VERITY INC \DE\, 10-Q, 1998-04-14

VERITY INC \DE\
10-Q, 1998-04-14
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 FEBRUARY 28, 1998

[ ] 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 11,269,000 as of February 28, 1998.

This report consists of 21 pages. The Exhibit Index to this report is
located on page 20.

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

VERITY, INC.

FORM 10-Q

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements........................................ 1
Condensed Consolidated Balance Sheets as of May 31, 1997
and February 28, 1998..................................... 1
Condensed Consolidated Statements of Operations for the
Three Months Ended February 28, 1997 and 1998 and the Nine
Months Ended February 28, 1997 and 1998................... 2
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended February 28, 1997 and 1998................... 3
Notes to Condensed Consolidated Financial Statements........ 4
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of
Operations................................................ 7

PART II: OTHER INFORMATION
Item 1: Legal Proceedings........................................... 18
Item 2: Changes in Securities....................................... 18
Item 3: Defaults upon Senior Securities............................. 18
Item 4: Submissions of Matters to a Vote of Security Holders........ 18
Item 5: Other Information........................................... 18
Item 6: Exhibits and Reports on Form 8-K............................ 18
Signatures............................................................ 19
</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, FEBRUARY 28,
1997 1998
-------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 2,934 $ 3,909
Short-term investments.................................... 15,183 11,663
Trade accounts receivable, less allowance for doubtful
accounts of $540 in 1997 and $560 in 1998.............. 10,868 9,424
Prepaid and other current assets.......................... 1,694 1,035
-------- --------
Total current assets.............................. 30,679 26,031
Property and equipment, at cost, net of accumulated
depreciation and amortization............................. 10,048 8,407
Long-term investments....................................... 7,057 5
Other assets................................................ 1,659 629
-------- --------
Total assets...................................... $ 49,443 $ 35,072
======== ========

LIABILITIES
Current liabilities:
Current portion of long-term debt and capital lease
obligations............................................ $ 617 $ 255
Accounts payable.......................................... 4,409 2,877
Accrued compensation...................................... 2,106 3,730
Other accrued liabilities................................. 1,156 1,703
Deferred revenue.......................................... 3,715 4,831
-------- --------
Total current liabilities......................... 12,003 13,396
Long-term debt and capital lease obligations, net of
current portion........................................ 167 10
-------- --------
Total liabilities................................. 12,170 13,406
======== ========

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 11,269,000
shares in 1998......................................... 11 11
Additional paid-in capital.................................. 90,012 90,904
Notes receivable from stockholders.......................... (1,090) (62)
Unrealized gain on investments.............................. 6 14
Accumulated deficit......................................... (51,666) (69,201)
-------- --------
Total stockholders' equity........................ 37,273 21,666
-------- --------
Total liabilities and stockholders' equity........ $ 49,443 $ 35,072
======== ========
</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 NINE MONTHS ENDED
FEBRUARY 28, FEBRUARY 28,
------------------ -------------------
1997 1998 1997 1998
-------- ------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Software products.................................... $ 9,181 $ 8,652 $ 26,136 $ 18,434
Service and other.................................... 1,942 2,553 5,395 7,299
-------- ------- -------- --------
Total revenues............................... 11,123 11,205 31,531 25,733
-------- ------- -------- --------
Costs of revenues:
Software products.................................... 585 682 2,204 2,248
Service and other.................................... 918 1,148 2,771 4,127
-------- ------- -------- --------
Total costs of revenues...................... 1,503 1,830 4,975 6,375
-------- ------- -------- --------
Gross profit......................................... 9,620 9,375 26,556 19,358
-------- ------- -------- --------
Operating expenses:
Research and development............................. 4,050 3,405 10,839 12,591
Acquisition of in-process research and development... 10,029 -- 10,029 --
Marketing and sales.................................. 5,466 5,530 15,454 17,323
General and administrative........................... 1,196 1,340 3,548 4,976
Restructuring charges................................ -- -- -- 3,006
-------- ------- -------- --------
Total operating expenses..................... 20,741 10,275 39,870 37,896
-------- ------- -------- --------
Loss from operations................................... (11,121) (900) (13,314) (18,538)
Other income, net...................................... 296 340 1,428 1,153
-------- ------- -------- --------
Net loss before provision for income taxes............. (10,825) (560) (11,886) (17,385)
Provision for income taxes............................. -- 50 -- 150
-------- ------- -------- --------
Net loss............................................... $(10,825) $ (610) $(11,886) $(17,535)
======== ======= ======== ========
Net loss per share-basic and diluted................... $ (1.00) $ (0.05) $ (1.10) $ (1.57)
======== ======= ======== ========
Number of shares used in per share calculation-basic
and diluted.......................................... 10,841 11,254 10,800 11,152
======== ======= ======== ========
</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>
NINE MONTHS ENDED
FEBRUARY 28,
--------------------
1997 1998
-------- --------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(11,886) $(17,535)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 2,732 3,966
Non-cash restructuring charges......................... -- 1,351
Provision for doubtful accounts........................ 150 (87)
Amortization of discount on securities................. (517) (23)
Exchange loss.......................................... 12 --
Changes in operating assets and liabilities:
Trade accounts receivable............................ 120 1,532
Prepaid and other current assets..................... (719) 589
Accounts payable..................................... 139 (1,533)
Accrued compensation and other accrued liabilities... 895 860
Deferred revenue..................................... 433 1,071
Write-off in-process research and development........ 10,029 --
-------- --------
Net cash provided by (used in) operating
activities...................................... 1,388 (9,809)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment..................... (6,923) (1,006)
Purchases of marketable securities........................ (49,272) (10,596)
Maturity of marketable securities......................... 33,800 5,000
Proceeds from sale of marketable securities............... 30,462 16,127
Investment in preferred stock............................. (167) 50
Acquisition of Cognisoft Corporation...................... (10,000) --
Capitalization of software................................ (1,035) (198)
Increase in other assets.................................. (28) --
-------- --------
Net cash provided by (used in) investing
activities...................................... (3,163) 9,377
-------- --------
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 1,028
Proceeds from the sale of common stock.................... 1,093 892
Principal payments on notes payable and capital lease
obligations............................................ (125) (520)
-------- --------
Net cash provided by financing activities......... 1,103 1,400
-------- --------
Effect of exchange rate changes on cash..................... (65) 7
-------- --------
Net increase (decrease) in cash and cash
equivalents..................................... (737) 975
Cash and cash equivalents, beginning of period.............. 2,482 2,934
-------- --------
Cash and cash equivalents, end of period.................... $ 1,745 $ 3,909
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest.................. $ 153 $ 95
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Assets acquired in Cognisoft acquisition.................. $ 548 --
Liabilities assumed in Cognisoft acquisition.............. $ 500 --
Cognisoft acquisition consideration included in accrued
liabilities............................................ $ 77 --
</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 FEBRUARY 28, 1998 AND FOR THE QUARTERS ENDED
FEBRUARY 28, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)

1. INTERIM FINANCIAL DATA (UNAUDITED):

The unaudited financial statements for the quarters ended February 28, 1997
and 1998 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 LOSS PER SHARE

The Company has adopted Statement of Financial Accounting Standards No. 128
(SFAS No. 128), "Earnings Per Share," which requires the presentation of basic
and diluted net income per share. Basic net income per common share is computed
using the weighted average number of common shares outstanding during the
period. Diluted net income per share is computed using the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. Dilutive common equivalent shares consist of stock options. The Company
has restated all prior period per share data presented as required by SFAS No.
128. No adjustments were required as a result of the revised computations. For
the three months and nine months ended February 28, 1997 and 1998, common
equivalent shares from stock options, warrants and preferred stock are excluded
from the computation since their effect is antidilutive.

3. RECENT ACCOUNTING PRONOUNCEMENTS

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 FEBRUARY 28, 1998 AND FOR THE QUARTERS ENDED
FEBRUARY 28, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)

In October 1997, the Accounting Standards Executive Committee issued
Statement of Position 97-2 (SOP 97-2), "Software Revenue Recognition," which
delineates the accounting for software product and maintenance revenues. SOP
97-2 supersedes the Accounting Standards Executive Committee Statement of
Position 91-1, "Software Revenue Recognition," and is effective for transactions
entered into in fiscal years beginning after December 15, 1997. The Company is
evaluating the requirements of SOP 97-2 and the effects, if any, on the
Company's current revenue recognition policies.

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 obtained a new
secured line of credit with the same bank subsequent to the quarter ended
February 28, 1998. See Note 8 to Condensed Consolidated Financial Statements.

5. CAPITALIZED SOFTWARE

During the three months ended February 28, 1998, the Company did not
capitalize or amortize any software development costs as their amounts were not
material. As of February 28, 1998, 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
had a one year term and could 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.

7. RESTRUCTURING CHARGES

During the quarter ended November 30, 1997, the Company implemented a
worldwide restructuring of its operations which resulted in workforce reductions
and business consolidations. In connection with the restructuring, the Company
recorded a $3.0 million restructuring charge in the quarter ended November 30,
1997, 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 $1.3
million is a current liability at February 28, 1998. Of the $1.3 million, $0.8
million relates to severance costs to be paid out in future quarters, $0.4
million to the termination of certain lease obligations which are scheduled to
be paid out over the remaining life of the lease agreements and $0.1 million to
other costs associated with the restructuring.

8. SUBSEQUENT EVENTS

In March 1998, the Company negotiated a $5 million line of credit under an
agreement with a bank which expires on September 30, 1998. The line of credit is
collateralized by all corporate assets, excluding leased equipment. Borrowings
under the line of credit bear interest at the lender's prime rate (8.5% at

5
<PAGE> 8
VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF FEBRUARY 28, 1998 AND FOR THE QUARTERS ENDED
FEBRUARY 28, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)

February 28, 1998). The agreement requires the Company to comply with certain
financial covenants and prohibits the assumption of any major debt, except for
equipment leases, without the bank's approval.

6
<PAGE> 9

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

OVERVIEW

HEREIN, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW IN
"RISK FACTORS."

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'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 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 February 28, 1998, the Company had cumulative operating losses of $59.5
million, with net losses of $313,000, $17.9 million and $17.5 million for fiscal
1996, fiscal 1997 and the nine months ended February 28, 1998, respectively. For
the three months ended February 28, 1998, total revenues increased 0.7% over the
corresponding fiscal 1997 period, primarily as a result of a 31.5% increase in
service and other revenues. Total revenues for the three months ended February
28, 1998 increased 22.0% from the $9.2 million for the previous three months
ended November 30, 1997. Operating expenses for the three months ended February
28, 1998 decreased in absolute dollars and as a percentage of revenues from the
prior three months, due primarily to $3.0 million of restructuring charges
incurred during the three months ended November 30, 1997. 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.

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 a $3.0 million restructuring charge in the quarter ended
November 30, 1997, 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 was
appointed as the Company's President and Chief Executive Officer, and the
Company entered into an agreement with Regent Pacific Management Corporation
("Regent Pacific"), a management firm of which Mr. Sbona is the Chief Executive
Officer. Pursuant to the agreement, Regent Pacific provides management services
to the Company at a fee of $50,000 per week, 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 original agreement had a
one year term, but could 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

7
<PAGE> 10

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.

On March 11, 1998, the Company announced that it had filed a lawsuit in the
United States District Court for the District of Delaware against Lotus
Development Corporation for copyright infringement, unfair competition, breach
of a 1992 agreement under which Verity licenses certain software to Lotus,
misappropriation of trade secrets, and unjust enrichment and conversion. The
suit alleges breach of a 1992 license agreement between Verity and Lotus in
which Verity licensed certain search software to Lotus. The suit seeks
injunctive relief and damages, among other remedies. The Company also announced
that it has elected to terminate the agreement due to Lotus's breach. There can
be no assurance that the Company will prevail in its action to recover damages
and obtain injunctive relief, and the Lotus litigation may result in significant
expenses which may have a material adverse effect on the Company's business,
operating results and financial condition.

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.

8
<PAGE> 11

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 NINE MONTHS
ENDED ENDED
FEBRUARY 28, FEBRUARY 28,
----------------- ----------------
1997 1998 1997 1998
------ ----- ----- -----
<S> <C> <C> <C> <C>
Revenues:
Software products.................................. 82.5% 77.2% 82.9% 71.6%
Service and other.................................. 17.5 22.8 17.1 28.4
------ ----- ----- -----
Total revenues............................. 100.0 100.0 100.0 100.0
------ ----- ----- -----
Costs of revenues:
Software products.................................. 5.3 6.1 7.0 8.8
Service and other.................................. 8.2 10.2 8.8 16.0
------ ----- ----- -----
Total costs of revenues.................... 13.5 16.3 15.8 24.8
------ ----- ----- -----
Gross profit......................................... 86.5 83.7 84.2 75.2
------ ----- ----- -----
Operating expenses:
Research and development........................... 36.4 30.4 34.4 48.9
In-process research and development................ 90.2 -- 31.8 --
Marketing and sales................................ 49.1 49.3 49.0 67.3
General and administrative......................... 10.8 12.0 11.2 19.3
Restructuring charge............................... -- -- -- 11.7
------ ----- ----- -----
Total operating expenses................... 186.5 91.7 126.4 147.2
------ ----- ----- -----
Loss from operations................................. (100.0) (8.0) (42.2) (72.0)
Interest and other expenses.......................... 2.7 3.0 4.5 4.5
------ ----- ----- -----
Loss before provision for income taxes............... (97.3) (5.0) (37.7) (67.5)
Provision for income taxes........................... -- 0.4 -- 0.6
------ ----- ----- -----
Net loss............................................. (97.3)% (5.4)% (37.7)% (68.1)%
====== ===== ===== =====
</TABLE>

Revenues

Total revenues decreased 18.4% from $31.5 million for the nine months ended
February 28, 1997 to $25.7 million for the nine months ended February 28, 1998.
Total revenues increased 0.7% from $11.1 million for the three months ended
February 28, 1997 to $11.2 million for the three months ended February 28, 1998.
Total revenues for the comparable nine month period decreased primarily due to
decreased revenues from licensing of enterprise products and Internet/publishing
products. Software product revenues decreased as a percentage of total revenues
from 82.9% and 82.5% for the nine months and three months ended February 28,
1997 respectively, to 71.6% and 77.2%, respectively for the comparable periods
in fiscal 1998. Conversely, service and other revenues increased as a percentage
of total revenues from 17.1% and 17.5% for the nine months and three months
ended February 28, 1997 respectively, to 28.4% and 22.8%, respectively, for the
comparable periods in fiscal 1998.

