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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

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FORM 10-Q

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(MARK ONE)

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

For the quarterly period ended February 29, 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)

DELAWARE 77-0182779
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) 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 [X] NO [ ]

The number of shares outstanding of the Registrant's Common Stock, $0.001
par value, were 31,267,000 as of March 15, 2000.

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2

VERITY, INC.

FORM 10-Q

TABLE OF CONTENTS

PAGE
----

PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Balance Sheets as of May 31, 1999 and
February 29, 2000........................................... 1
Condensed Consolidated Statements of Operations for the
Three Months Ended February 28, 1999 and February 29, 2000
and the Nine Months Ended February 28, 1999 and February 29,
2000........................................................ 2
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended February 28, 1999 and February 29, 2000........ 3
Notes to Condensed Consolidated Financial Statements........ 4
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 8
Item 3: Quantitative and Qualitative Disclosures About Market
Risk........................................................ 23

PART II: OTHER INFORMATION
Item 1: Legal Proceedings........................................... 24
Item 2: Changes in Securities and Use of Proceeds................... 24
Item 3: Defaults upon Senior Securities............................. 24
Item 4: Submission of Matters to a Vote of Security Holders......... 24
Item 5: Other Information........................................... 24
Item 6: Exhibits and Reports on Form 8-K............................ 24
Signature ............................................................ 25

i
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PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VERITY, INC.

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

ASSETS

MAY 31, FEBRUARY 29,
1999 2000
-------- ------------
(UNAUDITED)

Current assets:
Cash and cash equivalents................................. $ 7,907 $ 12,525
Short-term investments.................................... 28,327 98,188
Trade accounts receivable, net............................ 17,174 17,840
Prepaid and other......................................... 1,481 3,587
-------- --------
Total current assets.............................. 54,889 132,140
Property and equipment, net................................. 5,693 5,040
Long-term investments....................................... 4,132 31,179
Other assets................................................ 312 195
-------- --------
Total assets...................................... $ 65,026 $168,554
======== ========

LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 3,786 $ 5,344
Accrued compensation...................................... 6,665 9,151
Other accrued liabilities................................. 1,989 1,872
Deferred revenue.......................................... 9,167 11,118
-------- --------
Total current liabilities......................... 21,607 27,485
-------- --------

STOCKHOLDERS' EQUITY
Common stock, $0.001 par value:
Authorized: 30,000,000 shares in 1999 and 100,000,000
shares in 2000;
Issued and outstanding: 25,612,000 shares in 1999 and
31,012,000 shares in 2000.............................. 26 31
Additional paid-in capital.................................. 99,412 178,485
Unrealized gain (loss) on investments....................... 27 (231)
Accumulated deficit......................................... (56,046) (37,216)
-------- --------
Total stockholders' equity........................ 43,419 141,069
-------- --------
Total liabilities and stockholders' equity........ $ 65,026 $168,554
======== ========

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

1
4

VERITY, INC.

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

THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
FEBRUARY 28, FEBRUARY 29, FEBRUARY 28, FEBRUARY 29,
1999 2000 1999 2000
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)

Revenues:
Software products............................ $12,468 $22,514 $33,854 $47,081
Service and other............................ 4,267 6,706 11,311 18,621
------- ------- ------- -------
Total revenues....................... 16,735 29,220 45,165 65,702
------- ------- ------- -------
Costs of revenues:
Software products............................ 211 254 1,049 571
Service and other............................ 1,159 2,050 3,315 5,960
------- ------- ------- -------
Total costs of revenues.............. 1,370 2,304 4,364 6,531
------- ------- ------- -------
Gross profit................................... 15,365 26,916 40,801 59,171
------- ------- ------- -------
Operating expenses:
Research and development..................... 3,521 4,018 10,095 11,480
Marketing and sales.......................... 6,783 10,589 19,343 27,371
General and administrative................... 1,630 1,779 4,621 4,959
------- ------- ------- -------
Total operating expenses............. 11,934 16,386 34,059 43,810
------- ------- ------- -------
Income from operations......................... 3,431 10,530 6,742 15,361
Other income, net.............................. 229 1,800 813 3,919
------- ------- ------- -------
Net income before provision for income taxes... 3,660 12,330 7,555 19,280
Provision for income taxes..................... 150 150 450 450
------- ------- ------- -------
Net income..................................... $ 3,510 $12,180 $ 7,105 $18,830
======= ======= ======= =======
Net income per share -- basic.................. $ 0.14 $ 0.39 $ 0.30 $ 0.64
======= ======= ======= =======
Net income per share -- diluted................ $ 0.12 $ 0.34 $ 0.26 $ 0.55
======= ======= ======= =======
Number of shares -- basic...................... 24,543 31,159 23,815 29,548
======= ======= ======= =======
Number of shares -- diluted.................... 29,082 36,306 27,045 34,425
======= ======= ======= =======

