##### Table of Contents

---



SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



FORM 10-Q



|x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
|- | ----------------------------------------------------------------------------------------

| | For the quarterly period ended June 30, 2004 or
| | -----------------------------------------------



| ̈ | 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: 000-32417



VERISITY LTD.

(Exact name of registrant as specified in its charter)



|                                             |  |                    
|-------------------------------------------- |  | -------------------
|Israel                                       |  | Not Applicable     
|(State or other Jurisdiction of              |  | (I.R.S. Employer   
|Incorporation or Organization)               |  | Identification No.)
|                                             | 
|331 E. Evelyn Ave, Mountain View, California |  | 94041              
|(Address of principal US executive offices)  |  | (Zip Code)         



(650) 934-6800

(Registrants telephone number, including area code)



Indicate by check mark whether the 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 ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).



Yes  x    No ̈



As of June 30, 2004, there were 23,744,182 of registrants ordinary shares, par value NIS 0.01 per share, outstanding.



---



---

##### Table of Contents

VERISITY LTD.



Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2004



Index





|                               |  |         |  |                                                                                       |  |     
|------------------------------ |  | ------- |  | ------------------------------------------------------------------------------------- |  | ----
|                               |  |         |  |                                                                                       |  | Page
|Part I  Financial Information |  |        
|                               |  |         | 
|                               |  | Item 1. |  | Condensed Consolidated Financial Statements (Unaudited):                              |  |     
|                               |  |         | 
|                               |  |         |  | Balance Sheets                                                                        |  | 1   
|                               |  |         |  | Statements of Operations                                                              |  | 2   
|                               |  |         |  | Statements of Cash Flows                                                              |  | 3   
|                               |  |         |  | Notes to Condensed Consolidated Financial Statements                                  |  | 4   
|                               |  |         | 
|                               |  | Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 13  
|                               |  |         | 
|                               |  | Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 20  
|                               |  |         | 
|                               |  | Item 4. |  | Controls and Procedures                                                               |  | 21  
|                               | 
|Part II  Other Information    |  |        
|                               |  |         | 
|                               |  | Item 1. |  | Legal Proceedings                                                                     |  | 21  
|                               |  |         | 
|                               |  | Item 2. |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities      |  | 21  
|                               |  |         | 
|                               |  | Item 3. |  | Defaults Upon Senior Securities                                                       |  | 21  
|                               |  |         | 
|                               |  | Item 4. |  | Submission of Matters to a Vote of Security Holders                                   |  | 21  
|                               |  |         | 
|                               |  | Item 5. |  | Other Information                                                                     |  | 24  
|                               |  |         | 
|                               |  | Item 6. |  | Exhibits and Reports on Form 8-K                                                      |  | 24  
|                               | 
|Signature                      |  | 25     
|                               | 
|Certifications                 |  |        



---

##### Table of Contents

PART I  FINANCIAL INFORMATION

|Item 1. | Condensed Consolidated Financial Statements
|------- | -------------------------------------------



VERISITY LTD.



CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                                                                                                                  |  |               |         |   |                  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                  |  | June 30, 2004 |         |   | December 31,2003 |  
|                                                                                                                                  |  | Unaudited     |         |   |                  |  
|ASSETS                                                                                                                            |  |               |         |   |                  |   |         |  
|Current assets:                                                                                                                   |  |               |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                         |  | $             | 53,100  |   |                  | $ | 91,004  |  
|Accounts receivable, net of allowance for doubtful accounts of $53 and $2 as of June 30, 2004 and December 31, 2003,
respectively |  |               | 14,623  |   |                  |   | 11,444  |  
|Inventory                                                                                                                         |  |               | 3,229   |   |                  |   |        |  
|Prepaid expenses and other current assets                                                                                         |  |               | 7,505   |   |                  |   | 4,412   |  
|                                                                                                                                  |  |               |         |   |                  |   |         |  
|Total current assets                                                                                                              |  |               | 78,457  |   |                  |   | 106,860 |  
|Property and equipment, net                                                                                                       |  |               | 4,640   |   |                  |   | 3,298   |  
|Other assets                                                                                                                      |  |               | 668     |   |                  |   | 386     |  
|Unbilled receivables                                                                                                              |  |               | 5,643   |   |                  |   |        |  
|Deferred compensation, net                                                                                                        |  |               | 4,515   |   |                  |   |        |  
|Intangible assets, net                                                                                                            |  |               | 18,284  |   |                  |   |        |  
|Goodwill                                                                                                                          |  |               | 52,910  |   |                  |   |        |  
|                                                                                                                                  |  |               |         |   |                  |   |         |  
|Total assets                                                                                                                      |  | $             | 165,117 |   |                  | $ | 110,544 |  
|                                                                                                                                  |  |               |         |   |                  |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                              |  |               |         |   |                  |   |         |  
|Current liabilities:                                                                                                              |  |               |         |   |                  |   |         |  
|Accounts payable                                                                                                                  |  | $             | 1,370   |   |                  | $ | 1,177   |  
|Accrued compensation                                                                                                              |  |               | 6,081   |   |                  |   | 4,827   |  
|Deferred taxes, net                                                                                                               |  |               | 3,631   |   |                  |   |        |  
|Deferred revenues                                                                                                                 |  |               | 26,265  |   |                  |   | 27,791  |  
|Other current liabilities                                                                                                         |  |               | 7,945   |   |                  |   | 6,851   |  
|                                                                                                                                  |  |               |         |   |                  |   |         |  
|Total current liabilities                                                                                                         |  |               | 45,292  |   |                  |   | 40,646  |  
|Long-term portion of deferred revenues                                                                                            |  |               | 13,951  |   |                  |   | 5,601   |  
|Other long-term liabilities                                                                                                       |  |               | 325     |   |                  |   | 481     |  
|Shareholders equity:                                                                                                             |  |               |         |   |                  |   |         |  
|Ordinary shares and additional paid-in capital                                                                                    |  |               | 111,345 |   |                  |   | 59,122  |  
|Deferred compensation                                                                                                             |  |               | (5,842  | ) |                  |   | (14     | )
|Retained earnings                                                                                                                 |  |               | 46      |   |                  |   | 4,708   |  
|                                                                                                                                  |  |               |         |   |                  |   |         |  
|Total shareholders equity                                                                                                        |  |               | 105,549 |   |                  |   | 63,816  |  
|                                                                                                                                  |  |               |         |   |                  |   |         |  
|Total liabilities and shareholders equity                                                                                        |  | $             | 165,117 |   |                  | $ | 110,544 |  
|                                                                                                                                  |  |               |         |   |                  |   |         |  



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



-1-



---

##### Table of Contents

VERISITY LTD.



