<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, 1998
 
                                       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                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                     IDENTIFICATION NUMBER)
</TABLE>
 
                                2125 O'NEL DRIVE
                           SAN JOSE, CALIFORNIA 95131
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
                            ------------------------
 
                                 (408) 573-3000
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
                            ------------------------
 
                             HTTP://WWW.CLARIFY.COM
                    (REGISTRANT'S HOME PAGE ON THE INTERNET)
 
                            ------------------------
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes [X]  No [ ]
 
     As of October 30, 1998 there were 22,041,425 shares of the Registrant's
$0.0001 par value 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
        September 30, 1998 and December 31, 1997....................    3
        Condensed Consolidated Statements of Operations
        For the three and nine months ended September 30, 1998 and
        1997........................................................    4
        Condensed Consolidated Statements of Cash Flows
        For the nine months ended September 30, 1998 and 1997.......    5
        Notes to Condensed Consolidated Financial Statements........    6
Item    Management's Discussion and Analysis of Financial Condition
  2.    and Results of Operations...................................    8
PART II.  OTHER INFORMATION
Item
  5...  Other Information...........................................   20
Item
  6.    Exhibits and Reports on Form 8-K............................   21
SIGNATURE...........................................................   23
</TABLE>
 
                                        2
<PAGE>   3
 
PART I.  FINANCIAL INFORMATION
 
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
                                  CLARIFY INC.
 
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                (IN THOUSANDS, EXCEPT PER SHARE DATA; UNAUDITED)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                              SEPTEMBER 30,    DECEMBER 31,
                                                                  1998             1997
                                                              -------------    ------------
<S>                                                           <C>              <C>
Current assets:
  Cash and cash equivalents.................................    $ 38,259         $20,744
  Short-term investments....................................       2,407          10,451
  Accounts receivable, net of allowance for doubtful
     accounts of $1,980 at September 30, 1998 and $1,310 at
     December 31, 1997......................................      36,765          32,854
  Prepaid expenses and other current assets.................       2,683           2,463
  Deferred income taxes.....................................       5,692           5,692
                                                                --------         -------
          Total current assets..............................      85,806          72,204
Property and equipment, net.................................       8,909           8,611
Long-term investments.......................................       7,019           5,167
Other noncurrent assets.....................................       1,792             849
                                                                ========         =======
          Total assets......................................    $103,526         $86,831
                                                                ========         =======
</TABLE>
 
                      LIABILITIES AND STOCKHOLDERS' EQUITY
 
<TABLE>
<S>                                                           <C>              <C>
Current liabilities:
  Accounts payables.........................................    $  4,722         $ 5,047
  Accrued payroll and related accruals......................       9,005           6,833
  Other accrued liabilities.................................       6,094           4,269
  Income taxes payable......................................       2,357           1,851
  Deferred revenue..........................................      17,970          11,734
                                                                --------         -------
          Total current liabilities.........................      40,148          29,734
                                                                --------         -------
Stockholders' equity:
  Common stock, $.0001 par value:
     Authorized: 55,000 shares; issued and outstanding:
      21,767 at September 30, 1998 and 21,335 at December
      31, 1997..............................................           2               2
  Capital in excess of par value............................      54,080          51,640
  Unrealized holding gain on investments, net...............          21              22
  Cumulative translation adjustment.........................           4               6
  Deferred compensation.....................................         (30)            (65)
  Retained earnings.........................................       9,301           5,492
                                                                --------         -------
          Total stockholders' equity........................      63,378          57,097
                                                                ========         =======
          Total liabilities and stockholders' equity........    $103,526         $86,831
                                                                ========         =======
</TABLE>
 
  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
                                        3
<PAGE>   4
 
                                  CLARIFY INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                (IN THOUSANDS, EXCEPT PER SHARE DATA; UNAUDITED)
 
<TABLE>
<CAPTION>
                                                      THREE MONTHS ENDED    NINE MONTHS ENDED
                                                        SEPTEMBER 30,         SEPTEMBER 30,
                                                      ------------------    ------------------
                                                       1998       1997       1998       1997
                                                      -------    -------    -------    -------
<S>                                                   <C>        <C>        <C>        <C>
Revenues:
  License fees......................................  $22,480    $13,946    $58,236    $39,400
  Services..........................................   11,977      7,945     30,946     21,280
                                                      -------    -------    -------    -------
          Total revenues............................   34,457     21,891     89,182     60,680
Cost of revenues:
  License fees......................................      477        585      1,592      1,596
  Services..........................................    6,974      4,753     18,392     12,884
                                                      -------    -------    -------    -------
          Total cost of revenues....................    7,451      5,338     19,984     14,480
                                                      -------    -------    -------    -------
          Gross Margin..............................   27,006     16,553     69,198     46,200
                                                      -------    -------    -------    -------
Operating expenses:
  Product development and engineering...............    4,987      4,434     14,691     11,807
  Sales and marketing...............................   16,827      9,811     42,348     24,977
  General and administrative........................    2,413      2,203      7,149      5,286
                                                      -------    -------    -------    -------
          Total operating expenses..................   24,227     16,448     64,188     42,070
                                                      -------    -------    -------    -------
          Operating income..........................    2,779        105      5,010      4,130
Interest and other income, net......................      409        360      1,036      1,052
                                                      -------    -------    -------    -------
  Income before provision for income taxes..........    3,188        465      6,046      5,182
Provision for income taxes..........................    1,180        172      2,237      1,918
                                                      -------    -------    -------    -------
          Net income................................  $ 2,008    $   293    $ 3,809    $ 3,264
                                                      =======    =======    =======    =======
Basic net income per share..........................  $  0.09    $  0.01    $  0.18    $  0.16
                                                      =======    =======    =======    =======
Shares used in per share computation -- basic.......   21,739     21,084     21,574     20,674
                                                      =======    =======    =======    =======
Diluted net income per share........................  $  0.09    $  0.01    $  0.17    $  0.15
                                                      =======    =======    =======    =======
Shares used in per share computation -- diluted.....   22,108     22,269     22,147     21,968
                                                      =======    =======    =======    =======
</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,
                                                              --------------------
                                                                1998        1997
                                                              --------    --------
<S>                                                           <C>         <C>
Cash flows from operating activities:
  Net income................................................  $  3,809    $  3,264
     Adjustments to reconcile net income to net cash
      provided by (used in) operating activities:
     Depreciation and amortization..........................     4,041       2,836
     Provision for doubtful accounts........................     1,520          --
     Other..................................................        71         338
     Changes in assets and liabilities:
       Accounts receivable..................................    (4,589)     (5,378)
       Prepaids and other current assets....................      (128)     (1,019)
       Accounts payable.....................................      (340)      1,688
       Accrued payroll and related accruals.................     2,121       1,750
       Other accrued liabilities............................     2,301       2,564
       Deferred revenue.....................................     5,519      (4,024)
                                                              --------    --------
 
