VERITY INC \DE\, 10-Q, 1998-01-14

VERITY INC \DE\
10-Q, 1998-01-14
COMPUTER PROCESSING & DATA PREPARATION

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<PAGE> 1

================================================================================

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 NOVEMBER 30, 1997

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

FOR THE TRANSITION PERIOD FROM
--------------- TO
---------------

COMMISSION FILE NUMBER: 0-26880

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

<TABLE>
<S> <C>
DELAWARE 77-0182779
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>

894 ROSS DRIVE
SUNNYVALE, CALIFORNIA 94089
(408) 541-1500
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)

------------------------

Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
YES [X] NO [ ]

------------------------

The number of shares outstanding of the Registrant's Common Stock, $0.001
par value, was 11,240,000
as of November 30, 1997.

This report consists of 22 pages. The Exhibit Index to this report is
located on page 19.

================================================================================
<PAGE> 2

VERITY, INC.

FORM 10-Q

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
NO.
----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements........................................................... 1
Condensed Consolidated Balance Sheets as of May 31, 1997 and November 30,
1997........................................................................... 1
Condensed Consolidated Statements of Operations for the three months ended
November 30, 1996 and 1997 and the Six Months Ended November 30, 1996 and
1997........................................................................... 2
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
November 30, 1996 and 1997..................................................... 3
Notes to Condensed Consolidated Financial Statements........................... 4

Item 2: Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... 6

PART II: OTHER INFORMATION

Item 1: Legal Proceedings.............................................................. 17
Item 2: Changes in Securities.......................................................... 17
Item 3: Defaults upon Senior Securities................................................ 17
Item 4: Submissions of Matters to a Vote of Security Holders........................... 17
Item 5: Other Information.............................................................. 17
Item 6: Exhibits and Reports on Form 8-K............................................... 17
Signatures............................................................................... 18
</TABLE>

i
<PAGE> 3

PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

VERITY, INC.

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

ASSETS

<TABLE>
<CAPTION>
MAY 31, NOVEMBER 30,
1997 1997
-------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents.......................................... $ 2,934 $ 3,489
Short-term investments............................................. 15,183 12,341
Trade accounts receivable, less allowance for doubtful accounts of
$540 in 1997 and in $550 in 1998................................ 10,868 8,679
Prepaid and other current assets................................... 1,694 1,520
-------- --------
Total current assets....................................... 30,679 26,029
Property and equipment, at cost, net of accumulated depreciation and
amortization....................................................... 10,048 9,387
Long-term investments................................................ 7,057 5
Other assets......................................................... 1,659 685
-------- --------
Total assets............................................... $ 49,443 $ 36,106
======== ========

LIABILITIES

Current liabilities:
Current portion of long-term debt and capital lease obligations.... $ 617 $ 442
Accounts payable................................................... 4,409 3,618
Accrued compensation............................................... 2,106 3,711
Other accrued liabilities.......................................... 1,156 1,696
Deferred revenue................................................... 3,715 4,412
-------- --------
Total current liabilities.................................. 12,003 13,879
Long-term debt and capital lease obligations, net of current
portion............................................................ 167 42
-------- --------
Total liabilities.......................................... 12,170 13,921
-------- --------

STOCKHOLDERS' EQUITY

Common stock, $.001 par value:
Authorized: 30,000,000 shares in 1997 and 1998;
Issued and outstanding 11,018,000 shares in 1997 and 11,240,000
shares in 1998..................................................... 11 11
Additional paid-in capital........................................... 90,012 90,808
Notes receivable from stockholders................................... (1,090) (62)
Unrealized gain on investments....................................... 6 19
Accumulated deficit.................................................. (51,666) (68,591)
-------- --------
Total stockholders' equity................................. 37,273 22,185
-------- --------
Total liabilities and stockholders' equity................. $ 49,443 $ 36,106
======== ========
</TABLE>

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

1
<PAGE> 4

VERITY, INC.

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

<TABLE>
<CAPTION>
THREE MONTHS
ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
----------------- ------------------
1996 1997 1996 1997
------- ------- ------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Software products...................................... $ 9,726 $ 6,666 $16,955 $ 9,782
Service and other...................................... 1,870 2,522 3,453 4,746
------- ------- ------- --------
Total revenues................................. 11,596 9,188 20,408 14,528
------- ------- ------- --------
Costs of revenues:
Software Products...................................... 1,003 861 1,619 1,566
Service and other...................................... 980 1,294 1,853 2,979
------- ------- ------- --------
Total costs of revenues........................ 1,983 2,155 3,472 4,545
------- ------- ------- --------
Gross profit........................................... 9,613 7,033 16,936 9,983
------- ------- ------- --------
Operating expenses:
Research and development............................... 3,290 4,153 6,789 9,186
Marketing and sales.................................... 5,459 6,048 9,988 11,793
General and administrative............................. 1,177 1,484 2,352 3,636
Restructuring charges.................................. -- 3,006 -- 3,006
------- ------- ------- --------
Total operating expenses....................... 9,926 14,691 19,129 27,621
------- ------- ------- --------
Loss from operations..................................... (313) (7,658) (2,193) (17,638)
Other income, net........................................ 535 549 1,132 813
------- ------- ------- --------
Net income (loss) before provision for income taxes...... 222 (7,109) (1,061) (16,825)
Provision for income taxes............................... -- 50 -- 100
------- ------- ------- --------
Net income (loss)........................................ $ 222 $(7,159) $(1,061) $(16,925)
======= ======= ======= ========
Net income (loss) applicable to common stockholders...... $ 222 $(7,159) $(1,061) $(16,925)
======= ======= ======= ========
Net income (loss) per share.............................. $ 0.02 $ (0.64) $ (0.10) $ (1.52)
======= ======= ======= ========
Number of shares used in per share calculation........... 11,421 11,168 10,779 11,101
======= ======= ======= ========
</TABLE>

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

2
<PAGE> 5

VERITY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
NOVEMBER 30,
--------------------
1996 1997
------- --------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.............................................................. $(1,061) $(16,925)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization...................................... 1,637 3,041
Non-cash restructuring charges..................................... -- 2,315
Provision for doubtful accounts.................................... 258 (79)
Amortization of discount on securities............................. (452) (19)
Equity in loss of investee company................................. 77 --
Exchange loss...................................................... 6 --
Changes in operating assets and liabilities:
Trade accounts receivable........................................ (4,108) 2,272
Prepaid and other current assets................................. (522) 108
Accounts payable................................................. 743 (786)
Accrued compensation and other accrued liabilities............... (22) (139)
Deferred revenue................................................. 292 670
------- --------
Net cash used in operating activities......................... (3,152) (9,542)
------- --------
Cash flows from investing activities:
Acquisition of property and equipment................................. (5,864) (1,127)
Purchases of marketable securities.................................... (40,730) (5,302)
Maturity of marketable securities..................................... 31,800 1,400
Proceeds from sale of marketable securities........................... 19,483 13,773
Investment in preferred stock......................................... (500) 50
Capitalization of software............................................ (803) (198)
------- --------
Net cash provided by investing activities..................... 3,386 8,596
------- --------
Cash flows from financing activities:
Borrowings under line of credit....................................... 1,500 1,500
Payments on line of credit............................................ (1,500) (1,500)
Proceeds from stockholders on notes receivable........................ 135 1,027
Proceeds from the sale of common stock................................ 933 796
Principal payments on notes payable and capital lease obligations..... (203) (300)
------- --------
Net cash provided by financing activities..................... 865 1,523
------- --------
Effect of exchange rate changes on cash................................. 12 (22)
------- --------
Net increase in cash and cash equivalents..................... 1,111 555
Cash and cash equivalents, beginning of period.......................... 2,482 2,934
------- --------
Cash and cash equivalents, end of period................................ $ 3,593 $ 3,489
======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.............................. $ 54 $ 81
</TABLE>

