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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------

FORM 10-Q
------------------------
(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED FEBRUARY 28, 2001

[ ] 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, was 34,620,000 as of March 30, 2001.
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2

VERITY, INC.

FORM 10-Q

TABLE OF CONTENTS

PAGE
----

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements........................................ 1
Condensed Consolidated Balance Sheets as of May 31, 2000 and
February 28, 2001........................................... 1
Condensed Consolidated Statements of Operations for the
Three Months Ended February 29, 2000 and February 28, 2001
and the Nine Months Ended February 29, 2000 and February 28,
2000........................................................ 2
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended February 29, 2000 and February 28, 2001........ 3
Notes to Condensed Consolidated Financial Statements........ 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 7
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 23
Item 2. Changes in Securities and Use of Proceeds................... 23
Item 3. Defaults upon Senior Securities............................. 23
Item 4. Submission of Matters to a Vote of Security Holders......... 23
Item 5. Other Information........................................... 23
Item 6. Exhibits and Reports on Form 8-K............................ 23
Signature............................................................ 24

i
3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VERITY, INC.

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

ASSETS

MAY 31, FEBRUARY 28,
2000 2001
-------- ------------
(UNAUDITED)

Current assets:
Cash and cash equivalents................................. $ 7,183 $ 12,640
Short-term investments.................................... 109,472 145,051
Trade accounts receivable, net............................ 23,418 35,670
Deferred tax assets....................................... 20,210 20,210
Prepaid and other......................................... 3,988 6,739
-------- --------
Total current assets.............................. 164,271 220,310
Property and equipment, net................................. 4,773 7,256
Long-term investments....................................... 37,616 53,380
Deferred tax assets......................................... 6,562 4,149
Other assets................................................ 156 39
-------- --------
Total assets...................................... $213,378 $285,134
======== ========
LIABILITIES
Current liabilities:
Accounts payable.......................................... $ 6,488 $ 8,398
Accrued compensation...................................... 9,327 13,074
Other accrued liabilities................................. 1,198 3,610
Deferred revenue.......................................... 12,731 16,007
-------- --------
Total current liabilities......................... 29,744 41,089
-------- --------
Commitments and contingencies (Note 6)
STOCKHOLDERS' EQUITY
Common stock, $0.001 par value:
Authorized: 200,000,000 shares issued and outstanding:
31,606,000 shares as of May 31, 2000 and 34,160,000
shares as of February 28, 2001......................... 31 34
Additional paid-in capital.................................. 207,040 241,729
Other comprehensive income (loss)........................... (401) 748
Retained earnings/(accumulated deficit)..................... (23,036) 1,534
-------- --------
Total stockholders' equity........................ 183,634 244,045
-------- --------
Total liabilities and stockholders' equity........ $213,378 $285,134
======== ========

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 29, FEBRUARY 28, FEBRUARY 29, FEBRUARY 28,
2000 2001 2000 2001
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)

Revenues:
Software products........................ $22,514 $28,722 $47,081 $ 77,078
Service and other........................ 6,706 9,293 18,621 26,747
------- ------- ------- --------
Total revenues................... 29,220 38,015 65,702 103,825
------- ------- ------- --------
Costs of revenues:
Software products........................ 254 378 571 1,110
Service and other........................ 2,050 3,074 5,960 8,610
------- ------- ------- --------
Total costs of revenues.......... 2,304 3,452 6,531 9,720
------- ------- ------- --------
Gross profit............................... 26,916 34,563 59,171 94,105
------- ------- ------- --------
Operating expenses:
Research and development................. 4,018 5,849 11,480 15,261
Marketing and sales...................... 10,589 14,733 27,371 40,557
General and administrative............... 1,779 2,949 4,959 7,649
------- ------- ------- --------
Total operating expenses......... 16,386 23,531 43,810 63,467
------- ------- ------- --------
Income from operations..................... 10,530 11,032 15,361 30,638
Other income, net.......................... 1,800 3,417 3,919 8,522
------- ------- ------- --------
Net income before provision for income
taxes.................................... 12,330 14,449 19,280 39,160
Provision for income taxes................. 150 5,274 450 14,590
------- ------- ------- --------
Net income................................. $12,180 $ 9,175 $18,830 $ 24,570
======= ======= ======= ========
Net income per share -- basic.............. $ 0.39 $ 0.27 $ 0.64 $ 0.74
======= ======= ======= ========
Net income per share -- diluted............ $ 0.34 $ 0.25 $ 0.55 $ 0.67
======= ======= ======= ========
Number of shares -- basic.................. 31,159 33,948 29,548 33,255
======= ======= ======= ========
Number of shares -- diluted................ 36,306 37,000 34,425 36,587
======= ======= ======= ========