Software product revenues. Software product revenues decreased 29.5% from
$26.1 million for the nine months ended February 28, 1997 to $18.4 million for
the nine months ended February 28, 1998. The decrease for the nine months ended
February 28, 1998 in comparison to the nine months ended February 28, 1997 was
due principally to decreased revenues from licensing of enterprise products and
Internet/publishing products. Software product revenues decreased 5.8% from $9.2
million for the three months end February 28, 1997 to $8.7 million for the three
months ended February 28, 1998. The decrease for the three months ended February
28, 1998 from the three months ended February 28, 1997 was due principally to
decreased revenues from licensing of enterprise products.

9
<PAGE> 12

Service and other revenues. Service and other revenues increased 35.3% from
$5.4 million for the nine months ended February 28, 1997 to $7.3 million for the
nine months ended February 28, 1998. Service and other revenues increased 31.5%
from $1.9 million for the three months ended February 28, 1997 to $2.6 million
for the three months ended February 28, 1998. 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 4.3% and 6.6% of total
revenues, respectively, for the nine months ended February 28, 1997 and 1998,
with European operations alone accounting for 4.3% and 6.6% of total revenues
for those periods. For the nine months ended February 28, 1997 and 1998, export
sales accounted for 22.2% and 27.5% of total revenues, respectively. Revenues
from foreign operations accounted for 4.4% and 4.8%, respectively, for the three
months ended February 28, 1997 and 1998, with European operations alone
accounting for 4.4% and 4.8% of total revenues for those periods. For the three
months ended February 28, 1997 and 1998, export sales accounted for 21.9% and
30.6% of total revenues, respectively. The increase in revenues from foreign
operations as a percentage of revenues resulted primarily from 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 Cisco Systems, Inc.
accounted for approximately 12.6% of the Company's revenues for the nine months
ended February 28, 1997. For the three months ended February 28, 1997, licensing
and maintenance of software products to Southwestern Bell Telephone accounted
for approximately 13.4% of the Company's revenues. No single customer accounted
for more than 10% of the Company's revenues for the nine months and three months
ended February 28, 1998. Revenues derived from sales to the federal government
and its agencies were 7.1% and 8.9% of the Company's revenues for the nine
months ended February 28, 1997 and 1998, respectively, and 6.3% and 7.1% of the
Company's revenues for the three months ended February 28, 1997 and 1998,
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 increased 2.0% from
$2.20 million for the nine months ended February 28, 1997 to $2.25 million for
the nine months ended February 28, 1998, representing 8.4% and 12.2%,
respectively, of the software product revenues. Costs of software products
increased 16.6% from $585,000 for the three months ended February 28, 1997 to
$682,000 for the three months ended February 28, 1998 representing 6.4% and
7.9%, respectively, of the software product revenues. The increase 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 February 28, 1998. The increase in costs as a percentage of software
product revenues was primarily related to decreased software product revenues
for the nine months ended February 28, 1998.

Costs of service and other. Costs of service and other revenues increased
48.9% from $2.8 million for the nine months ended February 28, 1997 to $4.1
million for the nine months ended February 28, 1998, representing 51.4% and
56.5%, respectively, of service and other revenues. Cost of service and other
revenues increased 25.1% from $918,000 for the three months ended February 28,
1997 to $1.1 million for the three months ended February 28, 1998, representing
47.3% and 45.0%, respectively, of service and other revenues. The increase in
absolute dollars was due principally to increases in consulting and technical
support personnel.

Operating expenses

Research and development. Research and development expenses increased 16.2%
from $10.8 million for the nine months ended February 28, 1997 to $12.6 million
for the nine months ended February 28, 1998, representing 34.4% and 48.9%,
respectively, of total revenues. Research and development expenses decreased
15.9% from $4.1 million for the three months ended February 28, 1997 to $3.4
million for the three months ended February 28, 1998, representing 36.4% and
30.4%, respectively, of total revenues. The increase in absolute costs for the
nine months ended February 28, 1998, was primarily due to a significant increase
in

10
<PAGE> 13

headcount of research and development personnel. In particular, the Company
incurred increased staffing expense relating principally to the recent
acquisition of KeyView. In addition, during the nine months ended February 28,
1997, the Company capitalized approximately $1.0 million of software development
costs in connection with the development of a number of products included in the
Company's SEARCH'97 product line, which when expensed were included in costs of
software products. The increase in costs as a percentage of total revenues was
primarily related to decreased revenues for the nine months ended February 28,
1998. The decrease in absolute costs and as a percentage of total revenues for
the three months ended February 28, 1998, was primarily due to the closure of
the Company's Applications Division (Cognisoft Corporation) and the U.K.
research and development unit (InSite). Future research and development expenses
may vary as a percentage of total revenues.

Marketing and sales. Marketing and sales expenses increased 12.1% from
$15.5 million in the nine months ended February 28, 1997 to $17.3 million for
the nine months ended February 28, 1998, representing 49.0% and 67.3%,
respectively, of total revenues. Marketing and sales expenses increased 1.2%
from $5.47 million for the three months ended February 28, 1997 to $5.53 million
for the three months ended February 28, 1998, representing 49.1% and 49.4%,
respectively, of total revenues. The increase in absolute costs for the nine
months ended February 28, 1998, 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 nine months ended February 28, 1998. The Company anticipates it will
continue to make significant investments in marketing and sales.

General and administrative. General and administrative expenses increased
40.2% from $3.5 million in the nine months ended February 28, 1997 to $5.0
million for the nine months ended February 28, 1998, representing 11.3% and
19.3%, respectively, of total revenues. General and administrative expenses
increased 12.0% from $1.2 million in the three months ended February 28, 1997 to
$1.3 million for the three months ended February 28, 1998, representing 10.8%
and 12.0%, 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 nine months ended February 28, 1998. The Company anticipates
that future general and administrative expenses will increase due to an increase
in legal expenses associated with the lawsuit filed with Lotus Development
Corporation. See Note 8 to Condensed Consolidated Financial Statements.

Restructuring charges. During the quarter ended November 30, 1997, the
Company implemented a worldwide restructuring of its operations which resulted
in workforce reductions and business consolidations. In connection with the
restructuring, the Company recorded a $3.0 million restructuring charge in the
quarter ended November 30, 1997, 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.

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.

11
<PAGE> 14

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, 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 February 28, 1998, the Company had $15.6 million in cash and cash equivalents
and available-for-sale securities.

The Company's operating activities generated cash of $1.4 million and used
cash of $9.8 million for the nine months ended February 28, 1997 and 1998,
respectively. In the nine months ended February 28, 1997, cash generated in
operations consisted primarily of the write-off of in-process research and
development and depreciation and amortization expense. For the nine months ended
February 28, 1998, 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 used cash of $3.2 million and provided
cash of $9.4 million for the nine months ended February 28, 1997 and 1998,
respectively. For the nine months ended February 28, 1997 cash used in investing
activities consisted primarily of purchases of marketable securities and the
acquisition of Cognisoft Corporation less proceeds from the sale and maturity of
marketable securities. For the nine months ended February 28, 1998, 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 $1.1 million and $1.4 million for
the nine months ended February 28, 1997 and 1998, respectively. In the nine
months ended February 28, 1997 and 1998, 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 February 28, 1998, the Company's principal sources of liquidity were its
cash, cash equivalents, and short-term investments of $15.6 million. The
Company's unsecured line of credit, which provided for up to $7.5 million in
credit, expired on November 29, 1997. In March 1998, the Company obtained a $5
million line of credit under an agreement with the same bank which expires on
September 30, 1998. The line of credit is collateralized by all corporate
assets, excluding leased equipment. Borrowings under the line of credit bear
interest at the lender's prime rate. The agreement requires the Company to
comply with certain financial covenants and prohibits the assumption of any
major debt, except for equipment leases, without the bank's approval. As of
February 28, 1998, no borrowings were outstanding under the new line of credit.
See Note 8 of Notes to Condensed Consolidated Financial Statements.

Capital expenditures, including capital leases, were approximately $6.9
million and $1.0 million for the nine months ended February 28, 1997 and 1998,
respectively. For the nine months ended February 28, 1997, these expenditures
consisted primarily of leasehold improvements and capital equipment related to
the Company's relocation to a new facility. In the nine months ended February
28, 1998, 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 calendar 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.

12
<PAGE> 15

RISK FACTORS

The Company operates in a rapidly changing environment that involves
numerous risks, a number of which are beyond the Company's control. The
following discussion highlights some of those risks. A comprehensive summary of
the risks can be found in the Company's Annual Report on Form 10-K for the
fiscal year ended May 31, 1997 and the Company's definitive Proxy Statement on
Schedule 14A as filed on September 15, 1997.

History of Losses; Strategic Realignment. Since inception, the Company has
incurred significant losses and substantial negative cash flow. In the nine
months ended February 28, 1998, the Company had a net loss of approximately
$17.5 million, and an operating loss of approximately $18.5 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. 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 was appointed 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 at a fee of $50,000 per week, 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 had a one year term, but could 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. If Company management is unable
to effectively manage the Company's operations,

13
<PAGE> 16

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.

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.

Litigation. On March 11, 1998, the Company announced that it had filed a
lawsuit in the United States strict Court for the District of Delaware against
Lotus Development Corporation for copyright infringement, unfair competition,
breach of a 1992 agreement under which the Company licensed certain software to
Lotus, misappropriation of trade secrets, and unjust enrichment and conversion.
The suit seeks injunctive relief and damages, among other remedies. The Company
also announced that it has elected to terminate the agreement due to Lotus's
breach. There can be no assurance that the Company will prevail in its action to
recover damages and obtain injunctive relief, and the Lotus litigation may
result in significant expenses which may have a material adverse effect on the
Company's business, operating results and financial condition.

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.

14
<PAGE> 17

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 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 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 4.3% and 6.6% of total revenues, respectively, for the nine months
ended February 28, 1997 and 1998, with European operations alone accounting for
4.3% and 6.6% of total revenues for those periods. For the nine months ended
February 28, 1997 and 1998, export sales accounted for 22.2% and 27.5% of total
revenues, respectively. Revenues from foreign operations accounted for 4.4% and
4.8%, respectively, for the three months ended February 28, 1997 and 1998, with
European operations alone accounting for 4.4% and 4.8% of total revenues for
those periods. For the three months ended February 28, 1997 and 1998, export
sales accounted for 21.9% and 30.6% of total revenues, respectively. The
increase in revenues from foreign operations as a percentage of revenues
resulted primarily from 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

15
<PAGE> 18

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 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 7.1% and 8.9% of the Company's revenues for the nine months ended
February 28, 1997 and 1998, respectively and 6.3% and 7.1% of the Company's
revenues for the three months ended February 28, 1997 and 1998, 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 8.9% of revenues in fiscal 1996, fiscal 1997 and
the nine months ended February 28, 1998, 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

16
<PAGE> 19

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 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> 20

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

Not Applicable

ITEM 5. OTHER INFORMATION

Not Applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

A. Exhibits -- See Exhibit Index

B. Form 8-K

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<PAGE> 21

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: April 14, 1998

19
<PAGE> 22

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT SEQUENTIAL
NUMBER DESCRIPTION OF DOCUMENT PAGE NO.
- ------- ----------------------- ----------
<S> <C> <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)................................................
10.7 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)..........................
10.22 Security and Loan Agreement between Imperial Bank and the
Company dated November 30, 1997.............................
27.1 Financial Data Schedule.....................................
</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.

(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.

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<PAGE> 23

(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 10.22

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

VERITY, INC.

