsequently
followed by increased revenues,
                                       14
<PAGE>   15

the Company's revenues, operating results and financial condition would be
materially adversely affected. Due to all the foregoing factors, it is likely
that in some future quarters the Company's operating results will be below the
expectations of public market analysts and investors. In such event, the market
price of the Company's common stock would likely be materially adversely
affected.

  Continued Volatility of Stock Price

     In the past, the price of the Company's common stock has been volatile.
Future announcements concerning the Company or its competitors, quarterly
variations in operating results, announcements of technological innovations by
the Company or its competitors, the introduction of new products or changes in
product pricing policies by the Company or its competitors, matters involving
the Company's proprietary rights or other litigation, changes in earnings
estimates or purchase recommendations by securities analysts or other factors
could cause the market price of the Company's common stock to fluctuate
substantially, particularly on a quarterly basis. In addition, stock prices for
many technology companies fluctuate widely for reasons that may be unrelated to
operating results of such companies. These fluctuations, as well as general
economic, market and political conditions, such as international currency and
stock market volatility, recessions or military conflicts, may materially and
adversely affect the market price of the Company's common stock. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been instituted against such
companies. Such litigation brought against the Company could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect on the Company's business, results of
operations and financial condition.

  Management of Growth

     The Company has grown rapidly in the last four years. The growth of the
Company's business and the expansion of the Company's customer base have placed
a significant strain on the Company's management and operations. The Company's
recent growth and expansion have resulted in substantial increases in the number
of its employees and the geographic area of its operations. The Company's
ability to support the growth of its operations will be substantially dependent
upon securing highly trained internal and third-party resources to conduct
pre-sales activity, product implementation, training, and other customer support
services. To accommodate this growth and the expected expansion of its staff,
the Company's officers and other key employees will be required to improve and
implement a variety of operational and financial systems and procedures, to
expand, train and manage its employee base, and to engage and work effectively
with third-party implementation providers. There can be no assurance that the
Company will be able to manage its recent or any future expansion successfully.
Any inability to do so would likely have a material adverse effect on the
Company's business, results of operations and financial condition.

  Integration of Acquired Businesses or Technologies

     The Company may acquire or make investments in complementary businesses,
products, services, or technologies. From time to time, the Company has had
discussions with companies regarding the acquisition of, or investment in, their
businesses, products, services, or technologies. There can be no assurance that
the Company will be able to identify suitable acquisition or investment
candidates. Even if the Company identifies suitable candidates, there can be no
assurance that the Company will be able to make such acquisitions or investments
on commercially acceptable terms, if at all. The Company may have difficulty in
assimilating the personnel and operations of any business that the Company may
acquire. In addition, the key personnel of the acquired company may decide not
to work for the Company. Furthermore, the Company may have difficulty in
converting the business strategy of any acquired company into one that is
consistent with the Company's strategic goals, or assimilating the products,
services, or technologies of companies it may acquire into its operations. These
difficulties could disrupt the Company's ongoing business, distract management
and employees, increase expenses, and adversely affect results of operations due
to accounting requirements such as goodwill recognition. Furthermore, the
Company may incur debt or issue equity securities to pay for any future
acquisitions. The issuance of equity securities could be dilutive to the
Company's existing stockholders.

                                       15
<PAGE>   16

  International Operations

     The Company established its European headquarters in the United Kingdom in
1994. Since then, additional offices have been opened in Germany, France, Japan,
Australia, Canada, Singapore, Mexico, and Brazil. To support the growth of the
Company's international operations, the Company continues to incur significant
costs to build its service and support infrastructure in advance of anticipated
revenues. Operating costs in many countries, including some of those in which
the Company operates, are often higher than in the United States. As a result of
such international expansion, the Company must continue to implement and improve
its operational and financial systems and procedures and to expand, train and
manage both its employee base and its relationships with third-party
implementation providers. International expansion has placed, and is expected to
continue to place, a significant strain on the Company's management and
operations. There can be no assurance that the Company's international
operations will continue to be successful or that the Company will be able to
manage effectively the increased level of international operations. To the
extent that the Company is unable to do so in a timely manner or is unable to
otherwise manage these activities effectively, the Company's growth in
international revenues, if any, will be limited, and the Company's business,
operating results and financial condition could be materially adversely
affected. In addition, there can be no assurance that the Company will be able
to maintain or increase international market demand for its products.

