VERITY INC \DE\, 10-Q, 2001-01-10

VERITY INC \DE\
10-Q, 2001-01-10
COMPUTER PROCESSING & DATA PREPARATION

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

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

FORM 10-Q
------------------------

(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2000

[ ] 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 33,777,000 as of December 15, 2000.

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<PAGE> 2

VERITY, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of May 31, 2000 and
November 30, 2000........................................... 1
Condensed Consolidated Statements of Operations for the
Three Months Ended November 30, 1999 and 2000, and the Six
Months Ended November 30, 1999 and 2000..................... 2
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended November 30, 1999 and 2000..................... 3
Notes to Condensed Consolidated Financial Statements........ 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 7
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 23
Item 2. Changes in Securities and Use of Proceeds................... 23
Item 3. Defaults upon Senior Securities............................. 23
Item 4. Submission of Matters to a Vote of Security Holders......... 23
Item 5. Other Information........................................... 24
Item 6. Exhibits and Reports on Form 8-K............................ 24
Signature ............................................................ 25
</TABLE>

i
<PAGE> 3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VERITY, INC.

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

ASSETS

<TABLE>
<CAPTION>
MAY 31, NOVEMBER 30,
2000 2000
-------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 7,183 $ 11,925
Short-term investments.................................... 109,472 145,619
Trade accounts receivable, net............................ 23,418 31,621
Deferred tax assets....................................... 20,210 20,210
Prepaid and other......................................... 3,988 6,071
-------- --------
Total current assets.............................. 164,271 215,446
Property and equipment, net................................. 4,773 5,465
Long-term investments....................................... 37,616 36,645
Deferred tax assets......................................... 6,562 8,422
Other assets................................................ 156 78
-------- --------
Total assets...................................... $213,378 $266,056
======== ========

LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 6,488 $ 7,911
Accrued compensation...................................... 9,327 10,919
Other accrued liabilities................................. 1,198 2,926
Deferred revenue.......................................... 12,731 14,128
-------- --------
Total current liabilities......................... 29,744 35,884
-------- --------
Commitments and contingencies (Note 6)

STOCKHOLDERS' EQUITY

Common stock, $0.001 par value:
Authorized: 200,000,000 shares Issued and outstanding:
31,606,000 shares as of May 31, 2000 and 33,757,000
shares as of November 30, 2000......................... 31 34
Additional paid-in capital.................................. 207,040 237,713
Other comprehensive income (loss)........................... (401) 66
Accumulated deficit......................................... (23,036) (7,641)
-------- --------
Total stockholders' equity........................ 183,634 230,172
-------- --------
Total liabilities and stockholders' equity........ $213,378 $266,056
======== ========
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
<PAGE> 4

VERITY, INC.

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

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
------------------ ------------------
1999 2000 1999 2000
------- ------- ------- -------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Software products................................. $10,093 $25,558 $24,567 $48,356
Service and other................................. 6,624 8,962 11,915 17,454
------- ------- ------- -------
Total revenues............................ 16,717 34,520 36,482 65,810
------- ------- ------- -------
Costs of revenues:
Software products................................. 173 385 317 732
Service and other................................. 2,290 2,978 3,910 5,536
------- ------- ------- -------
Total costs of revenues................... 2,463 3,363 4,227 6,268
------- ------- ------- -------
Gross profit........................................ 14,254 31,157 32,255 59,542
------- ------- ------- -------
Operating expenses:
Research and development.......................... 3,736 4,827 7,462 9,412
Marketing and sales............................... 8,718 13,800 16,782 25,824
General and administrative........................ 1,600 2,530 3,180 4,700
------- ------- ------- -------
Total operating expenses.................. 14,054 21,157 27,424 39,936
------- ------- ------- -------
Income from operations.............................. 200 10,000 4,831 19,606
Other income, net................................... 1,490 2,834 2,119 5,105
------- ------- ------- -------
Net income before provision for income taxes........ 1,690 12,834 6,950 24,711
Provision for income taxes.......................... 150 4,684 300 9,316
------- ------- ------- -------
Net income.......................................... $ 1,540 $ 8,150 $ 6,650 $15,395
======= ======= ======= =======
Net income per share -- basic....................... $ 0.05 $ 0.24 $ 0.23 $ 0.47
======= ======= ======= =======
Net income per share -- diluted..................... $ 0.04 $ 0.23 $ 0.20 $ 0.42
======= ======= ======= =======
Number of shares -- basic........................... 30,514 33,449 28,743 32,909
======= ======= ======= =======
Number of shares -- diluted......................... 35,357 35,846 33,484 36,381
======= ======= ======= =======
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
<PAGE> 5

VERITY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
SIX MONTHS ENDED
NOVEMBER 30,
----------------------
1999 2000
--------- ---------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 6,650 $ 15,395
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
Depreciation and amortization............................. 1,488 1,183
Deferred income taxes..................................... -- 8,446
Provision for doubtful accounts........................... (46) 48
Amortization of discount on securities.................... (787) (765)
Other..................................................... (110) --
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Trade accounts receivable................................. 3,193 (8,469)
Prepaid and other current assets.......................... (1,145) (2,179)
Accounts payable.......................................... 335 1,465
Accrued compensation and other accrued liabilities........ (205) 3,763
Deferred revenue.......................................... (680) 1,424
--------- ---------
Net cash provided by operating activities......... 8,693 20,311
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment..................... (1,112) (1,769)
Purchases of marketable securities........................ (247,032) (189,954)
Maturity of marketable securities......................... 124,180 73,662
Proceeds from sale of marketable securities............... 37,292 82,349
--------- ---------
Net cash used in investing activities............. (86,672) (35,712)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the sale of common stock, net............... 77,250 20,369
--------- ---------
Net cash provided by financing activities......... 77,250 20,369
--------- ---------
Effect of exchange rate changes on cash..................... 77 (226)
--------- ---------
Net increase (decrease) in cash and cash
equivalents..................................... (652) 4,742
Cash and cash equivalents, beginning of period.............. 7,907 7,183
--------- ---------
Cash and cash equivalents, end of period.................... $ 7,255 $ 11,925
========= =========
</TABLE>

The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 6

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF NOVEMBER 30, 2000 AND FOR THE THREE AND SIX MONTHS ENDED
NOVEMBER 30, 1999 AND 2000 AND THEREAFTER IS UNAUDITED)

1. INTERIM FINANCIAL DATA (UNAUDITED)

The unaudited financial statements as of November 30, 2000 and for the
three and six months ended November 30, 1999 and 2000 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. The
accompanying financial statements should be read in conjunction with the
Company's annual financial statements contained in the Company's Annual Report
on Form 10-K for the year ended May 31, 2000.

The Company's balance sheet as of May 31, 2000 was derived from the
Company's audited financial statements, but does not include all disclosures
necessary for the presentation to be in accordance with generally accepted
accounting principles.

2. COMPUTATION OF NET INCOME AND EARNINGS PER SHARE

Basic earnings per share are computed using the weighted average number of
common shares outstanding during the period. Diluted earnings per share are
computed using the weighted average number of common and common equivalent
shares outstanding during the period. Dilutive common equivalent shares consist
of stock options.