LOAN AND SECURITY AGREEMENT

- -------------------------------------------------------------------------------
<PAGE> 2
TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
1. DEFINITIONS AND CONSTRUCTIONS ......................................... 1
1.1 Definitions ...................................................... 1
1.2 Accounting Terms ................................................. 7

2. LOAN AND TERMS OF PAYMENT ............................................. 7
2.1 Advances ......................................................... 7
2.2 Interest Rates, Payments, and Calculations ....................... 9
2.3 Crediting Payments ............................................... 10
2.4 Fees ............................................................. 10
2.5 Additional Costs ................................................. 10

3. CONDITIONS OF LOANS ................................................... 11
3.1 Conditions Precedent to Initial Advances ......................... 11
3.2 Conditions Precedent to all Advances ............................. 11

4. CREATION OF SECURITY INTEREST ......................................... 12
4.1 Grant of Security Interest ....................................... 12
4.2 Delivery of Additional Documentation Required .................... 12
4.3 Right to Inspect ................................................. 12

5. REPRESENTATIONS AND WARRANTIES ........................................ 12
5.1 Due Organization and Qualification ............................... 12
5.2 Due Authorization; No Conflict ................................... 12
5.3 No Prior Encumbrances ............................................ 12
5.4 Bona Fide Accounts ............................................... 12
5.5 Merchantable Inventory ........................................... 12
5.6 Intellectual Property ............................................ 13
5.7 Name; Location of Chief Executive Office ......................... 13
5.8 Litigation ....................................................... 13
5.9 No Material Adverse Change in Financial Statements ............... 13
5.10 Solvency ......................................................... 13
5.11 Regulatory Compliance ............................................ 13
5.12 Environmental Condition .......................................... 13
5.13 Taxes ............................................................ 14
5.14 Subsidiaries ..................................................... 14
5.15 Government Consents .............................................. 14
5.16 Full Disclosure .................................................. 14

6. AFFIRMATIVE COVENANTS ................................................. 14
6.1 Good Standing .................................................... 14
6.2 Government Compliance ............................................ 14
6.3 Financial Statements, Reports, Certificates ...................... 14
6.4 Inventory; Returns ............................................... 15
6.5 Taxes ............................................................ 15
6.6 Insurance ........................................................ 15
6.7 Principal Depository ............................................. 16
6.8 Quick Ratio ...................................................... 16
6.9 Tangible Net Worth ............................................... 16
6.10 Debt-Tangible Net Worth .......................................... 16
6.11 Profitability .................................................... 16

</TABLE>

i
<PAGE> 3
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
6.12 Registration of Intellectual Property Rights ..................... 16
6.13 Further Assurances ............................................... 16

7. NEGATIVE COVENANTS .................................................... 17
7.1 Dispositions ..................................................... 17
7.2 Change in Business ............................................... 17
7.3 Mergers or Acquisitions .......................................... 17
7.4 Indebtedness ..................................................... 17
7.5 Encumbrances ..................................................... 17
7.6 Distributions .................................................... 17
7.7 Investments ...................................................... 17
7.8 Transactions with Affiliates ..................................... 17
7.9 Intellectual Property Agreements ................................. 17
7.10 Subordinated Debt ................................................ 18
7.11 Inventory ........................................................ 18
7.12 Compliance ....................................................... 18

8. EVENTS OF DEFAULT ..................................................... 18
8.1 Payment Default .................................................. 18
8.2 Covenant Default ................................................. 18
8.3 Material Adverse Effect .......................................... 18
8.4 Attachment ....................................................... 18
8.5 Insolvency ....................................................... 19
8.6 Other Agreements ................................................. 19
8.7 Subordinated Debt ................................................ 19
8.8 Judgments ........................................................ 19
8.9 Misrepresentations ............................................... 19

9. BANK'S RIGHTS AND REMEDIES ............................................ 19
9.1 Rights and Remedies .............................................. 19
9.2 Power of Attorney ................................................ 20
9.3 Accounts Collection .............................................. 21
9.4 Bank Expenses .................................................... 21
9.5 Bank's Liability for Collateral .................................. 21
9.6 Remedies Cumulative .............................................. 21
9.7 Demand; Protest .................................................. 21

10. NOTICES ............................................................... 21

11. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER ............................ 22

12. GENERAL PROVISIONS .................................................... 22
12.1 Successors and Assigns ........................................... 22
12.2 Indemnification .................................................. 22
12.3 Time of Essence .................................................. 22
12.4 Severability of Provisions ....................................... 23
12.5 Amendments in Writing, Integration ............................... 23
12.6 Counterparts ..................................................... 23
12.7 Survival ......................................................... 23
12.8 Confidentiality .................................................. 23

13. JUDICIAL REFERENCE .................................................... 23

</TABLE>

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<PAGE> 4
This LOAN AND SECURITY AGREEMENT (the "Agreement") is entered into as of
November 30, 1997, by and between IMPERIAL BANK ("Bank") and VERITY, INC.
("Borrower").

RECITALS

Borrower wishes to obtain credit from time to time from Bank, and Bank
desires to extend credit to Borrower. This Agreement sets forth the terms on
which Bank will advance credit to Borrower, and Borrower will repay the amounts
owing to Bank.

AGREEMENT

The parties agree as follows:

1. DEFINITIONS AND CONSTRUCTION

1.1 Definitions. As used in this Agreement, the following terms
shall have the following definitions:

"Accounts" means all presently existing and hereafter
arising accounts, contract rights, and all other forms of obligations owing to
Borrower arising out of the sale or lease of goods (including, without
limitation, the licensing of software and other technology) or the rendering of
services by Borrower, whether or not earned by performance, and any and all
credit insurance, guaranties, and other security therefor, as well as all
merchandise returned to or reclaimed by Borrower and Borrower's Books relating
to any of the foregoing.

"Advance" or "advances" means a cash advance under the
Revolving Facility.

"Affiliate" means, with respect to any Person, any Person
that owns or controls directly or indirectly such Person, any Person that
controls or is controlled by or is controlled by or is under common control with
such Person, and each of such Person's senior executive officers, directors,
and partners.

"Bank Expenses" means all: reasonable costs or expenses
(including reasonable attorneys' fees and expenses) incurred in connection with
the preparation, negotiation, administration, and enforcement of the Loan
Documents; and Bank's reasonable attorneys' fees and expenses incurred in
amending, enforcing or defending the Loan Documents (including fees and expenses
of appeal), whether or not suit is brought.

"Borrower's Books" means all of Borrower's books and
records including: ledgers; records concerning Borrower's assets or
liabilities, the Collateral, business operations or financial condition; and all
computer programs, or tape files, and the equipment, containing such
information.

"Business Day" means any day that is not a Saturday,
Sunday, or other day on which banks in the State of California are authorized or
required to close.

"Closing Date" means the date of this Agreement.

"Code" means the California Uniform Commercial Code.

"Collateral" means the property described on Exhibit A
attached hereto.

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<PAGE> 5
"Committed Line" means Two Million Five Hundred Thousand Dollars
($2,500,000); provided that, after Borrower has taken the actions specified in
Section 6.12 to Bank's reasonable satisfaction that would otherwise be required
only upon the occurrence of an Event of Default, the Committed Line shall be
Five Million Dollars ($5,000,000).

"Contingent Obligation" means, as applied to any Person, any direct
or indirect liability, contingent or otherwise, of that Person with respect to
(i) any indebtedness, lease, dividend, letter of credit or other obligation of
another, including, without limitation, any such obligation directly
or indirectly guaranteed, endorsed, co-made or discounted or sold with recourse
by that Person, or in respect of which that Person is otherwise directly or
indirectly liable; (ii) any obligations with respect to undrawn letters of
credit issued for the account of that Person; and (iii) all obligations arising
under any interest rate, currency or commodity swap agreement, interest rate
cap agreement, interest rate collar agreement, or other agreement or
arrangement designated to protect a Person against fluctuation in interest
rates, currency exchange rates or commodity prices; provided, however, that the
term "Contingent Obligation" shall not include endorsements for collection or
deposit in the ordinary course of business. The amount of any Contingent
Obligation shall be deemed to be an amount equal to the stated or determined
amount of the primary obligation in respect of which such Contingent Obligation
is made or, if not stated or determinable, the maximum reasonably anticipated
liability in respect thereof as determined by such Person in good faith;
provided, however, that such amount shall not in any event exceed the maximum
amount of the obligations under the guarantee or other support arrangement.

"Copyrights" means any and all copyright rights, copyright
applications, copyright registrations and like protections in each work or
authorship and derivative work thereof, whether published or unpublished and
whether or not the same also constitutes a trade secret, now or hereafter
existing, created, acquired or held.

"Current Liabilities" means, as of any applicable date, all amounts
that should, in accordance with GAAP, be included as current liabilities on the
consolidated balance sheet of Borrower and its Subsidiaries, as at such date,
plus, to the extent not already included therein, all outstanding Advances made
under this Agreement, including all Indebtedness that is payable upon demand or
within one year from the date of determination thereof unless such Indebtedness
is renewable or extendable at the option of Borrower or any Subsidiary to a
date more than one year from the date of determination, but excluding
Subordinated Debt.

"Daily Balance" means the amount of the Obligations owed at the end
of a given day.

"Equipment" means all present and future machinery, equipment, tenant
improvements, furniture, fixtures, vehicles, tools, parts and attachments in
which Borrower has any interest.

"ERISA" means the Employee Retirement Income Security Act of 1974,
as amended, and the regulations thereunder.

"Foreign Exchange Reserve" has the meaning set forth in Section 2.1.2
herein.

"GAAP" means generally accepted accounting principles as in effect
from time to time.

"Indebtedness" means (a) all indebtedness for borrowed money or the
deferred purchase price of property or services, including without limitation
reimbursement and other obligations with respect to surety bonds and letters
of credit, (b) all obligations evidenced by notes,

2
<PAGE> 6
bonds, debentures or similar instruments, (c) all capital lease obligations and
(d) all Contingent Obligations.

"Insolvency Proceeding" means any proceeding commenced by or against
any person or entity under any provision of the United States Bankruptcy Code,
as amended, or under any other bankruptcy or insolvency law, including
assignments for the benefit of creditors, formal or informal moratoria,
compositions, extension generally with its creditors, or proceedings seeking
reorganization, arrangement, or other relief.

"Intellectual Property Collateral" means

(a) Copyrights, Trademarks and Patents;

(b) Any and all trade secrets, and any and all intellectual property
rights in computer software and computer software products now or hereafter
existing, created, acquired or held;

(d) Any and all claims for damages by way of past, present and
future infringement of any of the rights included above, with the right, but
not the obligation, to sue for and collect such damages for said use or
infringement of the intellectual property rights identified above;

(e) All licensed or other rights to use any of the Copyrights,
Patents or Trademarks, and all license fees and royalties arising from such use
to the extent permitted by such license or rights;

(f) All amendments, renewals and extensions of any of the
Copyrights, Trademarks or Patents; and

(g) All proceeds and products of the foregoing, including without
limitation all payments under insurance or any indemnity or warranty payable in
respect of any of the foregoing.

"Inventory" means all present and future inventory in which Borrower
has any interest, including merchandise, raw materials, parts, supplies,
packing and shipping materials, work in process and finished products intended
for sale or lease or to be furnished under a contract of service, of every kind
and description now or at any time hereafter owned by or in the custody or
possession, actual or constructive, of Borrower, including such inventory as
is temporarily out of its custody or possession or in transit and including any
returns upon any accounts or other proceeds, including insurance proceeds,
resulting from the sale or disposition of any of the foregoing and any
documents of title representing any of the above, and Borrower's Books relating
to any of the foregoing.

"Investment" means any beneficial ownership of (including stock,
partnership interest or other securities) any Person, or any loan, advance or
capital contribution to any Person.

"IRC" means the Internal Revenue Code of 1986, as amended, and the
regulations thereunder.

"Letter of Credit" or "Letters of Credit" has the meaning set forth in
Section 2.1.1 herein.

3
<PAGE> 7
"LIEN" means any mortgage, lien, deed of trust, charge, pledge, security
interest or other encumbrance.

"Loan Documents" means, collectively, this Agreement, any note or notes
executed by Borrower, and any other agreement entered into between Borrower and
Bank in connection with this Agreement, all as amended or extended from time to
time.

"Material Adverse Effect" means a material adverse effect on (i) the
business operations or condition (financial or otherwise) of Borrower and
its Subsidiaries taken as a whole or (ii) the ability of Borrower to repay the
Obligations or otherwise perform its obligations under the Loan Documents.

"Maturity Date" means September 30, 1998.

"Negotiable Collateral" means all of Borrower's present and future letters
of credit of which it is a beneficiary, notes, drafts, instruments, securities,
documents of title, and chattel paper, and Borrower's Books relating to any of
the foregoing.

"Obligations" means all debt, principal, interest, Bank Expenses and other
amounts owed to Bank by Borrower pursuant to this Agreement or any other
agreement, whether absolute or contingent, due or to become due, now existing
or hereafter arising, including any interest that accrues after the
commencement of an Insolvency Proceeding and including any debt, liability, or
obligation owing from Borrower to others that Bank may have obtained by
assignment or otherwise.

"Patents" means all patents, patent applications and like protections
including without limitation improvements, divisions, continuations, renewals,
reissues, extensions and continuations-in-part of the same.

"Periodic Payments" means all installments or similar recurring payments
that Borrower may now or hereafter become obligated to pay to Bank pursuant to
the terms and provisions of any instrument, or agreement now or hereafter in
existence between Borrower and Bank.

"Permitted Indebtedness" means:

(a) Indebtedness of Borrower in favor of Bank arising under this
Agreement or any other Loan Document;

(b) Indebtedness existing on the Closing Date and disclosed in the
Schedule;

(c) Indebtedness secured by a Lien described in clause (c) of Permitted
Liens, provided the principal amount of such Indebtedness does not exceed the
lesser of the cost or fair market value of the Equipment financed with the
proceeds of such Indebtedness;

(d) Subordinated Debt;

(e) Indebtedness to trade creditors incurred in the ordinary course of
business;

(f) Other Indebtedness in an aggregate outstanding amount not exceeding
$100,000;

4
<PAGE> 8
(g) Contingent obligations of Borrower consisting of guaranties (and
other credit support) of the obligations of vendors and suppliers of Borrower
in respect of transactions entered into in the ordinary course of Borrower's
business; and

(h) Extensions, renewals, refundings, refinancings, modifications,
amendments and restatements of any of the items of Permitted Indebtedness (a)
through (g) above, provided that the principal amount thereof is not increased
or the terms thereof are not modified to impose more burdensome terms upon
Borrower.

"Permitted Investment" means:

(a) Investment existing on the Closing Date disclosed in the Schedule;

(b) (i) marketable direct obligations issued or unconditionally
guaranteed by the United States of America or any agency or any State thereof
maturing within one (1) year from the date of acquisition thereof, (ii)
commercial paper maturing no more than two (2) years from the date of creation
thereof and currently having the highest rating obtainable from either Standard
& Poor's Corporation or Moody's Investors Service, Inc., and (iii) certificates
of deposit maturing no more than one (1) year from the date of investment
therein issued by Bank and other investments in the aggregate amount not
exceeding $100,000;

(c) Investments (including debt obligations) received in connection with
the bankruptcy or reorganization of customers or suppliers and in settlement of
delinquent obligations of, and other disputes with customers or suppliers
arising in the ordinary course of Borrower's business;

(d) Investments consisting of (i) compensation of employees, officers and
directors of Borrower so long as the Board of Directors of Borrower determines
that such compensation is in the best interests of Borrower, (ii) travel
advances, employee relocation loans and other employee loans and advances in
the ordinary course of Borrower's business, (iii) loans to employees, officers
or directors relating to the purchase of equity securities of Borrower, and
(iv) other loans to officers and employees approved by the Board of Directors,
not to exceed $150,000 in the aggregate; and

(e) other Investments aggregating not in excess of $100,000 at any time.