     Net cash provided by operating activities..............    14,325       2,019
                                                              --------    --------
Cash flows from investing activities:
  Purchase of property and equipment........................    (4,395)     (4,078)
  Proceeds from disposal of property and equipment..........        --         267
  Purchase of investments...................................   (11,170)    (22,695)
  Sale and maturities of investments........................    17,290       8,492
  Increase in other assets..................................      (970)         84
                                                              --------    --------
     Net cash provided by (used in) investing activities....       755     (17,930)
                                                              --------    --------
 
Cash flows from financing activities:
  Proceeds from issuance of common stock, net...............     2,440       1,899
                                                              --------    --------
     Net cash provided by financing activities..............     2,440       1,899
                                                              --------    --------
 
Effect of foreign exchange rate changes on cash.............        (5)         72
                                                              --------    --------
 
Net increase (decrease) in cash and cash equivalents........    17,515     (13,940)
Cash and cash equivalents, beginning of period..............    20,744      34,477
                                                              --------    --------
Cash and cash equivalents, end of period....................  $ 38,259    $ 20,537
                                                              ========    ========
 
Supplemental disclosure of cash flow information:
  Cash paid during the year for interest....................  $      6    $      1
                                                              ========    ========
  Cash paid during the year for taxes.......................  $  1,731    $     94
                                                              ========    ========
Supplemental disclosure of non-cash investing and financing
  activities:
  Change in unrealized holding gain on investments, net.....  $     (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
                                  (UNAUDITED)
 
NOTE 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, 1998
and December 31, 1997 and the related unaudited condensed consolidated
statements of operations and cash flows for the nine months ended September 30,
1998 and 1997 have been prepared on substantially the same basis as the annual
consolidated financial statements. The December 31, 1997 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 months and nine months ended September 30, 1998 are not
necessarily indicative of results to be expected for the entire year.
 
     For software arrangements entered into after December 31, 1997, the Company
recognizes revenue in accordance with Statement of Position ("SOP") 97-2,
"Software Revenue Recognition." SOP 97-2 supercedes SOP 91-1 "Software Revenue
Recognition" and requires that if an arrangement to deliver software or a
software system does not require significant production, modification, or
customization of software, then revenue should be recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the vendor's fee is
fixed or determinable, and collectibility is probable. Accordingly, the Company
will generally recognize license fee revenue upon product shipment provided
there are no contingencies and collection is probable.
 
     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 1997 Annual Report on Form 10-K.
 
NOTE 2. COMPREHENSIVE INCOME
 
     Comprehensive income as defined by Statements of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income," is net income plus direct
adjustments to stockholders' equity.
 
     The following table reconciles comprehensive income to reported net income
(in thousands):
 
<TABLE>
<CAPTION>
                                                            THREE MONTHS       NINE MONTHS
                                                               ENDED              ENDED
                                                           SEPTEMBER 30,      SEPTEMBER 30,
                                                           --------------    ----------------
                  COMPREHENSIVE INCOME:                     1998     1997     1998      1997
                  ---------------------                    ------    ----    ------    ------
<S>                                                        <C>       <C>     <C>       <C>
Net income...............................................  $2,008    $293    $3,809    $3,264
  Cumulative translation adjustment......................  $ (246)   $ 46        (2)       28
  Unrealized holding gains on investments, net of tax....  $    4    $ --        (1)       --
                                                           ------    ----    ------    ------
          Total comprehensive income.....................  $1,766    $339    $3,806    $3,292
                                                           ======    ====    ======    ======
</TABLE>
 
                                        6
<PAGE>   7
                                  CLARIFY INC.
 
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                                  (UNAUDITED)
 
NOTE 3. COMPUTATION OF NET INCOME PER SHARE
 
     Basic net income per share is computed using the weighted average common
shares outstanding during the period. Diluted net income per share is computed
using the weighted average common shares and common equivalent shares
outstanding during the period. The following table reconciles the numerator and
denominator used in the computation of basic and diluted net income per share
(in thousands, except per share amounts):
 
<TABLE>
<CAPTION>
                                                         THREE MONTHS          NINE MONTHS
                                                            ENDED                 ENDED
                                                        SEPTEMBER 30,         SEPTEMBER 30,
                                                      ------------------    ------------------
                                                       1998       1997       1998       1997
                                                      -------    -------    -------    -------
<S>                                                   <C>        <C>        <C>        <C>
Numerator -- Basic and Diluted
Net income..........................................  $ 2,008    $   293    $ 3,809    $ 3,264
                                                      -------    -------    -------    -------
Net income available to common stockholders.........  $ 2,008    $   293    $ 3,809    $ 3,264
                                                      =======    =======    =======    =======
Denominator
Weighted average common shares outstanding..........   21,739     21,084     21,574     20,674
Effective of dilutive common stock options..........      369      1,185        573      1,294
                                                      -------    -------    -------    -------
Weighted average common shares and equivalents
  outstanding.......................................   22,108     22,269     22,147     21,968
                                                      =======    =======    =======    =======
Diluted net income per share........................  $  0.09    $  0.01    $  0.17    $  0.15
                                                      =======    =======    =======    =======
</TABLE>
 
NOTE 4. RECENT ACCOUNTING PRONOUNCEMENTS
 
     In July 1997, the FASB issued Statements of Accounting Standards No. 131
("SFAS No. 131"), "Disclosures about Segments of an Enterprise and Related
Information", which requires companies to report certain information about
operating segments, including certain information about their products,
services, the geographic area in which they operate and their major customers.
This statement supersedes FASB Statements Nos. 14, 18, 24 and 30. SFAS No. 131
is effective for financial statements for fiscal years beginning after December
15, 1997. The Company has adopted the provisions of SFAS No. 131 and,
accordingly, has elected not to provide separate quarterly segmental
disclosures.
 