     Furthermore, future increases in the value of the U.S. dollar abroad could
make the Company's products less competitive in international markets. As the
Company increases its international operations, fluctuations in international
currency exchange rates, increases in duty rates, exchange or price controls or
other restrictions on foreign currencies may individually or in the aggregate
have a material adverse effect on the Company's business, results of operations
and financial condition. While the Company's efforts to hedge foreign currency
denominated intercompany balances are designed to limit its exposure to
fluctuations in foreign currency exchange rates, there can be no assurance that
its efforts will have such an effect. To the extent that any exchange rate
fluctuations would have had a positive impact on the Company's financial
performance, the effect of such hedging transactions could be to eliminate or
reduce the gains that would have otherwise accrued to the Company. Furthermore,
the Company is subject to foreign exchange rate fluctuations as the financial
results of its international subsidiaries are translated into U.S. dollars in
consolidation.

     Additional risks inherent in the Company's international business
activities include, among others, unexpected changes in regulatory requirements,
economic turmoil in other countries, tariffs and other trade barriers, costs of
localizing products for other countries, lack of acceptance of localized
products in other countries, longer accounts receivable payment cycles,
difficulties in managing international operations, potentially adverse tax
consequences including restrictions on the repatriation of earnings, and the
burdens of complying with a wide variety of international laws. There can be no
assurance that such factors will not have a material adverse effect on the
Company's future international sales and, consequently, the Company's results of
operations and financial condition.

  Lengthy Sales and Implementation Cycles

     The Company's products are typically intended for use in applications that
may be critical to a customer's business. The license and implementation of the
Company's software products generally involves a significant commitment of
resources by prospective customers. As a result, the Company's sales process is
often subject to customer delays associated with the customer's potentially
lengthy internal approval processes which typically accompany significant
capital expenditures. For these and other reasons, the sales cycle associated
with the license of the Company's products is often lengthy and subject to
significant delays over which the Company has little or no control.

     Because of the attendant complexity, larger implementations can involve
multiple-quarter implementation cycles. When the Company has provided consulting
services to implement certain larger projects, a few customers have in the past
delayed payment of a portion of license fees until implementation was complete
and in some cases have disputed the consulting fees charged for implementation.
There can be no assurance that the Company will not experience additional delays
or disputes regarding payment in the future,

                                       16
<PAGE>   17

particularly if the Company receives orders for large, complex installations.
Therefore, the Company believes that its quarterly operating results are likely
to vary significantly in the future.

  Dependence on New Products and Rapid Technological Change

     The front-office solutions market, including the markets for customer
service, field service and logistics, quality assurance, help desk, and sales
and marketing applications, is characterized by rapid technological change,
frequent new product introductions, evolving industry standards, and rapid
changes in customer requirements. The introduction of products embodying new
technologies and the emergence of new industry standards can render existing
products obsolete and unmarketable. While the Company believes that it offers
one of the broadest product lines in the front-office solutions market, this
market continues to evolve and customer requirements continue to change. The
Company's future success will depend upon its ability to enhance its current
products and develop and introduce new products in response to technological
developments, evolving industry standards and the increasingly sophisticated
needs of its customers. There can be no assurance that the Company will be
successful in developing and marketing product enhancements or new products that
respond to technological change or evolving industry standards, or that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these products, or that
its new products and product enhancements will adequately meet the requirements
of the marketplace and achieve market acceptance. Furthermore, reallocation of
resources by the Company, such as the diversion of research and development
personnel to the development of a particular feature for a potential or existing
customer, can delay new products and certain product enhancements. If the
Company is unable, for technological or other reasons, to develop and introduce
new products or enhancements of existing products in a timely manner in response
to changing market conditions or customer requirements, the Company's business,
operating results and financial condition will be materially adversely affected.

     The Company has in the past introduced product upgrades and enhancements on
a frequent basis, and expects to continue to introduce upgrades and enhancements
of its existing products. The Company also currently plans to introduce and
market new products. The upgrades, enhancements and new products are subject to
significant technical risks, including the difficulty of ensuring that such
products will permit successful migration of customer data from a variety of
existing platforms. In the past, the Company has experienced delays in
development, which have resulted in delays in the commencement of commercial
shipments of new products and enhancements. There can be no assurance that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction or marketing of new or enhanced products.
In addition, there can be no assurance that such products will meet the
requirements of the marketplace and achieve market acceptance on a timely basis,
or that the Company's current or future products will conform to industry
requirements. If any potential new products, upgrades or enhancements are
delayed,experience quality problems or do not achieve market acceptance, the
Company's business, operating results and financial condition will be materially
adversely affected.