Basic and diluted net income per share are calculated as follows for the
three and six months ended November 30, 1999 and 2000 (in thousands, except per
share data):

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
------------------ -----------------
1999 2000 1999 2000
------- ------- ------- -------
<S> <C> <C> <C> <C>
Basic:
Weighted-average shares....................... 30,514 33,449 28,743 32,909
======= ======= ======= =======
Net income.................................... $ 1,540 $ 8,150 $ 6,650 $15,395
======= ======= ======= =======
Net income per share.......................... $ 0.05 $ 0.24 $ 0.23 $ 0.47
======= ======= ======= =======
Diluted:
Weighted-average shares....................... 30,514 33,449 28,743 32,909
Common equivalent shares from stock options... 4,843 2,397 4,741 3,472
------- ------- ------- -------
Shares used in per share calculation.......... 35,357 35,846 33,484 36,381
------- ------- ------- -------
Net income.................................... $ 1,540 $ 8,150 $ 6,650 $15,395
======= ======= ======= =======
Net income per share.......................... $ 0.04 $ 0.23 $ 0.20 $ 0.42
======= ======= ======= =======
</TABLE>

3. COMPREHENSIVE INCOME

The Company has adopted SFAS 130, "Reporting Comprehensive Income;"
however, the effects of the adoption were immaterial to all periods presented.

4
<PAGE> 7
VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF NOVEMBER 30, 2000 AND FOR THE THREE AND SIX MONTHS ENDED
NOVEMBER 30, 1999 AND 2000 AND THEREAFTER IS UNAUDITED)

4. BUSINESS SEGMENT

The Company has sales and marketing operations located outside the United
States in the Netherlands, United Kingdom, France, Germany, Sweden, Australia,
South Africa, Mexico, and a development and technical support operation in
Canada. Foreign subsidiary revenues consist primarily of maintenance and
consulting services.

<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
------------------ ------------------
1999 2000 1999 2000
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
USA....................................... $14,902 $32,562 $33,438 $62,021
Europe.................................... 1,815 1,958 3,044 3,789
Consolidated.............................. 16,717 34,520 36,482 65,810
Long-lived assets:
USA....................................... 4,718 4,198 4,718 4,198
Europe.................................... 400 818 400 818
ROW....................................... 432 527 432 527
Consolidated.............................. 5,550 5,543 5,550 5,543
</TABLE>

Transfers between geographic areas are recorded at amounts generally above
cost and in accordance with the rules and regulations of the respective
governing tax authorities. Long-lived assets of geographic areas are those
assets used in the Company's operations in each area.

No single customer accounted for more than 10% of the Company's total
revenues for the three and six months ended November 30, 1999 and the six months
ended November 30, 2000. For the three months ended November 30, 2000, revenues
derived from sales to one customer accounted for approximately 15% of the
Company's total revenue. Revenues derived from sales to the United States
government and its agencies were 10.0% and 6.3% of the Company's total revenues
for the three months ended November 30, 1999 and 2000, respectively, and 12.1%
and 6.4% of total revenues for the six months ended November 30, 1999 and 2000,
respectively.

5. RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS
133"), which establishes new standards of accounting and reporting for
derivative instruments and hedging activities. SFAS 133 requires that all
derivatives be recognized at fair value in the statement of financial position,
and that the corresponding gains or losses be reported either in the statement
of operations or as a component of comprehensive income, depending on the type
of hedging relationship that exists. SFAS 133 is effective for fiscal years
beginning after June 15, 2000. The Company is currently assessing the potential
impact of this pronouncement on its financial statements.

In December 1999, the Securities Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements, which outlines the basic criteria that must be met to recognize
revenue and provides guidance for presentation of revenue and for disclosure
related to revenue recognition policies in financial statements filed with the
SEC. In June 2000, the SEC issued SAB 101(B), which defers the implementation
date of SAB 101 to no later than the fourth fiscal quarter of fiscal years
commencing after December 15, 1999. The Company has evaluated the provision of
SAB 101 and it is in compliance with SAB 101.

5
<PAGE> 8
VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF NOVEMBER 30, 2000 AND FOR THE THREE AND SIX MONTHS ENDED
NOVEMBER 30, 1999 AND 2000 AND THEREAFTER IS UNAUDITED)

In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation -- an
Interpretation of APB 25." This Interpretation clarifies (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a non-compensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. This Interpretation was effective July 1,
2000, but certain conclusions in this Interpretation cover specific events that
occur after either December 15, 1998, or January 12, 2000. To the extent that
this Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. The adoption of FIN 44 did not have a material impact on the
Company's financial statements.

6. COMMITMENTS AND CONTINGENCIES

In December 1999, a number of complaints were filed in the United States
District Court for the Northern District of California seeking an unspecified
amount of damages on behalf of an alleged class of persons who purchased shares
of the Company's common stock during the period between December 1 and December
14, 1999. The complaints name as defendants the Company and certain of its
directors and officers, asserting that they violated federal securities laws by
misrepresenting Verity's business, earnings growth, ability to continue to
achieve profitable growth, and failing to disclose certain information about the
Company's business. While management intends to defend the actions against the
Company vigorously, there can be no assurance that an adverse result or
settlement with regards to these lawsuits would not have a material adverse
effect on the Company's financial condition or results of operations.

7. EFFECTIVE TAX RATE

During the quarter ended November 30, 2000, the Company assessed the
qualification of its research and development expenses for state and federal
research and development tax credits. Management expected the tax savings for
fiscal 2001 due to research and development tax credits would result in a
significantly lower effective tax rate, and accordingly, applied an effective
tax rate of 36.5% to the result of the quarter ended November 30, 2000. The
Company is currently assessing the impact of its research and development
expenses on the effective tax rate in future periods.

6
<PAGE> 9

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

The following discussion should be read in conjunction with the
consolidated financial statements and related notes, which appear in our Annual
Report on Form 10-K for the fiscal year ended May 31, 2000. The following
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of certain factors, including
those discussed below and elsewhere in this Quarterly Report on Form 10-Q,
particularly under the heading "-- Risk Factors" below.

OVERVIEW

We derive substantially all of our revenues from the license of custom
search and retrieval applications and consulting and other services related to
such applications. In 1995, we began refining and enhancing our core technology
to add functionality and facilitate incorporation of our technology in a variety
of markets. Recently, we have begun offering solutions and technology that
address the business portal market. The business portal market includes
corporate portals used for sharing information within an enterprise, e-commerce
portals for online selling and market exchange portals for business-to-business
activities. Business portals provide personalized information to employees,
partners, customers and suppliers. We expect that for the foreseeable future we
will derive the largest portions of our revenues from licensing our technology
for enterprise applications and business portal solutions.

During the quarterly periods ended August 31, 1997 to August 31, 1999 and
February 29, 2000 to November 30, 2000, we experienced increased revenues on a
quarterly basis. In addition, during the eleven consecutive quarterly periods
ended November 30, 2000, we experienced ten quarters of record revenues. Due to
a delay in closing three large transactions, revenues for the quarter ended
November 30, 1999 were lower than expected. In fiscal year 2000, we achieved net
income of $33.0 million. While our goal is to increase revenue and generate net
income in future periods, we cannot assure you that our strategy will be
successful, that we will experience the rate of revenue growth we experienced
from August 31, 1997 to November 30, 2000 in future periods, or that we will
continue to maintain positive cash flow or profitability.

Our revenues are derived from license fees for our software products and
fees for services complementary to our products, including software maintenance,
consulting and training. Fees for services generally are charged separately from
the license fees for our software products. We recognize revenues in accordance
with the provisions of American Institute of Certified Public Accountants
Statement of Position No. 97-2, "Software Revenue Recognition." We record
revenue from licensing of software products when evidence of an arrangement
exists, the fee is fixed and determinable, collection is probable and delivery
of the product has occurred. For agreements, which include multiple elements,
such as license, maintenance, training and consulting services, we allocate
revenue to all undelivered elements usually maintenance and other services,
based on objective evidence of its fair value, which is specific to us. Any
remaining amount is allocated to the delivered elements and recognized as
revenue when the conditions set forth above are met. We recognize revenue
allocated to maintenance fees for ongoing customer support and product updates
ratably over the period of the maintenance contract, which is typically twelve
months. Payments for maintenance fees are generally made in advance and are
non-refundable. For revenue allocated to training and consulting services, we
recognize revenue as the related services are performed.

