Verity 10Q 2002 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q


(Mark One)
þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended November 30, 2001

or

o		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)


Delaware		77-0182779
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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 þ No o

The number of shares outstanding of the Registrant’s Common Stock, $0.001 par value, was 34,978,000 as of November 30, 2001.

TABLE OF CONTENTS


PART I.FINANCIAL INFORMATION
	Item 1.Financial Statements
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.Quantitative and Qualitative Disclosures About Market Risk
PART II.OTHER INFORMATION
	Item 1.Legal Proceedings
	Item 2.Changes in Securities and Use of Proceeds
	Item 3.Defaults upon Senior Securities
	Item 4.Submission of Matters to a Vote of Security Holders
	Item 5.Other Information
	Item 6.Exhibits and Reports on Form 8-K
	SIGNATURE

VERITY, INC.

FORM 10-Q

TABLE OF CONTENTS


		Page

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of November 30, 2001 and May 31, 2001		2
	Condensed Consolidated Statements of Operations for the Three Months Ended November 30, 2001 and 2000, and the Six Months Ended November 30, 2001 and 2000		3
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended November 30, 2001 and 2000		4
	Notes to Condensed Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		9
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		24
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		25
Item 2.	Changes in Securities and Use of Proceeds		25
Item 3.	Defaults upon Senior Securities		25
Item 4.	Submission of Matters to a Vote of Security Holders		26
Item 5.	Other Information		26
Item 6.	Exhibits and Reports on Form 8-K		26
Signature			27

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

VERITY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS


			November 30,		May 31,
			2001		2001


			(In thousands, except share
			and per share data)
			(Unaudited)
ASSETS

Current assets:
	Cash and cash equivalents		$	12,185	$	12,210
	Short-term investments			107,471		126,687
	Trade accounts receivable, net			26,439		37,741
	Deferred tax assets			22,786		20,121
	Prepaid and other			7,056		6,788

		Total current assets		175,937		203,547
Property and equipment, net				7,866		7,804
Long-term investments				106,679		92,248

		Total assets	$	290,482	$	303,599

LIABILITIES

Current liabilities:
	Accounts payable		$	6,323	$	6,790
	Accrued compensation			9,698		11,799
	Other accrued liabilities			2,660		3,793
	Deferred revenue			13,718		17,073

		Total current liabilities		32,399		39,455

Contingencies (Note 5)
STOCKHOLDERS’ EQUITY

Common stock, $0.001 par value:
	Authorized: 200,000,000 shares
	Issued and outstanding: 34,978,000 shares as of November 30, 2001; and 35,158,000 shares as of May 31, 2001			35		35
Additional paid-in capital				249,475		252,733
Other comprehensive income				2,198		652
Retained earnings				6,375		10,724

		Total stockholders’ equity		258,083		264,144

		Total liabilities and stockholders’ equity	$	290,482	$	303,599

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

VERITY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



			Three Months Ended					Six Months Ended
			November 30,					November 30,

			2001			2000		2001			2000


			(In thousands, except per share data)

			(Unaudited)					(Unaudited)
Revenues:
	Software products		$	13,274		$	25,558	$	23,541		$	48,356
	Service and other			9,286			8,962		19,124			17,454

		Total revenues		22,560			34,520		42,665			65,810

Costs of revenues:
	Software products			644			385		1,186			732
	Service and other			2,757			2,978		5,803			5,536

		Total costs of revenues		3,401			3,363		6,989			6,268

Gross profit				19,159			31,157		35,676			59,542

Operating expenses:
	Research and development			5,955			4,827		11,891			9,412
	Marketing and sales			13,396			13,800		27,994			25,824
	General and administrative			2,909			2,530		5,741			4,700
	Restructuring charge			1,563			—		1,563			—
	Charitable contribution			1,000			—		1,000			—

		Total operating expenses		24,823			21,157		48,189			39,936

Income (loss) from operations				(5,664	)		10,000		(12,513	)		19,606
Other income, net				2,629			2,834		5,499			5,105

Income (loss) before provision for income taxes				(3,035	)		12,834		(7,014	)		24,711
Provision for (benefit from) income taxes				(1,153	)		4,684		(2,665	)		9,316