  Dependence Upon Key Personnel

     The loss of the services of one or more of the Company's executive officers
could have a material adverse effect on the Company's business, operating
results and financial condition. In the past, the Company has experienced
turnover in key personnel. Additions of new, and departures of existing,
personnel, particularly in key positions, could have a material adverse effect
upon the Company's business, operating results, and financial condition. The
Company's future performance depends significantly upon the continued service
and performance of its executive officers and key personnel. The Company's
future success also depends on its continuing ability to attract and retain
highly qualified technical, sales, financial and managerial personnel. The
Company recently hired a significant number of employees, and in order to
maintain its ability to grow in the future, the Company will be required to
further increase the total number of employees significantly in the future.
Competition for such personnel is intense, and there can be no assurance that
the Company will be able to retain its key technical, sales, financial and
managerial employees or that it will be able to attract, assimilate or retain
other highly qualified technical, sales, financial and managerial personnel in
the future.

                                       17
<PAGE>   18

  Product Concentration

     To date, a significant portion of the Company's revenues have been
attributable to sales of the Clarify eFrontOffice(TM), suite of products. As a
result, factors adversely affecting the pricing of or demand for Clarify
eFrontOffice, such as competition or technological change, could have a material
adverse effect on the Company's business, operating results, and financial
condition. The Company's future financial performance will depend, in
significant part, on the successful development, introduction and customer
acceptance of new and enhanced versions of Clarify eFrontOffice. There can be no
assurance that the Company will continue to be successful in marketing Clarify
eFrontOffice or other products.

  Product Liability

     The Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims. However, it is possible that the limitation of liability
provisions contained in the Company's license agreements may not be effective
under the laws of certain jurisdictions. Although the Company has not
experienced any product liability claims to date, the sale and support of
products by the Company entails the risk of such claims, and there can be no
assurance that the Company will not be subject to such claims in the future. A
successful product liability claim brought against the Company could have a
material adverse effect upon the Company's business, operating results and
financial condition.

  Expansion of Distribution Channels

     The Company has historically sold its products primarily through its direct
sales force. The Company's ability to achieve significant revenue growth in the
future will depend in large part on its success in recruiting, training, and
retaining sufficient sales personnel and establishing and maintaining
relationships with distributors, resellers and systems integrators. The Company
is currently investing, and plans to continue to invest, significant resources
to expand its domestic and international direct sales force and develop
distribution relationships with certain third-party distributors, resellers and
systems integrators. There can be no assurance that the Company will be able to
attract a sufficient number of third-party distribution partners or that such
partners will be able to successfully distribute the Company's products. Any
inability to establish and maintain successful relationships with distributors,
resellers or systems integrators could have a material adverse effect on the
Company's business, operating results or financial condition. In addition, there
can be no assurance that the Company will be able to successfully expand its
direct sales force or other distribution channels. Any failure by the Company to
expand its direct sales force or other distribution channels would materially
adversely affect the Company's business, operating results and financial
condition.

  Year 2000 Readiness

     The Year 2000 computer issue creates a risk for the Company. If the
Company's systems do not accommodate the change in date to the year 2000, there
could be an adverse impact on the Company's operations. For example, if the
Company's computer systems and software products with date-sensitive functions
do not distinguish 21st century dates from 20th century dates in the date code
fields, system failures and erroneous data may result. The Company has formed a
task force to assess its Year 2000 readiness.

REVIEW PROCESS

     The Company's Year 2000 review process is divided into four components:

     1) Product Review (including review of third-party embedded software)

     2) Corporate Review (including business processes, hardware, software and
facilities)

     3) Supplier Review

     4) Customer Review

                                       18
<PAGE>   19

     The general phases common to all four component reviews are: (1) analyzing
Year 2000 issues; (2) categorizing any identified risks as fatal, critical or
marginal; (3) assessing the Year 2000 readiness of identified items; (4) testing
of identified items; and (5) repairing, renovating or replacing fatal or
critical items that are not Year 2000 ready.

     PRODUCT REVIEW

     The Company has completed all phases of its product review. The Company's
products have been developed and tested to accommodate the following Year 2000
issues:

     - General integrity -- no value for current date will cause interruptions
       in desired operations.

     - Data integrity -- all manipulations of time-related data will produce
       desired results for all valid date values within the application domain.

     - Implicit century -- for any date element represented without century, the
       correct century is unambiguous for all manipulations involving that
       element.

     - Leap year -- the product recognizes Year 2000 as a leap year.