     In June of 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, and for hedging activities. It requires
that an entity recognizes all derivatives as either assets or liabilities in the
statement of financial position and measures 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 2000. Management
believes that this Statement will not have a significant impact on the Company.
 
NOTE 5. HEDGING OF INTERCOMPANY BALANCES
 
     In June 1998, the Company initiated hedging activities to mitigate the
impact of foreign exchange rate changes on intercompany balances. The Company is
using foreign exchange forward contracts as a vehicle for hedging these
intercompany balances. A forward foreign exchange contract obligates the Company
to exchange predetermined amounts of specified foreign currencies at specified
exchange rates on stipulated future dates and to make or receive an equivalent
U.S. dollar payment equal to the value of such exchange. Realized and unrealized
gains and losses resulting from changes in the spot exchange rate (including
those from open, matured, and terminated contracts) are included in other
income. These gains and losses offset gains and losses on intercompany balances,
which are also included in other income, net. The related amounts due to or from
counter parties are included in other assets or other liabilities. As of
September 30, 1998, the Company had $8.0 million of forward foreign exchange
contracts outstanding, consisting of Japanese yen, German marks, French francs,
Australian dollars and British pounds, all maturing within 30 days.
                                        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. 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 1997 annual report on Form 10-K. Readers
should carefully review the risks described in other documents the Company files
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 report on Form 10-Q. The Company
undertakes no obligation to publicly release any revisions to forward-looking
statements or reflect events or circumstances after the date of this document.
 
OVERVIEW
 
     Clarify Inc. ("Clarify" or the "Company"), founded in August 1990, is a
leading developer and provider of integrated enterprise front office solutions.
Clarify helps companies build service into every customer interaction, with
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, Clarify allows
companies to attract, acquire and retain customers at significantly reduced
costs. A variety of industries employ Clarify's solutions, including high-tech,
health care, telecommunications, financial services and retail.
 
     Clarify markets its software and services primarily through its direct
sales organization in the United States, the United Kingdom, Germany, France,
Canada, Japan, Australia and Singapore. Clarify customers include, among others,
ADP, Amoco Corp., Cisco Systems, General Electric, Georgia-Pacific, Gillette,
Hewlett-Packard, Microsoft and Sprint PCS. The Company maintains its executive
offices at 2125 O'Nel Drive, San Jose, California 95131.
 
     In April 1996, the Company acquired Metropolis Software, Inc.
("Metropolis"), a sales force automation software provider. The Company issued
approximately 663,000 shares of common stock for all of the shares of common
stock of Metropolis in a transaction that was accounted for as a pooling of
interests. The Company also assumed options to purchase Metropolis stock that
remain outstanding as options to purchase the Company's common stock.
Substantially all of the business operations and employees of Metropolis have
been integrated with the business operations of the Company. The Company expects
to liquidate the remaining shell corporation of Metropolis during the fourth
quarter of 1998.
 
                                        8
<PAGE>   9
 
PERCENT OF TOTAL REVENUES
 
     The following table sets forth for the quarter and nine months ended
September 30, 1998 and September 30, 1997, the Company's Condensed Consolidated
Statements of Income expressed as a percentage of total revenues:
 
<TABLE>
<CAPTION>
                                                               THREE MONTHS      NINE MONTHS
                                                                  ENDED             ENDED
                                                              SEPTEMBER 30,     SEPTEMBER 30,
                                                              --------------    --------------
                                                              1998     1997     1998     1997
                                                              -----    -----    -----    -----
<S>                                                           <C>      <C>      <C>      <C>
Revenues:
  License fees..............................................   65.2%    63.7%    65.3%    64.9%
  Services..................................................   34.8     36.3     34.7     35.1
                                                              -----    -----    -----    -----
          Total revenues....................................  100.0    100.0    100.0    100.0
 
Cost of revenues:
  License fees..............................................    1.4      2.7      1.8      2.6
  Services..................................................   20.2     21.7     20.6     21.3
                                                              -----    -----    -----    -----
          Total cost of revenues............................   21.6     24.4     22.4     23.9
                                                              -----    -----    -----    -----
          Gross Margin......................................   78.4     75.6     77.6     76.1
 
Operating expenses:
  Product development and engineering.......................   14.5     20.2     16.5     19.4
  Sales and marketing.......................................   48.8     44.8     47.5     41.2
  General and administrative................................    7.0     10.1      8.0      8.7
                                                              -----    -----    -----    -----
          Total operating expenses..........................   70.3     75.1     72.0     69.3
                                                              -----    -----    -----    -----
          Operating income..................................    8.1      0.5      5.6      6.8
 
Interest and other income, net..............................    1.2      1.6      1.2      1.7
                                                              -----    -----    -----    -----
          Income before provision for income taxes..........    9.3      2.1      6.8      8.5
Provision for income taxes..................................    3.4      0.8      2.5      3.1
                                                              -----    -----    -----    -----
          Net income........................................    5.9%     1.3%     4.3%     5.4%
                                                              =====    =====    =====    =====
</TABLE>
 