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

3
<PAGE> 6

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF NOVEMBER 30, 1997 AND FOR THE QUARTERS ENDED
NOVEMBER 30, 1996 AND 1997 AND THEREAFTER IS UNAUDITED)

1. INTERIM FINANCIAL DATA (UNAUDITED)

The unaudited financial statements for the quarters ended November 30, 1996
and 1997 have been prepared on the same basis as the audited financial
statements and, in the opinion of management, include all material adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of
the financial position and results of operations in accordance with generally
accepted accounting principles. Although certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to the
rules and regulations of the Securities and Exchange Commission, the Company
believes the disclosures made are adequate to make the information presented not
misleading. It is suggested that the accompanying financial statements be read
in conjunction with the Company's annual financial statements on Form 10-K for
the year ended May 31, 1997.

The Company's balance sheet as of May 31, 1997 was derived from the
Company's audited financial statements but does not include all disclosures
necessary for the presentation to be in accordance with generally accepted
accounting principles.

2. COMPUTATION OF NET INCOME AND LOSS PER SHARE

Net income and loss per share is computed using the weighted average number
of shares of common stock outstanding. Common equivalent shares from stock
options, warrants and preferred stock are excluded from the computation when
their effect is antidilutive.

3. RECENT ACCOUNTING PRONOUNCEMENTS

In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128 (SFAS No. 128), "Earnings
Per Share," which specifies the computation, presentation and disclosure
requirements for earnings per share. SFAS No. 128 supersedes Accounting
Principles Board Opinion No. 15, and is effective for financial statements
issued for interim and annual periods ending after December 15, 1997 and
requires that prior periods be restated. The impact of the adoption of SFAS No.
128 on the financial statements of the Company has not yet been determined.

In June 1997, the FASB issued SFAS No. 130, "Comprehensive Income." SFAS
No. 130 becomes effective for fiscal years beginning after December 15, 1997 and
requires reclassification of earlier financial statements for comparative
purposes. SFAS No. 130 requires that changes in the amounts of certain items,
including foreign currency translation adjustments and gains and losses on
certain securities be shown in the financial statements. SFAS No. 130 does not
require a specific format for the financial statement in which comprehensive
income is reported, but does require that an amount representing total
comprehensive income be reported in that statement. Management has not yet
determined the effect, if any, of the adoption of SFAS No. 130 on the
consolidated financial statements.

Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." This Statement will change
the way public companies report information about segments of their business in
annual financial statements and requires them to report selected segment
information in their quarterly reports issued to stockholders. It also requires
entity-wide disclosures about the products and services an entity provides, the
material countries in which it holds assets and reports revenues, and its major
customers. The Statement is effective for fiscal years beginning after December
15, 1997. Management has not yet determined the effect, if any, of the adoption
of SFAS No. 131 on the consolidated financial statements.

4
<PAGE> 7

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF NOVEMBER 30, 1997 AND FOR THE QUARTERS ENDED
NOVEMBER 30, 1996 AND 1997 AND THEREAFTER IS UNAUDITED)

4. BANK LINE OF CREDIT

The Company's unsecured line of credit, which provided for up to $7.5
million in credit, expired on November 29, 1997. The Company is currently
renegotiating a new line of credit with the same bank.

5. CAPITALIZED SOFTWARE

During the three months ended November 30, 1997, the Company did not
capitalize any software development costs. The Company amortized approximately
$410,000 of software development costs and expensed approximately $370,000 as
part of the Company's restructuring charge for products that the Company no
longer intends to market. As of November 30, 1997, the Company does not have any
remaining capitalized software development costs.

6. MANAGEMENT IN TRANSITION

On July 31, 1997, Mr. Gary J. Sbona replaced Mr. Philippe F. Courtot as the
Company's President and Chief Executive Officer, and the Company entered into an
agreement with Regent Pacific Management Corporation, a management firm of which
Mr. Sbona is the Chief Executive Officer. Pursuant to the agreement, Regent
Pacific provides management services to the Company, including the services of
Mr. Sbona as Chief Executive Officer and President and at least three other
Regent Pacific personnel as part of the Company management team. The agreement
has a one year term and may be canceled by the Company after expiration of the
initial 26 week period, with a minimum compensation to Regent Pacific of
$1,300,000 for the initial period.

On October 9, 1997, the Company announced the resignation of Donald C.
McCauley as Vice President and Chief Financial Officer. Mr. McCauley had served
as the Company's Chief Financial Officer since joining the Company as a
consultant in March 1994.

7. RESTRUCTURING CHARGES

During the quarter ended November 30, 1997, the Company implemented a
worldwide restructuring of its corporate structure which resulted in workforce
reductions and business consolidations. In connection with the restructuring,
the Company recorded in the quarter ended November 30, 1997, a $3.0 million
restructuring charge, of which approximately $1.6 million was related to
severance costs associated with the reduction in the worldwide workforce,
approximately $0.5 million to the termination of certain lease agreements,
approximately $0.6 million to the write-off of certain assets and approximately
$0.3 million to other costs associated with the restructuring.

Of the total $3.0 million in restructuring charges, approximately $2.3
million is a current liability at November 30, 1997. Of the $2.3 million, $1.5
million relates to severance costs to be paid out in future quarters, $0.5
million to the termination of certain lease obligations which are scheduled to
be paid out over the remaining life of the lease agreements and $0.3 million to
other costs associated with the restructuring.

8. STOCK OPTION REPRICING

On September 5, 1997, the Company's Board of Directors approved a plan
whereby each employee at Verity's Business Applications Division (formerly
Cognisoft Corporation) holding options to purchase the Company's common stock
was given a choice to either retain certain of his or her current stock options
or to cancel and exchange such options for new options to purchase four (4)
shares of common stock for each five (5) shares subject to the canceled options.
The exercise price per share for the new options was set equal to the fair
market price on September 5, 1997.

5
<PAGE> 8

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

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

OVERVIEW

Verity develops, markets and supports software tools and applications that
enable individuals, enterprises and publishers to intelligently search, filter
and disseminate textual information residing on enterprise networks, online
services, the Internet, CD-ROM and other electronic media. The Company was
founded in 1988, and, historically, derived the substantial majority of its
revenue from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products.