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

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VERITY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

NINE MONTHS ENDED
----------------------------
FEBRUARY 28, FEBRUARY 29,
1999 2000
------------ ------------
(UNAUDITED)

Cash flows from operating activities:
Net income................................................ $ 7,105 $ 18,830
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 2,179 2,118
Non-cash restructuring charges......................... (365) --
Provision for doubtful accounts........................ 38 5
Amortization of discount on securities................. (644) (274)
Other.................................................. -- (20)
Changes in operating assets and liabilities:
Trade accounts receivable............................ 2,359 (858)
Prepaid and other current assets..................... (35) (2,142)
Accounts payable..................................... (241) 1,589
Accrued compensation and other accrued liabilities... 1,910 2,615
Deferred revenue..................................... (1,067) 1,947
-------- ---------
Net cash provided by operating activities......... 11,239 23,810
-------- ---------
Cash flows from investing activities:
Acquisition of property and equipment..................... (549) (1,466)
Purchases of marketable securities........................ (73,154) (323,720)
Maturity of marketable securities......................... 35,655 139,631
Proceeds from sale of marketable securities............... 21,844 87,197
-------- ---------
Net cash used in investing activities............. (16,204) (98,358)
-------- ---------
Cash flows from financing activities:
Proceeds from the sale of common stock, net............... 5,476 79,078
Principal payments on notes payable and capital lease
obligations............................................ (152) --
-------- ---------
Net cash provided by financing activities......... 5,324 79,078
-------- ---------
Effect of exchange rate changes on cash..................... (5) 88
-------- ---------
Net increase in cash and cash equivalents......... 354 4,618
Cash and cash equivalents, beginning of period.............. 5,505 7,907
-------- ---------
Cash and cash equivalents, end of period.................... $ 5,859 $ 12,525
======== =========

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

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VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF FEBRUARY 29, 2000 AND FOR THE THREE AND NINE MONTHS ENDED
FEBRUARY 28, 1999 AND FEBRUARY 29, 2000 AND THEREAFTER IS UNAUDITED)

1. INTERIM FINANCIAL DATA (UNAUDITED)

The unaudited financial statements as of February 29, 2000 and for the
three and nine months ended February 28, 1999 and February 29, 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, 1999.

The Company's balance sheet as of May 31, 1999 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 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.

On October 21, 1999, the Company's board of directors authorized a
two-for-one split of its common stock effective December 3, 1999 in the form of
a stock dividend for stockholders of record at the close of business on November
17, 1999. All share data information in the accompanying condensed consolidated
financial statements and in these notes is restated to reflect the stock split.

3. COMPREHENSIVE INCOME

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

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VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF FEBRUARY 29, 2000 AND FOR THE THREE AND NINE MONTHS ENDED
FEBRUARY 28, 1999 AND FEBRUARY 29, 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 and Australia and a
development and technical support operation in Canada. Foreign branch and
subsidiary revenues consist primarily of maintenance and consulting services.

THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
FEBRUARY 28, FEBRUARY 29, FEBRUARY 28, FEBRUARY 29,
1999 2000 1999 2000
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)

Revenues:
USA.............................. $15,670 $ 27,504 $42,343 $ 60,942
Europe........................... 1,065 1,716 2,822 4,760
ROW.............................. -- -- -- --
Consolidated..................... 16,735 29,220 45,165 65,702

Operating income:
USA.............................. 5,399 11,568 11,974 18,010
Europe........................... 585 53 1,838 1,302
ROW.............................. (40) (321) 50 (145)
Eliminations..................... (2,513) (770) (7,120) (3,806)
Consolidated..................... 3,431 10,530 6,742 15,361

Identifiable assets:
USA.............................. 50,363 161,026 50,363 161,026
Europe........................... 3,793 6,941 3,793 6,941
ROW.............................. 392 587 392 587
Consolidated..................... 54,548 168,554 54,548 168,554

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. Operating income consists of total net sales less
operating expenses, and does not include interest and other income, net, or
income taxes. Identifiable assets of geographic areas are those assets used in
the Company's operations in each area.