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

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5

VERITY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

NINE MONTHS ENDED
----------------------------
FEBRUARY 29, FEBRUARY 28,
2000 2001
------------ ------------
(UNAUDITED)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 18,830 $ 24,570
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
Depreciation and amortization............................. 2,118 1,974
Deferred income taxes..................................... -- 13,117
Provision for doubtful accounts........................... 5 198
Amortization of discount on securities.................... (274) (1,041)
Other..................................................... (20) --
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Trade accounts receivable................................. (858) (12,148)
Prepaid and other current assets.......................... (2,142) (2,765)
Accounts payable.......................................... 1,589 1,936
Accrued compensation and other accrued liabilities........ 2,615 6,318
Deferred revenue.......................................... 1,947 3,287
--------- ---------
Net cash provided by operating activities......... 23,810 35,446
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment..................... (1,466) (4,313)
Purchases of marketable securities........................ (323,720) (406,702)
Maturity of marketable securities......................... 139,631 211,477
Proceeds from sale of marketable securities............... 87,197 146,071
--------- ---------
Net cash used in investing activities............. (98,358) (53,467)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the sale of common stock, net............... 79,078 23,987
--------- ---------
Net cash provided by financing activities......... 79,078 23,987
--------- ---------
Effect of exchange rate changes on cash..................... 88 (509)
--------- ---------
Net increase in cash and cash equivalents......... 4,618 5,457
Cash and cash equivalents, beginning of period.............. 7,907 7,183
--------- ---------
Cash and cash equivalents, end of period.................... $ 12,525 $ 12,640
========= =========

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

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6

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF FEBRUARY 28, 2001 AND FOR THE THREE AND NINE MONTHS ENDED
FEBRUARY 29, 2000 AND FEBRUARY 28, 2001 AND THEREAFTER IS UNAUDITED)

1. INTERIM FINANCIAL DATA (UNAUDITED)

The unaudited financial statements as of February 28, 2001 and for the
three and nine months ended February 29, 2000 and February 28, 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, 2000.

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

2. COMPUTATION OF NET INCOME AND EARNINGS PER SHARE

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

Basic and diluted net income per share are calculated as follows for the
three and nine months ended February 29, 2000 and February 28, 2001 (in
thousands, except per share data):

Basic:
Weighted-average shares.......... 31,159 33,948 29,548 33,255
======= ======= ======= =======
Net income....................... $12,180 $ 9,175 $18,830 $24,570
======= ======= ======= =======
Net income per share............. $ 0.39 $ 0.27 $ 0.64 $ 0.74
======= ======= ======= =======
Diluted:
Weighted-average shares.......... 31,159 33,948 29,548 33,255
Common equivalent shares from
stock options................. 5,147 3,052 4,877 3,332
------- ------- ------- -------
Shares used in per share
calculation................... 36,306 37,000 34,425 36,587
------- ------- ------- -------
Net income....................... $12,180 $ 9,175 $18,830 $24,570
======= ======= ======= =======
Net income per share............. $ 0.34 $ 0.25 $ 0.55 $ 0.67
======= ======= ======= =======

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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7
VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF FEBRUARY 28, 2001 AND FOR THE THREE AND NINE MONTHS ENDED
FEBRUARY 29, 2000 AND FEBRUARY 28, 2001 AND THEREAFTER IS UNAUDITED)

4. BUSINESS SEGMENT

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

Revenues:
USA.............................. $27,504 $35,646 $60,942 $ 97,668
Europe........................... 1,716 2,369 4,760 6,157
Consolidated..................... 29,220 38,015 65,702 103,825
Long-lived assets:
USA.............................. 4,430 5,114 4,430 5,114
Europe........................... 370 826 370 826
Rest Of World.................... 434 1,355 434 1,355
Consolidated..................... 5,234 7,295 5,234 7,295

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 nine months ended February 29, 2000 and February 28, 2001. For
the three months ended February 29, 2000 and February 28, 2001, revenues derived
from sales to one customer accounted for approximately 21% and 12% of the
Company's total revenues, respectively. Revenues derived from sales to the
United States government and its agencies were 4.9% and 6.4% of the Company's
total revenues for the three months ended February 29, 2000 and February 28,
2001, respectively. For the nine months ended February 29, 2000 and February 28,
2001, revenues derived from sales to the United States government were 8.9% and
6.4% of the Company's total revenues, respectively.