  Revenues
 
     Total revenues increased from $21.9 million in the third quarter of 1997 to
$34.5 million in the third quarter of 1998, representing an increase of 57%,
while total revenues increased from $60.7 million for the first nine months of
1997 to $89.2 million for the first nine months of 1998, representing an
increase of 47%. International revenues accounted for approximately 25% of total
revenues in the third quarter of 1998 compared to 7% in the third quarter of
1997. The absolute increases in total revenues are a result of growth in both
license fees and service revenues. The Company does not believe that the
percentage increases in revenues achieved should 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
fee revenues consist of revenues 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. The Company recognizes initial license fee revenue and sales
of additional licenses upon product shipment provided there are no contingencies
and collection is probable, in accordance with Statement of Position 97-2
entitled "Software Revenue Recognition." Service revenues consist primarily of
maintenance, consulting and training revenues. Maintenance revenues are
recognized ratably over the term of the support period, which is typically
twelve months. Consulting and training revenues generally are recognized when
the services are performed. Consulting services consist primarily of
implementation services related to the installation of the Company's software
and generally do not require significant production, modification or
customization to the underlying software code.
 
     License Fees. License fee revenues increased from $13.9 million in the
third quarter of 1997 to $22.5 million in the third quarter of 1998,
representing an increase of 62%. License fee revenues increased
 
                                        9
<PAGE>   10
 
from $39.4 million for the first nine months of 1997 to $58.2 million for the
first nine months of 1998, representing an increase of 48%. The growth in
license fee revenues was due to further market acceptance of the Company's
existing products, continued enhancement and increased breadth of the Company's
product offerings, increased follow-on sales to existing customers, sales of the
Company's products to new industry segments and increased sales as a result of
the expansion of the Company's direct sales force and marketing organization.
The Company expects that license revenues will fluctuate as a percentage of
total revenues in the future depending on the timing of new product
introduction, customer buying patters, 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. Revenues from services increased from $7.9 million in the third
quarter of 1997 to $12.0 million in the third quarter of 1998, representing an
increase of 52%. Service revenue increased from $21.3 million for the first nine
months of 1997 to $30.9 million for the first nine months of 1998, representing
an increase of 45%. The growth in service revenues was due primarily to an
increase in maintenance and maintenance renewals, and, to a lesser extent,
consulting and training services associated with increased sales of the
Company's applications. The Company expects revenues from services to increase
in future periods as the customer installed base increases, though the
percentage increases in service revenues achieved in prior periods should not be
anticipated in future periods.
 
  Costs of Revenues
 
     Cost of License Fees. Cost of license fees decreased from $0.6 million in
the third quarter of 1997 to $0.5 million in the third quarter of 1998,
representing a decrease of 17%. Cost of license fees for the third quarter of
1997 and 1998 represents 4% and 2% of license fee revenues, respectively. Cost
of license fees for the first nine months of both 1997 and 1998 was $1.6
million, representing 4% and 3% of license fee revenues, respectively. Cost of
license fees consists primarily of the costs of sublicensing third-party
software products, product media, product duplication, product documentation and
shipping. Costs related to research, design and development of products are
charged to product development and engineering expense as incurred. Cost of
license fees includes no amortization of capitalized software development costs.
Cost of license fees as a percentage of license fees may fluctuate from period
to period due to the increased or decreased sale of royalty bearing software
products.
 
     Cost of Services. Cost of services increased from $4.8 million in the third
quarter of 1997 to $7.0 million in the third quarter of 1998, representing 61%
and 58% of the related service revenues for the quarters ended September 30,
1997 and 1998, respectively. Cost of services increased from $12.9 million for
the first nine months of 1997 to $18.4 million for the first nine months of
1998, representing 61% and 60% of the related total service revenues,
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 from $4.4 million in the third quarter of 1997 to $5.0
million in the third quarter of 1998, representing 20% and 15% of total
revenues, respectively. Total product development and engineering expenses
increased from $11.8 million for the first nine months of 1997 to $14.7 million
for the first nine months of 1998, representing 19% and 17% of total revenues,
respectively. Product development and engineering expenses include expenses
associated with the development of new products, enhancements of existing
products and quality assurance activities and 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
                                       10
<PAGE>   11
 
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 from $9.8
million in the third quarter of 1997 to $16.8 million in the third quarter of
1998, representing 45% and 49% of total revenues, respectively. Sales and
marketing expenses increased from $25.0 million for the first nine months of
1997 to $42.3 million for the first nine months of 1998, representing 41% and
48% of total revenues, respectively. 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 expansion of
the Company's worldwide sales and marketing organization, higher sales
commissions associated with increased revenue and increased expenditures for
marketing activities. The increase in sales and marketing expenses as a
percentage of total revenues for the third quarter of 1998 compared to the third
quarter of 1997 reflects the significant investment that the Company made to
expand its direct sales force and other distribution channels, as well as
investments made for various marketing programs and activities. The Company
intends to continue to invest substantial resources in expanding its direct
sales force, both domestic and international, 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
from $2.2 million in the third quarter of 1997 to $2.4 million in the third
quarter of 1998, representing 10% and 7% of total revenues, respectively.
General and administrative expense increased from $5.3 million for the first
nine months of 1997 to $7.1 million for the first nine months of 1998,
representing 9% and 8% of total revenues, respectively. General and
administrative expense consists principally of salaries and benefits, travel
expenses, and related overhead costs for the finance, human resource and
executive and administrative personnel of the Company. The increase in dollar
amount was due primarily to increases in personnel, related overhead costs,
reserves for bad debt, 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, Net. Interest and other income, 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, net, increased to $409,000 in the third quarter of 1998 from $360,000 in
the third quarter of 1997.
 
     Provision for Income Taxes. The Company's effective tax rate for the third
quarters of 1997 and 1998 was 37%.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The Company's cash, cash equivalents and investments totaled $47.7 million
at September 30, 1998 representing approximately 46% of total assets compared to
$36.4 million at December 31, 1997, representing approximately 42% 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."
 