"Permitted Liens" means the following:

(a) Any Liens existing on the Closing Date and disclosed in the Schedule
or arising under this Agreement or the other Loan Documents;

(b) Liens for taxes, fees, assessments or other governmental charges or
levies, either not delinquent or being contested in good faith by appropriate
proceedings, provided the same have no priority over any of Bank's security
interests, unless required by law;

(c) Liens (i) upon or in any equipment acquired, leased or held by
Borrower or any of its Subsidiaries to secure the purchase price of such
equipment or indebtedness incurred solely for the purpose of financing the
acquisition or lease of such equipment, or (ii) existing on such equipment at
the time of its acquisition, provided that the Lien is confined solely to the
property so acquired and improvements thereon, and the proceeds of such
equipment;

(d) Leases or subleases and licenses or sublicenses granted to others in
the ordinary course of Borrower's business not interfering in any material
respect with the business of Borrower and its Subsidiaries taken as a whole,
and any interest or title of a lessor, licensor or under

5
<PAGE> 9
any lease or license provided that such leases, subleases, licenses and
sublicenses do not prohibit the grant of the security interest granted
hereunder;

(e) Liens arising from judgements, decrees or attachments to the
extent and only so long as such judgment, decree or attachment has not caused or
resulted in an Event of Default under Section 8.4;

(f) Liens in favor of customs and revenue authorities arising as
a matter of law to secure payment of customs duties in connection with the
importation of goods;

(g) Liens arising solely by virtue of any statutory or common
law provision relating to banker's liens, rights of set-off or similar rights
and remedies as to deposit accounts or other funds maintained with a creditor
depository institution;

(h) Liens, not otherwise permitted, which Liens secure
obligations of Borrower which do not in the aggregate exceed $100,000 at any
time; and

(i) Liens incurred in connection with the extension, renewal or
refinancing of the indebtedness secured by Liens of the type described in
clauses (a) through (h) above, provided that any extension, renewal or
replacement Lien shall be limited to the property encumbered by the existing
Lien and the principal amount of the indebtedness being extended, renewed or
refinanced does not increase.

"Person" means any individual, sole proprietorship, partnership,
limited liability company, joint venture, trust, unincorporated organization,
association, corporation, institution, public benefit corporation, firm, joint
stock company, estate, entity or governmental agency.

"Prime rate" means the variable rate of interest, per annum, most
recently announced by Bank, as its "prime rate," whether or not such announced
rate is the lowest rate available from Bank.

"Quick Assets" means, at any date as of which the amount thereof
shall be determined, the consolidated cash, cash-equivalents, accounts
receivable and investments, with maturities not to exceed one year, of Borrower
determined in accordance with GAAP.

"Responsible Officer" means each of the Chief Executive Officer,
the Chief Financial Officer and the Controller of Borrower.

"Revolving Facility" means the facility under which the Borrower
may request Bank to issue cash advances, as specified in Section 2.1 hereof.

"Schedule" means the schedule of exceptions attached hereto, if
any.

"Subordinated Debt" means any debt incurred by Borrower that is
subordinated to the debt owing by Borrower to Bank on terms acceptable to Bank
(and identified as being such by Borrower and Bank).

"Subsidiary" means any corporation or partnership in which (i)
any general partnership interest or (ii) more than 50% of the stock of which by
the terms thereof ordinary voting power to elect the Board of Directors,
managers or trustees of the entity shall, at the time as of which any
determination is being made, be owned by Borrower, either directly or through an
Affiliate.

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<PAGE> 10
"Tangible Net Worth" means at any date as of which the amount
thereof shall be determined, Borrower's net worth calculated in accordance with
GAAP minus intangible assets plus Subordinated Debt.

"Total Liabilities" means at any date as of which the amount
thereof shall be determined, all obligations that should, in accordance with
GAAP be classified as liabilities on the consolidated balance sheet of Borrower,
including in any event all Indebtedness, but specifically excluding Subordinated
Debt.

"Trademarks" means any trademark and servicemark rights, whether
registered or not, applications to register and registrations of the same and
like protections, and the entire goodwill of the business of Assignor connected
with and symbolized by such trademarks.

1.2 Accounting Terms. All accounting terms not specifically defined
herein shall be construed in accordance with GAAP and all calculations made
hereunder shall be made in accordance with GAAP. When used herein, the terms
"financial statements" shall include the notes and schedules thereto.

2. LOAN AND TERMS OF PAYMENT

2.1 Advances.

(a) Subject to and upon the terms and conditions of this
Agreement, Bank agrees to make Advances to Borrower in an aggregate amount not
to exceed the Committed Line minus the face amount of all outstanding Letters
of Credit (including drawn but unreimbursed Letters of Credit) and the Foreign
Exchange Reserve. Subject to the terms and conditions of this Agreement,
amounts borrowed pursuant to this Section 2.1 may be repaid and reborrowed at
any time without penalty, in whole or in part, prior to the Maturity Date.

(b) Whenever Borrower desires and Advance, Borrower will notify
Bank by facsimile transmission or telephone no later than 3:00 p.m. California
time, on the Business Day that the Advance is to be made. Each such
notification shall be promptly confirmed by a Payment/Advance Form in
substantially the form of Exhibit B hereto. Bank is authorized to make Advances
under this Agreement, based upon instructions received from a Responsible
Officer or such other individuals who shall have expressly been authorized by
Borrower, or without instructions if in Bank's discretion such Advances are
necessary to meet Obligations which have become due and remain unpaid. Bank
shall be entitled to rely on any telephonic notice given by a person whom Bank
reasonably believes to be a Responsible Officer or such other individuals who
shall have expressly been authorized by Borrower, and Borrower shall indemnify
and hold Bank harmless for any damages or loss suffered by Bank as a result of
such reliance. Bank will credit the amount of Advances made under this Section
2.1 to Borrower's deposit account designated for receipt of funds in respect of
such Advance.

(c) The Revolving Facility shall terminate on the Maturity
Date, at which time all Advances under this Section 2.1 shall be immediately
due and payable.

2.1.1 Letters of Credit

(a) Subject to the terms and conditions of this
Agreement, Bank agrees to issue or cause to be issued letters of credit (each a
"Letter of Credit," collectively, the "Letters of Credit") for the account of
Borrower in an aggregate face amount not to exceed the Committed Line minus the
sum of the then outstanding principal balance of the Advances, the face amount
outstanding Letters of Credit and the Foreign Exchange Reserve; provided that
the face amount of outstanding Letters of Credit (including drawn but
unreimbursed Letters of Credit) shall not in any

7
<PAGE> 11
case exceed One Million Dollars ($1,000,000). Each such Letter of Credit shall
have an expiry date no later than the Maturity Date. All such Letters of Credit
shall be, in form and substance, acceptable to Bank in its sole discretion and
shall be subject to the terms and conditions of Bank's form of application and
letter of credit agreement. All amounts actually paid by Bank in respect of a
Letter of Credit shall, when paid, constitute an Advance under this Agreement.

(b) The obligation of Borrower to immediately reimburse
Bank for drawings made under Letters of Credit shall be absolute, unconditional
and irrevocable, and shall be performed strictly in accordance with the terms of
this Agreement and such Letters of Credit, under all circumstances whatsoever.
Borrower shall indemnify, defend and hold Bank harmless from any loss, cost,
expense or liability, including, without limitation, reasonable attorneys' fees,
arising out of or in connection with any Letters of Credit.

(c) Borrower may request that Bank issue a Letter of Credit
payable in a currency other than United States Dollars. If a demand for payment
is made under any such Letter of Credit, Bank shall treat such demand as an
advance to Borrower of the equivalent of the amount thereof (plus cable charges)
in United States currency at the then prevailing rate of exchange in San
Francisco, California, for sales of that other currency for cable transfer to
the country of which it is the currency.

(d) Upon the issuance of any Letter of Credit payable in a
currency other than United States Dollars, Bank shall create a reserve under the
Committed Line for Letters of Credit against fluctuations in currency exchange
rates, in an amount equal to ten percent (10%) of the face amount of such Letter
of Credit. The amount of such reserve may be amended by Bank from time to time
to account for fluctuations in the exchange rate. The availability of funds
under the Committed Line shall be reduced by the amount of such reserve for so
long as such Letter of Credit remains outstanding.

2.1.2 Foreign Exchange Contract: Foreign Exchange
Settlements.

(a) Subject to the terms of this Agreement, Borrower may
enter into foreign exchange contracts (the "Exchange Contracts") not to exceed
an aggregate amount of One Million Dollars ($1,000,000) (the "Contract Limit"),
pursuant to which Bank shall sell to or purchase from Borrower foreign currency
on a spot or forward basis. Bank shall not be obligated to enter into any
Exchange Contracts with Borrower at any time Borrower is out of compliance with
any of the provisions of this Agreement. All Exchange Contracts must provide for
delivery of settlement on or before the Maturity Date. The amount available
under the Committed Line at any time shall be reduced by the following amounts
(the "Foreign Exchange Reserve") on any given day (the "Determination Date"):
(i) on all outstanding Exchange Contracts on which delivery is to be effected or
settlement allowed more than two business days after the Determination Date, ten
percent (10%) of the gross amount of the Exchange Contracts; plus (ii) on all
outstanding Exchange Contracts on which delivery is to be effected or settlement
allowed within two business days after the Determination Date, one hundred
percent (100%) of the gross amount of the Exchange Contracts.

(b) Bank may, in its discretion, terminate the Exchange
Contracts at any time when (a) an Event of Default has occurred and is
continuing for (b) that there is no sufficient availability under the Committed
Line and Borrower does not have available funds in its bank account to satisfy
the Foreign Exchange Reserve. If Bank terminates the Exchange Contracts in
accordance with this Agreement, and without limitation of any applicable
indemnities, Borrower agrees to reimburse Bank for any and all fees, costs and
expenses relating thereto or arising in connection therewith.

(c) Borrower shall not permit the total gross amount of all
Exchange Contracts on which delivery is to be effected and settlement allowed in
any two business

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<PAGE> 12
day period to be more than One Million Dollars ($1,000,000) (the "Settlement
Limit"), nor shall Borrower permit the total gross amount of all Exchange
Contracts to which Borrower is a party, outstanding at any one time, to exceed
the Contract Limit. Notwithstanding the above, however, the amount which may be
settled in any two (2) business day period may be increased above the Settlement
Limit up to, but in no event to exceed, the amount of the Contract Limit under
either of the following circumstances:

(i) if there is sufficient availability under the Committed
Line in the amount of the Foreign Exchange Reserve as of each Determination
Date, provided that Bank in advance shall reserve the full amount of the Foreign
Exchange Reserve against the Committed Line; or

(ii) if there is insufficient availability under the
Committed Line, as to settlements within any two (2) business day period,
provided that Bank, in its sole discretion, may: (A) verify good funds overseas
prior to crediting Borrower's deposit account with Bank (in the case of
Borrower's sale of foreign currency); or (B) debit Borrower's deposit account
with Bank prior to delivering foreign currency overseas (in the case of
Borrower's purchase of foreign currency).

(d) In the case of Borrower's purchase of foreign currency,
Borrower in advance shall instruct Bank upon settlement either to treat the
settlement amount as an advance under the Committed Line, or to debit Borrower's
account for the amount settled.

(e) Borrower shall execute all standard form applications and
agreements of Bank in connection with the Exchange Contracts and, without
limiting any of the terms of such applications and agreements, Borrower will pay
all standard fees and charges of Bank in connection with the Exchange Contracts.

(f) Without limiting any of the other terms of this Agreement or
any such standard form applications and agreements of Bank, Borrower agrees to
indemnify Bank and hold it harmless from and against any and all claims, debts,
liabilities, demands, obligations, actions, costs and expenses (including,
without limitation, reasonable attorneys' fees of counsel of Bank's choice), of
every nature and description which it may sustain or incur, based upon, arising
out of, or in any way relating to any of the Exchange Contracts or any
transactions relating thereto or contemplated thereby.

2.2 Interest Rates, Payments, and Calculations.

(a) Interest Rate. Except as set forth in Section 2.2(b), any
Advances shall bear interest, on the average Daily Balance, at a rate equal to
the Prime Rate.

(b) Late Payment Fee; Default Rate. If any payment is not made within
ten (10) days of the date such payment is due, Borrower shall pay Bank a late
fee equal to the lesser of (i) five percent (5%) of the amount of such unpaid
amount or (ii) the maximum amount permitted to be charged under applicable law.
All Obligations shall bear interest, from and after the date Borrower receives
written notice of the occurrence of an Event of Default and during the
continuance thereof, at a rate equal to five (5) percentage points above the
interest rate applicable immediately prior to the occurrence of the Event of
Default.

(c) Payments. Except as specified in Section 2.4(b), interest
hereunder shall be due and payable on the tenth (10th) calendar day of each
month during the term hereof. Bank shall, at its option, charge such interest,
all Bank Expenses, and all Periodic Payments against any of Borrower's deposit
accounts or against the Committed Line, in which case those amounts shall
thereafter accrue interest at the rate then applicable hereunder. Bank will
notify Borrower of all debits

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<PAGE> 13
and charges that Bank makes against Borrower's accounts in the ordinary course
of Bank's operations. Any interest not paid when due shall be compounded by
becoming a part of the Obligations, and such interest shall thereafter accrue
interest at the rate then applicable hereunder.