5. RECENT ACCOUNTING PRONOUNCEMENTS

In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use ("SOP 98-1"), which requires companies to
capitalize qualifying computer software costs, which are incurred during the
application development stage and amortize them over the software's estimated
useful life. SOP 98-1 is effective for fiscal years beginning after December 15,
1998. The Company does not expect that the adoption of SOP 98-1 will have a
material impact on its financial statements and related disclosures.

In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities
("SOP 98-5"), which requires companies to expense the costs of start-up
activities and organization costs as incurred. In general, SOP 98-5 is effective
for fiscal years beginning after December 15, 1998. The Company believes the
adoption of SOP 98-5 will not have a material impact on its results of
operations.

5
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VERITY, INC.

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 1998, AcSEC released Statement of Position 98-9, Modification
of SOP 97-2, Software Revenue Recognition ("SOP 98-9"), with Respect to Certain
Transactions. SOP 98-9 amends SOP 97-2 to require that an entity recognize
revenue for multiple element arrangements by means of the "residual method" when
(1) there is vendor-specific objective evidence ("VSOE") of the fair values of
all the undelivered elements that are not accounted for by means of long-term
contract accounting, (2) VSOE of fair value does not exist for one or more of
the delivered elements, and (3) all revenue recognition criteria of SOP 97-2
(other than the requirement for VSOE of the fair value of each delivered
element) are satisfied. The provisions of SOP 98-9 that extend the deferral of
certain paragraphs of SOP 97-2 became effective December 15, 1998. These
paragraphs of SOP 97-2 and SOP 98-9 will be effective for transactions that are
entered into in fiscal years beginning after March 15, 1999. Retroactive
application is prohibited. The Company does not expect that the adoption of SOP
98-9 will have a material impact on its financial statements.

6. COMPUTATION OF EARNINGS PER SHARE

Basic and diluted net income per share are calculated as follows for the
three months and nine months ended February 28, 1999 and February 29, 2000:

Basic:
Weighted-average shares..................... 24,543 31,159 23,815 29,548
======= ======= ======= =======
Net income.................................. $ 3,510 $12,180 $ 7,105 $18,830
======= ======= ======= =======
Net income per share........................ $ 0.14 $ 0.39 $ 0.30 $ 0.64
======= ======= ======= =======
Diluted:
Weighted-average shares..................... 24,543 31,159 23,815 29,548
Common equivalent shares from stock
options.................................. 4,539 5,147 3,230 4,877
------- ------- ------- -------
Shares used in per share calculation........ 29,082 36,306 27,045 34,425
------- ------- ------- -------
Net income.................................. $ 3,510 $12,180 $ 7,105 $18,830
======= ======= ======= =======
Net income per share........................ $ 0.12 $ 0.34 $ 0.26 $ 0.55
======= ======= ======= =======

7. COMMON STOCK REGISTRATION

On August 10, 1999, the Company completed the public offering of 1,775,000
shares of its common stock under a registration statement declared effective by
the Securities and Exchange Commission on August 4, 1999. Of these shares, the
Company sold 1,500,000 shares and selling stockholders sold 275,000 shares. The
sale of the 1,500,000 shares by the Company resulted in aggregate proceeds to
the Company of $63,960,000.

6
9
VERITY, INC.

On August 27, 1999, the Company sold 139,250 additional shares of its common
stock to the underwriters pursuant to the underwriters' exercise of their
over-allotment option, resulting in additional aggregate proceeds to the Company
of $5,937,620. Aggregate proceeds are after deduction of underwriting
commissions and discounts of $2.36 per share, but before payment of the
Company's offering expenses, which it estimated to be approximately $775,000.

8. 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 and 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
10

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, 1999. 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. Recently, we have refined and enhanced
our core technology to add functionality and facilitate incorporation of our
technology in a variety of applications addressing the enterprise, Internet,
online, and original equipment manufacturer, or OEM, markets. 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.