7
<PAGE> 10

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
NOVEMBER 30, NOVEMBER 30,
-------------- --------------
1999 2000 1999 2000
----- ----- ----- -----
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Software products................................. 60.4% 74.0% 67.3% 73.5%
Service and other................................. 39.6 26.0 32.7 26.5
----- ----- ----- -----
Total revenues............................ 100.0 100.0 100.0 100.0
----- ----- ----- -----
Costs of revenues:
Software products................................. 1.0 1.1 0.9 1.1
Service and other................................. 13.7 8.6 10.7 8.4
----- ----- ----- -----
Total costs of revenues................... 14.7 9.7 11.6 9.5
----- ----- ----- -----
Gross profit........................................ 85.3 90.3 88.4 90.5
----- ----- ----- -----
Operating expenses:
Research and development.......................... 22.3 14.0 20.5 14.3
Marketing and sales............................... 52.2 40.0 46.0 39.2
General and administrative........................ 9.6 7.3 8.7 7.2
----- ----- ----- -----
Total operating expenses.................. 84.1 61.3 75.2 60.7
----- ----- ----- -----
Income from operations.............................. 1.2 29.0 13.2 29.8
Interest and other expenses......................... 8.9 8.2 5.9 7.7
----- ----- ----- -----
Income before provision for income taxes............ 10.1 37.2 19.1 37.5
Provision for income taxes.......................... 0.9 13.6 0.9 14.1
----- ----- ----- -----
Net income.......................................... 9.2% 23.6% 18.2% 23.4%
===== ===== ===== =====
</TABLE>

Revenues

Our total revenues increased 80.4% from $36.5 million for the six months
ended November 30, 1999, to $65.8 million for the six months ended November 30,
2000, and 106.5% from $16.7 million for the three months ended November 30, 1999
to $34.5 million for the three months ended November 30, 2000. The increases for
the six-month and three-month periods ended November 30, 2000 were due
principally to increased revenues from our enterprise application and business
portal solutions business as well as an increase in maintenance and consulting
services. Software product revenues increased as a percentage of total revenues
from 67.3% and 60.4% for the six months and three months ended November 30,
1999, respectively, to 73.5% and 74.0%, respectively, for the comparable periods
in fiscal 2001. Service and other revenues decreased as a percentage of total
revenues from 32.7% and 39.6% for the six and three months ended November 30,
1999, respectively, to 26.5% and 26.0% for the six and three months ended
November 30, 2000, respectively.

Software product revenues. Software product revenues increased 96.8% from
$24.6 million for the six months ended November 30, 1999 to $48.4 million for
the six months ended November 30, 2000. For the three months ended November 30,
2000, software product revenues increased 153.2% to $25.6 million from $10.1
million for the three months ended November 30, 1999. The increases for the six
and three months ended November 30, 2000 in comparison to the same periods in
fiscal 2000 were due principally to increased revenues from our enterprise
application and business portal solutions business.

Service and other revenues. Our service and other revenues consist
primarily of fees for software, maintenance, consulting and training. Service
and other revenues increased 46.5% from $11.9 million for the six months ended
November 30, 1999 to $17.5 million for the six months ended November 30, 2000.
For the three months ended November 30, 2000, service and other revenues
increased 35.3% to $9.0 million from

8
<PAGE> 11

$6.6 million for the three months ended November 30, 1999. The increase in
service and other revenues for the six and three months ended November 30, 2000
was primarily due to increase in maintenance revenues, which resulted from a
significant growth in our customer base.

Service and other revenues from foreign operations accounted for 8.3% and
5.8% of total revenues for the six months ended November 30, 1999 and 2000,
respectively. For the three months ended November 30, 1999 and 2000, service and
other revenues from foreign operations accounted for 10.9% and 5.7% of total
revenues, respectively. Our export sales consist primarily of products licensed
for delivery outside of the United States. For the six months ended November 30,
1999 and 2000, export sales accounted for 18.1% and 28.1% of total revenues,
respectively. For the three months ended November 30, 1999 and 2000, export
sales accounted for 22.4% and 34.4% of total revenues, respectively. We expect
that revenues derived from foreign operations and export sales will continue to
vary in future periods as a percentage of total revenues.

No single customer accounted for more than 10% of the Company's total
revenues for the three and six months ended November 30, 1999 and the six months
ended November 30, 2000. For the three months ended November 30, 2000, revenues
derived from sales to one customer accounted for approximately 15% of the
Company's total revenue. Revenues derived from sales to the United States
government and its agencies were 12.1% and 6.4% of our total revenues for the
six months ended November 30, 1999 and 2000, respectively, and 10.0% and 6.3% of
total revenues for the three months ended November 30, 1999 and 2000,
respectively. We expect 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. The cost of our software products consists
primarily of product media, duplication, manuals, packaging materials, shipping
expenses and royalties, and in certain instances, licensing of third-party
software incorporated in our products. Costs of software products increased
130.9% from $317,000 for the six months ended November 30, 1999 to $732,000 for
the same comparable period in fiscal 2001, representing 1.3% and 1.5%,
respectively, of the software product revenues. Cost of software products
increased 122.5% from $173,000 for the three months ended November 30, 1999 to
$385,000 for the three months ended November 30, 2000, representing 1.7% and
1.5%, respectively, of the software product revenues during these periods. The
increase in absolute dollars and for the six and three months ended November 30,
2000, was primarily attributable to increasing costs of third party software
components and costs associated with the introduction of our Portal One suite of
products. The decrease in costs as a percentage of software product revenues for
the three months ended November 30, 2000, was principally due to the significant
increase in software revenue for the period.

Costs of service and other. Our costs of service and other revenues consist
of costs incurred in providing consulting services, customer training, telephone
support and product upgrades to customers. Costs of service and other revenues
increased 41.6% from $3.9 million for the six months ended November 30, 1999 to
$5.5 million for the same comparable period in fiscal 2001, representing 32.8%
and 31.7%, respectively, of service and other revenues for these periods. Costs
of service and other revenue increased 30.0% from $2.3 million for the three
months ended November 30, 1999 to $3.0 million for the three months ended
November 30, 2000, representing 34.6% and 33.2%, respectively, of service and
other revenues for these periods. The increase in absolute dollars of service
and other revenues for the six months and three months ended November 30, 2000
was due to an increase in the staffing of our professional services organization
to support an increase in customer base. The decrease in costs as a percentage
of service and other revenues for the six and three months ended November 30,
2000 was primarily related to an increase in service and other revenues for
these periods.

Operating Expenses

Research and development. Research and development expenses increased 26.1%
from $7.5 million for the six months ended November 30, 1999 to $9.4 million for
the six months ended November 30, 2000, representing 20.5% and 14.3%,
respectively, of total revenues for these periods. Research and development

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expenses increased 29.2% from $3.7 million for the three months ended November
30, 1999 to $4.8 million for the three months ended November 30, 2000,
representing 22.3% and 14.0%, respectively, of total revenues for these periods.
The increase in absolute dollars for the six and three months ended November 30,
2000 was primarily due to an increase in research and development personnel and
outside consulting services to focus on enhancement of existing products and
development of new products addressing the business portal market. The decrease
in costs as a percentage of total revenues for the six and three months ended
November 30, 2000 was primarily related to the increased revenues during these
periods. We believe that research and development expenses may increase in the
future primarily due to the introduction of new products and other anticipated
product development efforts. Our future research and development expenses may
continue to vary as a percentage of total revenues.