(d) Computation. In the event the Prime Rate is changed from time to
time hereafter, the applicable rate of interest hereunder shall be increased or
decreased effective as of 12:01 a.m. on the day the Prime Rate is changed, by an
amount equal to such change in the Prime Rate. Bank shall notify Borrower of the
change in the ordinary course of Borrower's business. All interest chargeable
under the Loan Documents shall be computed on the basis of a three hundred sixty
(360) day year for the actual number of days elapsed.

2.3 Crediting Payments. Prior to the occurrence of an Event of Default,
Bank shall credit a wire transfer of funds, check or other item of payment to
such deposit account or Obligation as Borrower specifies. After the occurrence
and during the continuance of an Event of Default, the receipt by Bank of any
wire transfer of funds, check, or other item of payment shall be immediately
applied to conditionally reduce Obligations, but shall not be considered a
payment on account unless such payment is of immediately available federal funds
or unless and until such check or other item of payment is honored when
presented for payment. Notwithstanding anything to the contrary contained
herein, any wire transfer or payment received by Bank after 12:00 noon
California time shall be deemed to have been received by Bank as of the opening
of business on the immediately following Business Day. Whenever any payment to
Bank under the Loan Documents would otherwise be due (except by reason of
acceleration) on a date that is not a Business Day, such payment shall instead
be due on the next Business Day, and additional fees or interest, as the case
may be, shall accrue and be payable for the period of such extension, provided
however, that no late fee shall accrue because the relevant date is not a
Business Day.

2.4 Fees. Borrower shall pay to Bank the following:

(a) Facility Fee. A Facility Fee equal to Twenty Thousand Dollars
($20,000), which fee shall be due on the Closing Date and shall be fully earned
and nonrefundable;

(b) Financial Examination and Appraisal Fees. Bank's customary fees
and out-of-pocket expenses for Bank's audits of Borrower's Accounts, and for
each appraisal of Collateral and financial analysis and examination of Borrower
performed from time to time by Bank or its agents provided, however, that
Borrower shall be required to reimburse Bank once per year for such audits,
appraisals and examinations unless an Event of Default has occurred; and

(c) Bank Expenses. Upon the date hereof, all Bank Expenses incurred
through the Closing Date, including reasonable attorneys' fees and expenses not
to exceed $7,500, and, after the date hereof, all Bank Expenses, including
reasonable attorneys' fees and expenses, as an when they become due.

2.5 Additional Costs. In case any change after the date hereof in any law,
regulation, treaty or official directive or the interpretation or application
thereof by any court or any governmental authority charged with the
administration thereof or the compliance with any guideline or request of any
central bank or other governmental authority (whether or not having the force of
law), in each case after the date of this Agreement:

(a) subjects Bank to any tax with respect to payments of principal or
interest or any other amounts payable hereunder by Borrower or otherwise with
respect to the transactions contemplated hereby (except for taxes on the overall
net income of Bank imposed by the United States of America or any political
subdivision thereof);

10
<PAGE> 14
(b) imposes, modifies or deems applicable any deposit
insurance, reserve, special deposit or similar requirement against assets held
by, or deposits in or for the account of, or loans by, Bank; or

and the result of any of the foregoing is to increase the cost to Bank, reduce
the income receivable by Bank or impose any expense upon Bank with respect to
any loans, Bank shall notify Borrower thereof. Borrower agrees to pay to Bank
the amount of such increase in cost, reduction in income or additional expense
as and when such cost, reduction or expense is incurred or determined, upon
presentation by Bank of a statement of the amount and setting forth Bank's
calculation thereof, all in reasonable detail, which statement shall be deemed
true and correct absent manifest error. Bank agrees that it will allocate all
such increased costs among its customers similarly affected in good faith and
in a manner consistent with Bank's customary practice.

2.6 Term. This Agreement shall become effective on the Closing Date,
and subject to Section 12.7, shall continue in full force and effect for a term
ending on the Maturity Date. Notwithstanding the foregoing, Bank shall have the
right to terminate its obligation to make Advances under this Agreement during
the continuance of an Event of Default. Notwithstanding termination, Bank's
Lien on the Collateral shall remain in effect for so long as any Obligations
are outstanding. Provided no Obligations are outstanding, Borrower shall have
the right to terminate this Agreement upon written notice to Bank. Upon any
termination, Bank's Lien on the Collateral shall terminate provided no
Obligations are outstanding and Bank shall cooperate with Borrower promptly to
make such filings (e.g., financing statements and termination of the
Intellectual Property Security Agreement) as Borrower may reasonably request to
evidence such termination.

3. CONDITIONS OF LOANS

3.1 Conditions Precedent to Initial Advance. The obligation of Bank
to make the initial Advance is subject to the condition precedent that Bank
shall have received, in form and substance satisfactory to Bank, the following:

(a) this Agreement;

(b) a certificate of the Secretary of Borrower with respect to
incumbency and resolutions authorizing the execution and delivery of this
Agreement;

(d) insurance certificate;

(e) payment of the fees and Bank Expenses then due specified in
Section 2.4 hereof; and

(f) such other documents, and completion of such other matters,
as Bank may reasonably deem necessary or appropriate.

3.2 Conditions Precedent to all Advances. The obligation of Bank to
make each Advance, including the initial Advance, is further subject to the
following conditions:

(a) timely receipt by Bank of the Payment/Advance Form as
provided in Section 2.1; and

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<PAGE> 15
(b) the representations and warranties contained in Section 5
shall be true and correct in all material respects on and as of the date of
such Payment/Advance Form and on the effective date of each Advance as though
made at and as of each such date, and no Event of Default shall have occurred
and be continuing, or would result from such Advance. The making of each
Advance shall be deemed to be a representation and warranty by Borrower on the
date of such Advance as to the accuracy of the facts referred to in this
Section 3.2(b).

4. CREATION OF SECURITY INTEREST

4.1 Grant of Security Interest. Borrower grants and pledges to Bank
a continuing security interest in all presently existing and hereafter acquired
or arising Collateral in order to secure prompt repayment of any and all
Obligations and in order to secure prompt performance by Borrower of each of
its covenants and duties under the Loan Documents. Except as set forth in the
Schedule, such security interest constitutes a valid, first priority security
interest in the presently existing Collateral, and will constitute a valid,
first priority security interest in Collateral acquired after the date hereof
assuming Bank has timely and properly filed and taken all other actions
necessary or desirable to perfect and protect such security interest.

4.2 Delivery of Additional Documentation Required. Borrower shall
from time to time execute and deliver to Bank, at the request of Bank, all
Negotiable Collateral, all financing statements and other documents that Bank
may reasonably request, in form satisfactory to Bank, to perfect and continue
perfected Bank's security interests in the Collateral and in order to fully
consummate all of the transactions contemplated under the Loan Documents.

4.3 Right to Inspect. Bank (through any of its officers, employees,
or agents) shall have the right, upon reasonable prior notice, from time to
time during Borrower's usual business hours, to inspect Borrower's Books and to
make copies thereof and to check, test, and appraise the Collateral in order to
verify Borrower's financial condition or the amount, condition of, or any other
matter relating to, the Collateral.

5. REPRESENTATIONS AND WARRANTIES

Borrower represents and warrants as follows:

5.1 Due Organization and Qualification. Borrower and each Subsidiary
is a corporation duly existing and in good standing under the laws of its state
of incorporation and qualified and licensed to do business in, and is in good
standing in, any state in which the conduct of its business or its ownership of
property requires that it be so qualified and where the failure to so qualify
could result in a Material Adverse Effect.

5.2 Due Authorization; No Conflict. The execution, delivery, and
performance of the Loan Documents are within Borrower's powers, have been duly
authorized, and are not in conflict with nor constitute a breach of any
provision contained in Borrower's Certificate of Incorporation or Bylaws, nor
will they constitute an event of default under any material agreement to which
Borrower is a party or by which Borrower is bound except to the extent that
certain intellectual property agreements prohibit the assignment of the rights
thereunder to a third party without the Borrower's or other party's consent.
Borrower is not in default under any agreement to which it is a party or by
which it is bound, which default could have a Material Adverse Effect.

5.3 No Prior Encumbrances. Borrower has good and indefeasible title
to the Collateral, free and clear of Liens, except for Permitted Liens.

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<PAGE> 16

5.4 Bona Fide Accounts. The Accounts are bona fide existing obligations.
The property giving rise to such Accounts has been delivered to the account
debtor or to the account debtor's agent for immediate shipment to and
unconditional acceptance by the account debtor.

5.5 Merchantable Inventory. All Inventory is in all material respects of
good and marketable quality, free from all material defects, normal wear and
tear excepted; provided, however, that the Inventory is the product of rapidly
changing technology and therefore is subject to technological obsolescence.

5.6 Intellectual Property. Borrower is the sole owner of the Intellectual
Property Collateral, except for non-exclusive licenses granted by Borrower to
its customers in the ordinary course of business or except as permitted under
this Agreement. To Borrower's best knowledge, each of the Patents is valid and
enforceable, and no part of the Intellectual Property Collateral has been
judged invalid or unenforceable, in whole or in part, and as of the date
hereof, Borrower has no knowledge that nor has it received any communication
that a claim has been made that any part of the Intellectual Property
Collateral violates the rights of any third party.

5.7 Name; Location of Chief Executive Office. Except as disclosed in the
Schedule, Borrower has not done business under any name other than that
specified on the signature page hereof. The chief executive office of Borrower
is located at the address indicated in Section 10 hereof.

5.8 Litigation. Except as set forth in the Schedule, there are no actions
or proceedings pending by or against Borrower or any Subsidiary before any court
or administrative agency in which an adverse decision could have a Material
Adverse Effect or a material adverse effect on Borrower's interest or Bank's
security interest in the Collateral. Borrower does not have knowledge of any
such pending or threatened actions or proceedings.

5.9 No Material Adverse Change in Financial Statements. All consolidated
historical financial statements related to Borrower and any Subsidiary that
have been delivered by Borrower to Bank fairly present in all material respects
Borrower's consolidated financial condition as of the date thereof and
Borrower's consolidated results of operations for the period then ended. There
has not been a material adverse change in the consolidated financial condition
of Borrower since the date of the most recent of such financial statements
submitted to Bank.

5.10 Solvency. The fair saleable value of Borrower's assets (including
goodwill minus disposition costs) exceeds the fair value of its liabilities; the
Borrower is not left with unreasonably small capital after the transactions
contemplated by this Agreement; and Borrower is able to pay its debts (including
trade debts) as they mature.

5.11 Regulatory Compliance. Borrower and each Subsidiary has met the
minimum funding requirements of ERISA with respect to any employee benefit
plans subject to ERISA. No event has occurred resulting from Borrower's failure
to comply with ERISA that is reasonably likely to result in Borrower's
incurring any liability that could have a Material Adverse Effect. Borrower is
not an "investment company" or a company "controlled" by an "investment
company" within the meaning of the Investment Company Act of 1940. Borrower is
not engaged principally, or as one of the important activities, in the business
of extending credit for the purpose of purchasing or carrying margin stock
(within the meaning of Regulations G, T and U of the Board of Governors of the
Federal Reserve System). Borrower has complied with all the provisions of the
Federal Fair Labor Standards Act. Borrower has not violated any statutes, laws,
ordinances or rules applicable to it, violation of which could have a Material
Adverse Effect.

5.12 Environmental Condition. None of Borrower's or any Subsidiary's
properties or assets has ever been used by Borrower or any Subsidiary or, to
the best of Borrower's knowledge, by previous owners or operators, in the
disposal of, or to produce, store, handle, treat, release, or

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<PAGE> 17
transport, any hazardous waste or hazardous substance other than in accordance
with applicable law; to the best of Borrower's knowledge, none of Borrower's
properties or assets has ever been designated or identified in any manner
pursuant to any environmental protection statute as a hazardous waste or
hazardous substance disposal site, or a candidate for closure pursuant to any
environmental protection statute; no lien arising under any environmental
protection statute has attached to any revenues or to any real or personal
property owned by Borrower or any Subsidiary; and neither Borrower nor any
Subsidiary has received a summons, citation, notice, or directive from the
Environmental Protection Agency or any other federal, state or other
governmental agency concerning any action or omission by Borrower or any
Subsidiary resulting in the releasing, or otherwise disposing of hazardous waste
or hazardous substances into the environment.

5.13 Taxes. Borrower and each Subsidiary has filed or caused
to be filed all tax returns required to be filed, and has paid, or has made
adequate provision for the payment of, all taxes reflected therein.

5.14 Subsidiaries. Except as set forth in Schedule 5.14,
Borrower does not own any stock, partnership interest or other equity securities
of any Person, except for Permitted Investments and has no Subsidiaries.

5.15 Government Consents. Borrower and each Subsidiary has
obtained all consents, approvals and authorizations of, made all declarations or
filings with, and given all notices to, all governmental authorities that are
necessary for the continued operation of Borrower's business as currently
conducted, except to the extent that any failure to do so would not have a
Material Adverse Effect.

5.16 Full Disclosure. No representation, warranty or other
statement made by Borrower in any certificate or written statement furnished to
Bank contains any untrue statement of a material fact or omits to state a
material fact necessary in order to make the statements contained in such
certificates or statements not misleading.

6. AFFIRMATIVE COVENANTS

Borrower covenants and agrees that, until payment in full of all
outstanding Obligations, and for so long as Bank may have any commitment to make
an Advance hereunder, Borrower shall do all of the following:

6.1 Good Standing. Borrower shall maintain its and each of its
Subsidiaries' corporate existence and good standing in its jurisdiction of
incorporation and maintain qualification in each jurisdiction in which the
failure to so qualify could have a Material Adverse Effect. Borrower shall
maintain, and shall cause each of its Subsidiaries to maintain, to the extent
consistent with prudent management of Borrower's business, in force all
licenses, approvals and agreements, the loss of which could have a Material
Adverse Effect.