During fiscal 1997 and early fiscal 1998, we incurred substantial net
losses and our quarterly revenues fluctuated significantly. In particular, we
incurred reduced revenues on a quarter-to-quarter basis in the first quarter of
fiscal 1997, the third quarter of fiscal 1997 and the first quarter of fiscal
1998. In this period, we experienced significant turnover in our workforce,
including turnover of several members of senior management. Also, we experienced
difficulties in integrating or leveraging our acquisitions of Cognisoft
Corporation and 64K Incorporated in fiscal 1997. Under these circumstances, 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 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 at least four other Regent Pacific personnel as part of
our management team.

Starting in fiscal 1998, the new management team implemented changes
designed to refocus our business on our core products and markets and to
streamline operations. In connection with the changes, we incurred a $3.0
million restructuring charge in the quarter ended November 30, 1997. Our
restructuring and renewed focus contributed to significantly improved results
during the second half of fiscal 1998 and during fiscal 1999. During the
quarterly periods ended August 31, 1997 to August 31, 1999, we experienced
increased revenues on a quarterly basis. In addition, during the quarterly
periods ended May 31, 1998 to August 31, 1999, we experienced six straight
quarters of record revenues and profitability. However, due to a delay in
closing three large transactions, revenues for the three months ended November
30, 1999 were lower than we expected. For the three months ended February 29,
2000, our revenues and net income were at record levels of $29.2 million and
$12.2 million, respectively. We incurred a net loss of $16.5 million in fiscal
1998, which included the $3.0 million restructuring charge. In fiscal 1999, we
achieved net income of $12.1 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 February 29, 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. 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." We recognize maintenance revenues from
ongoing customer support and product upgrades ratably over the term of the
applicable maintenance agreement, which is typically 12 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. Statement of Position No. 97-2 supersedes Statement of Position

8
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No. 91-1, "Software Revenue Recognition," and was effective for transactions we
entered into in fiscal years beginning after December 15, 1997.

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:

Revenues:
Software products........................ 74.5% 77.0% 75.0% 71.7%
Service and other........................ 25.5 23.0 25.0 28.3
----- ----- ----- -----
Total revenues................... 100.0 100.0 100.0 100.0
----- ----- ----- -----
Costs of revenues:
Software products........................ 1.3 0.9 2.4 0.9
Service and other........................ 6.9 7.0 7.3 9.0
----- ----- ----- -----
Total costs of revenues.......... 8.2 7.9 9.7 9.9
----- ----- ----- -----
Gross profit............................... 91.8 92.1 90.3 90.1
----- ----- ----- -----
Operating expenses:
Research and development................. 21.0 13.8 22.4 17.5
Marketing and sales...................... 40.6 36.2 42.8 41.7
General and administrative............... 9.7 6.1 10.2 7.5
----- ----- ----- -----
Total operating expenses......... 71.3 56.1 75.4 66.7
----- ----- ----- -----
Income from operations..................... 20.5 36.0 14.9 23.4
Interest and other expenses................ 1.4 6.2 1.8 5.9
----- ----- ----- -----
Income before provision for income taxes... 21.9 42.2 16.7 29.3
Provision for income taxes................. 0.9 0.5 1.0 0.6
----- ----- ----- -----
Net income................................. 21.0% 41.7% 15.7% 28.7%
===== ===== ===== =====

Revenues

Our total revenues increased 45.5% from $45.2 million for the nine months
ended February 28, 1999 to $65.7 million for the nine months ended February 29,
2000. The increase was due primarily to increased revenues from the licensing of
Internet/Publishing products. Our total revenues increased 74.6% from $16.7
million for the three months ended February 28, 1999, to $29.2 million for the
three months ended February 29, 2000. The increase for the three-month period
ended February 29, 2000 was due principally to increased revenues from the
licensing of Enterprise products and Internet/Publishing products. Software
product revenues decreased as a percentage of total revenues from 75.0% for the
nine months ended February 28, 1999 to 71.7% for the nine months ended February
29, 2000. For the three months ended February 29, 2000, software product
revenues increased as a percentage of total revenues to 77.0% compared to 74.5%
for the three months ended February 28, 1999. Service and other revenues for the
nine months ended February 28, 1999 and February 29, 2000 increased as a
percentage of total revenues from 25.0% to 28.3%, respectively. Conversely, for
the three months ended February 28, 1999 and February 29, 2000, service and
other revenues decreased from 25.5% to 23.0% as a percentage of total revenues,
respectively.