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)



|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                               |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                               |  | 2004                       |        |   | 2003                     |   |        | 2004 |  |   | 2003   |  
|                                               |  | Unaudited                  |        |   | Unaudited                |  
|Revenue:                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|License                                        |  | $                          | 7,816  |   |                          | $ | 7,605  |      |  | $ | 13,701 |   |  | $ | 14,571 |  
|Maintenance                                    |  |                            | 5,671  |   |                          |   | 4,597  |      |  |   | 10,638 |   |  |   | 9,101  |  
|Other services                                 |  |                            | 214    |   |                          |   | 301    |      |  |   | 404    |   |  |   | 528    |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                                  |  |                            | 13,701 |   |                          |   | 12,503 |      |  |   | 24,743 |   |  |   | 24,200 |  
|Cost of revenue:                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|License                                        |  |                            | 727    |   |                          |   | 38     |      |  |   | 881    |   |  |   | 73     |  
|Maintenance                                    |  |                            | 482    |   |                          |   | 554    |      |  |   | 1,141  |   |  |   | 1,099  |  
|Other services                                 |  |                            | 121    |   |                          |   | 167    |      |  |   | 246    |   |  |   | 285    |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenue                          |  |                            | 1,330  |   |                          |   | 759    |      |  |   | 2,268  |   |  |   | 1,457  |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                                   |  |                            | 12,371 |   |                          |   | 11,744 |      |  |   | 22,475 |   |  |   | 22,743 |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                            |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Research and development                       |  |                            | 4,231  |   |                          |   | 2,626  |      |  |   | 7,694  |   |  |   | 5,225  |  
|Sales and marketing                            |  |                            | 7,236  |   |                          |   | 5,400  |      |  |   | 13,693 |   |  |   | 10,572 |  
|General and administrative                     |  |                            | 2,110  |   |                          |   | 1,458  |      |  |   | 3,954  |   |  |   | 2,848  |  
|Non-cash charges related to equity issuances   |  |                            | 1,217  |   |                          |   | 66     |      |  |   | 1,985  |   |  |   | 32     |  
|Amortization of deferred compensation          |  |                            | 854    |   |                          |   |       |      |  |   | 1,423  |   |  |   |       |  
|Amortization of intangible assets              |  |                            | 1,041  |   |                          |   |       |      |  |   | 1,735  |   |  |   |       |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                       |  |                            | 16,689 |   |                          |   | 9,550  |      |  |   | 30,484 |   |  |   | 18,677 |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Operating income (loss)                        |  |                            | (4,318 | ) |                          |   | 2,194  |      |  |   | (8,009 | ) |  |   | 4,066  |  
|Interest income                                |  |                            | 108    |   |                          |   | 208    |      |  |   | 245    |   |  |   | 415    |  
|Other income (expense), net                    |  |                            | 7      |   |                          |   | (25    | )    |  |   | (27    | ) |  |   | (65    | )
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss) before income taxes          |  |                            | (4,203 | ) |                          |   | 2,377  |      |  |   | (7,791 | ) |  |   | 4,416  |  
|Income taxes provision (benefit)               |  |                            | (1,753 | ) |                          |   | 190    |      |  |   | (3,129 | ) |  |   | 352    |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                              |  | $                          | (2,450 | ) |                          | $ | 2,187  |      |  | $ | (4,662 | ) |  | $ | 4,064  |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Basic earnings (loss) per share:               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Basic net income (loss) per ordinary share     |  | $                          | (0.11  | ) |                          | $ | 0.11   |      |  | $ | (0.21  | ) |  | $ | 0.21   |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Number of shares used in per share calculation |  |                            | 23,330 |   |                          |   | 19,740 |      |  |   | 22,576 |   |  |   | 19,680 |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Diluted earnings (loss) per share:             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Diluted net income (loss) per ordinary share   |  | $                          | (0.11  | ) |                          | $ | 0.10   |      |  | $ | (0.21  | ) |  | $ | 0.19   |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Number of shares used in per share calculation |  |                            | 23,330 |   |                          |   | 21,348 |      |  |   | 22,576 |   |  |   | 21,188 |  
|                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



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



-2-



---

##### Table of Contents

VERISITY LTD.



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                                   |  |                          |         |   |      |   |        |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | -
|                                                                                                   |  | Six Months EndedJune 30, |        
|                                                                                                   |  | 2004                     |         |   | 2003 |  
|                                                                                                   |  | Unaudited                |        
|Cash flows from operating activities:                                                              |  |                          |         |   |      |   |        |  
|Net income (loss)                                                                                  |  | $                        | (4,662  | ) |      | $ | 4,064  |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |  |                          |         |   |      |   |        |  
|Depreciation and amortization                                                                      |  |                          | 901     |   |      |   | 527    |  
|Non-cash charges related to equity issuances                                                       |  |                          | 1,985   |   |      |   | (127   | )
|Amortization of deferred compensation                                                              |  |                          | 1,423   |   |      |   |       |  
|Amortization of intangible assets                                                                  |  |                          | 1,735   |   |      |   |       |  
|Amortization of inventory step up                                                                  |  |                          | 15      |   |      |   |       |  
|Changes in operating assets and liabilities:                                                       |  |                          |         |   |      |   |        |  
|Accounts receivable                                                                                |  |                          | (1,218  | ) |      |   | 4,243  |  
|Prepaid expenses and other assets                                                                  |  |                          | (1,262  | ) |      |   | (734   | )
|Inventory                                                                                          |  |                          | 520     |   |      |   |       |  
|Unbilled receivable                                                                                |  |                          | 3,606   |   |      |   |       |  
|Accounts payable                                                                                   |  |                          | (231    | ) |      |   | 76     |  
|Other liabilities and accrued compensation                                                         |  |                          | (1,460  | ) |      |   | (183   | )
|Deferred revenues                                                                                  |  |                          | 747     |   |      |   | (7,119 | )
|Deferred taxes                                                                                     |  |                          | (3,363  | ) |      |   |       |  
|                                                                                                   |  |                          |         |   |      |   |        |  
|Net cash provided by (used in) operating activities                                                |  |                          | (1,264  | ) |      |   | 747    |  
|Cash flows from investing activities:                                                              |  |                          |         |   |      |   |        |  
|Purchases of property and equipment                                                                |  |                          | (861    | ) |      |   | (862   | )
|Other assets                                                                                       |  |                          | (106    | ) |      |   | 1      |  
|Cash paid in conjunction with the acquisition of Axis, net                                         |  |                          | (37,022 | ) |      |   |       |  
|                                                                                                   |  |                          |         |   |      |   |        |  
|Net cash used in investing activities                                                              |  |                          | (37,989 | ) |      |   | (861   | )
|Cash flows from financing activities:                                                              |  |                          |         |   |      |   |        |  
|Net proceeds from issuance of ordinary shares                                                      |  |                          | 1,343   |   |      |   | 1,284  |  
|Payments under capital lease obligations                                                           |  |                          | 6       |   |      |   | (6     | )
|                                                                                                   |  |                          |         |   |      |   |        |  
|Net cash provided by financing activities                                                          |  |                          | 1,349   |   |      |   | 1,278  |  
|Net increase (decrease) in cash and cash equivalents                                               |  |                          | (37,904 | ) |      |   | 1,164  |  
|Cash and cash equivalents at beginning of the period                                               |  |                          | 91,004  |   |      |   | 79,509 |  
|                                                                                                   |  |                          |         |   |      |   |        |  
|Cash and cash equivalents at end of the period                                                     |  | $                        | 53,100  |   |      | $ | 80,673 |  
|                                                                                                   |  |                          |         |   |      |   |        |  
|Non-cash financial activities:                                                                     |  |                          |         |   |      |   |        |  
|Issuance of ordinary shares for acquisition of Axis                                                |  | $                        | 35,366  |   |      |   |        |  
|Fair value of Axis' assumed options                                                                |  | $                        | 12,894  |   |      |   |        |  



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



-3-



---

##### Table of Contents

VERISITY LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



|1. | Basis of Presentation
|-- | ---------------------



The Company



These unaudited interim condensed consolidated financial statements reflect the Companys financial position as of June 30, 2004. The statements also
show the Companys statements of operations for the three and six month periods ended June 30, 2004 and 2003, and the statements of cash flow for the six month periods ended June 30, 2004 and 2003. The December 31, 2003 condensed consolidated
balance sheet data was derived from the Companys audited financial statements and does not include all of the disclosures required by accounting principles generally accepted in the United States. These interim statements include all normal
recurring adjustments, which the Company believes are necessary to fairly present the Companys financial position. All material intercompany balances have been eliminated. Because all of the disclosures required by accounting principles
generally accepted in the United States are not included, these interim statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2003, included in the Companys annual report on
Form 10-K filed with the Securities and Exchange Commission on March 12, 2004. The statements of operations for the periods presented are not necessarily indicative of results for any future period, or for the entire year.