6.2 Government Compliance. Borrower shall meet, and shall
cause each Subsidiary to meet, the minimum funding requirements of ERISA with
respect to any employee benefit plans subject to ERISA. Borrower shall comply,
and shall cause each Subsidiary to comply, with all statutes, laws, ordinances
and government rules and regulations to which it is subject, noncompliance with
which could have a Material Adverse Effect or a material adverse effect on the
Collateral or the priority of Bank's Lien on the Collateral.

6.3 Financial Statements, Reports, Certificates. Borrower
shall deliver to Bank: (a) as soon as available, but in any event within ninety
(90) days after the end of Borrower's fiscal year, audited consolidated
financial statements of Borrower prepared in accordance with GAAP, consistently
applied, together with an unqualified opinion on such financial statements of an
<PAGE> 18
independent certified public accounting firm reasonably acceptable to Bank; (b)
within forty-five (45) days of the last day of each fiscal quarter, copies of
all statements, reports and notices sent or made available generally by Borrower
to its security holders or to any holders of Subordinated Debt and all reports
on Form 10-Q filed with the Securities and Exchange Commission for such period;
(c) promptly upon receipt of notice thereof, a report of any legal actions
pending against Borrower or any Subsidiary that could result in damages or
costs to Borrower or any Subsidiary of One Hundred Thousand Dollars ($100,000)
or more; (d) upon Bank's reasonable request, but in any event not less than
once every calendar quarter, notice of any material change in the composition
of the Intellectual Property Collateral, including, but not limited to, any
subsequent ownership right of the Borrower in or to any Copyright, Patent or
Trademark not specified in any intellectual property security agreement between
Borrower and Bank or knowledge of an event that materially adversely effects
the value of the Intellectual Property Collateral; and (e) such budgets, sales
projections, operating plans or other financial information as Bank may
reasonably request from time to time.

Within forty-five (45) days after the last day of each fiscal quarter,
Borrower shall deliver to Bank an aged listing of accounts receivable and
accounts payable.

Borrower shall deliver to Bank with the quarterly financial statements a
Compliance Certificate signed by a Responsible Officer in substantially the
form of Exhibit C hereto.

Bank shall have a right from time to time hereafter to audit Borrower's
Accounts at Borrower's expense, provided that such audits will be conducted no
more often than every six (6) months unless an Event of Default has occurred
and is continuing.

6.4 Inventory; Returns. Borrower shall keep all Inventory in good and
marketable condition, free from all material defects, subject to normal wear
and tear and normal obsolescence due to the technological basis of such
Inventory. Returns and allowances, if any, as between Borrower and its account
debtors shall be on the same basis and in accordance with the usual customary
practices of Borrower, as they exist at the time of the execution and delivery
of this Agreement. Borrower shall promptly notify Bank of all returns and
recoveries and of all disputes and claims, where the return, recovery, dispute
or claim involves more than Fifty Thousand Dollars ($50,000).

6.5 Taxes. Borrower shall make, and shall cause each Subsidiary to make,
due and timely payment or deposit of all material federal, state, and local
taxes, assessments, or contributions required of it by law, and will execute
and deliver to Bank, on demand, appropriate certificates attesting to the
payment or deposit thereof; and Borrower will make, and will cause each
Subsidiary to make, timely payment or deposit of all material tax payments and
withholding taxes required of it by applicable laws, including, but not limited
to, those laws concerning F.I.C.A., F.U.T.A., state disability, and local,
state, and federal income taxes, and will, upon request, furnish Bank with
proof satisfactory to Bank indicating that Borrower or a Subsidiary has made
such payments or deposits; provided that Borrower or a Subsidiary need not make
any payment if the amount or validity of such payment is contested in good
faith by appropriate proceedings and is reserved against (to the extent
required by GAAP) by Borrower.

6.6 Insurance.

(a) Borrower, at its expense, shall keep the Collateral insured
against loss or damage by fire, theft, explosion, sprinklers, and all other
hazards and risks, and in such amounts, as ordinarily insured against by other
owners in similar businesses conducted in the locations where Borrower's
business is conducted on the date hereof. Borrower shall also maintain insurance
relating to Borrower's ownership and use of the Collateral in amounts and of a
type that are customary to businesses similar to Borrower's.

PA/714594-3
February 12, 1998

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(b) All such policies of insurance shall be in such form, with such
companies, and in such amounts as reasonably satisfactory to Bank. All such
policies of property insurance shall contain a lender's loss payable
endorsement, in a form satisfactory to Bank, showing Bank as an additional loss
payee thereof and all liability insurance policies shall show the Bank as an
additional insured, and shall specify that the insurer must give at least twenty
(20) days notice to Bank before canceling its policy for any reason. Upon Bank's
request, Borrower shall deliver to Bank certified copies of such policies of
insurance and evidence of the payments of all premiums therefor. All proceeds
payable under any such policy shall, at the option of Bank, be payable to Bank
to be applied on account of the Obligations.

6.7 Principal Depository. Borrower shall maintain its principal depository
and operating accounts with Bank.

6.8 Quick Ratio. Borrower shall maintain, as of the last day of each
fiscal quarter, a ratio of Quick Assets to Current Liabilities of not less than
1.50 to 1.00.

6.9 Tangible Net Worth. Borrower shall maintain, as of the last day of
each fiscal quarter, a Tangible Net Worth of not less than Nineteen Million
Dollars ($19,000,000).

6.10 Debt-Tangible Net Worth. Borrower shall maintain, as of the last day
of each fiscal quarter, a ratio of Total Liabilities to Tangible Net Worth of
not more than 1.00 to 1.00.

6.11 Profitability. Borrower shall not suffer a loss in excess of
$7,500,000 for the fiscal quarter ending November 30, 1997 or a loss in excess
of $2,000,000 for the fiscal quarter ending February 28, 1998. Borrower shall be
profitable on an after tax basis for each fiscal quarter thereafter.

6.12 Registration of Intellectual Property Rights.

(a) As a condition to an increase of the Committed Line to
$5,000,000, and in any case upon the occurrence of an Event of Default, Borrower
shall (i) file or cause to be filed on an expedited basis a duly completed
application to register (to the extent not already registered) with the United
States Patent and Trademark Office or the United States Copyright Office, as
applicable, and thereafter shall diligently pursue the registration of those
intellectual property rights developed or acquired by Borrower from time to time
in connection with any product and (ii) execute, deliver, register and/or file
such additional instruments and documents from time to time as Bank shall
reasonably request to perfect Bank's security interest in the Intellectual
Property Collateral. Bank shall have the right, but not the obligation, to take,
at Borrower's sole expense, any actions that Borrower is required under this
Section 6.12(a) to take but which Borrower fails to take, after five (5) days'
notice to Borrower. Borrower shall reimburse and indemnify Bank for all
reasonable costs and reasonable expenses incurred in the reasonable exercise of
its rights under this Section 6.12(a).

(b) Borrower shall (i) use commercially reasonable efforts to
protect, defend and maintain the validity and enforceability of the Trademarks,
Patents and Copyrights, (ii) use its best efforts to detect infringements of the
Trademarks, Patents and Copyrights and promptly advise Bank in writing of
material infringements detected and (iii) not allow any Trademarks, Patents or
Copyrights to be abandoned, forfeited or dedicated to the public without the
written consent of Bank, which shall not be unreasonably withheld, unless
Borrower determines that reasonable business practices suggest that abandonment
is appropriate.

(c) For so long as the actions specified in Section 6.12(a) have not
been taken, Borrower shall cause the outstanding balance of Obligations under
this Agreement to be zero (0) for a period of five (5) consecutive days during
the term of this Agreement.

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<PAGE> 20
6.13 Further Assurances. At any time and from time to time Borrower
shall execute and deliver such further instruments and take such further action
as may reasonably be requested by Bank to effect the purposes of this Agreement.

7. NEGATIVE COVENANTS

Borrower covenants and agrees that, so long as any credit hereunder
shall be available and until payment in full of the outstanding Obligations or
for so long as Bank may have any commitment to make any Advances, Borrower will
not do any of the following:

7.1 Dispositions. Convey, sell, lease, transfer or otherwise dispose
of (collectively, a "Transfer"), or permit any of its Subsidiaries to Transfer,
all or any part of its business or property, other than: (i) Transfers of
Inventory in the ordinary course of business; (ii) Transfers of non-exclusive
licenses and similar arrangements for the use of the property of Borrower or its
Subsidiaries; or (iii) Transfers of worn-out or obsolete Equipment; (iv) the
sale of the capital stock of Verity Interactive SARL or (v) other Transfers not
in excess of $250,000 in the aggregate during the term of this Agreement.

7.2 Change in Business. Engage in any business, or permit any of its
Subsidiaries to engage in any business, other than the businesses currently
engaged in by Borrower and any business substantially similar or related thereto
(or incidental thereto), or suffer a material change in Borrower's ownership.
Borrower will not, without thirty (30) days prior written notification to Bank,
relocate its chief executive office.

7.3 Mergers or Acquisitions. Merge or consolidate, or permit any of
its Subsidiaries to merge or consolidate, with or into any other business
organization, or acquire, or permit any of its Subsidiaries to acquire, all or
substantially all of the capital stock or property of another Person except for
the merger or consolidation of one or more Subsidiaries of Borrower with or into
Borrower or the merger or consolidation of two or more Subsidiaries of Borrower.

7.4 Indebtedness. Create, incur, assume or be or remain liable with
respect to any Indebtedness, or permit any Subsidiary so to do, other than
Permitted Indebtedness.

7.5 Encumbrances. Create, incur, assume or suffer to exist any Lien
with respect to any of its property (including without limitation the
Intellectual Property Collateral), or assign or otherwise convey any right to
receive income, including the sale of any Accounts, or permit any of its
Subsidiaries so to do, except for Permitted Liens.

7.6 Distributions. Pay any dividends or make any other distribution
or payment on account of or in redemption, retirement or purchase of any capital
stock, except Borrower may at any time when an Event of Default is not
continuing, repurchase from an officer, director or employee shares of equity
securities of Borrower held by them upon such person's termination of employment
or rendering of service to Borrower.

7.7 Investments. Directly or indirectly acquire or own, or make any
Investment in or to any Person, or permit any of its Subsidiaries so to do,
other than Permitted Investments.

7.8 Transactions with Affiliates. Directly or indirectly enter into
or permit to exist any material transaction with any Affiliate of Borrower
except for transactions that are in the ordinary course of Borrower's business,
upon fair and reasonable terms that are no less favorable to Borrower than would
be obtained in an arm's length transaction with a nonaffiliated Person.

7.9 Intellectual Property Agreements. Borrower shall not permit the
inclusion in any material contract to which it becomes a party of any provisions
that could or might in any way

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<PAGE> 21
prevent the creation of a security interest in Borrower's rights and interests
in any property included within the definition of the Intellectual Property
Collateral acquired under such contracts, except to the extent that such
provisions are necessary in Borrower's exercise of its reasonable business
judgement.

7.10 Subordinated Debt. Make any payment in respect of any Subordinated
Debt, or permit any of its Subsidiaries to make any such payment, except in
compliance with the terms of such Subordinated Debt, or amended any material
provision contained in any documentation relating to the Subordinated Debt
without Bank's prior written consent which shall not be unreasonably withheld.

7.11 Inventory. Store the Inventory with a bailee, warehouseman, or
similar party unless Bank has received a pledge of the warehouse receipt
covering such Inventory. Except for Inventory sold in the ordinary course of
business and except for such other locations as Bank may approve in writing,
Borrower shall keep the Inventory only at the location set forth in Section 10
hereof and such other locations of which Borrower gives Bank prior written
notice and as to which Borrower signs and files a financing statement where
needed to perfect Bank's security interest.

7.12 Compliance. Become an "investment company" controlled by an
"investment company," within the meaning of the Investment Company Act of 1940,
or become principally engaged in, or undertake as one of its important
activities, the business of extending credit for the purpose of purchasing or
carrying margin stock, or use the proceeds of any Advance for such purpose.
Fail to meet the minimum funding requirements of ERISA, permit a Reportable
Event or Prohibited Transaction, as defined in ERISA, to occur, fail to comply
in a material respect with the Federal Fair Labor Standards Act or violate any
law or regulation, which violation could have a Material Adverse Effect or a
material adverse effect on the Collateral or the priority of Bank's Lien on the
Collateral, or permit any of its Subsidiaries to do any of the foregoing.