Software product revenues. Software product revenues increased 39.1% from
$33.9 million for the nine months ended February 28, 1999 to $47.1 million for
the nine months ended February 29, 2000. The increase for the nine months ended
February 29, 2000 in comparison to the nine months ended February 28, 1999 was
due principally to increased revenues from licensing of Internet/Publishing
products. Software product revenues increased 80.6% from $12.5 million for the
three months ended February 28, 1999 to $22.5 million for the three months ended
February 29, 2000. The increase for the three months ended February 29, 2000

9
12

from the three months ended February 28, 1999 was due principally to increased
revenues from licensing of Enterprise products and Internet/Publishing products.

Service and other revenues. Our service and other revenues consist
primarily of fees for software, maintenance, consulting and training. Service
and other revenues increased 64.6% from $11.3 million for the nine months ended
February 28, 1999 to $18.6 million for the nine months ended February 29, 2000.
Service and other revenues increased 57.2% from $4.3 million for the three
months ended February 28, 1999 to $6.7 million for the three months ended
February 29, 2000. Maintenance revenues increased significantly between the
comparable periods primarily due to a growth in customer base. Consulting
revenues increased significantly between the comparable periods primarily due to
a growth in customer base and introduction of a new product, which requires
additional consulting services.

Service and other revenues from foreign operations accounted for 6.2% of
total revenues for the nine months ended February 28, 1999 and February 29,
2000. For the three months ended February 28, 1999 and February 29, 2000,
service and other revenues from foreign operations accounted for 6.3% and 3.5%
of total revenues, respectively. Our export sales consist primarily of products
licensed for delivery outside of the United States. For the nine months ended
February 28, 1999 and February 29, 2000, export sales accounted for 25.6% and
19.4% of total revenues, respectively. For the three months ended February 28,
1999 and February 29, 2000, export sales accounted for 25.4% and 20.9% 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 our revenues for the nine
months ended February 28, 1999 and February 29, 2000 and the three months ended
February 28, 1999. For the three months ended February 29, 2000, revenues
derived from sales to one customer accounted for approximately 21% of our total
revenues. Revenues derived from sales to the federal government and its agencies
were 9.7% and 8.9% of our total revenues for the nine months ended February 28,
1999 and February 29, 2000, respectively, and 10.7% and 4.9% of total revenues
for the three months ended February 28, 1999 and February 29, 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 decreased
45.6% from $1.0 million for the nine months ended February 28, 1999 to $571,000
for the nine months ended February 29, 2000, representing 3.1% and 1.2%,
respectively, of the software product revenues during these periods. Costs of
software products increased 20.4% from $211,000 for the three months ended
February 28, 1999 to $254,000 for the three months ended February 29, 2000,
representing 1.7% and 1.1%, respectively, of the software product revenues
during these periods. The decrease in absolute dollars and as a percentage of
software product revenues during the nine-month period ended February 29, 2000,
was primarily due to decreasing costs of third party software components in
fiscal 2000. For the three months ended February 29, 2000, the increase in
absolute dollars was primarily due to increasing costs of third party software
components. The decrease as a percentage of software product revenues was
principally due to increased total revenues for the three months ended February
29, 2000.

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 79.8% from $3.3 million for the nine months ended February 28, 1999 to
$6.0 million for the nine months ended February 29, 2000, representing 29.3% and
32.0%, respectively, of service and other revenues during these periods. Costs
of service and other revenues increased 76.9% from $1.2 million for the three
months ended February 29, 1999 to $2.1 million for the three months ended
February 29, 2000, representing 27.2% and 30.6%, respectively, of service and
other revenues during these periods. The increase in absolute dollars during the
nine-month period ended February 29, 2000, was due

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principally to an increase in the staffing of our professional services
organization. The increase in costs as a percentage of service and other
revenues was primarily related to a shift in the mix of service and other
revenues from higher margin maintenance revenues to lower margin consulting
revenues. For the three months ended February 29, 2000, the increase in absolute
dollars and as a percentage of costs of service and other revenues was primarily
due to an increase in the staffing of our professional services organization.