     Net cash provided by operating activities was $2.0 million in the first
nine months of 1997 compared to $14.3 million for the first nine months of 1998.
Net cash provided by operating activities for the nine months ended September
30, 1998 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.
 
                                       11
<PAGE>   12
 
     The change in accounts receivable corresponds to the overall growth in
customer licensing activity offset by cash collections. Accounts receivable days
sales outstanding ("DSO"), the ratio of the quarter-end accounts receivable
balance to quarterly revenues, multiplied by 90, was 96 days as of September 30,
1998 compared to 107 days as of December 31, 1997 and 94 days as of September
30, 1997. Since much of the Company's contracting activity is concentrated
toward the end of each quarter and the Company provides extended payment terms
to certain credit worthy customers, the Company believes that its DSO may be
elevated in future periods.
 
     Net cash provided by investing activities was $0.8 million in the first
nine months of 1998. Net cash used in investing activities was $17.9 million in
the first nine months of 1997. Included in these totals are the sales and
maturities of investments, partially offset by purchases of long and short-term
investments and by the acquisition of property and equipment.
 
     Net cash provided by financing activities consisted primarily of proceeds
from the issuance of common stock pursuant to the Company's Employee Stock
Purchase Plan and the exercise of options granted under the Company's 1991 and
1995 Stock Option/Stock Issuance Plans.
 
     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 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.
 
          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 1997 annual report on Form 10-K.
 
  Limited Operating History; Limited and Variable Profitability
 
     The Company was founded in August 1990 and did not begin shipping products
until 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
                                       12
<PAGE>   13
 
continues to be a trend toward larger enterprise license transactions, which can
have sales cycles of up to a year or more and require approval by a customer's
upper management. These transactions are typically difficult to manage and
predict. Failure to close any expected individually significant transactions
could cause the Company's revenues and operating results in a period to fall
short of expectations, and could result in 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 because customers have tended to implement the
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. In recent
years, for example, the Company has generally had weaker demand in the quarter
ending in March.
 
     The foregoing factors make estimating quarterly revenue 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 a
substantial portion of the Company's expenses are relatively fixed in a 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 build-up and 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 results and
evolving business needs. To the extent such expenses precede or are not
subsequently followed by increased revenues, 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 quarter the
Company's operating results will be below the expectations of public market
analysts and investors. In such event, the 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, the
introduction of new products or changes in product pricing policies by the
Company or its competitors, proprietary rights or other litigation, changes in
earnings estimates by 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 which 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 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.
 
                                       13
<PAGE>   14
 
  Management of Growth
 
     The Company has grown rapidly in the last three years. The growth of the
Company's business and the expansion of the Company's customer base has 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
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
having in place 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.
 
  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, and Singapore. To support the growth of the Company's
international operations, the Company continues to incur significant costs to
build its service and support infrastructure ahead 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 this
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.
These factors have placed, and are 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 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 could make
the Company's products less competitive in foreign markets. As the Company
increases its international operations, it may be materially adversely affected
by fluctuations in currency exchange rates, increases in duty rates, exchange or
price controls or other restrictions on foreign currencies. 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 foreign 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,
tariffs and other trade barriers, costs of localizing products for foreign
countries, lack of acceptance of localized products in foreign 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
foreign 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.
 
                                       14
<PAGE>   15
 
  Intense Competition
 
     The front office solutions market, including the markets for customer
service, field service and logistics, help desk, quality assurance and sales and
marketing applications, is currently intensely competitive and subject to rapid
change. The Company believes that the principal competitive factors affecting
the markets for its products include quality, functionality, performance,
breadth of product line, integration of products, frequency of upgrades and
updates, manageability of products, customer support, company reputation and
price. Competitors vary in size and in the scope and breadth of the products and
services offered. The Company encounters competition from a number of sources,
including: (i) other software companies, (ii) third-party professional services
organizations that develop custom software and (iii) management information
systems departments of potential customers that develop custom internal
software. In addition, the Company expects additional competition from other
established companies as the front office solutions market continues to develop
and expand. Increased competition could result in price reductions, reduced
gross margins and loss of market share, any of which could materially adversely
affect the Company's business, operating results and financial condition. Among
software companies competing with the Company, principal competitors include
Siebel Systems, Inc. and The Vantive Corporation. Some of the Company's current
competitors, and many of the Company's potential competitors, have significantly
greater financial, technical, product development, marketing and other resources
than the Company. As a result, they may be able to respond more quickly to new
or emerging technologies and changes in customer requirements, or to devote
greater resources to the development, promotion and sale of their products than
the Company.
 
     In addition, many competitors and potential competitors have significant
established distribution networks and large customer installed bases. The
Company also expects that competition may increase as a result of software
industry consolidations. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the Company's prospective customers. Accordingly, it is possible that these
competitors will rapidly acquire significant market share. Furthermore,
companies with greater technical, marketing and other resources than the Company
could compete directly with the Company either as a result of acquisition of a
competitor or by direct entry into the market for the Company's products. There
can be no assurance that the Company will be able to compete successfully
against current or future competitors or that competitive pressures faced by the
Company will not materially adversely affect its business, operating results and
financial condition.
 
     The Company relies on a number of systems consulting and systems
integration firms for implementation and other customer support services, as
well as recommendations of its products during the evaluation stage of the
purchase process. Although the Company seeks to maintain close relationships
with these third-party implementation providers, many of these third parties
have similar, and often more established, relationships with the Company's
principal competitors. If the Company is unable to develop and maintain
effective, long-term relationships with these third parties, it would adversely
affect the Company's competitive position. Further, there can be no assurance
that these third parties, many of which have significantly greater financial,
marketing and technical resources than the Company, will not in the future
compete directly with the Company or otherwise discontinue their relationship
with or their support of the Company and its products.
 