In early fiscal 1994, the Company shifted its strategy from the sale of
high-priced products requiring significant customization to leveraging the
Company's core technology to develop a number of new, lower-priced products that
address the needs of broader markets. During this period, the Company also
focused on building strategic alliances for the primary purpose of expanding the
user base of the Company's technology, rather than generating significant
revenues. The objectives of the Company's strategy are to establish its software
as a de facto standard and to offset lower unit prices for its products with
higher sales volumes.

The Company's ongoing implementation of this strategy has involved several
significant actions. During recent years, the Company has reduced significantly
its average unit license fees. Also, during this period, the Company has devoted
significant resources to modify and enhance its core technology to support a
broader set of search and retrieval solutions for use on desktop and
enterprise-wide systems, and over the Internet. Key engineering efforts in this
regard have included the continued enhancement of the functionality of the
Company's search engine and the modification of software to facilitate its
incorporation in third parties' information management, publishing and groupware
software applications. In recent years, the Company's engineering efforts have
also resulted in the development of new applications of software for use with
CD-ROM, online services and the Internet. The Company's core SEARCH'97
technology is deployed within the Company's own suite of applications, and also
as an embedded feature within broadly distributed third-party software
applications, such as Lotus Notes, Adobe Acrobat, Frame FrameViewer and
Documentum Server and WorkSpace. The Company has also licensed its SEARCH'97
technology to prominent providers of Internet products and online services,
including Netscape Communications, NetManage, Quarterdeck, AT&T WorldNet
Services, and MCI's Delphi Internet, together with Internet publishers,
including Cisco Systems, Compaq Computer, the Financial Times and Tandem
Computer.

Since inception, the Company has incurred significant losses and
substantial negative cash flow. Due in part to the transition, the Company
experienced declining revenues and increased net losses in fiscal years 1994 and
1995. At November 30, 1997, the Company had cumulative operating losses of $58.6
million, with net losses of $313,000, $17.9 million and $16.9 million for fiscal
1996, fiscal 1997 and the six months ended November 30, 1997, respectively. For
the three months ended November 30, 1997, total revenues decreased 20.8% over
the corresponding fiscal 1997 period, primarily as a result of a 31.5% decrease
in software product revenues. Total revenues for the three months ended November
30, 1997 increased 72.1% from the $5.3 million for the previous three months
ended August 31, 1997. Operating expenses for the three months ended November
30, 1997 increased in absolute dollars from the prior three months, due
primarily to $3.0 million of restructuring charges incurred during the three
months ended November 30, 1997. Operating expenses for the three months ended
November 30, 1997 decreased from the prior three months as a percentage of
revenues, due primarily to an increase in revenues. While it is the Company's
goal to increase revenues and generate net income in future periods, no
assurance can be given that the Company's revenues will increase from quarter to
quarter in future periods, or that the Company will achieve positive cash flow
or profitability.

6
<PAGE> 9

The ongoing implementation of the Company's new strategy has placed, and
may continue to place, a significant strain on the Company's resources,
including its personnel.

In this regard, during the past few years the Company has replaced the
majority of its work force and substantially reorganized all of the departments
within the Company. During the quarter ended November 30, 1997, the Company
implemented a worldwide restructuring of its corporate structure which resulted
in workforce reductions and business consolidations. In connection with the
restructuring, the Company recorded in the quarter ended November 30, 1997, a
$3.0 million restructuring charge, of which approximately $1.6 million was
related to severance costs associated with the reduction in the worldwide
workforce, approximately $0.5 million to the termination of certain lease
agreements, approximately $0.6 million to the write-off of certain assets and
approximately $0.3 million to other costs associated with the restructuring. The
Company believes that hiring and retaining qualified individuals at all levels
in the Company is essential to its success, and there can be no assurance that
the Company will be successful in attracting and retaining the necessary
personnel. As noted above, the Company has experienced significant turnover,
including turnover of several senior members of management. In particular, on
July 31, 1997, Mr. Gary J. Sbona replaced Mr. Philippe F. Courtot as the
Company's President and Chief Executive Officer, and the Company entered into an
agreement with Regent Pacific Management Corporation, a management firm of which
Mr. Sbona is the Chief Executive Officer. Pursuant to the agreement, Regent
Pacific provides management services to the Company, including the services of
Mr. Sbona as Chief Executive Officer and President and at least three other
Regent Pacific personnel as part of the Company management team. The agreement
has a one year term and may be canceled by the Company after expiration of the
initial 26 week period, with a minimum compensation to Regent Pacific of
$1,300,000 for that initial period. The agreement requires that the Company
indemnify Regent Pacific and Mr. Sbona for certain liabilities arising out of
the performance of services under the agreement. Also, on October 9, 1997, the
Company announced the resignation of Donald C. McCauley as Vice President and
Chief Financial Officer. If Company management is unable to effectively manage
the Company's operations, identify opportunities in a timely fashion, and
evaluate and manage the Company's business and competitive position, the
Company's results of operations and financial condition will be materially and
adversely affected. Furthermore, there can be no assurance that the Company will
successfully develop and introduce new products on a timely basis or that its
new or recently introduced products will achieve market acceptance. See Note 6
to Condensed Consolidated Financial Statements.

The Company's revenues are derived from license fees for its software
products and fees for services complementary to its products, including software
maintenance, consulting and training. Fees for services generally are charged
separately from the license fees for the Company's software products. The
Company recognizes revenues in accordance with the provisions of American
Institute of Certified Public Accountants Statement of Position No. 91-1,
Software Revenue Recognition. Accordingly, maintenance revenues from ongoing
customer support and product upgrades are recognized ratably over the term of
the applicable maintenance agreement, which is typically 12 months. Payments for
maintenance fees generally are received in advance and are nonrefundable.
Revenues for consulting and training generally are recognized when the services
are performed.

7
<PAGE> 10

RESULTS OF OPERATIONS

The following table sets forth the percentage of revenues represented by
certain items in the Company's Condensed Consolidated Statements of Operations
for the periods indicated:

<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
NOVEMBER 30, NOVEMBER 30,
--------------- ----------------
1996 1997 1996 1997
----- ----- ----- ------
<S> <C> <C> <C> <C>
Revenues:
Software products..................................... 83.9% 72.6% 83.1% 67.3%
Service and other..................................... 16.1 27.4 16.9 32.7
----- ----- ----- ------
Total revenues................................ 100.0 100.0 100.0 100.0
----- ----- ----- ------
Costs of revenues:
Software products..................................... 8.6 9.4 7.9 10.8
Service and other..................................... 8.5 14.1 9.1 20.5
----- ----- ----- ------
Total costs of revenues....................... 17.1 23.5 17.0 31.3
----- ----- ----- ------
Gross profit............................................ 82.9 76.5 83.0 68.7
----- ----- ----- ------
Operating expenses:
Research and development.............................. 28.4 45.2 33.3 63.2
Marketing and sales................................... 47.1 65.8 48.9 81.2
General and administrative............................ 10.1 16.2 11.5 25.0
Restructuring charge.................................. -- 32.7 -- 20.7
----- ----- ----- ------
Total operating expenses...................... 85.6 159.9 93.7 190.1
----- ----- ----- ------
Loss from operations.................................... (2.7) (83.4) (10.7) (121.4)
Interest and other expenses............................. 4.6 6.0 5.5 5.6
----- ----- ----- ------
Income before provision for income taxes................ 1.9.. (77.4) (5.2) (115.8)
Provision for income taxes.............................. -- 0.5 -- 0.7
----- ----- ----- ------
Net income (loss)....................................... 1.9% (77.9)% (5.2)% (116.5)%
===== ===== ===== ======
</TABLE>