Use of Estimates



The preparation of financial statements in conformity with generally accepted accounting principles in the United States
requires the Company to base its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.



|2. | Share-Based Compensation
|-- | ------------------------



The Company accounts for employee share option grants in accordance with Accounting Principles Board Opinion No. 25, Accounting For Stock Issued to
Employees (APB 25) and related interpretations. Under APB 25, when the exercise price of share options granted to employees equals or exceeds the market price of the underlying shares on the date of grant, no compensation expense
is recognized. The Company has adopted the disclosure only alternative described in Statement of Financial Accounting Standards (SFAS) 123, Accounting for Stock-Based Compensation.



For purposes of disclosures pursuant to SFAS 123 as amended by SFAS 148, the
estimated fair value of options is amortized to expense over the options vesting period.



The following table illustrates the effect on reported net income and net income per share as if we had applied the fair value recognition provisions of SFAS 123 to share-based compensation:



-4-



---

##### Table of Contents

|                                                                                 |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | - | ------------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                 |  | Three MonthsEnded June 30,           |        |   | Six Months EndedJune 30,             |  
|                                                                                 |  | 2004                                 |        |   | 2003                                 |   |        | 2004 |  |   | 2003   |  
|                                                                                 |  | (in thousands, exceptper share data) |        |   | (in thousands, exceptper share data) |  
|Net income (loss) as reported                                                    |  | $                                    | (2,450 | ) |                                      |   | 2,187  |      |  | $ | (4,662 | ) |  | $ | 4,064  |  
|Stock-based compensation expense included in reported net income (loss)          |  |                                      | 282    |   |                                      |   | 36     |      |  |   | 436    |   |  |   | 83     |  
|Total stock based compensation expense determined under fair value based methods |  |                                      | (2,168 | ) |                                      |   | (2,646 | )    |  |   | (4,510 | ) |  |   | (4,998 | )
|                                                                                 |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net Income (loss)                                                      |  | $                                    | (4,336 | ) |                                      |   | (423   | )    |  |   | (8,736 | ) |  |   | (851   | )
|                                                                                 |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|Basic net income (loss) per share:                                               |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|As reported                                                                      |  | $                                    | (0.11  | ) |                                      | $ | 0.11   |      |  | $ | (0.21  | ) |  | $ | 0.21   |  
|                                                                                 |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|Pro forma                                                                        |  | $                                    | (0.19  | ) |                                      | $ | (0.02  | )    |  | $ | (0.39  | ) |  | $ | (0.04  | )
|                                                                                 |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|Diluted net income (loss) per share:                                             |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|As reported                                                                      |  | $                                    | (0.11  | ) |                                      | $ | 0.10   |      |  | $ | (0.21  | ) |  | $ | 0.19   |  
|                                                                                 |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  
|Pro forma                                                                        |  | $                                    | (0.19  | ) |                                      | $ | (0.02  | )    |  | $ | (0.39  | ) |  | $ | (0.04  | )
|                                                                                 |  |                                      |        |   |                                      |   |        |      |  |   |        |   |  |   |        |  





The fair value of all options granted during the three months ended June 30, 2004 and 2003 was estimated as of the date of grant using the Black-Scholes option pricing
model with the following weighted average assumptions:



|                                               |  |                             |         |   |      |   |         |  
|---------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                               |  | Three Months EndedJune\ 30, |        
|                                               |  | 2004                        |         |   | 2003 |  
|Volatility                                     |  |                             | 48      | % |      |   | 80      | %
|Expected dividend yields                       |  |                             | 0       | % |      |   | 0       | %
|Weighted-average risk-free interest rates      |  |                             | 3.40    | % |      |   | 2.10    | %
|Weighted-average fair value of options granted |  | $                           | 5.52    |   |      | $ | 10.16   |  
|Expected life:                                 |  |                             |         |   |      |   |         |  
|Option plans                                   |  |                             | 4.0     |   |      |   | 4.0     |  
|Purchase plan                                  |  |                             | 0.52.0 |   |      |   | 0.52.0 |  



The weighted average assumptions used
in the first quarters of 2004 and 2003, were reported in the Companys quarterly reports on Form 10-Q for the first quarter of 2004 and 2003.



|3. | Basic and Diluted Net Income (Loss) Per Share
|-- | ---------------------------------------------



Basic net income per share and diluted net loss per share are computed based on the weighted average number of ordinary shares outstanding during each
period. Diluted net income per share is computed based on the weighted average number of ordinary shares outstanding during each period, plus dilutive potential ordinary shares considered outstanding during the period, in accordance with Financial
Accounting Standards Board (FASB) Statement No. 128, Earnings per Share.



-5-



---

##### Table of Contents

The following is a reconciliation of the denominator used in basic and diluted net income (loss) per
share computations for the three and six months ended on June 30, 2004 and 2003 (in thousands, except per share data):

|                                                                      |  |                            |        |                          |      |   |        |  |   |        |   |  |   |       
|--------------------------------------------------------------------- |  | -------------------------- | ------ | ------------------------ | ---- | - | ------ |  | - | ------ | - |  | - | ------
|                                                                      |  | Three Months EndedJune 30, |        | Six Months EndedJune 30,
|                                                                      |  | 2004                       |        |                          | 2003 |   | 2004   |  |   | 2003  
|                                                                      |  | Unaudited                  |        | Unaudited               
|Net income (loss)                                                     |  | $                          | (2,450 | )                        |      | $ | 2,187  |  | $ | (4,662 | ) |  | $ | 4,064 
|                                                                      |  |                            |        |                          |      |   |        |  |   |        |   |  |   |       
|Shares used in computing basic net income (loss) per ordinary share   |  |                            | 23,330 |                          |      |   | 19,740 |  |   | 22,576 |   |  |   | 19,680
|                                                                      |  |                            |        |                          |      |   |        |  |   |        |   |  |   |       
|Weighted-average number of ordinary shares under the treasury method  |  |                            |       |                          |      |   | 1,608  |  |   |       |   |  |   | 1,508 
|                                                                      |  |                            |        |                          |      |   |        |  |   |        |   |  |   |       
|Shares used in computing diluted net income (loss) per ordinary share |  |                            | 23,330 |                          |      |   | 21,348 |  |   | 22,576 |   |  |   | 21,188
|                                                                      |  |                            |        |                          |      |   |        |  |   |        |   |  |   |       
|Diluted net income (loss) per ordinary share                          |  | $                          | (0.11  | )                        |      | $ | 0.10   |  | $ | (0.21  | ) |  | $ | 0.19  
|                                                                      |  |                            |        |                          |      |   |        |  |   |        |   |  |   |       



|4. | Segment, Customers and Geographic Information
|-- | ---------------------------------------------



The Company operates in one industry segment which is focused on the development, marketing and support of software and hardware products that provide
systems and semiconductor companies with the ability to automate the functional verification of system and integrated circuit designs. Operations in Israel and in the United States include research and development and sales and marketing. Operations
in Europe, Taiwan and Japan include sales and marketing.