Marketing and sales. Marketing and sales expenses increased 53.9% from
$16.8 million for the six months ended November 30, 1999 to $25.8 million for
the six months ended November 30, 2000, representing 46.0% and 39.2%,
respectively, of total revenues during these periods. Marketing and sales
expenses increased 58.3% from $8.7 million for the three-month period ended
November 30, 1999 to $13.8 million for the three-month period ended November 30,
2000, representing 52.2% and 40.0%, respectively, of total revenues for these
periods. The increase in absolute costs for the six and three months ended
November 30, 2000 was primarily related to the continuous expansion of our
marketing and sales organizations, the continued development of our sales
distribution channels in the United States and Europe and outbound marketing
activities associated with the re-branding of our company. The decrease in costs
as a percentage of total revenues for the six and three months ended November
30, 2000 was primarily related to the increased revenues during the periods. We
anticipate that we will continue to make significant investments in marketing
and sales.

General and administrative. General and administrative expenses increased
47.8% from $3.2 million for the six months ended November 30, 1999 to $4.7
million for the six months ended November 30, 2000, representing 8.7% and 7.2%,
respectively, of total revenues during these periods. For the three months ended
November 30, 2000, general and administrative expenses increased 58.1% from $1.6
million for the three months ended November 30, 1999 to $2.5 million,
representing 9.6% and 7.3%, respectively, of total revenues for the comparable
periods. The increase in absolute costs for the six and three months ended
November 30, 2000 was primarily related to increases in professional service
fees required to support our continued growth. The decrease in costs as a
percentage of total revenues for the six and three months ended November 30,
2000 was primarily related to the increased revenues during the periods.

Income Taxes

Prior to the quarter ended May 31, 2000, we established a valuation
allowance as an offset to our deferred tax assets due to the uncertainty
surrounding the realization of such assets. On a regular basis, we review the
recoverability of the deferred tax assets. At May 31, 1999, we had a valuation
allowance totaling $18.9 million as an offset to our deferred tax assets. At May
31, 2000, we assessed the realizability of the deferred tax assets and the
entire valuation allowance was released based on management's assessment. It is
more likely than not that all the net deferred tax assets will be realized
through future taxable earnings.

During the quarter ended November 30, 2000, we assessed the qualification
of our research and development expenses for state and federal research and
development tax credits. We expected the tax savings for fiscal 2001 due to
research and development tax credits would result in a significantly lower
effective tax rate, and accordingly, applied an effective tax rate of 36.5% to
the result of our quarter ended November 30, 2000. We are currently assessing
the impact of our research and development expenses on our effective tax rate in
future periods.

LIQUIDITY AND CAPITAL RESOURCES

As of November 30, 2000, we had $194.2 million in cash and cash equivalents
and available-for-sale securities compared to $154.3 million at May 31, 2000.

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Our operating activities provided cash of $8.7 million and $20.3 million
for the six months ended November 1999 and 2000, respectively. Cash provided by
operating activities in the six months ended November 30, 1999 was primarily due
to our net income, a decrease in accounts receivable, and depreciation and
amortization expense offset in part by an increase in prepaid and other current
assets and a decrease in deferred revenue. Cash provided in connection with
operating activities for the six months ended November 30, 2000 was primarily
due to our net income, depreciation and amortization expense, an increase in
liabilities and deferred revenues, offset in part by an increase in accounts
receivable and other current assets.

Our investing activities used cash of $86.7 million and $35.7 million for
the six months ended November 30, 1999 and 2000, respectively. For the six
months ended November 30, 1999 and 2000, cash used by investing activities
consisted primarily of purchases of marketable securities partially offset by
proceeds from the sale and maturity of marketable securities.

Cash provided by financing activities was $77.3 million and $20.4 million
for the six months ended November 30, 1999 and 2000, respectively. In the six
months ended November 30, 1999, financing activities consisted primarily of
proceeds from the sale of our common stock in conjunction with our public
offering and the sales of common stock as a result of stock options exercised.
In the six months ended November 30, 2000, financing activities consisted
primarily of proceeds from the sale of common stock as a result of stock options
exercised.

At November 30, 2000, our principal sources of liquidity were our cash and
cash equivalents and short-term investments of $157.5 million. As of November
30, 2000, we had no outstanding debt obligations.

Capital expenditures were approximately $1.1 million and $1.8 million for
the six months ended November 30, 1999 and 2000, respectively. For the six
months ended November 30, 1999 and 2000, these expenditures consisted
principally of purchases of property and equipment, primarily for computer
hardware and software.

We believe that our current cash and cash equivalents and our funds
generated from operations, if any, will provide adequate liquidity to meet our
capital and operating requirements through at least fiscal 2002. Thereafter, or
if our spending plans change, we may find it necessary to seek to obtain
additional sources of financing to support our capital needs, but we cannot
assure you that such financing will be available on commercially reasonable
terms, or at all.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS
133"), which establishes new standards of accounting and reporting for
derivative instruments and hedging activities. SFAS 133 requires that all
derivatives be recognized at fair value in the statement of financial position,
and that the corresponding gains or losses be reported either in the statement
of operations or as a component of comprehensive income, depending on the type
of hedging relationship that exists. SFAS 133 is effective for fiscal years
beginning after June 15, 2000. We are currently assessing the potential impact
of this pronouncement on our financial statements.

In December 1999, the Securities Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements, which outlines the basic criteria that must be met to recognize
revenue and provides guidance for presentation of revenue and for disclosure
related to revenue recognition policies in financial statements filed with the
SEC. In June 2000, the SEC issued SAB 101(B), which defers the implementation
date of SAB 101 to no later than the fourth fiscal quarter of fiscal years
commencing after December 15, 1999. We have evaluated the provision of SAB 101
and we are in compliance with SAB 101.

compensation awards in a business combination. This Interpretation was effective
July 1, 2000, but certain conclusions in this Interpretation cover specific
events that occur after either December 15, 1998, or January 12, 2000. To the
extent that this Interpretation covers events occurring during the period after
December 15, 1998, or January 12, 2000, but before the effective date of July 1,
2000 the effects of applying this Interpretation are recognized on a prospective
basis from July 1, 2000. The adoption of FIN 44 did not have a material effect
on the financial statements.

IMPACT OF EUROPEAN MONETARY CONVERSION

We are aware of the issues associated with the changes in Europe resulting
from the formation of a European economic and monetary union. One change
resulting from this union required EMU member states to irrevocably fix their
respective currencies to a new currency, the Euro, as of January 1, 1999, at
which date the euro became a functional legal currency of these countries.
During the next three years, business in the EMU member states will be conducted
in both the existing national currencies, such as the French franc or the
Deutsche mark, and the euro. As a result, companies operating or conducting
business in EMU member states will need to ensure that their financial and other
software systems are capable of processing transactions and properly handling
these currencies, including the euro. The adoption of Euro by EMU member states
has had no material impact on our operations or financial results.

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RISK FACTORS

The risks and uncertainties described below are not the only risks and
uncertainties we face. Additional risks and uncertainties not presently known to
us or that we currently deem immaterial also may impair our business operations.
If any of the following risks actually occur, our business, results of
operations and financial condition would suffer. In that event, the trading
price of our common stock could decline, and our stockholders may lose all or
part of their investment in our common stock. The risks discussed below also
include forward-looking statements and our actual results may differ
substantially from those discussed in these forward-looking statements.

RISKS RELATED TO OUR BUSINESS

OUR GROWTH RATE MAY SLOW AND WE MAY NOT BE ABLE TO MAINTAIN PROFITABILITY

Despite our recent financial performance, we have in the past incurred
significant losses and substantial negative cash flow. In the future, our
revenues may grow at a rate slower than was experienced in previous periods and,
on a quarter-to-quarter basis, our growth in net sales may be significantly
lower than our historical quarterly growth rate, particularly over the last
eleven quarters. To achieve revenue growth, we must:

- increase market acceptance of our products;

- respond effectively to competitive developments;

- attract, retain and motivate qualified personnel; and

- upgrade our technologies and commercialize our products and services
incorporating such technologies.