5. RECENT ACCOUNTING PRONOUNCEMENTS

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

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

5
8
VERITY, INC.

6. COMMITMENTS AND CONTINGENCIES

In December 1999, a number of complaints were filed in the United States
District Court for the Northern District of California seeking an unspecified
amount of damages on behalf of an alleged class of persons who purchased shares
of the Company's common stock during the period between December 1 and December
14, 1999. The complaints name as defendants the Company and certain of its
directors and officers, asserting that they violated federal securities laws by
misrepresenting the Company's business, earnings growth, ability to continue to
achieve profitable growth, and failing to disclose certain information about the
Company's business. The complaints were consolidated into a single action, and
in August 2000, the complaint was dismissed without prejudice with leave to
amend. The plaintiffs re-filed an amended complaint, and the Company filed a
motion to dismiss this amended complaint on October 27, 2000. By order dated
February 13, 2001 the court granted the motion in part and denied it in part.
The court dismissed with prejudice all claims except a single claim relating to
alleged communications with a securities analyst near the end of the Company's
second fiscal 2000 quarter. The court restricted pretrial discovery to the
single remaining claim. Discovery has just commenced, and is expected to be
concluded by June 2001. No trial date has been set. While management intends to
defend the action vigorously, there can be no assurance that an adverse result
or settlement would not have a material adverse effect on the Company's
financial condition or results of operations.

7. EFFECTIVE TAX RATE

During the quarter ended February 28, 2001 the Company assessed the
qualification of its research and development expenses for state and federal
research and development tax credits. Management expected the tax savings for
fiscal 2001 due to research and development tax credits would result in a
significantly lower effective tax rate, and accordingly, applied an effective
tax rate of 36.5% to the result of the quarter ended February 28, 2001. The
Company is currently assessing the impact of its research and development
expenses on the effective tax rate in future periods.

8. LOANS TO OFFICERS

In January 2001, the Company granted loans to two of its officers in the
form of full recourse promissory notes. The loan amounts were approximately $2.1
million and $350,000 bearing an interest of 5.94% per annum. The notes were
repaid in January and March 2001, which included interest in the amounts of
$3,000 and $5,000, respectively.

9. SUBSEQUENT EVENTS

On March 12, 2001, the Company extended its 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 the
Company 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 the Company and continues to provide
additional Regent Pacific management services to the Company. The agreement
provides the Company with an option to further extend the term of this agreement
through February 2003. This agreement may be canceled at the option of the board
after February 2003.

6
9

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

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

OVERVIEW

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

During the quarterly periods ended August 31, 1997 to August 31, 1999 and
February 29, 2000 to February 28, 2001, we experienced increased revenues on a
quarterly basis. In addition, during the twelve consecutive quarterly periods
ended February 28, 2001, we experienced eleven quarters of record revenues. Due
to a delay in closing three large transactions, revenues for the quarter ended
November 30, 1999 were lower than expected. In fiscal year 2000, we achieved net
income of $33.0 million. While our goal is to increase revenue and generate net
income in future periods, we cannot assure you that our strategy will be
successful, that we will experience the rate of revenue growth we experienced
from August 31, 1997 to February 28, 2001 in future periods, or that we will
continue to maintain positive cash flow or profitability.

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

In March 2001, we extended our retainer agreement with Regent Pacific
Management Corporation through August 31, 2002. Under this amended agreement,
Regent Pacific continues to provide the services of Gary J. Sbona as our
Chairman and Chief Executive Officer, and continues to provide additional Regent
Pacific management services to us. The amendment provides us with an option to
further extend the term of this agreement through February 2003. This agreement
may be canceled at the option of the board after February 2003.