REVENUES

Total revenues decreased 28.8% from $20.4 million for the six months ended
November 30, 1996 to $14.5 million for the six months ended November 30, 1997.
Total revenues decreased 20.8% from $11.6 million for the three months ended
November 30, 1996 to $9.2 million for the three months ended November 30, 1997.
Total revenues for the comparable six month period decreased primarily due to
decreased revenues from licensing of Internet/publishing products and tools.
Software product revenues decreased as a percentage of total revenues from 83.1%
and 83.9% for the six months and three months ended November 30, 1996
respectively, to 67.3% and 72.6%, respectively for the comparable periods in
fiscal 1998. Conversely, service and other revenues increased as a percentage of
total revenues from 16.9% and 16.1% for the six months and three months ended
November 30, 1996, respectively, to 32.7% and 27.4%, respectively, for the
comparable periods in fiscal 1998.

Software product revenues. Software product revenues decreased 42.3% from
$17.0 million for the six months ended November 30, 1996 to $9.8 million for the
six months ended November 30, 1997. The decrease for the six months ended
November 30, 1997 in comparison to the six months ended November 30, 1996 was
due principally to decreased revenues from licensing of Internet/publishing
products and tools. Software product revenues decreased 31.5% from $9.7 million
for the three months end November 30, 1996 to $6.7 million for the three months
ended November 30, 1997. The decrease for the three months ended November 30,
1997 from the three months ended November 30, 1996 was due principally to
decreased revenues from licensing of Internet/publishing products.

Service and other revenues. Service and other revenues increased 37.4% from
$3.5 million for the six months ended November 30, 1996 to $4.7 million for the
six months ended November 30, 1997. Service and

8
<PAGE> 11

other revenues increased 34.9% from $1.9 million for the three months ended
November 30, 1996 to $2.5 million for the three months ended November 30, 1997.
Maintenance and consulting revenues increased significantly between the
comparable periods, but these increases were partially offset by reduced
training revenues.

Revenues from foreign operations accounted for 4.2% and 8.1% of total
revenues, respectively, for the six months ended November 30, 1996 and 1997,
with European operations alone accounting for 4.2% and 8.1% of total revenues
for those periods. For the six months ended November 30, 1996 and 1997, export
sales accounted for 22.3% and 25.1% of total revenues, respectively. Revenues
from foreign operations accounted for 4.5% and 6.6%, respectively, for the three
months ended November 30, 1996 and 1997, with European operations alone
accounting for 4.5% and 6.6% of total revenues for those periods. For the three
months ended November 30, 1996 and 1997, export sales accounted for 21.3% and
27.0% of total revenues, respectively. The increase in revenues from foreign
operations as a percentage of revenues resulted primarily from increased
consulting revenues contributed by the Company's subsidiary, Verity Interactive,
and decreased domestic revenues. The Company expects that revenues derived from
foreign operations and export sales will continue to vary in future periods as a
percentage of total revenues.

Licensing and maintenance of software products to KPMG International
accounted for approximately 10.8% of the Company's revenues for the six months
ended November 30, 1997 and for approximately 11.7% of the Company's revenues
for the three months ended November 30, 1997. Licensing and maintenance of
software products to Cisco Systems, Inc. accounted for approximately 19.8% of
the Company's revenues for the six months ended November 30, 1996 and for
approximately 32.6% of the Company's revenues for the three months ended
November 30, 1996. Revenues derived from sales to the federal government and its
agencies were 7.5% and 10.3% of the Company's revenues for the six months ended
November 30, 1996 and 1997, respectively and 6.3% and 11.2% of the Company's
revenues for the three months ended November 30, 1996 and 1997, respectively.
The Company expects that revenues from such government sales will continue to
vary in future periods as a percentage of revenues.

COSTS OF REVENUES

Costs of software products. Costs of software products decreased 3.3% from
$1.62 million for the six months ended November 30, 1996 to $1.57 million for
the six months ended November 30, 1997, representing 9.6% and 16.0%,
respectively, of the software product revenues. Costs of software products
decreased 14.2% from $1.0 million for the three months ended November 30, 1996
to $861,000 for the three months ended November 30, 1997 representing 10.3% and
12.9% respectively of the software product revenues. The decrease in absolute
dollars was principally due to the inclusion of licensed software relating to
third party software components included in certain products during the periods
ended November 30, 1996. The increase in costs as a percentage of software
product revenues was primarily related to decreased software product revenues
for the six months ended November 30, 1997.

Costs of service and other. Costs of service and other revenues increased
60.8% from $1.9 million for the six months ended November 30, 1996 to $3.0
million for the six months ended November 30, 1997, representing 53.7% and
62.8%, respectively, of service and other revenues. Cost of service and other
revenues increased 32.0% from $980,000 for the three months ended November 30,
1996 to $1.3 million for the three months ended November 30, 1997, representing
52.4% and 51.3%, respectively, of service and other revenues. The increase in
absolute dollars and in costs as a percentage of service and other revenues was
due principally to increases in consulting personnel.

OPERATING EXPENSES

Research and development. Research and development expenses increased 35.5%
from $6.8 million for the six months ended November 30, 1996 to $9.2 million for
the six months ended November 30, 1997, representing 33.3% and 63.2%,
respectively, of total revenues. Research and development expenses increased
26.2% from $3.3 million for the three months ended November 30, 1996 to $4.2
million for the three months ended November 30, 1997, representing 28.4% and
45.2%, respectively, of total revenues. The increase in

9
<PAGE> 12

absolute costs was primarily due to a significant increase in headcount of
research and development personnel. In particular, in the six months ended
November 30, 1997, the Company incurred increased staffing expense relating
principally to the recent acquisition of KeyView. In addition, during the six
months ended November 30, 1996, the Company capitalized approximately $800,000
of software development costs in connection with the development of a number of
products included in the Company's SEARCH'97 product line. The increase in costs
as a percentage of total revenues was primarily related to decreased revenues
for the six months ended November 30, 1997. Future research and development
expenses may vary as a percentage of total revenues.

Marketing and sales. Marketing and sales expenses increased 18.1% from
$10.0 million in the six months ended November 30, 1996 to $11.8 million for the
six months ended November 30, 1997, representing 48.9% and 81.2%, respectively,
of total revenues. Marketing and sales expenses increased 10.8% from $5.5
million for the three months ended November 30, 1996 to $6.0 million for the
three months ended November 30, 1997, representing 47.1% and 65.8%,
respectively, of total revenues. The increase in absolute costs was primarily
related to the Company's expansion of its sales organization in the United
States and Europe. The increase in costs as a percentage of total revenues was
primarily related to decreased revenues for the six months ended November 30,
1997. The Company anticipates it will continue to make significant investments
in marketing and sales.