We cannot assure you that we will be successful in achieving any of these
goals or that we will experience increased revenues, positive cash flows, or
maintain profitability.

OUR REVENUES AND OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS, WHICH COULD
ADVERSELY AFFECT OUR STOCK PRICE

The results of operations for any quarter are not necessarily indicative of
results to be expected in future periods. We expect our stock price to vary with
our operating results and, consequently, any adverse fluctuations in our
operating results could have an adverse effect on our stock price. Our operating
results have in the past been, and will continue to be, subject to quarterly
fluctuations as a result of a number of factors. These factors include:

- the size and timing of orders;

- changes in the budget or purchasing patterns of corporations and
government agencies, foreign country exchange rates, or pricing pressures
from competitors;

- increased competition in the software and Internet industries;

- the introduction and market acceptance of new technologies and standards
in search and retrieval, Internet, document management, database,
networking, and communications technology;

- variations in sales channels, product costs, the mix of products sold, or
the success of quality control measures;

- the integration of people, operations, and products from acquired
businesses and technologies;

- changes in operating expenses and personnel;

- the overall trend toward industry consolidation; and

- changes in general economic conditions and specific economic conditions
in the computer and software industries.

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Any of the factors, some of which are discussed in more detail below, could
have a material adverse impact on our operations and financial results, and
consequently our stock price.

THE SIZE AND TIMING OF LARGE ORDERS MAY MATERIALLY AFFECT OUR QUARTERLY
OPERATING RESULTS

The size and timing of individual orders may cause our operating results to
fluctuate. The dollar amounts of large orders for our products have been
increasing, and therefore the operating results for a quarter could be
materially adversely affected if one or more large orders are either not
received or are delayed or deferred by customers. A significant portion of our
revenues in recent quarters has been derived from these relatively large sales
to a limited number of customers, and we currently anticipate that future
quarters will continue to reflect this trend. Sales cycles for these customers
can be up to six months or longer. In addition, customer order deferrals in
anticipation of new products may cause our operating results to fluctuate. Like
many software companies, we have generally recognized a substantial portion of
our 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 our products could have a material adverse
effect on our business, results of operations and financial condition in any
particular quarter. In addition, to the extent that significant sales occur
earlier than expected, operating results for subsequent quarters may fail to
keep pace or even decline.

OUR EXPENDITURES ARE TIED TO ANTICIPATED REVENUES, AND THEREFORE IMPRECISE
FORECASTS MAY RESULT IN POOR OPERATING RESULTS

Revenues are difficult to forecast because the market for search and
retrieval software is uncertain and evolving. Because we generally ship software
products within a short period after receipt of an order, we typically do 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 our revenues is derived from royalties based upon sales by third-party
vendors of products incorporating our technology. These revenues may be subject
to extreme fluctuation and are difficult for us to predict. Our expense levels
are based, in part, on our expectations as to future revenues and are to a large
extent fixed. Therefore, we 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 our expectations or any material delay of customer orders
would have an almost immediate adverse affect on our operating results and on
our ability to achieve profitability.

WE HAVE BEEN SUED, AND ARE AT RISK OF FUTURE SECURITIES CLASS ACTION LITIGATION,
DUE TO OUR PAST AND EXPECTED STOCK PRICE VOLATILITY

In the past, securities class action litigation has often been brought
against a company following a decline in the market price of its securities. For
example, in December 1999 our stock price dramatically declined, and a number of
lawsuits were filed against us. See "Part II -- Item 1. Legal Proceedings" for a
description of these lawsuits. Because we expect our stock price to continue to
fluctuate significantly, we may be the target of similar litigation in the
future. This and other securities litigation could result in substantial costs
and divert management's attention and resources, and could seriously harm our
business.

WE MUST SUCCESSFULLY INTRODUCE NEW PRODUCTS OR OUR CUSTOMERS WILL PURCHASE OUR
COMPETITORS PRODUCTS AND OUR BUSINESS WILL BE ADVERSELY AFFECTED

During the past few years, management and other personnel have focused on
modifying and enhancing our core technology to support a broader set of search
and retrieval solutions for use on enterprise-wide systems over online services,
the Internet and on CD-ROM. In order for our strategy to succeed and to remain
competitive, we must leverage our core technology to develop new product
offerings by us and by our original equipment manufacturer, or OEM, customers
that address the needs of these new markets. These development efforts are
expensive. If these products do not generate substantial revenues, our business
and results of operations will be adversely affected. We cannot assure you that
such products will be successfully completed on a timely basis or at all, will
achieve market acceptance or will generate significant revenues.

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Our development efforts are focused on expanding our suite of products,
designing enhancements to our core technology and addressing additional
technical challenges inherent in integrating our products with those of our
strategic partners and developing new applications for enterprise, e-commerce,
OEM and sophisticated CD-ROM publishing markets. We plan to undertake
development of further enhancements of the search performance, scalability,
functionality and deployability of our products. We cannot assure you that these
products will be developed and released on a timely basis, or that these
products will achieve market acceptance.

Our future operating results will depend upon our ability to increase the
installed base of our information retrieval technology and to generate
significant product revenues from our core products. Our future operating
results will also depend upon our ability to successfully market our technology
to online and Internet publishers who use this technology to index their
published information in our format. To the extent that customers do not adopt
our technology for indexing their published information, users will be unable to
search such information using our search and retrieval products, which in turn
will limit the demand for our products.

WE FACE INTENSE COMPETITION FROM COMPANIES WITH SIGNIFICANTLY GREATER FINANCIAL,
TECHNICAL, AND MARKETING RESOURCES, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO
MAINTAIN OR INCREASE SALES OF OUR PRODUCTS

The business portal software market is intensely competitive and we cannot
assure you that we will maintain our current position of market share. A number
of companies offer competitive products addressing this market. We compete with
Alta Vista, Autonomy, Excalibur, Inktomi, Dataware, Hummingbird/PC Docs/Fulcrum,
Infoseek, Lotus, Mercado, Viador, Epicentric, Thunderstone and Microsoft, among
others. We also compete indirectly with database vendors, such as Oracle, that
offer information search and retrieval capabilities with their core database
products and web platform companies, such as Netscape.

In the future, we may encounter competition from a number of companies.
Many of our existing competitors, as well as a number of other potential new
competitors, have significantly greater financial, technical and marketing
resources than we do. Because the success of our strategy is dependent in part
on the success of our strategic partners, competition between our strategic
partners and the strategic partners of our competitors, or failure of our
strategic partners to achieve or maintain market acceptance could have a
material adverse effect on our competitive position. Although we believe that
our products and technologies compete favorably with competitive products, we
cannot assure you that we will be able to compete successfully against our
current or future competitors or that competition will not have a material
adverse effect on our results of operations and financial condition.

WE RELY ON REGENT PACIFIC MANAGEMENT CORPORATION FOR THE MANAGEMENT OF VERITY,
AND THE LOSS OF THESE SERVICES COULD ADVERSELY AFFECT OUR BUSINESS

Regent Pacific Management Corporation, a management firm of which Gary J.
Sbona is chairman and chief executive officer, provides management services for
our company. The management services provided under our agreement with Regent
Pacific include the services of Mr. Sbona as our chairman of the board and chief
executive officer, and other Regent Pacific personnel as part of our management
team. Our agreement with Regent Pacific Management Corporation extends through
August 31, 2001. Under this agreement, Regent Pacific continues to provide the
services of Gary J. Sbona as our Chairman and Chief Executive Officer, and
continues to provide additional Regent Pacific management services to our
company. The agreement provides us with an option to further extend the term of
this agreement through February 2002. If the agreement with Regent Pacific were
canceled or not renewed, the loss of the Regent Pacific personnel could have a
material adverse effect on our operations, especially during the transition
phase to new management. Similarly, if any adverse change in our relationship
with Regent Pacific occurs, it could hinder management's ability to direct our
business and materially and adversely affect our results of operations and
financial condition.