8. EVENTS OF DEFAULT

Any one or more of the following events shall constitute an Event of
Default by Borrower under this Agreement:

8.1 Payment Default. If Borrower fails to pay the principal of, or any
interest on, any Advances when due and payable; or fails to pay any portion of
any other Obligations not constituting such principal or interest, including
without limitation Bank Expenses, within thirty (30) days of receipt by
Borrower of an invoice for such other Obligations;

8.2 Covenant Default. If Borrower fails to perform any obligation under
Article 6 or violates any of the covenants contained in Article 7 of this
Agreement, or fails or neglects to perform, keep, or observe any other material
term, provision, condition, covenant, or agreement contained in this
Agreement, in any of the Loan Documents, or in any other present or future
agreement between Borrower and Bank and as to any default under such other
term, provision, condition, covenant or agreement that can be cured, has failed
to cure such default within thirty (30) days after Borrower receives notice
thereof or any officer of Borrower becomes aware thereof;

8.3 Material Adverse Effect. If there occurs a Material Adverse Effect or
a material impairment of the value or priority of Bank's security interests in
the Collateral;

8.4 Attachment. If any material portion of Borrower's assets is attached,
seized, subjected to a writ of distress warrant, or is levied upon, or comes
into the possession of any trustee, receiver or person acting in a similar
capacity and such attachment, seizure, writ or distress warrant or levy has not
been removed, discharged or rescinded within thirty (30) days, or if Borrower is
enjoined, restrained, or in any way prevented by court order from continuing to
conduct all or any material part of its business affairs, or if a judgment or
other claim becomes a lien or encumbrance upon any material portion of
Borrower's assets, or if a notice of lien, levy, or assessment is filed of
record with

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<PAGE> 22
respect to any of Borrower's assets by the United States Government, or any
department, agency, or instrumentality thereof, or by any state, county,
municipal, or governmental agency, and the same is not paid within thirty (30)
days after Borrower receives notice thereof, provided that none of the foregoing
shall constitute an Event of Default where such action or event is stayed or an
adequate bond has been posted pending a good faith contest by Borrower (provided
that no Advances will be required to be made during such cure period);

8.5 Insolvency. If Borrower becomes insolvent, or if an
Insolvency Proceeding is commenced by Borrower, or if an Insolvency Proceeding
is commenced against Borrower and is not dismissed or stayed within sixty (60)
days (provided that no Advances will be made prior to the dismissal of such
Insolvency Proceeding);

8.6 Other Agreements. If there is a default in any agreement to
which Borrower is a party with a third party or parties resulting in a right by
such third party or parties, whether or not exercised, to accelerate the
maturity of any Indebtedness in an amount in excess of One Hundred Thousand
Dollars ($100,000) or that could have a Material Adverse Effect;

8.7 Subordinated Debt. If Borrower makes any payment on account
of Subordinated Debt, except to the extent such payment is allowed under any
subordination agreement entered into with Bank;

8.8 Judgments. If a judgment or judgments for the payment of
money in an amount, individually or in the aggregate, of at least One Hundred
Thousand Dollars ($100,000) shall be rendered against Borrower and shall remain
unsatisfied and unstayed for a period of thirty (30) days (provided that no
Advances will be made prior to the satisfaction or stay of such judgment); or

8.9 Misrepresentations. If any material misrepresentation or
material misstatement exists now or hereafter in any warranty or representation
set forth herein or in any certificate delivered to Bank by any Responsible
Officer pursuant to this Agreement or to induce Bank to enter into this
Agreement or any other loan Document.

9. BANK'S RIGHTS AND REMEDIES

9.1 Rights and Remedies. Upon the occurrence and during the
continuance of an Event of Default, Bank may, at its election, without notice of
its election and without demand, do any one or more of the following, all of
which are authorized by Borrower:

(a) Declare all Obligations, whether evidenced by this
Agreement, by any of the other Loan Documents, or otherwise, immediately due and
payable (provided that upon the occurrence of an Event of Default described in
Section 8.5 all Obligations shall become immediately due and payable without any
action by Bank);

(b) Cease advancing money or extending credit to or for
the benefit of Borrower under this Agreement or under any other agreement
between Borrower and Bank;

(c) Demand that Borrower (i) deposit cash with Bank in an
amount equal to the amount of any Letters of Credit remaining undrawn, as
collateral security for the repayment of any future drawings under such Letters
of Credit, and Borrower shall forthwith deposit and pay such amounts, and (ii)
pay in advance all Letters of Credit fees scheduled to be paid or payable over
the remaining term of the Letters of Credit;

(d) Settle or adjust disputes and claims directly with
account debtors for amounts, upon terms and in whatever order that Bank
reasonably considers advisable;

19
<PAGE> 23
(e) Without notice to or demand upon Borrower, make such
payments and do such acts as Bank considers necessary or reasonable to protect
its security interest in the Collateral. Borrower agrees to assemble the
Collateral if Bank so requires, and to make the Collateral available to Bank as
Bank may designate. Borrower authorizes Bank to enter the premises where the
Collateral is located, to take and maintain possession of the Collateral, or
any part of it, and to pay, purchase, contest, or compromise any encumbrance,
charge, or lien which in Bank's determination appears to be prior or superior to
its security interest and to pay all expenses incurred in connection therewith.
With respect to any of Borrower's owned premises, Borrower hereby grants Bank
a license to enter into possession of such premises and to occupy the same,
without charge, in order to exercise any of Bank's rights or remedies provided
herein, at law, in equity, or otherwise;

(f) Without notice to Borrower set off and apply to the
Obligations any and all (i) balances and deposits of Borrower held by Bank, or
(ii) indebtedness at any time owing to or for the credit or the account of
Borrower held by Bank;

(g) Ship, reclaim, recover, store, finish, maintain, repair,
prepare for sale, advertise for sale, and sell (in the manner provided for
herein) the Collateral. Bank is hereby granted a license or other right,
solely pursuant to the provisions of this Section 9.1, to use, without charge,
Borrower's labels, patents, copyrights, rights of use of any name, trade
secrets, trade names, trademarks, service marks, and advertising matter, or any
property of a similar nature, as it pertains to the Collateral in completing
production of, advertising for sale, and selling any Collateral and, in
connection with Bank's exercise of its rights under this Section 9.1,
Borrower's rights under all licenses and all franchise agreements shall inure
to Bank's benefits;

(h) Sell the Collateral at either a public or private sale, or
both, by way of one or more contracts or transactions, for cash or on terms, in
such manner and at such places (including Borrower's premises) as Bank
determines is commercially reasonable, and apply any proceeds to the Obligations
in whatever manner or order Bank deems appropriate;

(i) Bank may credit bid and purchase at any public sale; and

(j) Any deficiency that exists after disposition of the
Collateral as provided above will be paid immediately by Borrower.

9.2 Power of Attorney. Effective only upon the occurrence and during
the continuance of an Event of Default, Borrower hereby irrevocably appoints
Bank (and any of Bank's designated officers, or employees) as Borrower's true
and lawful attorney to: (a) send requests for verification of Accounts or notify
accounts debtors of Bank's security interest in the Accounts; (b) endorse
Borrower's name on any checks or other forms of payment or security that may
come into Bank's possession; (c) sign Borrower's name on any invoice or bill of
lading relating to any Account, drafts against account debtors, schedules and
assignments of Accounts, verifications of Accounts, and notices to account
debtors; (d) make, settle,and adjust all claims under and decisions with respect
to Borrower's policies of insurance; (e) settle and adjust disputes and claims
respecting the accounts directly with account debtors, for amounts and upon
terms which Bank determines to be reasonable; (f) to modify, in its sole
discretion, any intellectual property security agreement entered into between
Borrower and Bank without first obtaining Borrower's approval of or signature to
such modification solely by amending Exhibit A, Exhibit B and Exhibit C,
thereof, as appropriate, to (i) include reference to any right, title or
interest in any Copyrights, Patents or Trademarks acquired by Borrower after the
execution hereof or (ii) to delete any reference to any right, title or interest
in any Copyrights, Patents or Trademarks in which Borrower no longer has or
claims any right, title or interest; (g) to file, in its sole discretion, one or
more financing or continuation statements and amendments thereto, relative to
any of the Collateral without the signature of Borrower where permitted by law;
and (h) dispose of the Collateral in accordance with, but only to the extent
permitted under, the Code (and to register such disposition with appropriate
government authorities); provided Bank may exercise such Power of

20
<PAGE> 24
attorney to sign the name of Borrower on any of the documents described in
Section 4.2 regardless of whether an Event of Default has occurred. The
appointment of Bank as Borrower's attorney in fact, and each and every one of
Bank's rights and powers, being coupled with an interest, is irrevocable until
all of the Obligations have been fully repaid and performed and Bank's
obligation to provide advances hereunder is terminated.

9.3 Accounts Collection. Upon the occurrence and during the
continuance of an Event of Default, Bank may notify any Person owing funds to
Borrower of Bank's security interest in such funds and verify the amount of
such Account. Borrower shall collect all amounts owing to Borrower for Bank,
receive in trust all payments as Bank's trustee, and immediately deliver such
payments to Bank in their original form as received from the account debtor,
with proper endorsements for deposit.

9.4 Bank Expenses. If Borrower fails to pay any amounts or furnish
any required proof of payment due to third persons or entities, as required
under the terms of this Agreement, then Bank may do any or all of the
following; (a) make payment of the same or any part thereof; (b) set up such
reserves under the Revolving Facility as Bank deems necessary to protect Bank
from the exposure created by such failure; or (c) obtain and maintain insurance
policies of the type discussed in Section 6.6 of this Agreement, and take any
action with respect to such policies as Bank deems prudent. Any amounts so paid
or deposited by Bank shall constitute Bank Expenses, shall be immediately due
and payable, and shall bear interest at the then applicable rate hereinabove
provided, and shall be secured by the Collateral. Any payments made by Bank
shall not constitute an agreement by Bank to make similar payments in the
future or a waiver by Bank of any Event of Default under this Agreement.

9.5 Bank's Liability for Collateral. So long as Bank complies with
reasonable banking practices, Bank shall not in any way or manner be liable or
responsible for: (a) the safekeeping of the Collateral; (b) any loss or damage
thereto occurring or arising in any manner or fashion from any cause; (c) any
diminution in the value thereof; or (d) any act or default of any carrier,
warehouseman, bailee, forwarding agency, or other person whomsoever. All risk
of loss, damage or destruction of the Collateral shall be borne by Borrower.

9.6 Remedies Cumulative. Bank's rights and remedies under this
Agreement, the Loan Documents, and all other agreements shall be cumulative.
Bank shall have all other rights and remedies not inconsistent herewith as
provided under the Code, by law, or in equity. No exercise by Bank of one right
or remedy shall be deemed an election, and no waiver by Bank of any Event of
Default on Borrower's part shall be deemed a continuing waiver. No delay by
Bank shall constitute a waiver, election, or acquiescence by it. No waiver by
Bank shall be effective unless made in a written document signed on behalf of
Bank and then shall be effective only in the specific instance and for the
specific purpose for which it was given.

9.7 Demand; Protest. Borrower waives demand, protest, notice of
protest, notice of default or dishonor, notice of payment and nonpayment, notice
of any default, nonpayment at maturity, release, compromise, settlement,
extension, or renewal of accounts, documents, instruments, chattel paper, and
guarantees at any time held by Bank on which Borrower may in any way be liable.

10. NOTICES

Unless otherwise provided in this Agreement, all notices or
demands by any party relating to this Agreement or any other agreement entered
into in connection herewith shall be in writing and (except for financial
statements and other informational documents which may be sent by first-class
mail, postage prepaid) shall be personally delivered or sent by a recognized
overnight delivery service, certified mail, postage prepaid, return receipt
requested, or by telefacsimile to Borrower or to Bank, as the case may be, at
its addresses set forth below:

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<PAGE> 25
If to Borrower: Verity, Inc.
894 Ross Drive
Sunnyvale, CA 94099
Attn: Vice President, Administration and Controller
FAX: (408) 542-2020

If to Bank: Imperial Bank
226 Airport Parkway
San Jose, CA 95110-1024
Attn: Corporate Banking Center
FAX: (408) 451-8523

The parties hereto may change the address at which they are to receive notices
hereunder, by notice in writing in the foregoing manner given to the other.

11. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER

The Loan Documents shall be governed by, and construed in accordance
with, the internal laws of the State of California, without regard to
principles of conflicts of law. Each of Borrower and Bank hereby submits to the
exclusive jurisdiction of the state and Federal courts located in the County of
Santa Clara, State of California. BORROWER AND BANK EACH HEREBY WAIVE THEIR
RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR
ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS
CONTEMPLATED THEREIN, INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY
CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS. EACH PARTY RECOGNIZES AND
AGREES THAT THE FOREGOING WAIVER CONSTITUTES A MATERIAL INDUCEMENT FOR IT TO
ENTER INTO THIS AGREEMENT. EACH PARTY REPRESENTS AND WARRANTS THAT IT HAS
REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL AND THAT IT KNOWINGLY AND
VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL
COUNSEL.

12. GENERAL PROVISIONS

12.1 Successors and Assigns. This Agreement shall bind and inure to
the benefit of the respective successors and permitted assigns of each of the
parties; provided, however, that neither this Agreement nor any rights
hereunder may be assigned by Borrower without Bank's prior written consent,
which consent may be granted or withheld in Bank's sole discretion. Bank shall
have the right without the consent of or notice to Borrower to sell, transfer,
negotiate, or grant participation in all or any part of, or any interest in,
Bank's obligations, rights and benefits hereunder.

12.2 Indemnification. Borrower shall defend, indemnify and hold
harmless Bank and its officers, employees, and agents against; (a) all
obligations, demands, claims, and liabilities claimed or asserted by any other
party in connection with the transactions contemplated by the Loan Documents;
and (b) all losses or Bank Expenses in any way suffered, incurred, or paid by
Bank as a result of or in any way arising out of, following, or consequential
to transactions between Bank and Borrower whether under the Loan Documents, or
otherwise (including without limitation reasonable attorneys fees and
expenses), except for losses caused by Bank's gross negligence or willful
misconduct.

12.3 Time of Essence. Time is of the essence for the performance of
all obligations set forth in this Agreement.

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<PAGE> 26
12.4 Severability of Provisions. Each provision of this Agreement
shall be severable from every other provision of this Agreement for the purpose
of determining the legal enforceability of any specific provision.

12.5 Amendments in Writing, Integration. This Agreement cannot be
amended or terminated orally. All prior agreements, understandings,
representations, warranties, and negotiations between the parties hereto with
respect to the subject matter of this Agreement, if any, are merged into this
Agreement and the Loan Documents.

12.6 Counterparts. This Agreement may be executed in any number of
counterparts and by different parties on separate counterparts, each of which,
when executed and delivered, shall be deemed to be an original, and all of
which, when taken together, shall constitute but one and the same Agreement.

12.7 Survival. All covenants, representations and warranties made in
this Agreement shall continue in full force and effect so long as any
Obligations remain outstanding. The obligations of Borrower to indemnify Bank
with respect to the expenses, damages, losses, costs and liabilities described
in Section 12.2 shall survive until all applicable statute of limitations
periods with respect to actions that may be brought against Bank have run.