The
following is a summary of operations within geographic areas based on the location of the entity making the sales and the location of the long-lived assets (in thousands):



-6-



---

##### Table of Contents

|                                               |  |                             |        |                           |   |               |  |                  |        |  |   |       
|---------------------------------------------- |  | --------------------------- | ------ | ------------------------- | - | ------------- |  | ---------------- | ------ |  | - | ------
|                                               |  | Three Months Ended June 30, |        | Six Months Ended June 30,
|                                               |  | 2004                        |        | 2003                      |   | 2004          |  | 2003            
|                                               |  | Unaudited                   |        | Unaudited                
|Revenues from sales to unaffiliated customers: |  |                             |        |                           |   |               |  |                  |        |  |   |       
|United States                                  |  | $                           | 10,242 |                           | $ | 9,522         |  | $                | 18,539 |  | $ | 18,314
|Israel                                         |  |                             | 564    |                           |   | 721           |  |                  | 1,019  |  |   | 1,838 
|Europe                                         |  |                             | 2,386  |                           |   | 2,260         |  |                  | 4,362  |  |   | 4,048 
|Japan                                          |  |                             | 509    |                           |   |              |  |                  | 823    |  |   |      
|                                               |  |                             |        |                           |   |               |  |                  |        |  |   |       
|                                               |  | $                           | 13,701 |                           | $ | 12,503        |  | $                | 24,743 |  | $ | 24,200
|                                               |  |                             |        |                           |   |               |  |                  |        |  |   |       
|                                               |  |                             |        |                          
|                                               |  |                             |        |                           |   | June 30, 2004 |  | December 31,2003
|                                               |  |                             |        |                           |   | Unaudited     |  |                 
|Long lived assets:                             |  |                             |        |                           |   |               |  |                  |        |  |   |       
|United States                                  |  |                             |        |                           |   |               |  | $                | 21,091 |  | $ | 1,492 
|Israel                                         |  |                             |        |                           |   |               |  |                  | 1,724  |  |   | 1,762 
|Europe                                         |  |                             |        |                           |   |               |  |                  | 28     |  |   | 44    
|Japan                                          |  |                             |        |                           |   |               |  |                  | 81     |  |   |      
|                                               |  |                             |        |                           |   |               |  |                  |        |  |   |       
|                                               |  |                             |        |                           |   |               |  | $                | 22,924 |  | $ | 3,298 
|                                               |  |                             |        |                           |   |               |  |                  |        |  |   |       



-7-



---

##### Table of Contents

|5. | Inventory
|-- | ---------



Inventory is stated at the lower of cost or market, with cost determined on a first-in, first-out basis. Inventory consisted of the following (in
thousands):



|                |  |               |      
|--------------- |  | ------------- | -----
|                |  | June 30, 2004
|                |  | Unaudited    
|Work in process |  | $             | 590  
|Finished goods  |  |               | 2,639
|                |  |               |      
|                |  | $             | 3,229
|                |  |               |      



|6. | Acquisition
|-- | -----------



On December 11, 2003, Verisity Ltd. and Axis Systems Inc. (Axis) entered into an Agreement and Plan of Merger (Merger Agreement)
with the intended result of Axis becoming a wholly-owned subsidiary of Verisity. On February 9, 2004 Verisity and Axis closed this merger pursuant to the Merger Agreement in a transaction accounted for using the purchase method. Accordingly, the
results of operation of Axis have been included in the Companys financial statements since the date of acquisition.



Verisitys primary objective in acquiring Axis was based on the Companys belief that the combined Company would benefit from the following:



| |  | Axiss complementary technologies and products in the functional verification market provide Verisity with a more comprehensive and highly differentiated verification process
automation (VPA) platform that can take complex electronic design projects from specification to verification closure. It will provide the combined company the ability to more fully penetrate and expand its existing customer base and broaden its
target market to include simulation, acceleration and emulation by integrating certain key technologies of each company into new products as well as merging existing product lines;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Axiss intellectual property portfolio and related expertise, especially intellectual property relating to third generation simulation technology that can serve as a software
simulator, an accelerator, or an in-system emulator. This technology is packaged into three tightly linked solutions: (i) Xsim, a mixed Verilog, VHDL, and SystemC event-based simulator, (ii) Xtreme, a recompiled version of the simulator that is
targeted to run on a high performance parallel processing machine, and (iii) XoC, an extension of Xtreme that enables the co-verification of hardware with embedded software.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Access to Axiss customer relationships, providing cross-selling opportunities to existing customers as well as opportunities to build new relationships and better leverage the
combined sales and marketing resources of both companies while providing a much broader range of VPA solutions and methodologies to its combined customer base.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The purchase price exceeded the net assets acquired resulting in the recognition of goodwill. The Company attributed
particular value to several of Axiss underlying technologies, beyond its existing product lines, which the Company plans to integrate with several of its own technologies to create new



-8-



---

##### Table of Contents

products which will significantly enhance and broadened its VPA platform offerings and allow the Company to address a
much larger target market, as mentioned above. Moreover, these underlying Axis technologies are mature, high performance and highly interoperable which will significantly reduce the Companys integration time and time to market with new
products versus having had to develop similar technologies and products over a much longer time period through its own internal development efforts.



The financial statements reflect an estimated purchase price of approximately $81.2 million, determined as follows (in thousands):



|                                                         |  |        |        |  
|-------------------------------------------------------- |  | ------ | ------ | -
|                                                         |  | Amount |       
|Cash consideration                                       |  | $      | 40,571 |  
|Less: Value of cash for key employee retention           |  |        | (5,938 | )
|Value of Verisity ordinary shares issued                 |  |        | 35,366 |  
|Less: Value of shares for key employee retention         |  |        | (5,177 | )
|Fair value of Axis options assumed                       |  |        | 12,894 |  
|Restricted incentive Verisity ordinary shares            |  |        | 1,480  |  
|Restricted incentive Verisity ordinary share units (RSU) |  |        | 340    |  
|Less: Deferred Compensation for Restricted Shares & RSUs |  |        | (1,820 | )
|Estimated transaction costs                              |  |        | 3,500  |  
|                                                         |  |        |        |  
|Total purchase price                                     |  | $      | 81,216 |  
|                                                         |  |        |        |  



The total purchase
price of $81.2 million includes cash of $40.6 million, Verisity ordinary shares valued at $35.3 million, assumed stock options with a fair value of $12.9 million (intrinsic value of $4.0 million), restricted incentive Verisity ordinary shares and
restricted ordinary shares units valued at $1.8 million and estimated direct transaction costs of $3.5 million, reduced by amounts related to future employment that will be accounted for as deferred compensation costs of $11.1 million in respect of
cash and share proceeds of certain key employees under retention agreements and $1.8 million in respect of restricted incentive Verisity ordinary shares and restricted ordinary shares units.



The fair value of Axis assumed options of $12.9 million was determined
based on the fair value of Verisity ordinary shares as of the acquisition date using the Black-Scholes option pricing model applying the following assumptions: expected life of 4 years, risk-free interest rate of 2.8%, expected volatility of 62% and
no expected dividend yield. The intrinsic value of the unvested options, totaling approximately $949,000, has been recorded as deferred stock compensation and will be amortized over the vesting period on a multiple option approach basis.



Under the purchase method of accounting, the total estimated
purchase price as shown in the table below is allocated to Axiss net tangible and intangible assets based on their estimated fair values as of the date of the completion of the merger. Based on the final valuation and other factors, the
purchase price is allocated as follows:



-9-



---

##### Table of Contents

|                                                      |  |        |       
|----------------------------------------------------- |  | ------ | ------
|                                                      |  | Amount
|Net tangible assets                                   |  | $      | 8,286 
|Amortizable intangible assets:                        |  |        |       
|Developed and core technology, patents                |  |        | 10,620
|Customer contracts and lists, distribution agreements |  |        | 8,200 
|Maintenance contracts                                 |  |        | 1,200 
|Goodwill                                              |  |        | 52,910
|                                                      |  |        |       
|Total purchase price allocation                       |  | $      | 81,216
|                                                      |  |        |       



Based on the final
valuation and other factors, the estimated purchase price, with respect to net tangible assets, is allocated as follows:



|                                        |  |        |        |  
|--------------------------------------- |  | ------ | ------ | -
|                                        |  | Amount |       
|Cash and cash equivalents               |  | $      | 8,280  |  
|Accounts receivable                     |  |        | 3,202  |  
|Unbilled Receivables                    |  |        | 8,121  |  
|Inventory                               |  |        | 3,764  |  
|Deferred Expenses                       |  |        | 1,886  |  
|Net Property and Equipment              |  |        | 1,381  |  
|Net Deferred Taxes                      |  |        | (6,994 | )
|Account Payable and Accrued Liabilities |  |        | (5,277 | )
|Deferred revenues                       |  |        | (6,077 | )
|                                        |  |        |        |  
|Net tangible assets                     |  | $      | 8,286  |  
|                                        |  |        |        |  



Intangible
assets



Of the total estimated purchase price $20.0
million has been allocated to amortizable intangible assets acquired.