Net income (loss)			$	(1,882	)	$	8,150	$	(4,349	)	$	15,395

Net income (loss) per share — basic			$	(0.05	)	$	0.24	$	(0.12	)	$	0.47

Net income (loss) per share — diluted			$	(0.05	)	$	0.23	$	(0.12	)	$	0.42

Number of shares — basic				35,161			33,449		35,261			32,909

Number of shares — diluted				35,161			35,846		35,261			36,381

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

VERITY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



					Six Months Ended
					November 30,

					2001			2000


					(In thousands)

					(Unaudited)
Cash flows from operating activities:
	Net income (loss)				$	(4,349	)	$	15,395
	Adjustments to reconcile net income to net cash provided by (used in) operating activities:
		Depreciation and amortization				2,265			1,183
		Deferred income taxes				(2,665	)		8,446
		Provision for doubtful accounts				59			48
		Amortization of discount on securities				(911	)		(765	)
		Changes in operating assets and liabilities:
			Trade accounts receivable			11,242			(8,469	)
			Prepaid and other current assets			(266	)		(2,179	)
			Accounts payable			(466	)		1,465
			Accrued compensation and other accrued liabilities			(3,234	)		3,763
			Deferred revenue			(3,355	)		1,424

				Net cash provided by (used in) operating activities		(1,680	)		20,311


Cash flows from investing activities:
	Acquisition of property and equipment					(2,328	)		(1,769	)
	Purchases of marketable securities					(278,209	)		(189,954	)
	Maturity of marketable securities					174,382			73,662
	Proceeds from sale of marketable securities					111,203			82,349

				Net cash provided by (used in) investing activities		5,048			(35,712	)


Cash flows from financing activities:
	Proceeds from the sale of common stock, net					6,736			20,369
	Repurchase of common stock					(9,994	)		—

				Net cash provided by (used in) financing activities		(3,258	)		20,369

Effect of exchange rate changes on cash						(135	)		(226	)

				Net increase (decrease) in cash and cash equivalents		(25	)		4,742
Cash and cash equivalents, beginning of period						12,210			7,183

Cash and cash equivalents, end of period					$	12,185		$	11,925

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

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Information as of November 30, 2001 and for the three and six months ended

November 30, 2000 and 2001 and thereafter is unaudited)

1. Interim Financial Data

The unaudited condensed consolidated financial statements for Verity, Inc. (the “Company” or “Verity”) as of November 30, 2001 and for the three and six months ended November 30, 2000 and 2001 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, 2001.

The Company’s balance sheet as of May 31, 2001 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 (Loss) and Net Income (Loss) 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. All common equivalent shares have been excluded from the computation of diluted net loss per share for the three months and six months ended November 30, 2001 because the effect would be anti-dilutive.

Basic and diluted net income (loss) per share are calculated as follows for the three and six months ended November 30, 2000 and 2001 (in thousands, except per share data):



		Three Months Ended					Six Months Ended
		November 30,					November 30,

		2001			2000		2001			2000

Basic:
	Weighted-average shares		35,161			33,449		35,261			32,909

	Net income (loss)	$	(1,882	)	$	8,150	$	(4,349	)	$	15,395

	Net income (loss) per share	$	(0.05	)	$	0.24	$	(0.12	)	$	0.47

Diluted:
	Weighted-average shares		35,161			33,449		35,261			32,909
	Common equivalent shares from stock options		—			2,397		—			3,472

	Shares used in per share calculation		35,161			35,846		35,261			36,381

	Net income (loss)	$	(1,882	)	$	8,150	$	(4,349	)	$	15,395

	Net income (loss) per share	$	(0.05	)	$	0.23	$	(0.12	)	$	0.42

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

3. Comprehensive Income (Loss)

The Company has adopted Statement of Financial Accounting Standards No. 130 (“SFAS No. 130”), “Reporting Comprehensive Income.” Comprehensive income (loss) is defined as the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The following are the components of comprehensive income (loss) (in thousands):



	Three Months Ended					Six Months Ended
	November 30,					November 30,

	2001			2000		2001			2000

Net income (loss)	$	(1,882	)	$	8,150	$	(4,349	)	$	15,395
Unrealized gains on available-for-sale investments or securities, net		836			170		1,546			467

Comprehensive income (loss)	$	(1,046	)	$	8,320	$	(2,803	)	$	15,862

4. Business Segment

The Company has sales and marketing operations located outside the United States in the Netherlands, United Kingdom, France, Germany, Sweden, South Africa, Mexico, Australia, a joint investment partnership in Brazil and a development and technical support operation in Canada. Foreign branch and subsidiary revenues consist primarily of maintenance and consulting services and is being allocated based on foreign branch and subsidiary location.