     The Company's current products meet the requirements for general integrity,
data integrity, implicit century recognition and leap year recognition for the
Year 2000 in all material respects. As an added measure of security, the Company
has conducted an independent third-party Y2K certification of the Clarify
FrontOffice 98(TM) suite of sales and service applications and verified that the
Clarify products are Y2K ready in all material respects. The Company expects to
post test result summary data on its Clearanswer client website in the fourth
quarter of 1999.

     Although the Company does not warranty version 5.x of the Clarify product
suite, the Company has completed testing the suite to provide risk data to
customers who choose to remain on that version.

     THIRD-PARTY EMBEDDED PRODUCTS REVIEW

     The Company did not test, and therefore does not warrant, any third-party
embedded products or applications distributed as part of the Clarify FrontOffice
98 (CFO98) Bill of Materials to be Year 2000 ready when such embedded products
or applications are run in stand-alone mode. The Company has tested, and
therefore certifies to be Year 2000 ready, only the custom implementations of
third-party embedded products or applications accessible only from within the
CFO98 application and only when CFO98 is properly installed and used and
unmodified from its intended use. The Company released its next generation
product, eFrontOffice(TM), in April 1999 which incorporates updated versions of
third-party software as well as all patches to base Clarify code, including any
and all identified Year 2000-related updates. The Company believes that
eFrontOffice, and all subsequent releases of such product, will continue to be
Year 2000 ready in all material respects.

     INFORMATION TECHNOLOGY REVIEW

     The Company has completed all assessment, testing and remediation of its
critical business systems and is in the process of completing minor remediations
efforts internationally. The Company estimates that minor remediation efforts
will continue through December 1999 as we monitor, evaluate and apply vendor
patches. Although the Company currently believes its information technology is
Year 2000 ready in all material respects, current systems and products may
contain undetected errors or defects with Year 2000 date functions that may
result in material costs to the Company.

     SUPPLIER REVIEW

     The Company has completed assessment and remediation efforts for all
primary and secondary suppliers. The Company maintains a database of its
suppliers and their Year 2000 readiness status. Contingency plans exist for
suppliers that are not Year 2000 ready, which plans include engaging replacement
suppliers that are

                                       19
<PAGE>   20

Year 2000 ready. The Company believes that all primary and secondary suppliers
are Year 2000 ready in all material respects.

     CUSTOMER REVIEW

     The Company intends to remain proactive in maintaining a Year 2000 ready
installed base. The Company has implemented initiatives to assist clients in
upgrading older versions of the Company's product suite to ensure a Year 2000
ready installed base at the turn of the century. Such initiatives to date
include communications programs for clients on our websites, newsletters, a Year
2000 hotline, survey campaigns and the education of our direct sales force. The
Company maintains a Year 2000 Program Office in conjunction with the
professional services, marketing and sales organizations to develop programs to
assist clients with their Year 2000 migration efforts.

     FACILITIES REVIEW

     The Company relocated its headquarters in May 1999 and required all
products and facilities vendors participating in the relocation to warranty
their products and internal systems as being Year 2000 ready. All facilities
worldwide have been surveyed. Year 2000 awareness programs are in progress for
all field offices.

     CONTINGENCY PLANS

     The Company has completed contingency planning efforts for core business
processes and facilities to protect against a potential interruption in
continuity of operations in any of its critical operational areas due to Year
2000-related problems. The Company is in review and revision of contingency
plans and expects final versions to be published in the fourth quarter of 1999.
The Company does not believe that the costs of developing and implementing its
Year 2000 contingency plans will have a material effect on its results of
operations or financial condition.

     BUDGET

     The Company does not believe that the total costs associated with the
Company's Year 2000 review process and any required modifications to become Year
2000 ready will be material to the Company's results of operations or financial
condition. The Company currently estimates the total costs associated with its
Year 2000 review process to be approximately $500,000. The use of internal
resources or existing infrastructure is not accounted for in this estimate. The
total amount expended through September 30, 1999 was approximately $350,000 to
purchase lab testing equipment, augment staffing and complete independent third
party Year 2000 readiness certification of the Company's current products.
Additionally, $50,000 was allocated and expended internally on the testing of
older versions of the Clarify suite to bolster internal knowledge so as to
provide risk assessment and remediation advice to those customers who are unable
to migrate to current versions of the Company's products. The Company currently
estimates that the future costs of completing the Year 2000 review process will
be approximately $150,000 to augment staff and complete remediation efforts
worldwide. The Company has funded and plans to continue to fund its Year 2000
review process from its operating cash flows. The estimated cost of the
Company's Year 2000 review process does not represent a significant percentage
of the Company's planned 1999 budget for computer hardware and software. The
Company does not anticipate that any existing information technology review
procedures will need to be deferred as part of its Year 2000 efforts.