General and administrative. General and administrative expenses increased
54.6% from $2.4 million in the six months ended November 30, 1996 to $3.6
million for the six months ended November 30, 1997, representing 11.5% and
25.0%, respectively, of total revenues. General and administrative expenses
increased 26.1% from $1.2 million in the three months ended November 30, 1996 to
$1.5 million for the three months ended November 30, 1997, representing 10.2%
and 16.2%, respectively, of total revenues. The increase in absolute costs was
primarily related to expenses associated with management in transition. See
"Risk Factors -- Management in Transition; Employee Turnover." The increase in
costs as a percentage of total revenues was primarily related to decreased
revenues for the six months ended November 30, 1997.

Restructuring charges. During the quarter ended November 30, 1997, the
Company implemented a worldwide restructuring of its corporate structure which
resulted in workforce reductions and business consolidations. In connection with
the restructuring, the Company recorded in the quarter ended November 30, 1997,
a $3.0 million restructuring charge of which $1.6 million was related to
severance costs associated with the reduction in the worldwide workforce, $0.5
million to the termination of certain lease agreements, $0.6 million to the
write-off of certain assets and $0.3 million to other costs associated with the
restructuring.

Of the total $3.0 million in restructuring charges, approximately $2.3
million is a current liability at November 30, 1997. Of the $2.3 million,
approximately $1.5 million relates to severance costs to be paid out in future
quarters, approximately $0.5 million to the termination of certain lease
obligations which will be paid out over the remaining life of the lease
agreements and approximately $0.3 million to other costs associated with the
restructuring. See Note 7 of Notes to Condensed Consolidated Financial
Statements.

INCOME TAXES

The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
Management evaluates on a quarterly basis the recoverability of the deferred tax
assets and the level of the valuation allowance. At such time as it is
determined that it is more likely than not that deferred tax assets are
realizable, the valuation allowance will be appropriately reduced.

LIQUIDITY AND CAPITAL RESOURCES

Since its inception, the Company has financed its operations primarily
through proceeds of approximately $23.6 million from private sales of Preferred
Stock, proceeds from its initial public offering and secondary public offering
of Common Stock and, to a lesser extent, bank credit lines and capital operating
leases. The Company completed its initial public offering of Common Stock in
October 1995 and realized net proceeds of $32.5 million. In January 1996, the
Company completed its secondary public offering of Common Stock,

10
<PAGE> 13

which generated net proceeds of $16.5 million. The Company has used a portion of
those proceeds to repay borrowings under its line of credit in the amount of
$1.6 million. As of November 30, 1997, the Company had $15.8 million in cash and
cash equivalents and available-for-sale securities.

The Company's operating activities used cash of $3.2 million and $9.5
million for the six months ended November 30, 1996 and 1997, respectively. In
the six months ended November 30, 1996, an increase in accounts receivable was
partially offset by depreciation and amortization expense. For the six months
ended November 30, 1997, the Company's net loss for the period was partially
offset by depreciation and amortization expense, non-cash restructuring charges
and a decrease in accounts receivable.

The Company's investing activities provided cash of $3.4 million and $8.6
million for the six months ended November, 1996 and 1997, respectively. For the
six months ended November 30, 1996 and November 30, 1997, cash provided by
investing activities consisted primarily of proceeds from the sale and maturity
of marketable securities partially offset by purchases of marketable securities
and purchases of property and equipment.

Cash provided by financing activities was $865,000 and $1.5 million for the
six months ended November 30, 1996 and 1997, respectively. In the six months
ended November 30, 1996 and 1997, financing activities consisted primarily of
proceeds from the sale of Common Stock in connection with the Company's Employee
Stock Purchase Plan and proceeds from stockholders on notes receivable.

At November 30, 1997, the Company's principal sources of liquidity were its
cash, cash equivalents, and short-term investments of $15.8 million. The
Company's unsecured line of credit, which provided for up to $7.5 million in
credit, expired on November 29, 1997. The Company is currently renegotiating a
new line of credit with the same bank.

Capital expenditures, including capital leases, were approximately $5.9
million and $1.1 million for the six months ended November 30, 1996 and 1997,
respectively. For the six months ended November 30, 1996, these expenditures
consisted primarily of leasehold improvements and capital equipment related to
the Company's relocation to a new facility. In the six months ended November 30,
1997, these expenditures consisted principally of purchases of property and
equipment, primarily for computer hardware and software.

The Company believes that its current cash and cash equivalents and funds
generated from operations, if any, will provide adequate liquidity to meet the
Company's capital and operating requirements through at least fiscal 1998.
Thereafter, or if the Company's spending plans change, the Company may find it
necessary to seek to obtain additional sources of financing to support its
capital needs, but there is no assurance that such financing will be available
on commercially reasonable terms, or at all.

11
<PAGE> 14

RISK FACTORS

In addition to the other information in this report on Form 10-Q, the
following risk factors should be considered carefully in evaluating the Company
and its business:

History of Losses; Strategic Realignment. Since inception, the Company has
incurred significant losses and substantial negative cash flow. In the six
months ended November 30, 1997, the Company had a net loss of approximately
$16.9 million, and an operating loss of approximately $17.6 million. The Company
was founded in 1988, and historically derived the substantial majority of its
revenues from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products. In early fiscal 1994, the Company shifted its strategy to focus
increasingly on more versatile, lower-priced software applications which require
less specialized consulting. To achieve revenue growth, the Company must, among
other things, increase market acceptance of the Company's technology, achieve
significantly increased sales levels, respond effectively to competitive
developments, continue to attract, retain and motivate qualified persons, and
continue to upgrade its technologies and commercialize products and services
incorporating such technologies. There can be no assurance that the Company's
strategy will be successful or that the Company will experience increased
revenues or become profitable or cash flow positive at any time in the future.

Management in Transition; Employee Turnover. The Company is experiencing a
period of transition and new product introductions that have placed, and will
continue to place, a significant strain on its resources, including personnel.
During the past few years, management and other personnel have focused on
modifying and enhancing the Company's core technology to support a broader set
of search and retrieval solutions for use on desktop and enterprise-wide
systems, and over online services, the Internet and on CD-ROM. In order for the
Company's strategy to succeed, the Company must, among other things, leverage
its core technology to develop new product offerings by the Company and by its
original equipment manufacturer ("OEM") customers that address the needs of
these new markets. Many of the Company's products are still being developed or
have only recently been introduced, and there is no assurance that such products
will be successfully completed on a timely basis, will achieve market acceptance
or will generate significant revenues. Projects relating to these efforts,
including the development and commercial deployment of the Company's SEARCH'97
suite of products, including its Agent Server products, continued enhancement of
the functionality of the Company's search engine, and technical integration of
the Company's products with the products of the Company's strategic partners,
when added to the day-to-day activities of the Company, will continue to strain
the Company's resources and personnel.