7
10

RESULTS OF OPERATIONS

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

Revenues:
Software products........................ 77.0% 75.6% 71.7% 74.2%
Service and other........................ 23.0 24.4 28.3 25.8
----- ----- ----- -----
Total revenues................... 100.0 100.0 100.0 100.0
----- ----- ----- -----
Costs of revenues:
Software products........................ 0.9 1.0 0.9 1.1
Service and other........................ 7.0 8.1 9.0 8.3
----- ----- ----- -----
Total costs of revenues.......... 7.9 9.1 9.9 9.4
----- ----- ----- -----
Gross profit............................... 92.1 90.9 90.1 90.6
----- ----- ----- -----
Operating expenses:
Research and development................. 13.8 15.4 17.5 14.7
Marketing and sales...................... 36.2 38.8 41.7 39.0
General and administrative............... 6.1 7.7 7.5 7.4
----- ----- ----- -----
Total operating expenses......... 56.1 61.9 66.7 61.1
----- ----- ----- -----
Income from operations..................... 36.0 29.0 23.4 29.5
Interest and other expenses................ 6.2 9.0 5.9 8.2
----- ----- ----- -----
Income before provision for income taxes... 42.2 38.0 29.3 37.7
Provision for income taxes................. 0.5 13.9 0.6 14.0
----- ----- ----- -----
Net income................................. 41.7% 24.1% 28.7% 23.7%
===== ===== ===== =====

Revenues

Our total revenues increased 58.0% from $65.7 million for the nine months
ended February 29, 2000 to $103.8 million for the nine months ended February 28,
2001, and 30.1% from $29.2 million for the three months ended February 29, 2000
to $38.0 million for the three months ended February 28, 2001. The increases for
the nine and three months ended February 28, 2001 were due primarily to
increased revenues from our business portal solutions and our enterprise
application businesses and, to a lesser extent, an increase in maintenance and
consulting. Software product revenues increased as a percentage of total
revenues from 71.7% for the nine months ended February 29, 2000 to 74.2% for the
nine months ended February 28, 2001. For the three months ended February 28,
2001, software product revenues decreased as a percentage of total revenues to
75.6% compared to 77.0% for the three months ended February 29, 2000. Service
and other revenues for the nine months ended February 29, 2000 and February 28,
2001 decreased as a percentage of total revenues from 28.3% to 25.8%,
respectively. Conversely, for the three months ended February 29, 2000 and
February 28, 2001, service and other revenues increased from 23.0% to 24.4% as a
percentage of total revenues, respectively.

Software product revenues. Software product revenues increased 63.7% from
$47.1 million to $77.1 million and 27.6% from $22.5 million to $28.7 million for
the nine and three months ended February 29, 2000 and February 28, 2001,
respectively. The increases for the nine and three month periods ended February
28, 2001 were due principally to revenues from our business portal solutions
and, to a lesser extent, our enterprise application businesses.

Service and other revenues. Our service and other revenues consist
primarily of fees for software, maintenance, consulting and training. Service
and other revenues increased 43.6% from $18.6 million for the nine months ended
February 29, 2000 to $26.7 million for the nine months ended February 28, 2001.
Service

8
11

and other revenues increased 38.6% from $6.7 million for the three months ended
February 29, 2000 to $9.3 million for the three months ended February 28, 2001.
Maintenance revenues increased significantly between the comparable periods
primarily due to a growth in customer base. Consulting revenues increased
between the comparable periods primarily due to a growth in customer base and
introduction of our new portal one suite of products, which require additional
consulting services.

Service and other revenues from foreign operations accounted for 6.2% and
6.0% of total revenues for the nine months ended February 29, 2000 and February
28, 2001, respectively. For the three months ended February 29, 2000 and
February 28, 2001, service and other revenues from foreign operations accounted
for 3.5% and 6.2% of total revenues, respectively. The increase for the three
months ended February 28, 2001 was primarily attributable to continued market
acceptance and demand in Europe. Our export sales consist primarily of products
licensed for delivery outside of the United States. For the nine months ended
February 29, 2000 and February 28, 2001, export sales accounted for 19.4% and
29.3% of total revenues, respectively. For the three months ended February 29,
2000 and February 28, 2001, export sales accounted for 20.9% and 31.3% of total
revenues, respectively. The increases are principally due to our continued
expansion in the international markets. 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 29, 2000 and February 28, 2001. For the three months ended
February 29, 2000 and February 28, 2001, revenues derived from sales to one
customer accounted for approximately 21% and 12% of our total revenues,
respectively. Revenues derived from sales to the United States government and
its agencies were 4.9% and 6.4% of our total revenues for the three months ended
February 29, 2000 and February 28, 2001, respectively. For the nine months ended
February 29, 2000 and February 28, 2001, revenues derived from sales to the
United States government were 8.9% and 6.4% of our total revenues, respectively.
We expect that revenues from such government sales will continue to vary in
future periods as a percentage of revenues.