		Three Months Ended				Six Months Ended
		November 30,				November 30,

		2001		2000		2001		2000

Revenues:
	USA	$	19,562	$	32,562	$	36,743	$	62,021
	Europe		2,684		1,958		5,417		3,789
	ROW		314		—		505		—

	Consolidated	$	22,560	$	34,520	$	42,665	$	65,810


						November 30,		May 31,
						2001		2001

Long-lived assets:
	USA					$	5,492	$	5,211
	Europe						919		951
	ROW						1,455		1,642

	Consolidated					$	7,866	$	7,804

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 six months ended November 30, 2000 and the three and six months ended November 30, 2001. 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 6.3% and 6.3% of the Company’s total revenues for the three months ended November 30, 2000 and 2001, respectively, and 6.4% and 6.3% of total revenues for the six months ended November 30, 2000 and 2001, respectively.

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

5. Contingencies

On June 7, 2001, Verity filed a complaint in federal district court in the Northern District of California, San Jose Division, against BroadVision, Inc. (Case No. C01-20501-PVT-ADR). BroadVision is a software company that Verity in the past has licensed to distribute Verity’s copyrighted software known as the Verity Developer Kit (“VDK”). Verity alleges in its complaint that under the terms of the parties’ licenses, BroadVision was authorized to distribute certain limited portions of VDK as an embedded component of specified software applications of BroadVision. Verity further alleges that BroadVision has distributed portions of VDK that it was not authorized to distribute, failed to prevent end users from accessing unlicensed functions and encouraged end users to make use of unlicensed functions of VDK. Verity further alleges that it terminated its license with BroadVision on April 24, 2001 and that BroadVision no longer has any right to distribute any portion of VDK.

Based on the foregoing allegations, Verity has asserted claims against BroadVision for copyright infringement, declaratory relief, unfair competition, interference with economic advantage, breach of contract, and breach of the implied covenant of good faith and fair dealing. Verity seeks by its complaint, among other things, an injunction to prohibit BroadVision from further distribution of VDK, damages, including statutory damages, according to proof based on BroadVision’s unauthorized distribution of VDK and attorneys’ fees.

BroadVision answered Verity’s complaint on June 28, 2001 and denied the material allegations of the Complaint and asserted affirmative defenses to Verity’s claims. BroadVision also asserted a counterclaim alleging that Verity had breached the parties’ license and the implied covenant of good faith and fair dealing contained therein (1) by failing to pay BroadVision referral fees that it claims Verity owes to BroadVision for BroadVision’s efforts in securing the sale of Verity Advanced K-2 Search Modules; and (2) by failing to provide support to BroadVision for VDK after Verity terminated the parties’ license. BroadVision seeks by its complaint, among other things, damages according to proof, a declaration that BroadVision has not breached the parties’ license and attorneys’ fees.

Verity answered BroadVision’s counterclaim on July 23, 2001 and denied the material allegations of the counterclaim and asserted various affirmative defenses to BroadVision’s claims.

The action is currently in the discovery phase. A trial date has been set for March 10, 2003.

The Company intends to defend all of these actions vigorously. However, there can be no assurance that any of the complaints discussed above will be resolved without costly litigation, or in a manner that is not materially adverse to Verity’s financial position, results of operations or cash flows. No estimate can be made of the possible loss or possible range of loss associated with the resolution of these contingencies.

6. Restructuring Charge

During the quarter ended November 30, 2001, the Company implemented a worldwide restructuring of its corporate structure to reduce expenses due to macro-economic and capital spending issues affecting the software industry. In connection with the restructuring, the Company recorded in the quarter ended November 30, 2001, a $1.6 million restructuring charge, of which approximately $1.2 million was related to severance costs associated with the reduction in the worldwide workforce by 65 employees, approximately $0.3 million to legal and other outside services in connection with the restructuring and approximately $0.1 million to other costs associated with the restructuring. The restructuring impacted operations in the U.S., Canada, the U.K., Germany, France, the Netherlands, Sweden and South Africa.