In connection with its strategy, the Company has also replaced the majority
of its work force and substantially reorganized all of the departments within
the Company. While experiencing substantial turnover, the Company increased the
number of research and development personnel from 29 at the beginning of fiscal
1994 to 108 at November 30, 1997. Continuity of personnel can be an important
factor in the successful completion of the Company's development projects, and
ongoing turnover in the Company's research and development personnel could
materially and adversely impact the Company's development and marketing efforts.
The Company believes that hiring and retaining qualified individuals at all
levels in the Company is essential to its success, and there can be no assurance
that the Company will be successful in attracting and retaining the necessary
personnel. As noted above, the Company has experienced significant turnover,
including turnover of several senior members of management. In particular, on
July 31, 1997, Mr. Gary J. Sbona replaced Mr. Philippe F. Courtot as the
Company's President and Chief Executive Officer, and the Company entered into an
agreement with Regent Pacific Management Corporation, a management firm of which
Mr. Sbona is the Chief Executive Officer. Pursuant to the agreement, Regent
Pacific will provide management services to the Company, including the services
of Mr. Sbona as Chief Executive Officer and President and at least three other
Regent Pacific personnel as part of the Company management team. The agreement
has a one year term and may be canceled by the Company after expiration of the
initial 26 week period, with a minimum compensation to Regent Pacific of
$1,300,000 for that initial period. On October 9, 1997, the Company announced
the resignation of Donald C. McCauley as Vice President and Chief Financial
Officer. Mr. McCauley had served as the Company's Chief Financial Officer since
joining the Company as a

12
<PAGE> 15

consultant in March 1994. If Company management is unable to effectively manage
the Company's operations, identify opportunities in a timely fashion, and
evaluate and manage the Company's business and competitive position, results of
operations and financial condition will be materially and adversely affected.

Fluctuations in Operating Results. The Company's quarterly operating
results have varied and are expected to vary significantly in the future. These
fluctuations may be caused by many factors, including, among others, the size
and timing of individual orders; customer order deferrals in anticipation of new
products; changes in the budgets or purchasing patterns of government agencies;
timing of introduction or enhancement of products by the Company or its
competitors; market acceptance of new products; technological changes in search
and retrieval, database, networking, or communications technology; competitive
pricing pressures; changes in the Company's operating expenses; personnel
changes; foreign currency exchange rates; mix of products sold; quality control
of products sold; and general economic conditions.

A significant portion of the Company's revenues in recent quarters has been
derived from relatively large sales to a limited number of customers, and the
Company currently anticipates that future quarters will continue to reflect this
trend. Sales cycles for these customers can be up to six months or longer. In
addition, like many software companies, the Company has generally recognized a
substantial portion of its revenues in the last month of each quarter, with
these revenues concentrated in the last weeks of the quarter. Accordingly, the
cancellation or deferral of even a small number of purchases of the Company's
products could have a material adverse effect on the Company's business, results
of operations and financial condition in any particular quarter. To the extent
that significant sales occur earlier than expected, operating results for
subsequent quarters may fail to keep pace or even decline.

Product revenues are also difficult to forecast because the market for
search and retrieval software is uncertain and evolving. Because the Company
generally ships software products within a short period after receipt of an
order, the Company typically does not have a material backlog of unfilled
orders, and revenues in any quarter are substantially dependent on orders booked
in that quarter. In addition, a portion of the Company's revenues are derived
from royalties based upon sales by third-party vendors of products incorporating
the Company's technology. These revenues may be subject to extreme fluctuation
and are difficult for the Company to predict. The Company's expense levels are
based, in part, on its expectations as to future revenues and to a large extent
are fixed. Therefore, the Company may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. Any significant
shortfall of demand in relation to the Company's expectations or any material
delay of customer orders would have an almost immediate adverse affect on the
Company's operating results and on the Company's ability to achieve
profitability.

The Company's revenues, and particularly its software products revenues,
increased significantly in fiscal 1997 over fiscal 1996. As evidenced in the
period ending August 31, 1997, however, there can be no assurance that the
Company's revenues will increase significantly or at all in future periods.

As a result of the foregoing and other factors, 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.
Fluctuations in operating results have in the past, and may in the future, also
result in volatility in the price of the shares of the Company's Common Stock.

Developing Market; Unproven Acceptance of the Company's Products. The
Company has recently introduced or announced several products addressing a
market which has only recently begun to develop, is rapidly evolving and is
characterized by an increasing number of market entrants who have introduced or
developed products and services addressing search and retrieval requirements
over private and public networks, CD-ROM, online services and the Internet.
There is no assurance that such products will be developed and released on a
timely basis, or that such products will achieve market acceptance.

As is typical in the case of a new and evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty. The software industry addressing the information
management requirements of networked systems, CD-ROM, online services and the
Internet is young and has few proven products. Moreover, critical issues
concerning the commercial use of online

13
<PAGE> 16

services and the Internet (including security, reliability, cost, ease of use
and access, and quality of service) remain unresolved and may impact the growth
of the Internet and online markets, together with the software standards and
electronic media employed in such markets.

The Company's future operating results will depend in substantial part upon
its ability to increase the installed base of its intelligent search and
filtering technology and to begin to generate significant product revenues from
its Topic Enterprise Server, Topic Client, SEARCH'97 CD Publisher, SEARCH'97
Information Server, SEARCH'97 Agent Server, KeyView products and other products
addressing the information retrieval and viewing requirements of individuals and
corporations from data sources within an enterprise, and on CD-ROM, online
services and the Internet. The Company's future operating results will also
depend upon its ability to successfully market its technology to online and
Internet publishers who use such technology to index their published information
in the format used by Verity. To the extent that such publishers do not adopt
the Company's technology for indexing their published information, users will be
unable to search such information using the Company's search and retrieval
products, which in turn will limit the demand for the Company's products.

Because the market for certain of the Company's products and services is
new and evolving, it is difficult to assess or predict with any assurance the
growth rate, if any, and size of this market. There can be no assurance that the
market for the Company's products and services will develop, or that the
Company's products or services will achieve market acceptance. If the market
fails to develop, develops more slowly than expected or becomes saturated with
competitors, or if the Company's products do not achieve significant market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected.

A significant element of the Company's strategy is to embed its SEARCH'97
technology in products offered by the Company's OEM customers. Many of the
markets for such products are also new and evolving and, therefore, subject to
the same risks faced by the Company in the markets for its own products. In
addition, consolidation in the industries served by the Company could, and
acquisition or development by any of the Company's significant customers of
technology competitive with the Company's would, materially and adversely affect
the Company's business and prospects.

Dependence on International Operations. Revenues from foreign operations
accounted for 4.2% and 8.1% of total revenues, respectively, for the six months
ended November 30, 1996 and 1997, with European operations alone accounting for
4.2% and 8.1% of total revenues for those periods. For the six months ended
November 30, 1996 and 1997, export sales accounted for 22.3% and 25.1% of total
revenues, respectively. Revenues from foreign operations accounted for 4.5% and
6.6%, respectively, for the three months ended November 30, 1996 and 1997, with
European operations alone accounting for 4.5% and 6.6% of total revenues for
those periods. For the three months ended November 30, 1996 and 1997, export
sales accounted for 21.3% and 27.0% of total revenues, respectively. The
increase in revenues from foreign operations as a percentage of revenues
resulted primarily from increased consulting revenues related to the recent
acquisition of Verity Interactive and decreased domestic revenues. The Company
expects that revenues derived from foreign operations and export sales will
continue to vary in future periods as a percentage of total revenues. Certain of
these revenues have been derived from sales to foreign government agencies which
may be subject to risks similar to those described below.