Costs of Revenues

Costs of software products. The cost of our software products consists
primarily of product media, duplication, manuals, packaging materials, shipping
expenses and royalties, and in certain instances, licensing of third-party
software incorporated in our products. Costs of software products increased
94.4% from $571,000 for the nine months ended February 29, 2000 to $1.1 million
for the nine months ended February 28, 2001, representing 1.2% and 1.4%,
respectively, of the software product revenues during these periods. Costs of
software products increased 48.8% from $254,000 for the three months ended
February 29, 2000 to $378,000 for the three months ended February 28, 2001,
representing 1.1% and 1.3%, respectively, of the software product revenues
during these periods. The increase in absolute dollars and as a percentage of
software product revenues during the nine-month and three-month periods ended
February 28, 2001 was primarily attributable to increasing costs of third party
software components and costs associated with the introduction of our new portal
suite of products.

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 44.5% from $6.0 million for the nine months ended February 29, 2000 to
$8.6 million for the nine months ended February 28, 2001, representing 32.0% and
32.2%, respectively, of service and other revenues during these periods. Costs
of service and other revenues increased 50.0% from $2.1 million for the three
months ended February 29, 2000 to $3.1 million for the three months ended
February 28, 2001, representing 30.6% and 33.1%, respectively, of service and
other revenues during these periods. The increase in absolute dollars and as a
percentage of costs of service and other revenues during the nine-month and
three-month periods ended February 28, 2001 was due principally to an increase
in the staffing of our technical support and professional services
organizations.

9
12

Operating Expenses

Research and development. Research and development expenses increased 32.9%
from $11.5 million for the nine months ended February 29, 2000 to $15.3 million
for the nine months ended February 28, 2001, representing 17.5% and 14.7%,
respectively, of total revenues for these periods. Research and development
expenses increased 45.6% from $4.0 million for the three months ended February
29, 2000 to $5.8 million for the three months ended February 28, 2001,
representing 13.8% and 15.4%, respectively, of total revenues for these periods.
The increase in absolute dollars for the nine and three months ended February
28, 2001 and as a percentage of total revenues for the three months ended
February 28, 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 decrease in costs as a percentage of total revenues for the nine months
ended February 28, 2001 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 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 48.2% from
$27.4 million for the nine months ended February 29, 2000 to $40.6 million for
the nine months ended February 28, 2001, representing 41.7% and 39.1%,
respectively, of total revenues during these periods. Marketing and sales
expenses increased 39.1% from $10.6 million for the three months ended February
29, 2000 to $14.7 million for the three months ended February 28, 2001,
representing 36.2% and 38.8%, respectively, of total revenues during these
periods. The increase in absolute costs for the nine and three months ended
February 28, 2001 and as a percentage of total revenues for the three months
ended February 28, 2001 was primarily related to the continuous expansion of our
marketing and sales organizations, the continued development of our sales
distribution channels in the United States and Europe and outbound marketing
activities associated with the re-branding of our company. The decrease in costs
as a percentage of total revenues for the nine months ended February 28, 2001
was primarily related to the increased revenues during the period. We anticipate
that we will continue to make significant investments in marketing and sales.

General and administrative. General and administrative expenses increased
54.2% from $5.0 million in the nine months ended February 29, 2000 to $7.6
million for the nine months ended February 28, 2001, representing 7.5% and 7.4%,
respectively, of total revenues during these periods. General and administrative
expenses increased 65.8% from $1.8 million in the three months ended February
29, 2000 to $2.9 million for the three months ended February 28, 2001,
representing 6.1% and 7.8%, respectively, of total revenues. The increase in
absolute costs for the nine months and three months ended February 28, 2001 and
as a percentage of total revenue for the three months ended February 28, 2001
was primarily related to increases in professional service fees required to
support our continued growth. The decrease in costs as a percentage of total
revenues for the nine months ended February 28, 2001 was primarily related to
the increased revenues during the period.