  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 delays associated with lengthy approval processes that
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 their complexity, larger implementations can involve
implementation cycles that can take multiple quarters. 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
 
                                       15
<PAGE>   16
 
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, 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 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. There can be no assurance that the Company will
be able to retain its key personnel. In addition, in the past there has been
turnover in certain key positions in the Company, including resignations by the
Vice-President of Marketing and Vice-President of Customer Service and Support
in February 1998, and the Chief Financial Officer in August 1997. In March 1998,
the Company's President and Chief Executive Officer, Dave Stamm, assumed the
position of Chairman of the Board and a new President and Chief Executive
Officer was named, and in April 1998, a new Chief Financial Officer was named.
Furthermore, in July 1998, a new Senior Vice-President of Worldwide Professional
Services and a Vice-President of Worldwide Marketing were named. 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 these officers. 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
significantly increase the total number of employees. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its key technical, sales, financial and managerial employees or that it can
attract, assimilate or retain other highly qualified technical, sales, financial
and managerial personnel in the future.
 
  Product Concentration
 
     To date, a significant portion of the Company's revenues have been
attributable to sales of ClearSupport, the Company's primary product.
ClearSupport has typically been the second of the Company's products to be
deployed with the greatest number of users and often as a foundation for other
applications. The Company expects ClearSupport to account for a significant
portion of the Company's future revenues. As a result, factors adversely
affecting the pricing of or demand for the ClearSupport product 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 the Company's ClearSupport product and other products. There can be no
assurance that the Company will continue to be successful in marketing the
ClearSupport product or other products.
 
  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 is continuing 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 on a timely basis that keep pace
with technological developments, 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
 
                                       16
<PAGE>   17
 
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 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 developmental
delays, 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, including
the next version of ClearSupport, 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.
 
  Risk of Product Defects
 
     Software products as complex as those offered by the Company frequently
contain errors or failures, especially when first introduced or when new
versions are released. Although the Company conducts extensive product testing,
the Company has in the past released products that contained defects, and has
discovered software errors in certain of its new products and enhancements after
their introduction and, as a result, has experienced delays in recognizing
revenues during the period required to correct these errors. The Company could
in the future lose revenues as a result of software errors or defects. The
Company's products are typically intended for use in applications that may be
critical to a customer's business. As a result, the Company expects that its
customers and potential customers have a greater sensitivity to product defects
than the market for software products generally. Although the Company has not
experienced material adverse effects resulting from any such errors to date,
there can be no assurance that, despite testing by the Company and by current
and potential customers, errors will not be found in new products or releases
after commencement of commercial shipments, resulting in loss of revenue or
delay in market acceptance, diversion of development resources, damage to the
Company's reputation, or increased service and warranty costs, any of which
could have a material adverse effect upon the Company's business, operating
results and financial condition.
 
  Dependence on Proprietary Technology; Risks of Infringement
 
     The Company's success is heavily dependent upon proprietary software
technology. The Company relies primarily on a combination of copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under trade secret and
copyright laws, which affords only limited protection. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary. Policing unauthorized use of the Company's
products is difficult, and while the Company is unable to determine the extent
to which piracy of its software products exists, software piracy can be expected
to be a persistent problem. In addition, the laws of some foreign countries do
not protect the Company's proprietary rights to as great an extent as the laws
of the United States. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the competitors will
not independently develop similar technology. The Company is not aware that any
of its products infringe on the proprietary
 
                                       17
<PAGE>   18
 
rights of third parties. There can be no assurance, however, that third parties
will not claim infringement by the Company with respect to current or future
products.
 
     The Company expects that software product developers will increasingly be
subject to infringement claims as the number of products and competitors in the
Company's industry segment grows and the functionality of products in different
industry segments overlaps. Any such claims, with or without merit could be
time-consuming, result in costly litigation, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such royalty
or licensing agreements, if required, may not be available on commercially
reasonable terms or at all, which could have a material adverse effect upon the
Company's business, operating results and financial condition.
 
  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 may entail 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 and training
sufficient sales personnel and establishing 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 recommend the
Company's products. The inability to establish 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" Issues
 
     The "Year 2000 Issue" refers generally to the problems that some software
may have in determining the correct century for the year. For example, software
with date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures or the
creation of erroneous results. The Company is aware of the issues associated
with the programming code in existing computer systems as the year 2000
approaches and has formed a task force to address its Year 2000 readiness.
 
     PROJECT
 
     The Company's project is divided into four major sections -- Information
Technology (including both hardware systems and application software), Product
(including embedded software), Facilities (such as security system and building
equipment), and Suppliers. The general phases common to all sections are (1)
inventorying Year 2000 items; (2) assigning risks to identified items as fatal,
critical or marginal; (3) assessing the Year 2000 compliance of items; (4)
testing of items; and (5) repairing, renovating or replacing items that are
determined not to be Year 2000 compliant.
 
                                       18
<PAGE>   19
 
     At September 30, 1998, the Company has completed the first three phases of
the Information Technology section. A hardware and software inventory has been
conducted and relevant suppliers have been rated fatal, critical or marginal.
Based on the rating and other factors, a certification completion date has been
assigned to each item. Available vendors' statements of compliance have also
been reviewed. Internal testing plans have been developed for the Company's core
business systems. A separate test lab has been established and the Company
expects to complete the testing of its core business systems by March 31, 1999.
The Company expects to complete its test plans and testing of the Company's
ancillary systems by May 31, 1999. Since the systems and technologies used
internally have been developed in the late 1980's and 1990's, the Company does
not anticipate to have major Year 2000 issues in its Information Technology
section.
 
     At September 30, 1998, the Company has completed all phases of the Product
section. The Company's products have been developed from inception with
consideration to the following Year 2000 issues:
 
          (1) General Integrity -- no value for current date will cause
     interruptions in desired operations.
 
          (2) Data Integrity -- all manipulations of time-related data will
     produce desired results for all valid date values within the application
     domain.
 
          (3) Implicit Century -- for any date element represented without
     century, the correct century is unambiguous for all manipulations involving
     that element.
 