Developed technology, which is comprised of products that have reached technological feasibility, includes products in most of Axiss product lines, principally the Axis Xcite, Xtreme, Xpert and Xchange products. Core technology and
patents represent a combination of Axis processes, patents and trade secrets developed through the design and development of reconfigurable computing (RCC) technology and fielded products that can handle software simulation, acceleration, emulation,
and hardware/software co-verification. Verisity expects to amortize the developed and core technology and patents on a straight-line basis over an average estimated life of five years.



Customer contracts represent existing contracts that relate primarily to underlying customer relationships pertaining to the
products and services provided by Axis. Customer lists and distribution agreements represent Axiss relationships with its installed base of products and service, and agreements with sales representatives and distributors. Verisity expects to
amortize the fair value of these assets on a straight-line basis over an average estimated life of five years. Maintenance contracts represent agreements to deliver support services to certain customers and Verisity expects to amortize the fair
value of these contracts on a straight line basis over an average estimated life of three years.



Of the total estimated purchase price, $53.0 million has been allocated to goodwill. Goodwill represents the excess of the purchase price of an acquired
business over the fair value of the underlying net



-10-



---

##### Table of Contents

tangible and intangible assets. The Company attributed particular value to several of Axiss underlying technologies
which the Company plans to integrate with several of its own technologies to create new products which will significantly enhance and broadened its verification process automation platform offerings and allow the Company to address a much larger
target market. Moreover, these underlying Axis technologies are mature, high performance and highly interoperable which will significantly reduce the Companys integration time and time to market with new products versus having to develop
similar technologies and products over a much longer time period through its own internal development efforts.



Of the total estimated purchase price no value is being allocated to in-process research and development. Axis is currently developing new products that
have generally reached technological feasibility and do not qualify for treatment as in-process research and development. Technological feasibility is defined as being equivalent to completion of a beta-phase working prototype in which there is no
remaining risk relating to the development.



The discount rates
used for the valuation of the various intangible assets of Axis were based on a weighted average cost of capital of 17.0 percent. The weighted average cost of capital was calculated employing estimates of required equity rates of return and
after-tax costs of debt based upon a group of peer companies. In order to estimate an appropriate equity rate of return, the Capital Asset Pricing Model was employed. Specifically, a discount rate of 15.0 percent was assigned to the developed
technology on the basis that the risk associated with this asset class was estimated to be lower than the overall Axis business since the technology was proven and was being sold in the marketplace as of the valuation date. Alternatively, a discount
rate of 17.0 percent was assigned to the customer and maintenance contracts on the basis that the risk associated with these assets was estimated to approximate the same risk as the overall Axis business.



The following unaudited pro forma financial information presents the combined
results of operations of Verisity and Axis as if the acquisition had occurred as of the beginning of fiscal 2003 and 2004, after giving effect to certain adjustments, including amortization of intangibles. The unaudited pro forma financial
information does not necessarily reflect the results of operations that would have occurred had the combined companies constituted a single entity during such periods, and is not necessarily indicative of results which may be obtained in the future.



|                              |  |                                       |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|----------------------------- |  | ------------------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                              |  | Three Months Ended June 30,           |        |   | Six Months EndedJune 30, |  
|                              |  | 2004                                  |        |   | 2003                     |   |        | 2004 |  |   | 2003   |  
|                              |  | Unaudited                             |        |   | Unaudited                |  
|                              |  | (in thousands, except per share data) |       
|Pro forma revenue             |  | $                                     | 13,701 |   |                          | $ | 17,311 |      |  | $ | 26,485 |   |  | $ | 34,505 |  
|                              |  |                                       |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net loss            |  | $                                     | (2,450 | ) |                          | $ | (1,672 | )    |  | $ | (6,603 | ) |  | $ | (1,618 | )
|                              |  |                                       |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Pro forma net loss per share: |  |                                       |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Basic                         |  | $                                     | (0.11  | ) |                          | $ | (0.07  | )    |  | $ | (0.29  | ) |  | $ | (0.07  | )
|                              |  |                                       |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Diluted                       |  | $                                     | (0.11  | ) |                          | $ | (0.07  | )    |  | $ | (0.29  | ) |  | $ | (0.07  | )
|                              |  |                                       |        |   |                          |   |        |      |  |   |        |   |  |   |        |  

Verisity has not given effect in the pro forma statement of operations for the 2003 period to the
deferred revenue adjustment on revenue as the adjustments are directly related to the merger and the effect is non-recurring. Such adjustments will be reflected in the post-merger statements of operations of the combined company.



The deferred revenue adjustment will have the effect of reducing the amount
of revenue the combined company will recognize in periods subsequent to the merger compared to the amount of revenue Axis would have recognized in the same period absent the merger.



-11-



---

##### Table of Contents

|7. | Goodwill and Other Intangible Assets
|-- | ------------------------------------



In accordance with SFAS 142 goodwill and intangible assets with indefinite lives will be tested for impairment at least annually (or more frequently if
certain indicators are present). In the event that the management of the combined company determines that the goodwill has become impaired, the combined company will incur an accounting charge for the amount of impairment during the fiscal quarter
in which the determination is made.



Intangible assets are
comprised of the following (in thousands):



|                                                      |  |               |  |                     |        |                         |   |        |            |  |   |       
|----------------------------------------------------- |  | ------------- |  | ------------------- | ------ | ----------------------- | - | ------ | ---------- |  | - | ------
|                                                      |  | June 30, 2004
|                                                      |  | Unaudited    
|                                                      |  | Life(Years)   |  | GrossCarryingAmount |        | AccumulatedAmortization |   |        | NetBalance
|Developed and core technology, patents                |  | 5             |  | $                   | 10,620 |                         | $ | (885   | )          |  | $ | 9,735 
|Customer contracts and lists, distribution agreements |  | 5             |  |                     | 8,200  |                         |   | (684   | )          |  | $ | 7,516 
|Maintenance contracts                                 |  | 3             |  |                     | 1,200  |                         |   | (167   | )          |  | $ | 1,033 
|                                                      |  |               |  |                     |        |                         |   |        |            |  |   |       
|                                                      |  |               |  | $                   | 20,020 |                         | $ | (1,736 | )          |  | $ | 18,284
|                                                      |  |               |  |                     |        |                         |   |        |            |  |   |       



Estimated future
intangible amortization expense, based on current balances, as of June 30, 2004 is as follows (in thousands):



|                          |  |        |       
|------------------------- |  | ------ | ------
|                          |  | Amount
|Year ending December 31:  |  |        |       
|2004 (remaining 6 months) |  |        | 2,081 
|2005                      |  |        | 4,164 
|2006                      |  |        | 4,164 
|2007                      |  |        | 3,797 
|2008                      |  |        | 3,764 
|2009                      |  |        | 314   
|                          |  |        |       
|                          |  | $      | 18,284
|                          |  |        |       



|8. | Income Taxes
|-- | ------------



The Company accounts for income taxes in accordance with SFAS 109, Accounting for Income Taxes. This Statement prescribes the use of the
liability method whereby deferred taxes assets and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.