Operating Expenses

Research and development. Research and development expenses increased 13.7%
from $10.1 million for the nine months ended February 28, 1999 to $11.5 million
for the nine months ended February 29, 2000, representing 22.4% and 17.5%,
respectively, of total revenues for these periods. Research and development
expenses increased 14.1% from $3.5 million for the three months ended February
28, 1999 to $4.0 million for the three months ended February 29, 2000,
representing 21.0% and 13.8%, respectively, of total revenues for these periods.
The increase in absolute dollars for the nine-month and three-month periods
ended February 29, 2000 was primarily due to an increase in research and
development personnel. The decrease in costs as a percentage of total revenues
for the nine months and three months ended February 29, 2000, was primarily
related to the increased revenues during this period. We believe that research
and development expenses may increase in the future primarily due to the
introduction of new products to our product line and other anticipated product
development efforts. Future research and development expenses may continue to
vary as a percentage of total revenues.

Marketing and sales. Marketing and sales expenses increased 41.5% from
$19.3 million for the nine months ended February 28, 1999 to $27.4 million for
the nine months ended February 29, 2000, representing 42.8% and 41.7%,
respectively, of total revenues during these periods. Marketing and sales
expenses increased 56.1% from $6.8 million for the three months ended February
28, 1999 to $10.6 million for the three months ended February 29, 2000,
representing 40.6% and 36.2%, respectively, of total revenues during these
periods. The increase in absolute costs for the nine-month and three-month
periods ended February 29, 2000 was primarily related to the continuous
expansion of our sales organization and an increase in outbound marketing
activities. The decrease in costs as a percentage of total revenues for the nine
months and three months ended February 29, 2000 is primarily related to the
increased revenues during these periods. We anticipate continuous significant
investments in marketing and sales.

General and administrative. General and administrative expenses increased
7.3% from $4.6 million in the nine months ended February 28, 1999 to $5.0
million for the nine months ended February 29, 2000, representing 10.2% and
7.5%, respectively, of total revenues during these periods. General and
administrative expenses increased 9.1% from $1.6 million in the three months
ended February 28, 1999 to $1.8 million for the three months ended February 29,
2000, representing 9.7% and 6.1%, respectively, of total revenues. The increase
in absolute costs for the nine months and three months ended February 29, 2000
was primarily related to increases in professional service fees required to
support our operations. The decrease in costs as a percentage of total revenues
was primarily related to the increased revenues for the nine months and three
months ended February 29, 2000.

Income Taxes

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

LIQUIDITY AND CAPITAL RESOURCES

Since our inception, we have financed our operations primarily through
proceeds of approximately $23.8 million from private sales of preferred stock,
proceeds from our initial public offering and secondary public offerings of
common stock and, to a lesser extent, bank credit lines and capital operating
leases. We completed our initial public offering of common stock in October 1995
and realized net proceeds of

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$32.5 million. In January 1996, we completed our second public offering of
common stock, which generated net proceeds of $16.5 million. In August 1999, we
completed another public offering of common stock, which generated net proceeds
of $71.0 million. We intend to use the net proceeds from the sale of the common
stock for general corporate purposes, including working capital, content
development and licensing, advertising and brand promotion, and potentially for
the acquisition of or investment in companies, technologies or assets that
complement our business. As of February 29, 2000, we had $141.9 million in cash
and cash equivalents and available-for-sale securities compared to $40.3 million
at May 31, 1999.

Our operating activities provided cash of $11.2 million and $23.8 million
for the nine months ended February 28, 1999 and February 29, 2000, respectively.
Cash provided by operating activities in the nine months ended February 28, 1999
was primarily due to our net income, a decrease in accounts receivable, and
depreciation and amortization expense, offset in part by a decrease in deferred
revenue. Cash provided in connection with operating activities for the nine
months ended February 29, 2000 was primarily due to our net income, depreciation
and amortization expense, an increase in accrued liabilities and deferred
revenue, offset in part by an increase in prepaid and other current assets.

Our investing activities used cash of $16.2 million and $98.4 million for
the nine months ended February 28, 1999 and February 29, 2000, respectively. For
the nine months ended February 28, 1999 and February 29, 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 $5.3 million and $79.1 million
for the nine months ended February 28, 1999 and February 29, 2000, respectively.
In the nine months ended February 28, 1999, financing activities consisted
primarily of proceeds from the sale of common stock as a result of stock options
exercised. In the nine months ended February 29, 2000, financing activities
consisted primarily of proceeds from the sale of common stock in conjunction
with our public offering and the sale of common stock as a result of stock
options exercised.