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Of the total $1.6 million restructuring charge, approximately $0.5 million remains unpaid at November 30, 2001. Of the $0.5 million, approximately $0.2 million relates to severance costs to be paid in future quarters, approximately $0.2 million to legal and other outside services, and approximately $0.1 million to other costs associated with the restructuring.

7. Stock Repurchase Program

Through October 24, 2001, Verity repurchased and retired 920,300 shares of its common stock through open market transactions, valued at approximately $10.0 million, pursuant to a repurchase program announced on September 12, 2001. Pursuant to this program, the Company may repurchase shares of its common stock from time to time up to a total value of $50.0 million. The program will terminate at the end of the current fiscal year unless extended or shortened by the Board of Directors.

8. Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”) “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. This statement becomes effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137 (“SFAS No. 137”) “Accounting for Derivative Instruments — Deferral of the Effect Date of SFAS Statement No. 133.” SFAS No. 137 defers the effective date of SFAS No. 133 until June 15, 2000. The adoption of SFAS No. 133 did not affect results of operations or financial position.

In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141 (“SFAS No. 141”), “Business Combinations.” This standard eliminates the pooling-of-interests method of accounting for business combinations, except for qualifying business combinations that were initiated prior to July 1, 2001, and applies to all business combinations accounted for under the purchase method that are completed after June 30, 2001.

In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”), “Goodwill and Other Intangible Assets.” This standard eliminates the amortization of goodwill and requires goodwill to be reviewed at least annually for impairment, the useful lives of previously recognized intangible assets to be reassessed and the remaining amortization periods to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001. The implementation of this standard is not expected to have a significant impact on the Company’s financial position or results of operations.

In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and the accounting and reporting provisions of APB No. 30, “Reporting Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001 as well as interim periods within those fiscal years. The Company is currently reviewing this statement to determine its effect on its Company’s financial position and results of operation.

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, 2001. 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

From 1988 to 1994, we derived 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. We now offer 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 continue to derive the largest portion of our revenues from licensing our technology for enterprise applications and business portal solutions.

On July 31, 1997 we retained Mr. Gary J. Sbona as our president and chief executive officer, and we entered into an agreement with Regent Pacific Management Corporation, a management firm of which Mr. Sbona is the chairman and chief executive officer. Pursuant to this agreement, Regent Pacific has provided management services for Verity, including the services of Mr. Sbona as chief executive officer and other Regent Pacific personnel as part of our management team.

There has been a general downturn in the economy, which increased during the first half of fiscal 2002. This has caused an increasing number of prospective customers to cancel, delay or downsize capital spending related business projects, due to budgetary and worldwide economic pressures within their businesses. This downturn has negatively impacted our year-to-date results for fiscal 2002 revenues. As a result, we reported a net loss for the first and second quarters of fiscal 2002.

As a result of the economic uncertainty, further fueled by the acts of terrorism on September 11, 2001, we have undertaken cost-cutting measures. On October 29, 2001, we announced that we would reduce our workforce by 65 employees, or approximately 13 percent of our work force, during the fiscal quarter ending November 30, 2001. These reductions have been completed.

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. Effective for contracts entered into starting June 1, 1998, we recognize revenues in accordance with the provisions of American Institute of Certified Public Accountants Statement of Position No. 97-2, “Software Revenue Recognition.” In December 1998, AcSEC released provisions of SOP 98-9 that extend the deferral of certain paragraphs of SOP 97-2. These paragraphs of SOP 97-2 and SOP 98-9 became effective for transactions that are entered into fiscal years beginning after March 15, 1999. We recognize maintenance revenues from ongoing customer support and product upgrades ratably over the term of the applicable maintenance agreement, which is typically twelve months. Generally, we receive payments for maintenance fees in advance and they are nonrefundable. We recognize revenues for consulting and training generally when the services are performed.

For agreements with 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.