-12-



---

##### Table of Contents

|9. | Guarantees
|-- | ----------



Under the terms of our standard contract with each of our customers, we agree to indemnify each customer against certain liabilities and damages to the
extent such liabilities and damages arise from claims that such customers use of our software or services infringes intellectual property rights of a third party. These terms are common in the high technology industry. We do not record a
liability for potential litigation claims related to indemnification obligations with our customers. We do not believe the likelihood of a material obligation is probable.



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------



The following discussion and analysis of our financial condition and results of operations should be read in conjunction
with our condensed consolidated financial statements and the related notes included elsewhere in this quarterly report on Form 10-Q. Some of the statements contained in this Form 10-Q are forward looking statements, including but not limited to
those specifically identified as such, that involve risks and uncertainties. The statements contained in this Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as
amended (the Securities Act) and Section 21E of the Exchange Act of 1934, as amended (the Exchange Act), including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the
future. All forward-looking statements included in this Form 10-Q are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. These statements involve known and unknown
risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as may,
will, should, expects, plans, anticipates, believes, estimates, predicts, potential, or continue, or the negative of these terms
or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Important factors that may
cause actual results to differ from expectations include those discussed in Risk Factors in our annual report on Form 10-K for the year ended December 31, 2003, filed with the Securities and Exchange Commission, and elsewhere in this
quarterly report on Form 10-Q.



Description of Business



We provide software and, with the acquisition in the previous quarter of
Axis Systems, Inc. discussed below, hardware products that automate the process of detecting flaws in the designs of electronic systems and ICs and enable our customers to deliver higher quality electronic products, accelerate time-to-market, reduce
overall product development costs, and better manage the predictability of their design verification process. We were founded in September 1995 and commenced operations in January 1996.



-13-



---

##### Table of Contents

In 1996, we released our original Specman functional verification software product. In the second quarter
of 1998, we released our SureCov software product. In the fourth quarter of 1998, we released Specman Elite, an enhanced version of our original Specman product. In 2003, we introduced further enhancements to our Specman Elite products as well as
several new products and methodologies targeted at chip and system level verification and overall verification project level management. We have also introduced several other products and support programs, which enhance the use of our products in
the functional verification process. Since these new products and services were introduced primarily in the latter part of 2003, we expect customers to sample them in low volume initially, before adopting them more broadly, therefore we expect their
contribution to total revenue to be modest in 2004.



We
currently derive substantially all of our revenue from the sale of licenses for a small number of software and hardware products and related maintenance and other services. Sales of our Specman Elite and other functional verification class of
products have accounted for 100% of our license revenue in the past. We expect that substantially all of our revenue in 2004 will continue to be generated from sales of licenses of our functional verification products and related maintenance and
other services, including products and services from our acquisition of Axis Systems in February 2004.



Throughout all of 2002 and the first half of 2003, our customers continued to face a difficult and unpredictable economic environment with respect to the
end markets for their products and their overall financial health. The year 2002 marked the third consecutive year of such a protracted downturn in the economic environment for the electronics industry in which our customers compete. These
uncertainties continued into 2003 and began to abate to some extent as the year progressed. The result of this prolonged uncertainty caused most customers to scrutinize carefully their R&D investments with spending decisions being delayed as
long as possible and, in some cases, additional development programs being further rationalized or discontinued and many smaller companies going out of business. While the economic environment appeared to improve during the second half of 2003, our
customers continued to demonstrate cautiousness in respect to their R&D spending decisions.



Orders for our functional verification products, maintenance and other services increased in 2002 over order levels recorded in 2000 and 2001, however the
rate at which new orders were received slowed in the latter half of the year and did not keep pace with the growth in reported revenue, due primarily to the economic environment. As a result, we reported a sequential revenue decline in the first
quarter of 2003 and flat revenue of just over $12 million per quarter for the remaining three quarters of 2003. New orders for our products and services declined in 2003 as compared to 2002, however, after hitting a low point in our seasonably weak
first quarter we did experience resurgence in the rate of new orders as the year progressed. In particular, new orders in the second half of 2003 grew compared to the same period in 2002.



In the first quarter of 2004, traditionally our seasonally weakest quarter, orders declined sequentially from a strong
fourth quarter 2003, but were up from the first quarter of 2003 and were at parity with revenue reported in the quarter. In the second quarter of 2004 orders increased sequentially from the first quarter of 2004 and from the second quarter of 2003
and were greater than the revenue reported in the period, providing growth to our backlog. Orders for time-based licenses in the first half of 2004 continued to grow as a proportion of overall orders, which generates a more ratable and somewhat
slower growing revenue stream over time. We cannot predict with any certainty if forward-looking orders will continue to grow, or when and if forward-looking revenue may increase. Please see the risk factors for the effect on our revenue if our
products are not adopted as discussed in Risk Factors in our annual report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission and elsewhere in this quarterly report on Form 10-Q.



We sell our products and related maintenance and other
services directly through our sales force and through indirect channels that include international distributors and sales representatives. Revenue from sales outside North America accounted for approximately 35.7% of our total revenue in the second
quarter of 2004 and 31.3% of our total revenue in the second quarter of 2003. We believe that international markets represent a significant growth opportunity for our business and we anticipate that international revenue will increase as a percent
of total revenue in the future.



-14-



---

##### Table of Contents

In order to increase market share in international locations and better serve our global customers, we
plan to further expand our international operations. We expect that this expansion will require a substantial investment in personnel, facilities and operations, which tend to be more costly than similar investments in domestic operations. As a
result of these investments in our international operations, we may experience an increase in cost of sales and other operating expenses disproportionate to revenue from those operations.



We license our software products to customers under either perpetual or time-based licenses. Further, with respect to these
time-based license arrangements for our software products, we allocate the revenue based on our standard price list, which has resulted in approximately 70% being allocated to license revenue and 30% being allocated to maintenance revenue. The term
for our time-based software licenses is typically one year. Our software products do not require customization or modification for our customers to install and use them. Customers purchasing maintenance receive Internet-based technical support,
telephone support and unspecified product updates when we choose to make updates available. Our perpetual and time-based licenses are always sold with maintenance. Maintenance for perpetual licenses may then be separately renewed. We believe these
product updates, which our customers have the right to use for the remaining term of their license, are the primary reason that a majority of our customers renew maintenance every year. Our services include training in the use of our products and
consulting services.



We sell our hardware system products in
conjuncton with high value software elements and we recognize revenue in accordance with American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9. Our hardware
related contracts with customers generally include perpetual license fees for software and hardware products and postcontract maintenance, typically for 12 months. Maintenance can be renewed annually at the customers discretion. However, VSOE
does not exist for the Companys postcontract maintenance; therefore, product and maintenance revenue is recognized ratably over the initial maintenance term, once there are no other undelivered elemnts except postcontract maintenance. Revenue
recognition begins when delivery has occurred and all other revenue recognition criteria have been met.



Recent Developments



On
February 9, 2004, we completed our acquisition of Axis Systems, Inc. (Axis), a company that provides certification and simulation software/hardware system solutions that enable System-on-Chip designers to verify the accuracy,
optimization and functionality of integrated circuits. Axis offers a unique, third-generation simulation technology that combines all languages and required engines for hardware, embedded software and system-level verification. The acquisition will
enable Verisity to create a comprehensive and highly differentiated VPA platform to exploit multiple discontinuities in the rapidly changing functional verification market. For more information regarding the terms of the acquisition, please see the
Companys public disclosures made in connection with the acquisition, including, but not limited to, our filings with the SEC. The acquisition was accounted for under the purchase method of accounting. Under the purchase method of accounting,
the total estimated purchase price is allocated to Axiss net tangible and intangible assets based on their estimated fair values as of the date of the completion of the merger. The purchase price exceeded the net assets acquired resulting in
the recognition of goodwill. Certain intangible assets and deferred compensation related to the merger will result in non-cash amortization expenses being reported over the useful life of the intangible assets and vesting period of the underlying
compensation, respectively. On the merger date future revenue related to firm contracts amounted to approximately $21.4 million. Of this amount, in accordance with Emerging Issues Task Force (EITF) No. 01-3 Accounting in a Business
Combination for Deferred Revenue of an Acquiree, approximately $15.3 million or 72% was permanently eliminated because the underlying obligations, primarily the delivery of software and hardware elements, had largely been met prior to the
merger date. Although this purchase accounting requirement will have no impact on our business or cash flow, it will adversely impact our reported GAAP revenue and make certain measurements stated as a percentage of revenue less meaningful,
particularly over the next twelve months during which approximately $11.5 million of the eliminated amount was scheduled to be reported as revenue for Axis.