There are a number of risks inherent in the Company's international
business activities, including unexpected changes in regulatory requirements,
tariffs and other trade barriers, costs and risks of localizing products for
foreign countries, longer accounts receivable payment cycles, potentially
adverse tax consequences, limits on repatriation of earnings and the burdens of
complying with a wide variety of foreign laws. Additionally, the Company does
not engage in hedging activities to protect against the risk of currency
fluctuations. Fluctuations in currency exchange rates could cause sales
denominated in U.S. dollars to become relatively more expensive to customers in
a particular country, leading to a reduction in sales or profitability in that
country. Also, such fluctuations could cause sales denominated in foreign
currencies to affect a reduction in the current U.S. dollar revenues derived
from sales in a particular country. Furthermore, future international activity
may result in increased foreign currency denominated sales and, in such event,
gains and

14
<PAGE> 17

losses on the conversion to U.S. dollars of accounts receivable and accounts
payable arising from international operations may contribute significantly to
fluctuations in the Company's results of operations. The financial stability of
foreign markets could also affect the Company's international sales. In
addition, revenues of the Company earned in various countries where the Company
does business may be subject to taxation by more than one jurisdiction, thereby
adversely affecting the Company's earnings. There can be no assurance that such
factors will not have an adverse effect on the revenues from the Company's
future international sales and, consequently, the Company's results of
operations.

Dependence on United States Government and the Risk of Contract
Termination. Revenues derived from sales to the federal government and its
agencies were 7.5% and 10.3% of the Company's revenues for the six months ended
November 30, 1996 and 1997, respectively and 6.3% and 11.2% of the Company's
revenues for the three months ended November 30, 1996 and 1997, respectively.
The Company expects that revenues from such government sales will continue to
vary in future periods as a percentage of revenues.

Agencies of the United States government have accounted for a significant
portion of the Company's revenues. Specifically, these agencies accounted for
approximately 10.5%, 9.5% and 10.3% of revenues in fiscal 1996, fiscal 1997 and
the six months ended November 30, 1997, respectively. Sales to government
agencies fluctuated as a percentage of revenues during these periods, and may
decline in the future. In recent years, budgets of many government agencies have
been reduced, causing certain customers and potential customers of the Company's
products to re-evaluate their needs. Such budget reductions are expected to
continue over at least the next several years. Future reductions in United
States spending on information technologies could have a material adverse effect
on the Company's operating results.

Almost all of the Company's government contracts contain termination
clauses which permit contract termination upon the Company's default or for
convenience of the other contracting party. There can be no assurance such
cancellations will not occur in the future, and any such termination could
adversely affect the Company's operating results.

Technological Change; Market Acceptance of Evolving
Standards. Historically, the Company has derived substantially all of its
revenues from the license of custom search and retrieval applications and
consulting and other services related to such applications. Recently, the
Company has refined and enhanced its core technology to add functionality and
facilitate incorporation of the Company's technology in a variety of
applications addressing the desktop, CD-ROM, enterprise, online and Internet
markets. Nevertheless, the Company expects that for the foreseeable future it
will continue to derive the largest portion of its revenues from licensing its
technology for enterprise applications.

The computer software industry is subject to rapid technological change,
changing customer requirements, frequent new product introductions and evolving
industry standards that may render existing products and services obsolete. As a
result, the Company's position in its existing markets or other markets that it
may enter could be eroded rapidly by product advancements by competitors. The
life cycles of the Company's products are difficult to estimate. The Company's
future success will depend, in part, upon its ability to enhance existing
products and to develop new products on a timely basis. In addition, its
products must keep pace with technological developments, conform to evolving
industry standards, particularly client/server and Internet communication and
security protocols, as well as publishing formats such as Hypertext Markup
Language ("HTML"), and address increasingly sophisticated customer needs. There
can be no assurance that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of new
products, or that new products and product enhancements will meet the
requirements of the marketplace and achieve market acceptance. If the Company is
unable to develop and introduce products in a timely manner in response to
changing market conditions or customer requirements, the Company's financial
condition and results of operations would be materially and adversely affected.

In addition, a significant strategy of the Company is to achieve
compatibility between the Company's products and the text publication formats
the Company believes are or will become popular and widely adopted. The Company
invests substantial resources in development efforts aimed at achieving such
compatibility. Any failure by the Company to anticipate or respond adequately to
technology or market developments could result in a loss of competitiveness or
revenue. For instance, to date the Company has

15
<PAGE> 18

focused its efforts on integration with the Adobe PDF and Lotus Notes
environments and, more recently, the Microsoft Exchange environment. Should any
of these products or technologies lose or fail to achieve acceptance in the
marketplace or be replaced by other products or technologies, the Company's
business could be materially adversely affected.

Because one of the Company's strategies is to embed its basic search engine
in key OEM application products, the Company's sales of its intelligent search
and filtering products depend in part on its ability to maintain compatibility
with these OEM applications. There is no assurance that the Company will be able
to maintain compatibility with these vendors' products or continue to be the
search technology of choice for such OEMs, and the failure to maintain
compatibility with or be selected by such OEMs would materially adversely affect
the Company's sales. Further, the failure of the products of the Company's key
OEM partners to achieve market acceptance could have a material adverse effect
on the Company's results of operations.

Software products as complex as those offered by the Company may contain
errors that may be detected at any point in the products' life cycles. The
Company has in the past discovered software errors in certain of its products
and has experienced delays in shipment of products during the period required to
correct these errors. There can be no assurance that, despite testing and
quality assurance efforts by the Company and by current and potential customers,
errors will not be found, resulting in loss of or delay in market acceptance and
sales, diversion of development resources, injury to the Company's reputation,
or increased service and warranty costs, any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition. Although the Company generally attempts to limit by contract its
exposure to incidental and consequential damages, and to cap the Company's
liabilities under the contract, if a court failed to enforce the liability
limiting provisions of the Company's contracts for any reason, or if liabilities
arose which were not effectively limited, the Company's operating results could
be materially and adversely affected.

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<PAGE> 19

PART II: OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

Not Applicable.

ITEM 2: CHANGES IN SECURITIES

Not Applicable.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

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

The Company's Annual Meeting of Stockholders was held on September 25,
1997. Proxies for the meeting were solicited pursuant to Regulation 14A. At the
meeting, management's nominee for director and three proposals were submitted to
the stockholders of the Company. Management's nominee for director was elected
by the following votes:

<TABLE>
<CAPTION>
SHARES
------------------
VOTING
NOMINEE FOR WITHHELD
---------------------------------------------------------- --------- ------
<S> <C> <C>
Steven A. MacDonald....................................... 8,490,079 79,714
</TABLE>

Steven M. Krausz and Charles P. Waite, Jr. continued to serve as directors
of the Company after the annual meeting and will continue to serve until the
Annual Meeting of Stockholders to be held in 1999.