Income Taxes

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

During the quarter ended February 28, 2001, we assessed the qualification
of our research and development expenses for state and federal research and
development tax credits. We expected the tax savings for fiscal 2001 due to
research and development tax credits would result in a significantly lower
effective tax rate, and accordingly, applied an effective tax rate of 36.5% to
the result of our quarter ended February 28, 2001. We are currently assessing
the impact of our research and development expenses on our effective tax rate in
future periods.

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LIQUIDITY AND CAPITAL RESOURCES

As of February 28, 2001, we had $211.1 million in cash and cash equivalents
and available-for-sale securities compared to $154.3 million at May 31, 2000.

Our operating activities provided cash of $23.8 million and $35.4 million
for the nine months ended February 29, 2000 and February 28, 2001, respectively.
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. Cash provided
by operating activities in the nine months ended February 28, 2001 was primarily
due to our net income, depreciation and amortization expense, increase in
liabilities and deferred revenues, offset in part by an increase accounts
receivable and other current assets.

Our investing activities used cash of $98.4 million and $53.5 million for
the nine months ended February 29, 2000 and February 28, 2001, respectively. For
the nine months ended February 29, 2000 and February 28, 2001, 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 $79.1 million and $24.0 million
for the nine months ended February 29, 2000 and February 28, 2001, respectively.
In the nine months ended February 29, 2000, financing activities consisted
primarily of proceeds from the sale of common stock in conjunction with our
secondary public offering and the sale of common stock as a result of stock
options exercised. In the nine months ended February 28, 2001, financing
activities consisted primarily of proceeds from the sale of common stock as a
result of stock options exercised.

At February 28, 2001, our principal sources of liquidity were our cash and
cash equivalents and short-term investments of $157.7 million. As of February
28, 2001, we had no outstanding debt obligations.

Capital expenditures, including capital leases, were approximately $1.5
million and $4.3 million for the nine months ended February 29, 2000 and
February 28, 2001, respectively. For the nine months ended February 29, 2000,
these expenditures consisted of purchases of property and equipment, primarily
for computer hardware and software. For the nine months ended February 28, 2001,
these expenditures consisted of purchases of property and equipment, primarily
for computer hardware and software as well as leasehold improvements as a result
of our rapid personnel expansion, and the 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 2002. Thereafter, or
if our spending plans change, we may find it necessary to seek to obtain
additional sources of financing to support our capital needs, but we cannot
assure you that such financing will be available on commercially reasonable
terms, or at all.

RECENT ACCOUNTING PRONOUNCEMENTS

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

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fiscal years commencing after December 15, 1999. We have evaluated the provision
of SAB 101 and we are in compliance with SAB 101.

IMPACT OF EUROPEAN MONETARY CONVERSION

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

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RISK FACTORS

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

RISKS RELATED TO OUR BUSINESS

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

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

- increase market acceptance of our products;

- respond effectively to competitive developments;

- attract, retain and motivate qualified personnel; and

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

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

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

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

- the size and timing of orders;

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

- increased competition in the software and Internet industries;

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

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

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

- changes in operating expenses and personnel;

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- 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.

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

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

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

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

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

During the past few years, management and other personnel have focused on
modifying and enhancing our core technology to support a broader set of search
and retrieval solutions for use on enterprise-wide systems and e-commerce sites
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

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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 and business portal 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
Autonomy, Alta Vista, Excalibur, Inktomi, Mercado, Google, Datachannel,
Dataware, Hummingbird/PC Docs/Fulcrum, Infoseek, Lotus, Viador, Epicentric,
Thunderstone, Plumtree and Microsoft, among others. We also compete indirectly
with database vendors, such as Oracle, that offer information search and
retrieval capabilities with their core database products and web platform
companies, such as Netscape.

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

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

Regent Pacific Management Corporation, a management firm of which Gary J.
Sbona is chairman and chief executive officer, provides management services for
our company. The management services provided under our agreement with Regent
Pacific include the services of Mr. Sbona as our chairman of the board and chief
executive officer, and other Regent Pacific personnel as part of our management
team. 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

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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 new management. Similarly, if any
adverse change in our relationship with Regent Pacific occurs, it could hinder
management's ability to direct our business and materially and adversely affect
our results of operations and financial condition.