-15-



---

##### Table of Contents

Following the completion of the acquisition, the results of operations of Axis have been included in our
consolidated financial statements. Accordingly, our results of operations for the six month period ended June 30, 2004 reflect Axiss operations since February 10, 2004, while our results of operations for the comparable 2003 period reflect
only Verisitys historical operations.



Three and Six months Ended June
30, 2004 Compared to Three and Six months Ended June 30, 2003



Total
Revenue



Our revenue consists of license revenue,
maintenance revenue and other services revenue. License revenue consists of fees paid by our customers to license our software and hardware systems products. Maintenance revenue consists of fees for annual support and product updates. Other services
revenue consists of training and consulting fees. Our total revenue was $13.7 million for the three months ended June 30, 2004, and $12.5 million for the comparable quarter of 2003, representing an increase of $1.2 million, or 9.6%, and was $24.7
million for the six months ended June 30, 2004 and $24.2 million for the comparable period of 2003, representing an increase of $0.5 million, or 2.2%. Approximately 96% of revenue in both the three months and six months periods ending June 30, 2004,
were derived from existing customers, including Axis customers prior to the merger, with the balance coming from new customers.



License revenue. Our license revenue was $7.8 million for the three months ended June 30, 2004, and $7.6 million for the comparable quarter of
2003, representing an increase of $0.2 million, or 2.8%, and was $13.7 million for the six months ended June 30, 2004, and $14.6 million for the comparable period of 2003, representing a decrease of $0.9 million, or 6.0%. The decrease in the six
month period resulted from decrease in revenue from perpetual licenses of $1.6 million, partially offset by increase in revenue from time-based licenses of $700,000. This reflects a further shift in customers demand towards time-based licenses
from perpetual licenses.



Maintenance revenue. Our
maintenance revenue was $5.7 million for the three months ended June 30, 2004, and $4.6 million for the comparable quarter of 2003, representing an increase of $1.1 million, or 23.4%, and was $10.6 million for the six months ended June 30, 2004, and
$9.1 million for the comparable period of 2003, representing an increase of $1.5 million, or 16.9%. These increases were primarily attributable to the recognition of revenue from maintenance services that we sold in connection with the sale of new
licenses, particularly in respect to time-based licenses, and ongoing maintenance contract obligations acquired from Axis.



Other services revenue. Our other services revenue was $214,000 for the three months ended June 30, 2004, and $301,000 for the comparable quarter
of 2003, representing a decrease of $87,000, or 28.9%, and was $404,000 for the six months ended June 30, 2004, and $528,000 for the comparable period of 2003, representing a decrease of $124,000, or 23.5%. These decreases were primarily
attributable to slightly lower training services.



Cost of Revenue



Cost of revenue consists of costs of software
licenses, components and assembly of hardware systems, and the cost of providing maintenance and other services. Cost of revenue was $1.3 million for the three months ended June 30, 2004, and $759,000 for the comparable quarter of 2003, representing
an increase of $0.6 million or 75.2%, and was $2.3 million for the six months ended June 30, 2004, and $1.5 million for the comparable period of 2003, representing an increase of $0.8 million, or 55.7%. These increases are primarily attributable to
costs related to increased hardware product content in the 2004



-16-



---

##### Table of Contents

period resulting from the Axis acquisition, as well as costs associated with increased revenue levels. Cost of revenue as
a percentage of total revenue was 9.7% for the three months ended June 30, 2004, and 6.1% for the comparable quarter of 2003, and was 9.2% for the six months ended June 30, 2004, and 6.0% for the comparable period of 2003.



Cost of license revenue. Cost of license revenue consists of costs of
software licenses, components and assembly of hardware systems and are recognized in the same manner as the underlying product revenue. Cost of license revenue was $727,000 for the three months ended June 30, 2004, and $38,000 for the comparable
quarter of 2003, representing an increase of $689,000 or 1813%, and was $881,000 for the six months ended June 30, 2004, and $73,000 for the comparable period of 2003, representing an increase of $808,000 or 1107%. These increases are primarily
attributable to components and assembly costs related to the sales of hardware products in the 2004 period. As a percent of license revenue, the cost of license revenue was 9.3% for the three months ended June 30, 2004, and 0.5% for the comparable
quarter of 2003, and was 6.4% for the six months ended June 30, 2004 and 0.5% for the six months ended June 30, 2003.



Cost of maintenance revenue. Cost of maintenance revenue was $482,000 for the three months ended June 30, 2004, and $554,000 for the comparable
quarter of 2003, representing a decrease of $72,000, or 13.0%, and was $1.1 million for the six months ended June 30, 2004 and 2003. As a percent of maintenance revenue, the cost of maintenance revenue decreased from 12.1% for the three months ended
June 30, 2003, to 8.5% for the comparable quarter of 2004, and from 12.1% for the six months ended June 30, 2003, to 10.7% for the comparable period of 2004.



Cost of other services revenue. Cost of other services revenue consists primarily of internal and contracted personnel and other expenses related
to providing training and consulting services to our customers. Cost of other services revenue was $121,000 for the three months ended June 30, 2004, and $167,000 for the comparable quarter of 2003, representing a decrease of $46,000, or 27.5%, and
was $246,000 for the six months ended June 30, 2004, and $285,000 for the comparable period of 2003, representing a decrease of $39,000, or 13.7%. These changes were primarily attributable to a decrease in demand for externally contracted services,
particularly in support of our training revenue. As a percent of other services revenue, the cost of other services revenue increased from 55.5% for the three months ended June 30, 2003, to 56.5% for the comparable quarter of 2004, and from 54.0%
for the six months ended June 30, 2003, to 60.9% for the comparable period of 2004. These increases reflect a slightly higher usage of contracted services to support our other services revenue.



Operating Expenses



Research and development. Research and development expenses consist
primarily of costs related to research and development personnel, including salaries and other personnel-related expenses, sub-contracting fees, facilities and depreciation from computer equipment used in our product and technology development.
Research and development expenses were $4.2 million for the three months ended June 30, 2004, and $2.6 million for the comparable quarter of 2003, representing an increase of $1.6 million, or 61.1%, and were $7.7 million for the six months ended
June 30, 2004, and $5.2 million for the comparable period of 2003, representing an increase of $2.5 million, or 47.3%. These increases were primarily related to the inclusion of engineering personnel acquired from Axis for the period beginning on
February 10, 2004, and to a lesser extent attributable to the number of developers employed in the continuing enhancement and integration of our software products. Research and development expenses as a percentage of total revenues were 30.9% for
the three months ended June 30, 2004, and 21.0% for the comparable quarter of 2003, and were 31.1% for the six months ended June 30, 2004, and 21.6% for the comparable period of 2003. We believe that significant investment in research and
development has been and will continue to be required to develop new products and enhance existing products to allow us to further penetrate our target markets. Furthermore, we expect to increase research and development expenses directly related to
the integration of certain of our technologies with technologies recently acquired with Axis to create new products that will significantly broaden our VPA platform and allow us to address much larger target markets. We therefore anticipate that the
absolute dollar amount of research and development expenses will increase in the future.