A second proposal to amend the 1995 Employee Stock Purchase Plan of the
Company to increase the number of shares of Common Stock of the Company
authorized for issuance thereunder from 500,000 shares to 1,300,000 shares, was
submitted to a vote of the stockholders of the Company. The proposal was
approved by the following vote:

<TABLE>
<CAPTION>
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
----------------------- ----------------------- ----------------------- -----------------------
<S> <C> <C> <C>
4,386,357 237,721 23,244 3,922,471
</TABLE>

A final proposal to ratify the appointment of Coopers & Lybrand LLP as the
Company's independent public accountants for the year ending May 31, 1998 was
also submitted to a vote of the stockholders of the Company. The proposal was
approved by the following vote:

ITEM 5: OTHER INFORMATION

Not Applicable.

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

A. Exhibits -- See Exhibit Index

B. Form 8-K

17
<PAGE> 20

SIGNATURES

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

VERITY, INC.

By: /s/ JAMES E. TICEHURST

--------------------------------------
James E. Ticehurst
Vice President, Administration and
Controller
(Principal Financial Officer)

Dated: January 14, 1998

18
<PAGE> 21

EXHIBIT INDEX

<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION OF DOCUMENT PAGES
------ --------------------------------------------------------------------- --------
<C> <S> <C>
2.1 Form of Agreement and Plan of Merger between Verity, Inc., a
California corporation, and Verity Delaware Corporation, a Delaware
corporation, filed September 22, 1995(1).............................
2.2 Agreement and Plan of Reorganization dated January 10, 1997 among
Verity, Inc., Cognisoft Acquisition Corporation and Cognisoft
Corporation, and certain shareholders of Cognisoft(7)................
2.3 Form of Stock Purchase Agreement dated as of May 31, 1997 among
Verity, 64K and certain shareholders of 64K(8).......................
2.4 Agreement for Purchase and Sale of Assets dated as of May 30, 1997
among FTP US, FTP Canada, Verity US and Verity Canada(9).............
3.1 Certificate of Incorporation of the Company(1).......................
3.2 By-Laws(1)...........................................................
3.3 Certificate of Retirement of Series of Preferred Stock(7)............
3.4 Certificate of Designation, Preferences and Rights of Series A
Preferred Stock(7)...................................................
4.1 Amended and Restated Rights Agreement dated August 1, 1995, as
amended(1)...........................................................
4.2 Form of Rights Agreement between Verity, Inc. and First National Bank
of Boston dated September 18, 1996(6)................................
10.1 Form of Indemnification Agreement for directors and officers(1)......
10.2 Amended and Restated 1995 Stock Option Plan and forms of agreements
thereunder(7)........................................................
10.3 1995 Employee Stock Purchase Plan(1),(4).............................
10.4 1995 Outside Directors Stock Option Plan and forms of agreement
thereunder(1),(4)....................................................
10.5 Employment Agreement between Philippe F. Courtot and the Company
dated July 15, 1993, together with related Amended and Restated Stock
Purchase Agreement dated as of June 1, 1995. (1),(4).................
10.6 Security and Loan Agreement between Imperial Bank and the Company
dated April 7, 1994, as amended(2)...................................
10.7 Series G Preferred Stock Purchase Agreement dated August 29,
1994(2)..............................................................
10.8 Series H Preferred Stock Purchase Agreement dated August 1,
1995(2)..............................................................
10.18 Lease Agreement between Ross Drive Investors and the Company dated
January 22, 1996(3)..................................................
10.19 Retainer Agreement between Regent Pacific Management Corporation and
Verity, Inc. dated July 13, 1997(10).................................
10.20 Confidential Severance Option Agreement between Verity, Inc. and
Richard Lo dated August 20, 1997(10)
10.21 Employment Agreement between Anthony J. Bettencourt and the Company
dated August 28, 1997(11)............................................
11.1 Statement of computation of net loss per share....................... 21
27.1 Financial Data Schedule.............................................. 22
</TABLE>

- ---------------

(1) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Registration Statement (No. 33-96228), declared effective on
October 5, 1995.

(2) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Registration Statement (No. 33-80567), declared effective on
January 17, 1996.

19
<PAGE> 22

(3) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Form 10-Q for the quarter ended February 29, 1996.

(4) Management contract or compensatory plan covering executive officers and
directors of the Company.

(5) Confidential Treatment has been granted for portions of these exhibits.

(6) Incorporated by reference from Exhibit No. 1 from the Company's Form 8-K as
filed with the Securities and Exchange Commission on October 10, 1996.

(7) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Form 10-Q for the quarter ended August 31, 1996.

(8) Relating to the 64K acquisition, incorporated by reference from Exhibit No.
2.1 to the Company's report on Form 8-K as filed with the Securities and
Exchange Commission on June 13, 1997.

(9) Relating to the KeyView acquisition, incorporated by reference from Exhibit
No. 2.1 to the Company's report on Form 8-K as filed with the Securities
and Exchange Commission on June 13, 1997.

(10) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Form 10-K for the year ended May 31, 1997.

(11) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Form 10-Q for the quarter ended August 31, 1997.

<PAGE> 1

EXHIBIT 11.1

VERITY, INC.

STATEMENT OF COMPUTATION OF NET INCOME AND LOSS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
------------------- --------------------
1996 1997 1996 1997
------- ------- ------- --------
<S> <C> <C> <C> <C>
Primary and Fully Diluted:
Weighted average common shares outstanding for
the period.................................... 10,814 11,168 10,779 11,101
Common equivalent shares from dilutive stock
options....................................... 607 -- -- --
------- ------- ------- --------
Shares used in per share calculation............... 11,421 11,168 10,779 11,101
------- ------- ------- --------
Net income (loss) applicable to common
stockholders..................................... $ 222 $(7,159) $(1,061) $(16,925)
======= ======= ======= ========
Net income (loss) per share........................ $ 0.02 $ (0.64) $ (0.10) $ (1.52)
======= ======= ======= ========
</TABLE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINING SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AT NOVEMBER 30, 1997 (UNAUDITED) AND THE
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED NOVEMBER 30, 1997
(UNAUDITED) IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-START> JUN-01-1997
<PERIOD-END> NOV-30-1997
<CASH> 3,489
<SECURITIES> 12,341
<RECEIVABLES> 9,229
<ALLOWANCES> 550
<INVENTORY> 0
<CURRENT-ASSETS> 26,029
<PP&E> 18,071
<DEPRECIATION> 8,684
<TOTAL-ASSETS> 36,106
<CURRENT-LIABILITIES> 13,879
<BONDS> 42
0
0
<COMMON> 11
<OTHER-SE> 22,174
<TOTAL-LIABILITY-AND-EQUITY> 36,106
<SALES> 9,782
<TOTAL-REVENUES> 14,528
<CGS> 1,566
<TOTAL-COSTS> 4,545
<OTHER-EXPENSES> 27,621
<LOSS-PROVISION> (79)
<INTEREST-EXPENSE> 81
<INCOME-PRETAX> (16,825)
<INCOME-TAX> 100
<INCOME-CONTINUING> (16,925)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (16,925)
<EPS-PRIMARY> (1.52)
<EPS-DILUTED> (1.52)

</TABLE>