          (4) Leap year -- the products recognizes Year 2000 as a leap year.
 
     The Company's current products meet all the requirements for General
Integrity, Data Integrity, Implicit Century and recognize Year 2000 as a leap
year. As an added measure of security, the Company is planning to seek
independent third-party certification of compliancy to its Clarify FrontOffice
98 suite. The Company also plans to apply its Year 2000 test plan and obtain
independent third-party compliance certification on its future products.
 
     The Company has not specifically tested third-party licensed products that
are incorporated into its products, but the Company is seeking assurances from
its vendors that licensed software is Year 2000 compliant. Also, certain prior
versions of the Company's supported products require a patch provided by the
Company in order to be Year 2000 compliance.
 
     The Company has completed the inventorying phase of the Facilities section
at September 30, 1998 and expects to complete the remaining phases by March 31,
1999. Also, at September 30, 1998, the Company has completed approximately 80%
of the inventorying, prioritizing and assessing phases and approximately 40% of
the testing and repairing, renovating and replacing phases of the Suppliers
section, respectively. The Company does not believe it is in high risk with
regards to these two sections and plans to complete all phases by March 31,
1999.
 
     COST
 
     The total cost associated with required modifications to become Year 2000
compliant is not expected to be material to the Company's financial position.
The estimated cost of the Year 2000 project is approximately $400,000. The use
of internal resources or existing infrastructure is not accounted for in this
estimate. The total amount expended through September 30, 1998 was approximately
$20,000 to purchase lab testing equipment. The estimated future cost of
completing the Year 2000 project is estimated to be approximately $130,000 to
augment staff and to purchase additional testing equipment and approximately
$250,000 to obtain independent third-party compliance certification on the
company's current products. The Company has and plans to fund its Year 2000
project from its operating cash flows. The estimated cost of the Company's Year
2000 project does not represent a material fraction of the Company's planned
1999 budget for computer hardware and software. The Company does not anticipate
that any existing Information Technology projects will need to be deferred as of
part of its Year 2000 efforts.
 
     RISK
 
     Though the Company's Year 2000 project is expected to significantly reduce
the Company's level of uncertainty about the Year 2000 problems, failure to
correct known or unknown material Year 2000 problems
 
                                       19
<PAGE>   20
 
could result in delay or loss or revenue, 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 compliance status of its customers. 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
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.
 
     CONTINGENCY PLAN
 
     The Company has not yet fully developed a comprehensive contingency plan to
address situations that may result if the Company is unable to achieve Year 2000
readiness of its critical operations. The cost of developing and implementing
such a plan may itself be material. The Company is planning to develop
replacement and renovation plans as necessary as a result of its internal tests.
 
  Issues Related to the European Monetary Conversion
 
     The Company is aware of the issues associated with the forthcoming changes
in Europe aimed at forming a European economic and monetary union (the "EMU").
One of the changes resulting from this union will require EMU member states to
irrevocably fix their respective currencies to a new currency, the Euro, on
January 1, 1999. On that day, the Euro will become 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
Franc or Deutsche Mark, 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 handling these currencies, including the Euro.
 
     The Company is still assessing the impact the EMU formation will have on
both its internal systems and the products it sells. The Company will take
appropriate corrective actions based on the results of such assessment. The
Company has not yet determined the cost related to addressing this issue and
there can be no assurance that this issue and its related costs will not have a
material 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 Preferred Stock and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those shares 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, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, 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.
Further, certain provisions of the Company's Certificate of Incorporation and
Bylaws and of Delaware law could delay or make more difficult a merger, tender
offer or proxy contest involving the Company.
 
                          PART II.  OTHER INFORMATION.
 
ITEM 5. OTHER INFORMATION
 
     Proposals of stockholders intended to be presented at the Company's 1999
annual meeting of stockholders must be received at the Company's principal
executive offices not later January 5, 1999 in order to be
 
                                       20
<PAGE>   21
 
included in the Company's proxy statement and form of proxy relating to the 1999
annual meeting. Pursuant to new amendments to Rule 14a-4(c) of the Securities
Exchange Act of 1934, as amended, if a stockholder who intends to present a
proposal at the 1999 annual meeting of stockholders does not notify the Company
of such proposal on or prior to March 6, 1999, then management proxies would be
allowed to use their discretionary voting authority to vote on the proposal when
the proposal is raised at the annual meeting, even though there is no discussion
of the proposal in the 1999 proxy statement. The Company currently believes that
the 1999 annual meeting of stockholders will be held during the second week of
June 1999.
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
     (a) EXHIBITS
 
<TABLE>
<CAPTION>
     NUMBER                           DESCRIPTION
     ------                           -----------
    <S>       <C>
    1.0       Rights Agreement, dated as of June 13, 1997 between the
              Company and Harris Trust Company of California, including
              the Certificate of Designation of Series A Junior
              Participating Preferred Stock, Form of Right Certificate and
              Summary of Rights to Purchase Preferred Shares attached
              thereto as Exhibits A, B and C, respectively, which is
              incorporated by reference to the Form 8-A filed with the
              Securities and Exchange Commission on June 24,1997.
    3.1(1)    Certificate of Incorporation of the Registrant, as amended
              to date
    3.2       Amended and Restated Bylaws of the Company which is
              incorporated by reference to the current report on form 8-K
              filed with the Securities and Exchange Commission on June
              25, 1997
    4.1(1)    Specimen Common Stock certificate
    4.2(1)    Restated Investor Rights Agreement, dated March 7, 1994,
              among the Registrant and the investors and founders named
              therein
    10.1(1)   Form of Indemnification Agreement
    10.2(1)   1991 Stock Option/Stock Issuance Plan
    10.3(2)   1995 Stock Option/Stock Issuance Plan
    10.4(2)   Employee Stock Purchase Plan
    10.5(1)   Loan and Security Agreement between Silicon Valley Bank and
              Clarify Inc.
    10.6(1)   Lease by and between Orchard Investment Company Number 6.9
              and Clarify Inc. dated March 16, 1992, as amended by the
              Second Amendment to Lease, dated 28-Feb-95
    10.7(1)   Master Equipment Lease Agreement by and between Costella
              Kirsch/GATXPartnership No. 1 and the Registrant, dated
              February 18, 1992
    10.8(1)   Master Equipment Lease Agreement by and between Venture
              Leasing Assoc. and the Registrant, dated May 7, 1991
    10.9(1)   Master Equipment Lease Agreement by and between Phoenix
              Leasing Incorporated and the Registrant, dated June 30, 1993
    10.10(3)  Offer Letter dated February 23,1998 between Anthony Zingale
              and Clarify Inc.
    10.11(3)  Stock Option Agreement between Anthony Zingale and Clarify
              Inc.
    10.12     Lease by and between CarrAmerica Realty Corporation and
              Clarify Inc. dated June 23, 1998.
    10.13     Stock Option Agreement between Jan A. Praisner and Clarify
              Inc.
    10.14     Stock Option Agreement between Kirsten Berg-Painter and
              Clarify Inc.
    10.15     Stock Option Agreement between Jeanne Urich and Clarify Inc.
    27.0      Financial Data Schedule for the nine months ended September
              30, 1998 (included only in the copy of this report filed
              electronically with the Commission)
</TABLE>
 