OUR BUSINESS MAY SUFFER DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES

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

- difficulties in complying with regulatory requirements and standards;

- tariffs and other trade barriers;

- costs and risks of localizing products for foreign countries;

- reliance on third parties to distribute our products;

- longer accounts receivable payment cycles;

- potentially adverse tax consequences;

- limits on repatriation of earnings; and

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

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

Service and other revenues derived from foreign operations accounted for
6.4%, 6.7% and 6.0% of total revenues, respectively, in fiscal 1999, 2000 and
nine months ended February 28, 2001. Our export sales consist primarily of
products licensed for delivery outside of the United States. In fiscal years
1999, 2000 and nine months ended February 28, 2001, export sales accounted for
27.1%, 19.0% and 29.3% of total revenues. We expect that revenues derived from
foreign operations and export sales will continue to account for a significant
percentage of our revenues for the foreseeable future. These revenues may
fluctuate significantly as a percentage of revenues from period to period. In
addition, a portion of these revenues was derived from sales to foreign
government agencies, which may be subject to risks similar to those described
immediately below.

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

Revenues derived from sales to the United States government and its
agencies were 8.1%, 7.8% and 6.4% of total revenues in fiscal years 1999, 2000
and nine months ended February 28, 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

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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.

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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 non-exclusive basis. We believe that there are alternative
sources for each of the material components of technology we license from third
parties. However, the termination of any of these licenses, or the failure of
the third-party licensors to adequately maintain or update their products, could
result in delay in our ability to ship these products while we seek to implement
technology offered by alternative sources. Any required replacement licenses
could prove costly. Also, any delay, to the extent it becomes extended or occurs
at or near the end of a

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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 previous or 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

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- 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 us or our competitors;

- quarterly variations in operating results;

- announcements of technological innovations;

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

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- 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;

- 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.

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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 February 28, 2001, approximately 73% 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 February 28, 2001:

FY2001 FY2002 FY2003 FY2004 TOTAL FAIR VALUE
------- ------- ------- ------- -------- ----------
(IN THOUSANDS)

Cash equivalents............. $12,640 -- -- -- $ 12,640 $ 12,640
Average interest rate........ 4.2%
Short-term investments....... $90,567 $54,484 -- $145,051 $145,051
Average interest rate........ 5.7% 6.3%
Long-term investments........ -- $13,629 $19,060 $20,691 $ 53,380 $ 53,380
Average interest rates....... -- 7.1% 5.8% 5.7%

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 Singaporean dollar and the
Brazilian real. 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 the Northern District of California seeking an unspecified
amount of damages on behalf of an alleged class of persons who purchased shares
of the Company's common stock during the period between December 1 and December
14, 1999. The complaints name as defendants the Company and certain of its
directors and officers, asserting that they violated federal securities laws by
misrepresenting Verity's business, earnings growth, ability to continue to
achieve profitable growth, and failing to disclose certain information about the
Company's business. The complaints were consolidated into a single action, and
in August 2000, the complaint was dismissed without prejudice with leave to
amend. The plaintiffs re-filed an amended complaint, and Verity filed a motion
to dismiss this amended complaint on October 27, 2000. By order dated February
13, 2001, the court granted the motion in part and denied it in part. The court
dismissed with prejudice all claims except a single claim relating to alleged
communications with a securities analyst near the end of the Company's second
fiscal 2000 quarter. The court restricted pretrial discovery to the single
remaining claim. Discovery has just commenced, and is expected to be concluded
by June 2001. No trial date has been set. While management intends to defend the
action vigorously, there can be no assurance that an adverse result or
settlement 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

Not Applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

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

Not Applicable.

ITEM 5. OTHER INFORMATION

Not Applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

A. Exhibits -- See Exhibit Index.

B. 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
Vice President & Corporate Controller
(Principal Accounting Officer)

Dated: April 10, 2001

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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)
10.5 1996 Non-Statutory Stock Option Plan, as amended.
10.6 1997 Non-Statutory Stock Option Plan for Verity, Canada, as
amended.
10.29 Amendment to Retainer Agreement between Regent Pacific
Management Corporation and Verity, Inc. dated March 12,
2001.
10.30 Promissory Note dated January 2, 2001 given by Anthony
Bettencourt in favor of Verity, Inc.
10.31 Promissory Note dated January 2, 2001 given by Todd Yamami
in favor of Verity, Inc.

- ---------------
(1) Incorporated by reference from the exhibits with corresponding numbers from
the Company's Quarterly Report on Form 10-Q for the quarter ending 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.