Capital expenditures, including capital leases, were approximately $549,000
and $1.5 million for the nine months ended February 28, 1999 and February 29,
2000, respectively. For the nine months ended February 28, 1999, these
expenditures consisted principally of purchases of property and equipment,
primarily for computer hardware and software. For the nine months ended February
29, 2000, these expenditures consisted of purchases of property and equipment,
primarily for computer hardware and software as a result of our rapid personnel
expansion, particularly our sales force, as well as increased office locations,
worldwide.

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 2001. 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

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YEAR 2000 COMPLIANCE

We have tested our software products and believe that they are year 2000
compliant. We have also inquired of significant vendors of our internal
accounting, management and product development systems as to their year 2000
readiness, and we have also tested our material internal systems. We believe
that based on these tests and assurances of our vendors, we do not expect to
incur material costs to resolve year 2000 issues for our products and internal
systems. Furthermore, we have not experienced any year 2000 problems and our
customers and vendors have not informed us of any material year 2000 problems.

We believe that we have identified all of the major information systems
used in connection with our internal operations and substantially completed all
modification, upgrades or replacements to minimize the possibility of material
disruption of our business from year 2000 problems. If it comes to our attention
that there are any year 2000 problems with our products or that some of our
third-party hardware and software used in our internal systems or our products
are not year 2000 compliant, then we will endeavor to make modifications to our
products and internal systems, or purchase new internal systems, to quickly
respond to the problem. Although we do not believe that the cost of these
modifications and replacements, if any, will materially affect our operating
results, we have no other contingency plan to address effects of year 2000
problems with our products and internal systems. The cost already incurred by us
and our future cost related to year 2000 compliance is not material.

Despite investigation and testing by us and our partners, our software
products, and the underlying systems and services may contain errors or defects
associated with Year 2000 date functions. We are unable to predict to what
extent our business may be affected if our software or the systems that operate
in conjunction with our software experience a material Year 2000 failure that
surfaces some time in the future.

We have not been a party to any litigation or any proceedings to date
involving our products or services related to year 2000 compliance issues;
however, we cannot assure you that we will not in the future be required to
defend our products or services in proceedings, or to negotiate the resolution
of claims based on year 2000 issues. Some commentators have predicted
significant litigation regarding year 2000 compliance issues, and we are aware
of such lawsuits against other software vendors. Because of the unprecedented
nature of such litigation, it is uncertain whether or to what extent we may be
affected by it. The costs of defending and resolving year 2000-related disputes,
and any liability of Verity for year 2000-related damages, including
consequential damages, could have a material adverse effect on our business,
results of operations and financial condition.

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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. We are still assessing the impact that the
conversion to the euro will have on our internal systems, the sale of our
products, and the European and global economies. We will take appropriate
corrective actions based on the results of such assessment. We have not yet
determined the cost related to addressing this issue.

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

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 eight 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

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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.

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.

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 Other Information -- 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.

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

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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 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, corporate
portals, e-commerce sites, online publishing and media sites, 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 information retrieval 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 the enterprise and
Internet markets. We compete with Dataware, Autonomy, Excalibur, Hummingbird/PC
Docs/ Fulcrum, Infoseek, Inktomi, Lotus 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, particularly Microsoft, 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.

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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
of Verity, and at least four other Regent Pacific personnel as part of Verity's
management team. On February 10, 2000, we extended our agreement with Regent
Pacific Management Corporation through August 31, 2001. This is the third
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 2002. This agreement may be canceled at the
option of the board after 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 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
6.1%, 6.4% and 6.2% of total revenues, respectively, in fiscal 1998, fiscal 1999
and the nine months ended February 29, 2000. Our export sales consist primarily
of products licensed for delivery outside of the United States. In fiscal years
1998 and 1999 and the nine months ended February 29, 2000, export sales
accounted for 26.6%, 27.1% and 19.4% of

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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 federal government and its agencies were
9.0%, 8.1% and 8.9% of total revenues in fiscal years 1998 and 1999 and the nine
months ended February 29, 2000, respectively. Future reductions in United States
spending on information technologies could have a material adverse effect on our
operating results. 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.

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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.