12.8 Confidentiality. In handling any confidential information Bank
and all employees and agents of Bank, including but not limited to accountants,
shall exercise the same degree of care that it exercises with respect to its
own proprietary information of the same types to maintain the confidentiality
of any non-public information thereby received or received pursuant to this
Agreement except that disclosure of such information may be made (i) to the
subsidiaries or affiliates of Bank in connection with their present or
prospective business relations with Borrower, (ii) to prospective transferees
or purchasers of any interest in the Loans, provided that they have entered
into a comparable confidentiality agreement in favor of Borrower and have
delivered a copy to Borrower, (iii) as required by law, regulations, rule or
order, subpoena, judicial order or similar order, (iv) as may be required in
connection with the examination, audit or similar investigation of Bank and (v)
as Bank may determine in connection with the enforcement of any remedies
hereunder. Confidential information hereunder shall not include information
that either: (a) is in the public domain or in the knowledge or possession of
Bank when disclosed to Bank, or becomes part of the public domain after
disclosure to Bank through no fault of Bank; or (b) is disclosed to Bank by a
third party, provided Bank does not have actual knowledge that such third party
is prohibited from disclosing such information.

13. JUDICIAL REFERENCE

(a) Other than (i) nonjudicial foreclosure and all matters in
connection therewith regarding security interests in real or personal property;
or (ii) the appointment of a receiver, or the exercise of other provisional
remedies (any and all of which may be initiated pursuant to applicable law),
each controversy, dispute or claim between the parties arising out of or
relating to this Agreement, which controversy, dispute or claim is not settled
in writing within thirty (30) days after the "Claim Date" (defined as the date
on which a party subject to this Agreement gives written notice to all other
parties that a controversy, dispute or claim exists), will be settled by a
reference proceeding in California in accordance with the provisions of Section
638 et seq. of the California Code of Civil Procedure, or their successor
section ("CCP"), which shall constitute the exclusive remedy for the settlement
of any controversy, dispute or claim concerning this Agreement, including
whether such controversy, dispute or claim is subject to the reference
proceeding and except as set forth above, the parties waive their rights to
initiate any legal proceedings against each other in any court or jurisdiction
other than the Superior Court in the County where the Real Property, if any, is
located or Santa Clara County if none (the "Court"). The referee shall be a
retired Judge of the Court selected by mutual agreement of the parties, and if
they cannot so agree within forty-five (45) days after the Claim

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<PAGE> 27
Date, the referee shall be promptly selected by the Presiding Judge of the Court
(or his representative). The referee shall be appointed to sit as a temporary
judge, with all of the powers for a temporary judge, as authorized by law, and
upon selection should take and subscribe to the oath of office as provided for
in Rule 244 of the California Rules of the Court (or any subsequently enacted
Rule). Each party shall have one peremptory challenge pursuant to CCP Section
170.6. The referee shall (a) be requested to set the matter for hearing within
sixty (60) days after the date of selection of the referee and (b) try any and
all issues of law or fact and report a statement of decision upon them, if
possible, within ninety (90) days of the Claim Date. Any decision rendered by
the referee will be final, binding and conclusive and judgement shall be entered
pursuant to CCP Section 644 in any court in the State of California having
jurisdiction. Any party may apply for a reference proceeding at any time after
thirty (30) days following notice to any other party of the nature of the
controversy, dispute or claim, by filing a petition for a hearing and/or trial.
All discovery permitted by this Agreement shall be completed no later than
fifteen (15) days before the first hearing date established by the referee. The
referee may extend such period in the event of a party's refusal to provide
requested discovery or unavailability of a witness due to absence or illness. No
party shall be entitled to "priority" in conducting discovery. Depositions may
be taken by either party upon seven (7) days written notice, and request for
production or inspection of documents which cannot be resolved by the parties
shall be submitted to the referee as provided herein. The Superior Court is
empowered to issue temporary and/or provisional remedies, as appropriate.

(b) Except as expressly set forth in this Agreement, the referee
shall determine the manner in which the reference proceeding is conducted
including the time and place of all hearings, the order of presentation of
evidence, and all other questions that arise with respect to the course of the
reference proceeding. All proceedings and hearings conducted before the referee,
except for trial, shall be conducted without a court reporter except that when
any party so requests, a court reporter will be used at any hearing conducted
before the referee. The party making such a request shall have the obligation to
arrange for and pay for the court reporter. The costs of the court reporter at
the trial shall be borne equally by the parties.

(c) The referee shall be required to determine all issues in
accordance with existing case law and the statutory laws of the State of
California. The rules of evidence applicable to proceedings at law in the State
of California will be applicable to the reference proceeding. The referee shall
be empowered to enter equitable as well as legal relief, to provide all
temporary and/or provisional remedies and to enter equitable orders that will be
binding upon the parties. The referee shall issue a single judgement at the
close of the reference proceeding which shall dispose of all of the claims of
the parties that are the subject of the reference. The parties hereto expressly
reserve the right to contest or appeal from the final judgement or any
appealable order or appealable judgement entered by the referee. The parties
hereto expressly reserve the right to findings of fact, conclusions of laws, a
written statement of decision, and the right to move for a new trial or a
different judgment, which new trial, if granted, is also to be a reference
proceeding under this Section 13.

(d) In the event that the enabling legislation which provides
for appointment of a referee is repealed (and no successor statute is enacted),
any dispute between the parties that would otherwise be determined by the
reference procedure herein described will be resolved and determined by
arbitration. The arbitration will be conducted by a retired judge of the Court,
in accordance with the California Arbitration Act, Section 1280 through
Section 1294.2 of the CCP as amended from time to time. The limitations with
respect to discovery as set forth hereinabove shall apply to any such
arbitration proceeding.

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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the date first above written.

VERITY, INC.

By: [SIG]
-----------------------------------------
Title: V.P. Administration and Controller
Assistant Secretary

IMPERIAL BANK

By: [SIG]
-----------------------------------------
Title: Assistant Vice President

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<PAGE> 29

EXHIBIT A

The Collateral shall consist of all right, title and interest of Borrower
in and to the following:

(a) All goods and equipment now owned or hereafter acquired, including,
without limitation, all machinery, fixtures, vehicles (including motor vehicles
and trailers), and any interest in any of the foregoing, and all attachments,
accessories, accessions, replacements, substitutions, additions, and
improvements to any of the foregoing, wherever located;

(b) All inventory, now owned or hereafter acquired, including without
limitation, all merchandise, raw materials, parts, supplies, packing and
shipping materials, work in process and finished products including such
inventory as is temporarily out of Borrower's custody or possession or in
transit and including any returns upon any accounts or other proceeds,
including insurance proceeds, resulting from the sale or disposition of any of
the foregoing and any documents of title representing any of the above, and
Borrower's Books relating to any of the foregoing;

(c) All contract rights and general intangibles now owned or hereafter
acquired, including, without limitation, goodwill, trademarks, servicemarks,
trade styles, trade names, patents, patent applications, leases, license
agreements, franchise agreements, blueprints, drawings, purchase orders,
customer lists, route lists, infringements, claims, computer programs, computer
discs, computer tapes, literature, reports, catalogs, design rights, income tax
refunds, payment of insurance and rights to payment of any kind;

(d) all now existing and hereafter arising accounts, contract rights,
royalties, license rights and all other forms of obligations owing to Borrower
arising out of the sale or lease of goods, the licensing of technology or the
rendering of services by Borrower, whether or not earned by performance, and
any and all credit insurance, guaranties, and other security therefor, as well
as all merchandise returned to or reclaimed by Borrower and Borrower's Books
relating to any of the foregoing;

(e) All documents, cash, deposit accounts, securities, securities
accounts, securities entitlements, letters of credit, certificates of deposit,
instruments and chattel paper now owned or hereafter acquired and Borrower's
Books relating to the foregoing;

(f) All copyright rights, copyright applications, copyright registrations
and like protections in each work of authorship and derivative work thereof,
whether published or unpublished, now owned or hereafter acquired; all trade
secret rights, including all rights to unpatented inventions, know-how,
operating manuals, license rights and agreements and confidential information,
now owned or hereafter acquired; all mask work or similar rights available for
the protection of semiconductor chips, now owned or hereafter acquired; all
claims for damages by way of any past, present and future infringement of any
of the foregoing; and

(g) Any and all claims, rights and interests in any of the above and all
substitutions for, additions and accessions to and proceeds thereof.

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EXHIBIT B

LOAN PAYMENT/ADVANCE TELEPHONE REQUEST FORM

DEADLINE FOR SAME DAY PROCESSING IS 3:00 P.M., P.S.T.

TO: EMERGING GROWTH INDUSTRIES DATE:________________________

FAX#: (650) 233-3020 TIME:________________________
- -------------------------------------------------------------------------------

FROM:__________________________________________________________________________
CLIENT NAME (BORROWER)

REQUESTED BY:__________________________________________________________________
AUTHORIZED SIGNER'S NAME

AUTHORIZED SIGNATURE:__________________________________________________________

PHONE NUMBER:__________________________________________________________________

FROM ACCOUNT #__________________________ TO ACCOUNT #__________________________

REQUESTED TRANSACTION TYPE REQUEST DOLLAR AMOUNT

PRINCIPAL INCREASE (ADVANCE) $_____________________________________
PRINCIPAL PAYMENT (ONLY) $_____________________________________
INTEREST PAYMENT (ONLY) $_____________________________________
PRINCIPAL AND INTEREST (PAYMENT) $_____________________________________

OTHER INSTRUCTIONS:____________________________________________________________
_______________________________________________________________________________

All representations and warranties of Borrower stated in the Loan
Agreement are true, correct and complete in all material respects as of the
date of the telephone request for and Advance confirmed by this Borrowing
Certificate; provided, however, that those representations and warranties
expressly referring to another date shall be true, correct and complete in all
material respects as of such date.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
BANK USE ONLY

TELEPHONE REQUEST:

The following person is authorized to request the loan payment transfer/loan
advance on the advance designated account and is known to me.

_________________________________________ ______________________________
Authorized Requester Phone #

_________________________________________ ______________________________
Received By (Bank) Phone #

_____________________________________________
Authorized Signature (Bank)
- -------------------------------------------------------------------------------

27
<PAGE> 31
EXHIBIT C

COMPLIANCE CERTIFICATE

TO: IMPERIAL BANK

FROM: VERITY, INC.

The undersigned authorized officer of Verity, Inc. hereby certifies that
in accordance with the terms and conditions of the Loan and Security Agreement
between Borrower and Bank (the "Agreement"), (i) Borrower is in complete
compliance for the period ending _______ with all required covenants except as
noted below and (ii) all representations and warranties of Borrower stated in
the Agreement are true and correct in all material respects as of the date
hereof. Attached herewith are the required documents supporting the above
certification. The Officer further certifies that these are prepared in
accordance with Generally Accepted Accounting Principles (GAAP) and are
consistently applied from one period to the next except as explained in an
accompanying letter or footnotes.

Please indicate compliance status by circling Yes/No under "Complies" column.

<TABLE>
<CAPTION>
Reporting Covenant Required Complies
- ----------------- -------- --------
<S> <C> <C>

Quarterly financial statements Quarterly within 45 days Yes No
Annual (CPA Audited) FYE within 90 days Yes No
A/R & A/P Agings Quarterly within 45 days Yes No
A/R Audit Initial and Semi-Annual Yes No
</TABLE>

<TABLE>
<CAPTION>
Financial Covenant Required Actual Complies
- ------------------ -------- ------ --------
<S> <C> <C> <C>
Maintain on a Quarterly Basis:
Minimum Quick Ratio 1.50:1.00 ____:1.00 Yes No
Minimum Tangible Net Worth $19,000,000 $________ Yes No
Debt-Tangible Net Worth 1.00:1.00 ____:1.00 Yes No
Profitability/Loss $1.00* $________ Yes No

</TABLE>

<TABLE>
<S> <C>
*11/30/97 Loss <$7,500,000; 2/28.98 Loss <$2,000,000. --------------------------------------------------

Comments Regarding Exceptions: See Attached. BANK USE ONLY

Sincerely, Received by:

----------------------------------
- ------------------------------------------------------- AUTHORIZED
SIGNATURE SIGNER

- ------------------------------------------------------- Date:
TITLE -----------------------------------------

- ------------------------------------------------------- Verified:
DATE -------------------------------------
AUTHORIZED
SIGNER

Date:
-----------------------------------------

Compliance Status: Yes No

----------------------------------------------
</TABLE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINING SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AT FEBRUARY 28, 1998 (UNAUDITED) AND THE
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED FEBRUARY 28, 1998
(UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-START> JUN-01-1997
<PERIOD-END> FEB-28-1998
<CASH> 3,909
<SECURITIES> 11,663
<RECEIVABLES> 9,984
<ALLOWANCES> 560
<INVENTORY> 0
<CURRENT-ASSETS> 26,031
<PP&E> 17,934
<DEPRECIATION> 9,527
<TOTAL-ASSETS> 35,072
<CURRENT-LIABILITIES> 13,396
<BONDS> 10
0
0
<COMMON> 11
<OTHER-SE> 21,655
<TOTAL-LIABILITY-AND-EQUITY> 35,072
<SALES> 18,434
<TOTAL-REVENUES> 25,733
<CGS> 2,248
<TOTAL-COSTS> 6,375
<OTHER-EXPENSES> 37,896
<LOSS-PROVISION> (87)
<INTEREST-EXPENSE> 95
<INCOME-PRETAX> (17,385)
<INCOME-TAX> 150
<INCOME-CONTINUING> (17,535)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (17,535)
<EPS-PRIMARY> (1.57)
<EPS-DILUTED> (1.57)

</TABLE>