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OUR BUSINESS MAY SUFFER DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES

Historically, our foreign operations and export sales account for a
significant portion of our annual revenues. Our international business
activities are subject to a number of risks, each of which could impose
unexpected costs on us that would have an adverse effect on our operating
results. These risks include:

- difficulties in complying with regulatory requirements and standards;

- tariffs and other trade barriers;

- costs and risks of localizing products for foreign countries;

- reliance on third parties to distribute our products;

- longer accounts receivable payment cycles;

- potentially adverse tax consequences;

- limits on repatriation of earnings; and

- burdens of complying with a wide variety of foreign laws.

We currently engage in only limited 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, these fluctuations could cause sales
denominated in foreign currencies to affect a reduction in the current U.S.
dollar revenues derived from sales in a particular country. Furthermore, future
international activity may result in increased foreign currency denominated
sales and, in such event, gains and losses on the conversion to U.S. dollars of
accounts receivable and accounts payable arising from international operations
may contribute significantly to fluctuations in our results of operations. The
financial stability of foreign markets could also affect our international
sales. In addition, revenues earned in various countries where we do business
may be subject to taxation by more than one jurisdiction, thereby adversely
affecting our earnings. We cannot assure you that such factors will not have an
adverse effect on the revenues from our future international sales and,
consequently, our results of operations.

Service and other revenues derived from foreign operations accounted for
6.4%, 6.7% and 4.6% of total revenues, respectively, in fiscal 1999, 2000 and
six months ended November 30, 2000. Our export sales consist primarily of
products licensed for delivery outside of the United States. In fiscal years
1999, 2000 and six months ended November 30, 2000, export sales accounted for
27.1%, 19.0% and 28.1% of total revenues. We expect that revenues derived from
foreign operations and export sales will continue to account for a significant
percentage of our revenues for the foreseeable future. These revenues may
fluctuate significantly as a percentage of revenues from period to period. In
addition, a portion of these revenues was derived from sales to foreign
government agencies, which may be subject to risks similar to those described
immediately below.

A SIGNIFICANT PORTION OF OUR REVENUES IS DERIVED FROM SALES TO THE FEDERAL
GOVERNMENT, WHICH ARE SUBJECT TO BUDGET CUTS AND, CONSEQUENTLY, THE POTENTIAL
LOSS OF REVENUES UPON WHICH WE HAVE HISTORICALLY RELIED

Revenues derived from sales to the United States government and its
agencies were 8.1%, 7.8% and 6.4% of total revenues in fiscal years 1999, 2000
and six months ended November 30, 2000, respectively. Future reductions in
United States spending on information technologies could have a material adverse
effect on our operating results. Sales to government agencies declined 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 our products to re-evaluate their
needs. These budget reductions are expected to continue over at least the next
several years.

Almost all of our government contracts contain termination clauses, which
permit contract termination upon our default or at the option of the other
contracting party. We cannot assure you such a cancellation will not occur in
the future, and any termination would adversely affect our operating results.

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IF WE ARE UNABLE TO ENHANCE OUR EXISTING PRODUCTS AND DEVELOP NEW PRODUCTS TO
RESPOND TO OUR RAPIDLY CHANGING MARKETS, OUR PRODUCTS MAY BECOME OBSOLETE

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, our position in our existing markets or other markets that we may enter
could be eroded rapidly by product advancements by competitors. If we are unable
to develop and introduce products in a timely manner in response to changing
market conditions or customer requirements, our financial condition and results
of operations would be materially and adversely affected.

The life cycles of our products are difficult to estimate. Our future
success will depend upon our ability to enhance existing products and to develop
new products on a timely basis. In addition, our 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, or HTML, and Extensible
Markup Language, or XML, and address increasingly sophisticated customer needs.
We cannot assure you that we 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.

We strive to achieve compatibility between our products and the text
publication formats we believe are or will become popular and widely adopted. We
invest substantial resources in development efforts aimed at achieving such
compatibility. Any failure by us to anticipate or respond adequately to
technology or market developments could result in a loss of competitiveness or
revenue. For instance, to date we have focused our 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, our business could be materially and adversely affected.

We embed our basic search engine in key OEM application products and,
therefore, our sales of information retrieval products depend on our ability to
maintain compatibility with these OEM applications. We cannot assure you that we
will be able to maintain compatibility with these vendors' products or continue
to be the search technology of choice for OEMs. The failure to maintain
compatibility with or be selected by OEMs would materially and adversely affect
our sales. Further, the failure of the products of our key OEM partners to
achieve market acceptance could have a material adverse effect on our results of
operations.

OUR SOFTWARE PRODUCTS ARE COMPLEX AND MAY CONTAIN ERRORS THAT COULD DAMAGE OUR
REPUTATION AND DECREASE SALES

Our complex software products may contain errors that may be detected at
any point in the products' life cycles. We have in the past discovered software
errors in some of our products and have experienced delays in shipment of
products during the period required to correct these errors. We cannot assure
you that, despite our testing and quality assurance efforts and similar efforts
by current and potential customers, errors will not be found. The discovery of
an error may result in loss of or delay in market acceptance and sales,
diversion of development resources, injury to our reputation, or increased
service and warranty costs, any of which could have a material adverse effect on
our business, results of operations and financial condition. Although we
generally attempt by contract to limit our exposure to incidental and
consequential damages, and to cap our liabilities to our proceeds under the
contract, if a court fails to enforce the liability limiting provisions of our
contracts for any reason, or if liabilities arise which are not effectively
limited, our operating results could be materially and adversely affected.

IF WE LOSE KEY PERSONNEL, OR ARE UNABLE TO ATTRACT ADDITIONAL QUALIFIED
PERSONNEL, OUR ABILITY TO CONDUCT AND GROW OUR BUSINESS WILL BE IMPAIRED

We believe that hiring and retaining qualified individuals at all levels is
essential to our success, and we cannot assure you that we will be successful in
attracting and retaining the necessary personnel. In addition, we are highly
dependent on our direct sales force for sales of our products as we have limited
distribution
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channels. Continuity of technical personnel is an important factor in the
successful completion of development projects, and any turnover of our research
and development personnel could materially and adversely impact our development
and marketing efforts.

Our future success also depends on our continuing ability to identify,
hire, train and retain other highly qualified sales, technical and managerial
personnel. Competition for this type of personnel is intense, and we cannot
assure you that we will be able to attract, assimilate or retain other highly
qualified technical and managerial personnel in the future. The inability to
attract, hire or retain the necessary sales, technical and managerial personnel
could have a material adverse effect upon our business, operating results and
financial condition.

OUR ABILITY TO COMPETE SUCCESSFULLY WILL DEPEND, IN PART, ON OUR ABILITY TO
PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH WE MAY NOT BE ABLE TO PROTECT

We rely on a combination of patent, trade secrets, copyright and trademark
laws, nondisclosure agreements and other contractual provisions and technical
measures to protect our intellectual property rights. The source code for our
proprietary software is protected both as a trade secret and as a copyrighted
work. Policing unauthorized use of our products, however, is difficult.
Litigation may be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation could result in substantial costs and diversion of
resources and could have a material adverse effect on our business, operating
results and financial condition regardless of the outcome of the litigation.