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:



			Three Months						Six Months
			Ended						Ended
			November 30,						November 30,

			2001			2000			2001			2000


			(Unaudited)						(Unaudited)
Revenues:
	Software products			58.8	%		74.0	%		55.2	%		73.5	%
	Service and other			41.2			26.0			44.8			26.5

		Total revenues		100.0			100.0			100.0			100.0

Costs of revenues:
	Software products			2.9			1.1			2.8			1.1
	Service and other			12.2			8.6			13.6			8.4

		Total costs of revenues		15.1			9.7			16.4			9.5

Gross profit				84.9			90.3			83.6			90.5

Operating expenses:
	Research and development			26.4			14.0			27.9			14.3
	Marketing and sales			59.4			40.0			65.6			39.2
	General and administrative			12.9			7.3			13.5			7.2
	Restructuring charge			6.9			—			3.7			—
	Charitable contribution			4.4			—			2.3			—

		Total operating expenses		110.0			61.3			113.0			60.7

Income (loss) from operations				(25.1	)		29.0			(29.4	)		29.8
Other income, net				11.7			8.2			12.9			7.7

Income (loss) before provision for income taxes				(13.4	)		37.2			(16.5	)		37.5
Provision for (benefit from) income taxes				(5.1	)		13.6			(6.3	)		14.1

Net income (loss)				(8.3	)%		23.6	%		(10.2	)%		23.4	%


	*Revenues*

Our total revenues decreased 35.2% from $65.8 million for the six months ended November 30, 2000, to $42.7 million for the six months ended November 30, 2001, and 34.6% from $34.5 million for the three months ended November 30, 2000 to $22.6 million for the three months ended November 30, 2001. The decreases for the six-month and three-month periods ended November 30, 2001 are attributable to the impact of the slowdown in worldwide economic conditions resulting in customers canceling, delaying and downsizing capital spending, partly offset by increased service and other revenue derived from our installed base.

Software product revenues.Software product revenues decreased 51.3% from $48.4 million for the six months ended November 30, 2000 to $23.5 million for the six months ended November 30, 2001. For the three months ended November 30, 2001, software product revenues decreased 48.1% to $13.3 million from $25.6 million for the three months ended November 30, 2000. The decreases for the six and three months ended November 30, 2001 in comparison to the same periods in fiscal 2001 were primarily a result of the slowdown in the economy and the resulting decline in information technology capital spending.

Service and other revenues.Our service and other revenues consist primarily of fees for software maintenance, consulting and training. Service and other revenues increased 9.6% from $17.5 million for the six months ended November 30, 2000 to $19.1 million for the six months ended November 30, 2001. For the three months ended November 30, 2001, service and other revenues increased 3.6% to $9.3 million from $9.0 million for the three months ended November 30, 2000. The increase in service and other revenues for the comparable periods was primarily due to an increase in maintenance revenue resulting from the renewal of existing maintenance contracts from prior period software revenue arrangements.

Service and other revenues from foreign operations accounted for 5.8% and 15.7% of total revenues for the six months ended November 30, 2000 and 2001, respectively. For the three months ended November 30, 2000 and 2001, service and other revenues from foreign operations accounted for 5.7% and 15.1% 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, 2000 and 2001, export sales accounted for 28.1% and 19.8% of total revenues, respectively. For the three months ended November 30, 2000 and 2001, export sales accounted for 34.4% and 18.2% 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.


	*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 62.0% from $0.7 million for the six months ended November 30, 2000 to $1.2 million for the same period in fiscal 2002, representing 1.5% and 5.0%, respectively, of the software product revenues. Cost of software products increased 67.3% from $0.4 million for the three months ended November 30, 2000 to $0.6 million for the three months ended November 30, 2001, representing 1.5% and 4.9%, respectively, of the software product revenues during these periods. The increase in absolute dollars of costs of software product revenues for the six and three months ended November 30, 2001 was primarily attributable to increasing costs of third party software components and certain start-up costs associated with our new fulfillment facility in the Netherlands. The increase in costs as a percentage of software product revenues for the six and three months ended November 30, 2001 was primarily attributable to these increased costs in absolute dollars, further influenced by decreased software product revenues. We are currently re-negotiating third party software contracts. If these re-negotiations are not completed in a timely and successful manner, our cost of software products will continue to remain higher than historical levels. In addition, during fiscal 2001 and 2002, we did not capitalize any software development costs since such costs were not material.