     Although the Company's Year 2000 review process is expected to reduce the
Company's level of uncertainty regarding any Year 2000 problems significantly,
failure to correct known or unknown material Year 2000 problems could result in
a delay or loss of revenues, diversion of development resources, damage to the
Company's reputation, or increased service and warranty costs, any of which
could materially adversely affect the Company's business, operating results or
financial condition. The Company does not currently have any information
concerning the Year 2000 readiness status of its customers' business operations,
beyond compliance with respect to the Company's products. As is the case with
other similarly-situated software companies, if the Company's current or future
customers fail to achieve Year 2000 compliance or if they

                                       20
<PAGE>   21

divert technology expenditures to address Year 2000 compliance problems, the
Company's business, results of operations or financial condition could be
materially adversely affected. In addition, some commentators have predicted
significant litigation regarding Year 2000 compliance issues. Due to the
unprecedented nature of such litigation, the Company is uncertain whether or to
what extent it may be affected by it.

  Euro Conversion

     The Company's international operations entail certain risks associated with
the formation of the European economic and monetary union (the "EMU"). On
January 1, 1999, EMU member states implemented a single currency, the "Euro". On
that day, the Euro became a functional legal currency within these countries.
During the next three years, business in the EMU member states will be conducted
in both the existing national currency, such as the French Franc or
Deutschemark, and the Euro. As a result, companies operating in or conducting
business in EMU member states will need to ensure that their financial and other
software systems are capable of processing transactions and properly processing
each country's respective currencies as well as the Euro.

     The Company is dedicated to addressing issues associated with EMU properly.
By January 1, 2002 all of the Company's customers in EMU member states must
convert all the monetary values in their databases to the Euro, having
previously reflected all values in the respective local currency. The Company
intends to ensure that its internal systems will be able to process the Euro as
the single monetary unit for all EMU member states simultaneously. At this time,
it is not possible to estimate the costs to the Company associated with its Euro
conversion effort and there can be no assurance that the Euro conversion effort
and its related costs will not have a materially adverse effect on the Company's
business, operating results, and financial condition.

  Effect of Certain Charter Provisions

     The Company's Board of Directors has the authority to issue up to 5,000,000
shares of undesignated preferred stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of such
preferred stock without any further vote or action by the stockholders. The
preferred stock could be issued with voting, liquidation, dividend and other
rights superior to those of the common stock. The rights of the holders of
common stock will be subject to, and may be adversely affected by, the rights of
the holders of any preferred stock that may be issued in the future. The
issuance of preferred stock could have the effect of making it more difficult
for a third party to acquire a majority of the outstanding voting stock of the
Company. The Company has no current plans to issue shares of preferred stock.
Furthermore, certain provisions of the Company's Certificate of Incorporation,
Bylaws, Stockholder Rights Plan, and Delaware law could delay, prevent or make
more difficult a merger, tender offer or proxy contest involving the Company.

                                       21
<PAGE>   22

                           PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     N/A

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

     N/A

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     N/A

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     N/A

ITEM 5. OTHER INFORMATION

     N/A

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

<TABLE>
<CAPTION>
    EXHIBIT
    NUMBER
    -------
    <C>        <S>
      27       Financial data schedule for the nine months ended September
               30, 1999 (included only in the copy of this report filed
               electronically with the Securities and Exchange Commission)
</TABLE>

(b) REPORTS ON FORM 8-K

     The Company filed one report on Form 8-K during the third quarter ended
September 30, 1999. The report was filed on August 30, 1999 and reported on the
change in the registrant's certifying accountant.

                                       22
<PAGE>   23

                                   SIGNATURE

     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.

                                          CLARIFY INC.

                                          By:      /s/ ANTHONY ZINGALE

                                            ------------------------------------
                                                      Anthony Zingale
                                               President and Chief Executive
                                                           Officer

                                          By:      /s/ JAN A. PRAISNER

                                            ------------------------------------
                                                      Jan A. Praisner
                                             Vice President and Chief Financial
                                                           Officer
                                                (Duly Authorized Officer and
                                                Principal Financial Officer)

Date: October 29, 1999

                                       23
<PAGE>   24
                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
    EXHIBIT
    NUMBER
    -------
    <C>        <S>
      27       Financial data schedule for the nine months ended September
               30, 1999 (included only in the copy of this report filed
               electronically with the Securities and Exchange Commission)
</TABLE>