Effective copyright and trade secret protection may be unavailable or
limited in some foreign countries. To license our products, we frequently rely
on "shrink wrap" licenses that are not signed by the end user and, therefore,
may be unenforceable under the laws of several jurisdictions. In addition,
employees, consultants and others who participate in the development of our
products may breach their agreements with us regarding our intellectual
property, and we may not have adequate remedies for any such breach. We also
realize that our trade secrets may become known through other means not
currently foreseen by us. Notwithstanding our efforts to protect our
intellectual property, our competitors may be able to develop products that are
equal or superior to our products without infringing on any of our intellectual
property rights.

OUR PRODUCTS EMPLOY TECHNOLOGY THAT MAY INFRINGE ON THE PROPRIETARY RIGHTS OF
THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION

Third parties may assert that our products infringe their proprietary
rights, or may assert claims for indemnification resulting from infringement
claims against us. Any such claims may cause us to delay or cancel shipment of
our products, which could materially adversely affect our business, financial
condition and results of operations. In addition, irrespective of the validity
or the successful assertion of such claims, we could incur significant costs in
defending against such claims.

WE ARE DEPENDENT ON PROPRIETARY TECHNOLOGY LICENSED FROM THIRD PARTIES, THE LOSS
OF WHICH COULD DELAY SHIPMENTS OF PRODUCTS INCORPORATING THIS TECHNOLOGY AND
COULD BE COSTLY

Some of the technology used by our products is licensed from third parties,
generally on a non-exclusive basis. We believe that there are alternative
sources for each of the material components of technology we license from third
parties. However, the termination of any of these licenses, or the failure of
the third-party licensors to adequately maintain or update their products, could
result in delay in our ability to ship these products while we seek to implement
technology offered by alternative sources. Any required replacement licenses
could prove costly. Also, any delay, to the extent it becomes extended or occurs
at or near the end of a fiscal quarter, could result in a material adverse
effect on our quarterly results of operations. While it may be necessary or
desirable in the future to obtain other licenses relating to one or more of our
products or relating to current or future technologies, we cannot assure you
that we will be able to do so on commercially reasonable terms or at all.

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POTENTIAL ACQUISITIONS MAY HAVE UNEXPECTED CONSEQUENCES OR IMPOSE ADDITIONAL
COSTS ON US

Our business is highly competitive and our growth is dependent upon market
growth and our ability to enhance our existing products and introduce new
products on a timely basis. One of the ways we will address the need to develop
new products is through acquisitions of complementary businesses and
technologies. From time to time, we consider and evaluate potential business
combinations both involving our acquisition of another company and transactions
involving the sale of Verity through, among other things, a possible merger or
consolidation of our business into that of another entity. Acquisitions involve
numerous risks, including the following:

- difficulties in integration of the operations, technologies, and products
of the acquired companies;

- the risk of diverting management's attention from normal daily operations
of the business;

- accounting consequences, including changes in purchased research and
development expenses, resulting in variability in our quarterly earnings;

- potential difficulties in completing projects associated with purchased
in process research and development;

- risks of entering markets in which we have no or limited direct prior
experience and where competitors in such markets have stronger market
positions;

- the potential loss of key employees of the acquired company; and

- the assumption of unforeseen liabilities of the acquired company.

We cannot assure you that our previous or future acquisitions will be
successful and will not adversely affect our financial condition or results of
operations. In fiscal 1997, we experienced difficulties in integrating and
leveraging our acquisitions of Cognisoft Corporation and 64K Incorporated. We
must also maintain our ability to manage any such growth effectively. Failure to
manage growth effectively and successfully integrate acquisitions we make could
harm our business and operating results.

RISKS RELATED TO OUR INDUSTRY

WE DEPEND ON INCREASING USE OF THE INTERNET, INTRANETS, EXTRANETS AND PORTALS
AND ON THE GROWTH OF ELECTRONIC COMMERCE. IF THE USE OF THE INTERNET, INTRANETS,
EXTRANETS AND PORTALS AND ELECTRONIC COMMERCE DO NOT GROW AS ANTICIPATED, OUR
BUSINESS WILL BE SERIOUSLY HARMED

The products of most of our customers depend on the increased acceptance
and use of the Internet as a medium of commerce and on the development of
corporate intranets and extranets and portals. As a result, acceptance and use
may not continue to develop at historical rates and a sufficiently broad base of
business customers may not adopt or continue to use the Internet as a medium of
commerce. The lack of such development would impair demand for our products and
would adversely affect our ability to sell our products. Demand and market
acceptance for recently introduced services and products over the Internet and
the development of corporate intranets and extranets and portals are subject to
a high level of uncertainty, and there exist few proven services and products.

The business of most of our customers would be seriously harmed if:

- use of the Internet, the Web and other online services does not continue
to increase or increases more slowly than expected;

- the infrastructure for the Internet, the Web and other online services
does not effectively support expansion that may occur; or

- the Internet, the Web and other online services do not create a viable
commercial marketplace, inhibiting the development of electronic commerce
and reducing the need for our products and services.

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<PAGE> 22

CAPACITY CONSTRAINTS MAY RESTRICT THE USE OF THE INTERNET AS A COMMERCIAL
MARKETPLACE, WHICH WOULD RESTRICT OUR GROWTH

The Internet may not be accepted as a viable long-term commercial
marketplace for a number of reasons. These include:

- potentially inadequate development of the necessary communication and
network infrastructure, particularly if rapid growth of the Internet
continues;

- delayed development of enabling technologies and performance
improvements;

- delays in the development or adoption of new standards and protocols; and

- increased governmental regulation.

Our ability to grow our business is dependent on the growth of the Internet
and, consequently, any such adverse events would impair our ability to grow our
business.

SECURITY RISKS AND CONCERNS MAY DETER THE USE OF THE INTERNET FOR CONDUCTING
ELECTRONIC COMMERCE, WHICH WOULD ADVERSELY AFFECT THE DEMAND FOR OUR PRODUCTS

A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. Advances
in computer capabilities, new discoveries in the field of cryptography or other
events or developments could result in compromises or breaches of our security
systems or those of other web sites to protect proprietary information. If any
well-publicized compromises of security were to occur, it could have the effect
of substantially reducing the use of the Internet for commerce and
communications, resulting in reduced demand for our products, thus adversely
affecting our revenues.

SECURITY RISKS EXPOSE US TO ADDITIONAL COSTS AND TO LITIGATION

Anyone who circumvents our security measures could misappropriate
proprietary information or cause interruptions in our services or operations.
The Internet is a public network, and data is sent over this network from many
sources. In the past, computer viruses, software programs that disable or impair
computers, have been distributed and have rapidly spread over the Internet. We
may be required to expend significant capital and other resources to protect
against the threat of security breaches or to alleviate problems caused by
breaches. To the extent that our activities may involve the storage and
transmission of proprietary information, such as credit card numbers, security
breaches could expose us to a risk of loss or litigation and possible liability.
Our security measures may be inadequate to prevent security breaches, and our
business would be harmed if we do not prevent them.

RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK

THE MARKET PRICE OF OUR COMMON STOCK WILL FLUCTUATE AND YOU MAY LOSE ALL OR PART
OF YOUR INVESTMENT

Our common stock is quoted for trading on the Nasdaq National Market. The
market price for our common stock may continue to be highly volatile for a
number of reasons including:

- future announcements concerning us or our competitors;

- quarterly variations in operating results;

- announcements of technological innovations;

- the introduction of new products or changes in product pricing policies
by us or our competitors;

- proprietary rights or other litigation; and

- changes in earnings estimates by analysts or other factors.

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<PAGE> 23

In addition, stock prices for many technology companies fluctuate widely
for reasons, which may be unrelated to operating results. These fluctuations, as
well as general economic, market and political conditions, such as recessions or
military conflicts, may materially and adversely affect the market price of our
common stock.