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 4.8% from $5.5 million for the six months ended November 30, 2000 to $5.8 million for the comparable period in fiscal 2002, representing 31.7% and 30.3%, respectively, of service and other revenues for these periods. Costs of service and other revenue decreased 7.4% from $3.0 million for the three months ended November 30, 2000 to $2.8 million for the three months ended November 30, 2001, representing 33.2% and 29.7%, respectively, of service and other revenues for these periods. The increase in absolute dollars of costs of service and other revenues for the six months ended November 30, 2001 was due to an increase in the staffing of our professional services organization to support an increase in customer base. The decrease in absolute dollars of costs of service and other revenues for the three months ended November 30, 2001 was due to reduced travel immediately following the terrorist acts of September 11, 2001 and to a reduced staff as a result of the workforce reduction. The decrease in costs as a percentage of service and other revenues for the six months ended November 30, 2001 was primarily related to an increase in service and other revenues for this period. The decrease in costs as a percentage of service and other revenues for the three months ended November 30, 2001 was primarily related to reduced travel immediately following the terrorist acts of September 11, 2001 and to a reduced staff as a result of the workforce reduction.


	*Operating Expenses*

Research and development.Research and development expenses increased 26.3% from $9.4 million for the six months ended November 30, 2000 to $11.9 million for the six months ended November 30, 2001, representing 14.3% and 27.9%, respectively, of total revenues for these periods. Research and development expenses increased 23.4% from $4.8 million for the three months ended November 30, 2000 to $6.0 million for the three months ended November 30, 2001, representing 14.0% and 26.4%, respectively, of total revenues for these periods. The increase in absolute dollars for the six and three months ended November 30, 2001 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 increase in research and development expenses as a percentage of total revenues for the six and three-month periods ended November 30, 2001, was primarily due to a decrease in revenues for the periods, further influenced by an increase in research and development expenses in absolute dollars. We anticipate that we will continue to make significant investments in research and development

Marketing and sales.Marketing and sales expenses increased 8.4% from $25.8 million for the six months ended November 30, 2000 to $28.0 million for the six months ended November 30, 2001, representing 39.2% and 65.5%, respectively, of total revenues during these periods. Marketing and sales expenses decreased 2.9% from $13.8 million for the three-month period ended November 30, 2000 to $13.4 million for the three-month period ended November 30, 2001, representing 40.0% and 59.4%, respectively, of total revenues for these periods. The increase in absolute dollars for the six months ended November 30, 2001, was primarily related to the continued development of our sales distribution channels in the United States and Europe. The decrease in absolute dollars for the three months ended November 30, 2001, was primarily related to decreased travel and marketing activities following the terrorist acts of September 11, 2001, and to savings associated with the workforce reduction. The increase in costs as a percentage of total revenues for the six and three months ended November 30, 2001 was primarily due to a decrease in revenues for the periods, and for the six months ended November 30, 2001 was further influenced by an increase in marketing and sales expenses in absolute dollars. We anticipate that we will continue to make significant investments in marketing and sales.

General and administrative.General and administrative expenses increased 22.2% from $4.7 million for the six months ended November 30, 2000 to $5.7 million for the six months ended November 30, 2001, representing 7.2% and 13.5%, respectively, of total revenues during these periods. For the three months ended November 30, 2001, general and administrative expenses increased 15.0% from $2.5 million for the three months ended November 30, 2000 to $2.9 million, representing 7.3% and 12.9%, respectively, of total revenues for the comparable periods. The increase in absolute dollars for the six and three months ended November 30, 2001 was primarily related to increased expenses for professional legal services, various tax studies, and other outside services. The increase in costs as a percentage of total revenues for the six and three months ended November 30, 2001 was due to a decrease in revenues for the periods and an increase in general and administrative expenses in absolute dollars.

Restructuring charge.During the quarter ended November 30, 2001, we implemented a worldwide restructuring of our corporate structure to focus on reducing expenses and improving efficiency due to macro-economic and capital spending issues affecting the software industry. In connection with the restructuring, we recorded in the quarter ended November 30, 2001, a $1.6 million restructuring charge, of which approximately $1.2 million was related to severance costs associated with the reduction in the worldwide workforce by 65 employees, approximately $0.3 million to legal and other outside services in connection with the restructuring, and approximately $0.1 million to other costs associated with the restructuring. The restructuring impacted operations in the U.S., Canada, the U.K., Germany, France, the Netherlands, Sweden and South Africa. Of the total $1.6 million restructuring charge, approximately $0.5 million remains unpaid at November 30, 2001. Of the $0.5 million, approximately $0.2 million relates to severance costs to be paid in future quarters, approximately $0.2 million to legal and other outside services, and approximately $0.1 million to other costs associated with the restructuring.