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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 and 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 have considered and evaluated 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. We
may engage in discussions relating to these types of transactions in the future.
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.

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RISKS RELATED TO OUR INDUSTRY

WE DEPEND ON INCREASING USE OF THE INTERNET, INTRANETS, EXTRANETS AND ON THE
GROWTH OF ELECTRONIC COMMERCE. IF THE USE OF THE INTERNET, INTRANETS, EXTRANETS
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. 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 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

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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.

OUR OR THIRD PARTIES' COMPUTER SYSTEMS MAY FAIL IN THE YEAR 2000, WHICH WOULD
DELAY OUR PRODUCT DEVELOPMENT AND THE SALE OF OUR PRODUCTS

Failure of our computer systems could adversely affect our product
development processes and/or our ability to cost-effectively manage Verity
during the time required to fix such problems. In addition, computer failures
could cause our customers to postpone or cancel orders for our products.
Unforeseen problems in our own computers and embedded systems and from
customers, suppliers and other organizations with which we conduct transactions
worldwide may still arise during year 2000. These statements constitute year
2000 disclosures under federal law.

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 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;

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- 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. On July 28, 1999, our Board of Directors approved an amendment of our
Stockholders Rights Plan. This amendment is intended as a means to guard against
abusive takeover tactics and is not in response to any particular proposal. The
amendment is aimed to discourage acquisitions of more than 15 percent of the
Verity's common stock without negotiations with the Board of Directors. In
addition, in July and September 1999, our Board of Directors and shareholders,
respectively, approved an amendment to our certificate of incorporation
increasing the number of shares of authorized common stock from 30,000,000
shares to 100,000,000 shares. The Board of Directors could sell these shares
strategically to approve a hostile takeover, for example by selling them in a
private transaction to investors who would oppose a takeover or favor the
current Directors, or could be issued in connection with our "poison pill."

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 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 February 29, 2000, approximately 76% of our total 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 February 29, 2000:

FY2000 FY2001 FY2002 FY2003 TOTAL FAIR VALUE
------- ------- ------- ------ ------- ----------
(IN THOUSANDS)

Cash equivalents............... $12,525 -- -- -- $12,525 $12,525
Average interest rate.......... 2.0%
Short-term investments......... $57,266 $40,922 -- -- $98,188 $98,188
Average interest rate.......... 5.9% 6.4%
Long-term investments.......... -- $11,400 $17,780 $1,999 $31,179 $31,179
Average interest rates......... 6.4% 6.0% 7.4%

Foreign Currency Risk. We transact business in various foreign currencies,
including the British pound, the German mark, the Dutch guilder and the French
Franc. 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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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 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 and 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.

ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS

On December 8, 1999, Imperial Bancorp exercised a warrant to purchase an
aggregate of 19,732 shares of Verity common stock. The exercise was a net
exercise and is exempt from registration pursuant to Section 3(a)(9) of the
Securities Act of 1933, as amended.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

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

Not Applicable.

ITEM 5: OTHER INFORMATION

Not Applicable.

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

A. Exhibits -- See Exhibit Index

B. 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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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
Corporate Controller
(Principal Accounting Officer)

Dated: March 24, 2000

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INDEX TO EXHIBITS

EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- -----------------------

2.1 Form of Agreement and Plan of Merger between Verity, Inc., a
California corporation, and Verity Delaware Corporation, a
Delaware corporation, filed September 22, 1995.(1)
3.1 Certificate of Incorporation of the Company. Reference is
made to Section 2 of Exhibit 2.1.
3.2 By-Laws.(1)
3.3 Certificate of Retirement of Series of Preferred Stock.(2)
3.4 Certificate of Designation, Preferences and Rights of Series
A Preferred Stock.(2)
3.5 Certificate of Amendment of Certificate of Incorporation of
Verity, Inc., dated September 21, 1999 and filed with the
Secretary of State of the State of Delaware.(3)
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.(4)
4.3 First Amendment to Rights Agreement dated as of July 23,
1999 among Verity, Inc. and BankBoston, N.A.(5)
10.27 Amendment to Retainer Agreement between Regent Pacific
Management Corporation and Verity, Inc. dated February 9,
2000.
27.1 Financial Data Schedule.

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

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

(3) Incorporated by reference to the like-numbered exhibit from the Company's
Form 10-Q for the quarter ended November 30, 1999.

(4) 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.

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