WE HAVE IMPLEMENTED CERTAIN ANTI-TAKEOVER PROVISIONS THAT MAY PREVENT OR DELAY
AN ACQUISITION OF VERITY THAT MIGHT BE BENEFICIAL TO OUR STOCKHOLDERS

Provisions of our certificate of incorporation and bylaws, as well as
provisions of Delaware law, could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. These
provisions include:

- establishment of a classified board of directors such that not all
members of the board may be elected at one time;

- the ability of the board of directors to issue without stockholder
approval up to 1,999,995 shares of preferred stock to increase the number
of outstanding shares and thwart a takeover attempt;

- no provision for cumulative voting in the election of directors, which
would otherwise allow less than a majority of stockholders to elect
director candidates;

- limitations on who may call special meetings of stockholders;

- prohibiting stockholder action by written consent, thereby requiring all
stockholder actions to be taken at a meeting of our stockholders; and

- establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted upon by
stockholders at stockholder meetings.

In September 1996, our Board of Directors adopted a Share Purchase Rights
Plan, commonly referred to as a "poison pill." In addition, the anti-takeover
provisions of Section 203 of the Delaware General Corporations Law and the terms
of our stock option plan may discourage, delay or prevent a change in control of
Verity.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk. The primary objective of our investment activities is
to preserve the principal while at the same time maximizing yields without
significantly increasing the risk. To achieve this objective, we maintain our
portfolio of cash equivalents and investments in a variety of securities,
including both government and corporate obligations and money market funds. As
of November 30, 2000, approximately 80% of our portfolio matures in one year or
less, with the remainder maturing in less than two years. We do not use
derivative financial instruments in our investment portfolio. We place our
investments with high credit quality issuers and, by policy, limit the amount of
credit exposure to any one issuer.

The following table presents the amounts of our cash equivalents and
investments that are subject to interest rate risk by year of expected maturity
and average interest rates as of November 30, 2000:

<TABLE>
<CAPTION>
FY2001 FY2002 FY2003 TOTAL FAIR VALUE
-------- ------- ------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Cash equivalents.............. $ 11,925 -- -- $ 11,925 $ 11,925
Average interest rate......... 3.6%
Short-term investments........ $116,547 $29,072 -- $145,619 $145,619
Average interest rate......... 6.6% 6.8%
Long-term investments......... -- $26,598 $10,047 $ 36,645 $ 36,645
Average interest rates........ -- 6.7% 7.0%
</TABLE>

Foreign Currency Risk. We transact business in various foreign currencies,
including the Euro, the British pound, the French franc, the German mark, the
Dutch guilder, the Canadian dollar, the Australian

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<PAGE> 24

dollar, the Swedish krona, the South African rand and the Mexican peso. We have
established a foreign currency hedging program utilizing foreign currency
forward exchange contracts to hedge certain sales contracts denominated in
foreign currency. Under this program, fluctuations in foreign currencies during
the period from the signing of the contract until payment are partially offset
by realized gains and losses on the hedging instruments. The goal of this
hedging program is to lock in exchange rates on our sales contracts denominated
in foreign currencies. The notional amount of hedged contracts and the estimated
fair value are not material.

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<PAGE> 25

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In December 1999, a number of complaints were filed in the United States
District Court for Northern District of California seeking an unspecified amount
of damages on behalf of an alleged class of persons who purchased shares of
Verity's common stock during the period between December 1 and December 14,
1999. The actions were consolidated into one action and a consolidated amended
complaint was filed. The complaint names as defendants Verity and certain of its
directors and officers, asserting that they violated federal securities laws by
misrepresenting Verity's business, earnings growth, ability to continue to
achieve profitable growth, and failing to disclose certain information about
Verity's business. In August 2000, the complaint was dismissed without prejudice
with leave to amend. The plaintiffs re-filed an amended complaint, and Verity
filed a motion to dismiss this amended complaint on October 27, 2000. While
management intends to defend the actions against Verity vigorously, there can be
no assurance that an adverse result or settlement with regards to this lawsuit
would not have a material adverse effect on Verity's financial condition or
results of operations.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not Applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

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

The Company's Annual Meeting of Stockholders was held on September 26,
2000, and was continued on October 3, 2000 and October 16, 2000. Proxies for the
meeting were solicited pursuant to Regulation 14A. At the meeting, management's
nominees for two director positions and three other proposals were submitted to
the stockholders of the Company. Management's nominees for director were elected
by the following vote:

<TABLE>
<CAPTION>
SHARES
----------------------
NOMINEE VOTING FOR WITHHELD
------- ---------- --------
<S> <C> <C>
Stephen A. MacDonald.......................... 28,412,841 298,863
Anthony J. Bettencourt........................ 28,398,059 313,645
</TABLE>

Gary J. Sbona, Steven M. Krausz, Charles P. Waite, Jr., Stephen A.
MacDonald, Karl C. Powell and Anthony J. Bettencourt continued to serve as
directors of the Company after the annual meeting. Mr. Sbona will continue to
serve as the Chairman of the Board and Mr. Powell will continue to serve as a
director until the Annual Meeting of Stockholders to be held in 2001. Mr. Krausz
and Mr. Waite will continue to serve until the Annual Meeting of Stockholders to
be held in 2002. Mr. Bettencourt and Mr. MacDonald will serve until the Annual
Meeting of Stockholders to be held in 2003.

A second proposal to approve an amendment to the Company's Certificate of
Incorporation to increase the authorized number of shares of common stock from
100,000,000 to 200,000,000 shares was submitted to a vote of the stockholders of
the Company. The proposal was approved by the following vote:

<TABLE>
<CAPTION>
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
---------------- -------------------- ----------- ----------------
<S> <C> <C> <C>
25,905,785... 2,764,318 41,601 N/A
</TABLE>

A third proposal to approve the Company's 1995 Stock Option Plan, as
amended, to increase the aggregate number of shares of common stock authorized
for issuance under such plan from 10,121,672 to 12,121,672 shares was submitted
to a vote of the stockholders of the Company. The meeting was adjourned on

23
<PAGE> 26

the third proposal. On October 16, 2000, the Annual Meeting was reconvened and
the proposal was approved by the following vote:

<TABLE>
<CAPTION>
FOR THE PROPOSAL AGAINST THE PROPOSAL ABSTENTIONS BROKER NON-VOTES
---------------- -------------------- ----------- ----------------
<S> <C> <C> <C>
11,795,270... 10,660,187 30,686 6,232,999
</TABLE>

A final proposal to ratify the selection of PricewaterhouseCoopers LLP as
independent accountants of the Company for its fiscal year ending May 31, 2001
was also submitted to a vote of the stockholders of the Company. The proposal
was approved by the following vote:

ITEM 5. OTHER INFORMATION

Not Applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:

A. Exhibits -- See Exhibit Index

B. Reports on Form 8-K

No Current Reports on Form 8-K were filed during the quarter covered by
this report.

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<PAGE> 27

SIGNATURE

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

VERITY, INC.

By: /s/ TODD K. YAMAMI
------------------------------------
Todd K. Yamami
Vice President & Corporate
Controller
(Principal Accounting Officer)
Dated: January 10, 2001

25
<PAGE> 28

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
3.1 Restated Certificate of Incorporation of the Company.
3.2 By-Laws.
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.(2)
4.3 First Amendment to Rights Agreement dated as of July 23,
1999 among Verity, Inc. and BankBoston, N.A.(3)
10.2 1995 Stock Option Plan, as amended.(4)
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 Exhibit No. 1 to the Company's Form 8-K as
filed with the Securities and Exchange Commission on October 10, 1996.

(3) Incorporated by reference to Exhibit 99.2 from the Company's Current Report
on Form 8-K filed on July 29, 1999.

(4) Incorporated by reference to Exhibit 99.1 from the Company's Registration
Statement on Form S-8 filed on December 11, 2000.