Charitable contribution.On September 14, 2001, we made a $1 million donation to help the victims of the September 11th terrorist attacks in New York, Pennsylvania, and Washington D.C. Our donation kicked off the United Way Silicon Valley 9/11 Response Fund. The donation provided immediate support to established emergency assistance agencies, such as the American Red Cross and Salvation Army, both of whom are founding members of the United Way locally and nationally.


	*Income Taxes*

Income tax expense includes U.S. and foreign income taxes, as well as the provision for U.S. taxes on undistributed earnings of international subsidiaries. Certain items of income and expense are not reported in tax returns and financial statements in the same year. The tax effect of this difference is reported as deferred income taxes.

During the quarter ended November 30, 2001, we assessed the qualification of our research and development expenses for state and federal research and development tax credits. We expect the tax savings for fiscal 2002 due to research and development tax credits to result in a marginally lower effective tax rate and accordingly applied an effective tax rate of 38.0% to the result of our quarter ended November 30, 2001. We will continually reassess the impact of our research and development expenses on our effective tax rate in future periods.

Liquidity and Capital Resources

As of November 30, 2001, we had $226.3 million in cash and cash equivalents and available-for-sale securities compared to $231.1 million at May 31, 2001.

Our operating activities provided cash of $20.3 million, and used cash of $1.7 million, for the six months ended November 30, 2000 and 2001, respectively. Cash provided by operating activities for the six months ended November 30, 2000 was primarily due to our net income, an increase in liabilities and deferred revenues, offset in part by an increase in accounts receivable and other current assets. Cash used in connection with operating activities in the six months ended November 30, 2001 was primarily due to our net loss and a decrease of accrued compensation and deferred revenue offset in part by a decrease in accounts receivable.

Our investing activities used cash of $35.7 million, and provided cash of $5.0 million, for the six months ended November 30, 2000 and 2001, respectively. For the six months ended November 30, 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. For the six months ended November 30, 2001, cash provided by investing activities consisted primarily of net sales of marketable securities.

Our financing activities provided cash of $20.4 million and used cash of $3.3 million for the six months ended November 30, 2000 and 2001, respectively. 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. In the six months ended November 30, 2001, cash used by financing activities consisted primarily of purchases of common stock through our stock repurchase program offset in part by proceeds from the sale of common stock as a result of stock options exercised and from the issuance of common stock in connection with our Employee Stock Purchase Plan.

At November 30, 2001, our principal sources of liquidity were our cash and cash equivalents and short-term investments of $119.7 million. As of November 30, 2001, we had no outstanding debt obligations.

Capital expenditures were approximately $1.8 million and $2.3 million for the six months ended November 30, 2000 and 2001, respectively. For the six months ended November 30, 2000 and 2001, 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 2003. 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 Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard No. 133 (“SFAS No. 133”) “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. This statement becomes effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137 (“SFAS No. 137”) “Accounting for Derivative Instruments — Deferral of the Effect Date of SFAS Statement No. 133.” SFAS No. 137 defers the effective date of SFAS No. 133 until June 15, 2000. The adoption of SFAS No. 133 did not affect our results of operations or financial position.

In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”), “Goodwill and Other Intangible Assets.” This standard eliminates the amortization of goodwill and requires goodwill to be reviewed at least annually for impairment, the useful lives of previously recognized intangible assets to be reassessed and the remaining amortization periods to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001. We do not expect the implementation of this standard to have a significant impact on our financial position or results of operations.

In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and the accounting and reporting provisions of APB No. 30, “Reporting Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001 as well as interim periods within those fiscal years. We are currently reviewing this statement to determine its effect on our financial position and results of operation.

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. Until December 31, 2001, 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.

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


	*We have recently sustained a loss and we may not be able to return to profitability*

We sustained a loss for the three months and six months ended November 30, 2001. In the future, our revenues may decline, remain flat, or grow at a rate slower than was experienced in periods prior to quarter ended August 31, 2001, especially in light of the recent economic slowdown. 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 achieve 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 downturn in capital spending by customers as a result of the recent economic slowdown;

	•	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.

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 and 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 the 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. Because we expect our stock price to continue to fluctuate significantly, we may be the target of similar litigation in the future. 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.