---------------
(1) Incorporated by reference from an exhibit filed with the Company's
    Registration Statement on Form S-1 (File Number 33-97004) declared effective
    by the Securities and Exchange Commission on November 2, 1995.
 
                                       21
<PAGE>   22
 
(2) Incorporated by reference from an exhibit filed with the Company's
    Registration Statement on Form S-8 (File Number 33-98928)filed with the
    Securities and Exchange Commission on November 3, 1995.
 
(3) Incorporated by reference from an exhibit filed with the Company's Annual
    Report on Form 10-K filed (File Number 000-26776) with the Securities and
    Exchange Commission on March 31, 1998.
 
(b) Reports on Form 8-K. No reports on Form 8-K were filed by the Registrant
    during the quarter ended September 30, 1998.
 
                                       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.
 
Date: November 10, 1998                    CLARIFY INC.
                                   (Registrant)
 
                                   By: /s/ JAN A. PRAISNER
                                      ------------------------------------------
                                      Jan A. Praisner
                                      Vice President and Chief Financial Officer
                                      (Duly Authorized Officer and Principal
                                       Financial Officer)
 
                                       23
<PAGE>   24
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
NUMBER                            DESCRIPTION
------                            -----------
<S>       <C>
 1.0      Rights Agreement, dated as of June 13, 1997 between the
          Company and Harris Trust Company of California, including
          the Certificate of Designation of Series A Junior
          Participating Preferred Stock, Form of Right Certificate and
          Summary of Rights to Purchase Preferred Shares attached
          thereto as Exhibits A, B and C, respectively, which is
          incorporated by reference to the Form 8-A filed with the
          Securities and Exchange Commission on June 24,1997.
 3.1 (1)  Certificate of Incorporation of the Registrant, as amended
          to date
 3.2      Amended and Restated Bylaws of the Company which is
          incorporated by reference to the current report on form 8-K
          filed with the Securities and Exchange Commission on June
          25, 1997
 4.1 (1)  Specimen Common Stock certificate
 4.2 (1)  Restated Investor Rights Agreement, dated March 7, 1994,
          among the Registrant and the investors and founders named
          therein
10.1 (1)  Form of Indemnification Agreement
10.2 (1)  1991 Stock Option/Stock Issuance Plan
10.3 (2)  1995 Stock Option/Stock Issuance Plan
10.4 (2)  Employee Stock Purchase Plan
10.5 (1)  Loan and Security Agreement between Silicon Valley Bank and
          Clarify Inc.
10.6 (1)  Lease by and between Orchard Investment Company Number 6.9
          and Clarify Inc. dated March 16, 1992, as amended by the
          Second Amendment to Lease, dated 28-Feb-95
10.7 (1)  Master Equipment Lease Agreement by and between Costella
          Kirsch/GATXPartnership No. 1 and the Registrant, dated
          February 18, 1992
10.8 (1)  Master Equipment Lease Agreement by and between Venture
          Leasing Assoc. and the Registrant, dated May 7, 1991
10.9 (1)  Master Equipment Lease Agreement by and between Phoenix
          Leasing Incorporated and the Registrant, dated June 30, 1993
10.10(3)  Offer Letter dated February 23, 1998 between Anthony Zingale
          and Clarify Inc.
10.11(3)  Stock Option Agreement between Anthony Zingale and Clarify
          Inc.
10.12     Lease by and between CarrAmerica Realty Corporation and
          Clarify Inc. dated June 23, 1998. Inc.
10.13     Stock Option Agreement between Jan A. Praisner and Clarify
          Inc.
10.14     Stock Option Agreement between Kirsten Berg-Painter and
          Clarify Inc.
10.15     Stock Option Agreement between Jeanne Urich and Clarify Inc.
27.0      Financial Data Schedule for the nine months ended September
          30, 1998 (included only in the copy of this report filed
          electronically with the Commission)
</TABLE>
 
---------------
 
(1) Incorporated by reference from an exhibit filed with the Company's
    Registration Statement on Form S-1 (File Number 33-97004) declared effective
    by the Securities and Exchange Commission on November 2, 1995.
 
(2) Incorporated by reference from an exhibit filed with the Company's
    Registration Statement on Form S-8 (File Number 33-98928) filed with the
    Securities and Exchange Commission on November 3, 1995.
 
(3) Incorporated by reference from an exhibit filed with the Company's Annual
    Report on Form 10-K filed (File Number 000-26776) with the Securities and
    Exchange Commission on March 31, 1998.
 
(b) Reports on Form 8-K. No reports on Form 8-K were filed by the Registrant
    during the quarter ended September 30, 1998.