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, Convera, 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 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 chairman of the board and chief executive officer and other Regent Pacific personnel as part of Verity’s management team. Gary J. Sbona is also deemed an employee of our company under common law. On March 12, 2001 we extended our agreement with Regent Pacific Management Corporation through August 31, 2002. This is the fourth amendment to the retainer agreement between Regent Pacific Management Corporation and Verity, Inc. since the original agreement dated July 31, 1997. Under this amended agreement, Regent Pacific continues to provide the services of Gary J. Sbona as Chairman and Chief Executive Officer of Verity, 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 2003. This agreement may be cancelled at the option of the board after February 2003. 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 a new management. Similarly, if any adverse change in Verity’s 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.


	*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%, 6.3%, and 15.7% of total revenues, respectively, in fiscal 1999, 2000, 2001, and the six months ended November 30, 2001, respectively. Our export sales consist primarily of products licensed for delivery outside of the United States. In fiscal years 1999, 2000, 2001, and the six months ended November 30, 2001, export sales accounted for 27.1%, 19.0%, 26.0%, and 19.8% of total revenues, respectively. 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. See Note 4 of Notes to Condensed Consolidated Financial Statements under Part 1, Item 1 of this Quarterly Report on Form 10-Q for a discussion of our international revenues, income from operations and long-lived assets by geographic region.


	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 federal and state governments and their agencies were 8.1%, 7.8%, 7.4%, and 6.3% of total revenues in fiscal years 1999, 2000, 2001, and the six months ended November 30, 2001, 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.


	*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 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 nonexclusive 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.


	*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 future acquisitions will be successful and will not adversely affect our financial condition or results of operations. 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.


	*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 Verity or its competitors;

	•	quarterly variations in operating results;

	•	announcements of technological innovations;

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


	•	proprietary rights or other litigation; and

	•	changes in earnings estimates by analysts or other factors.

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 2,000,000 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, 2001, approximately 50% of our portfolio matures in one year or less, with the remainder maturing in less than three 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, 2001:


	FY2002			FY2003			FY2004			FY2005			Total		Fair Value


	(In thousands)
Cash equivalents	$	12,185			—			—			—		$	12,185	$	12,185
Average interest rate		1.7	%		—			—			—
Short-term investments	$	88,240		$	19,231			—			—		$	107,471	$	107,471
Average interest rate		3.8	%		5.4	%		—			—
Long-term investments		—		$	54,799		$	46,735		$	5,145		$	106,679	$	106,679
Average interest rates		—			5.0	%		5.6	%		5.3	%

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 dollar, the Swedish krona, the South African rand, the Mexican peso, the Brazilian real and the Singaporean dollar. 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.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Verity answered BroadVision’s counterclaim on July 23, 2001 and denied the material allegations of the counterclaim and asserted various affirmative defenses to BroadVision’s claims.

The action is currently in the discovery stage. A trial date has been set for March 10, 2003.

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 October 10, 2001. Proxies for the meeting were solicited pursuant to Regulation 14A. At the meeting, management’s nominees for two director positions and one other proposal were submitted to the stockholders of the Company. Management’s nominees for director were elected by the following vote:



	Shares

Nominee	Voting For		Withheld

Gary J. Sbona		32,873,072		168,534
Karl C. Powell		32,867,820		173,786

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. 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. 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 2004.

A second proposal to ratify the selection of PricewaterhouseCoopers LLP as independent auditors of the Company for its fiscal year ending May 31, 2002 was also submitted to a vote of the stockholders of the Company. The proposal was approved by the following vote:

For the Proposal

Against the Proposal

Abstentions

Broker Non-Votes

32,933,433

96,777

11,396

N/A

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.

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 & Chief Financial Officer
	(Principal Financial Officer)

Dated: December 20, 2001

INDEX TO EXHIBITS


Exhibit
Number		Description of Document

	3.1	Restated Certificate of Incorporation of the Company.(1)
	3.2	By-Laws.(1)
	4.1	Amended and Restated Rights Agreement dated August 1, 1995, as amended.(2)
	4.2	Form of Rights Agreement between Verity, Inc. and First National Bank of Boston dated September 18, 1996.(3)
	4.3	First Amendment to Rights Agreement dated as of July 23, 1999 among Verity, Inc. and BankBoston, N.A.(4)


(1)	Incorporated by reference from the exhibits with corresponding numbers from the Company’s Form 10-Q for the quarter ended November 30, 2000.

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

(3)	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.

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

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	8th grade Good

Verity (VRTY) Inactive 10-Q2002 Q2 Quarterly report

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