-17-



---

##### Table of Contents

Sales and marketing. Sales and marketing expenses consist primarily of salaries, commissions,
travel for sales and marketing personnel and promotional and advertising costs. Sales and marketing expenses were $7.2 million for the three months ended June 30, 2004, and $5.4 million for the comparable quarter of 2003, representing an increase of
$1.8 million, or 34.0%, and were $13.7 million for the six months ended June 30, 2004, and $10.6 million for the comparable period of 2003, representing an increase of $3.1 million, or 29.5%. These increases are primarily attributable to the
integration of Axiss sales and marketing resources with Verisity beginning February 10, 2004. Sales and marketing expenses as a percentage of total revenues were 52.8% for the three months ended June 30, 2004, and 43.2% for the comparable
period of 2003, and were 55.3% for the six months ended June 30, 2004, and 43.7% for the comparable period of 2003. These increases as a percent of revenues is primarily attributable to proportionately lower revenue for Platform products in the
three and six months ended June 30, 2004 due to the purchase accounting effects on reportable revenue. We expect sales and marketing expenses to increase as we expand our geographic reach, hire additional personnel and increase technical sales
personnel in support of new products that we will introduce as a result of integrating Verisity and Axis technologies. We expect sales and marketing expenses to increase as we expand our geographic reach, hire additional personnel and expand our
strategic programs.



General and administrative. General
and administrative expenses consist primarily of salaries and other personnel-related expenses for our administrative, legal, human resources, investor relations and finance personnel, facilities, insurance and professional services fees. General
and administrative expenses were $2.1 million for the three months ended June 30, 2004, and $1.5 million for the comparable quarter of 2003, representing an increase of $652,000, or 44.7%. and were $4.0 million for the six months ended June 30,
2004, and $2.8 million for the comparable period of 2003, representing an increase of $1,106,000, or 38.8%. These increase are primarily attributable to the inclusion of Axiss expenses for the period beginning on February 10, 2004, and to a
lesser extent increased expenses associated with preparing to meet new public reporting requirements. General and administrative expenses as a percentage of total revenue were 15.4% for the three months ended June 30, 2004, and 11.7% for the
comparable quarter in 2003, and were 16.0% for the six months ended June 30, 2004, and 11.8% for the comparable period of 2003. We expect general and administrative expenses to increase for the foreseeable future as we expand our administrative
staff and incur expenses associated with being a public company, including the costs of annual and periodic reporting, and reporting in accordance with Section 404 of the Sarbanes-Oxley Act, investor relations programs and insurance.



Non-cash charges related to equity issuance, amortization of deferred
compensation and amortization of intangible assets.Non-cash charges related to equity issuances reflect the amortization of the deferred share-based compensation, representing the difference between the fair value of the ordinary shares for
financial reporting purposes and the exercise price of the underlying options. Non-cash charges related to equity issuances also include the amortization of deferred compensation associated with the Axis merger that is applicable to restricted
ordinary shares and restricted share units granted to certain Axis employees as part of the merger, the intrinsic value of the unvested Axis options, and in respect to ordinary share proceeds retained by the Company from certain key Axis
employees which are subject to vesting in connection with retention agreements. Non-cash charges related to equity issuances were $1.2 million for the three months ended June 30, 2004, and $66,000 for the comparable quarter of 2003, and were $2.0
million for the six months ended June 30, 2004, and $32,000 for the comparable period of 2003. Amortization of deferred compensation associated with the retention of cash proceeds in respect to the merger were $854,000 for the three months ended
June 30, 2004, and $1.4 million for the six months ended June 30, 2004. Amortization of intangible assets associated with the merger were $1.0 million for the three months ended June 30, 2004, and $1.7 million for the six months ended June 30, 2004.



Interest income, interest expenses and other income, net



Interest income, interest expenses and other income,
net consists of interest income on our cash and cash equivalents, net of interest expense on our obligations under capital leases and other



-18-



---

##### Table of Contents

miscellaneous expenses. Our interest income, interest expenses and other income, net decreased from $183,000 for the
three months ended June 30, 2003, to $115,000 for the comparable quarter of 2004, and from $350,000 for the six months ended June 30, 2003, to $218,000 for the comparable period of 2004. These decrease were primarily attributable to lower balances
of cash and cash equivalent due to the cash payment to Axis stockholders in connection with the merger. As a percent of total revenue, interest income, interest expenses and other income, net decreased from 1.5% for the three months ended June
30, 2003, to 0.8% for the comparable quarter of 2004, and from 1.4% for the six months ended June 30, 2003, to 0.9% for the comparable period of 2004.



Income taxes



We recorded an income tax benefit of $1.8 million in the three months ended June 30, 2004, and an income tax provision of $190,000 for the comparable
quarter of 2003, and income tax benefit of $3.1 million in the six months ended June 30, 2004, and an income tax provision of $352,000 for the comparable period of 2003. The income tax benefit for the three and six months ended June 30, 2004 is
primarily due to a tax benefit from current operating losses in the U.S. offset by income and withholding taxes in other jurisdictions. The provision for income taxes for the three and six months ended June 30, 2003 is primarily due to income taxes
in jurisdictions other than Israel and various withholding taxes.



We have not recognized any benefit from the future use of loss carryforwards outside of the U.S. for these periods or for any other period since inception because of uncertainty surrounding their realization, in accordance with FAS 109. The
amount of net operating losses that we can utilize may be limited under tax regulations in some circumstances, including acquisition activities.



Liquidity and Capital Resources



Since our inception, we have financed our operations primarily through the private sale of convertible preferred shares and the public offering of
ordinary shares. We have also financed our operations through the sale of ordinary shares pursuant to our equity incentive plans, equipment financing and cash generated from the sale of our products and services. As of June 30, 2004, we had cash and
cash equivalents of $53.1 million, retained earnings of $46,000 and working capital of $33.2 million.



We used $40.6 million of our cash balances to complete our acquisition of Axis Systems on February 9, 2004. However, we believe that cash flow from
operations together with our current cash and investment balances will be sufficient to meet our operating requirements for at least the next 12 months, including increased operating expenses and purchases of property and equipment as described
elsewhere in this Form 10-Q.



Net cash used by operating
activities was $1.3 million for the six months ended June 30, 2004, and net cash provided by operating activities was $0.7 million for the comparable period of 2003. Net cash provided, or used, by operating activities for each period resulted
primarily from the net income (loss) and net changes in balance sheet accounts deferred revenues and accounts receivable.



Net cash used in investing activities was $38.0 million for the six months ended June 30, 2004, primarily attributable to the cash used in the acquisition
of Axis, net of the cash acquired. Net cash used in investing activities was $861,000 for the six months ended June 30, 2003, consisted mostly of capital expenditures.



Net cash provided by financing activities was $1.3 million for the six months ended June 30, 2004, and $1.3 million for the
comparable period of 2003. Net cash provided by financing activities for both periods resulted primarily from exercise of share options by employees and the purchase of shares under our equity incentives plans.



-19-



---

##### Table of Contents

We believe that the cash flow from operations together with our current cash and cash equivalents
balances and current credit facilities will be sufficient to meet our operating requirements for at least the next 12 months, including increased operating expenses and purchases of capital equipment.



Although we are not currently in discussions and have no commitments or
agreements with respect to any new acquisitions or investments, it is possible that we may decide to undertake such strategic activities during the next 12 months to an extent that could require additional financial resources. In that case, we may
be required to raise additional financing through public or private financings, strategic relationships or other arrangements. However, we cannot be certain that this funding, if needed, will be available on terms attractive to us, or at all.
Furthermore, any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants.



|Item  3. | Quantitative and Qualitative Disclosure About Market Risk
|-------- | ---------------------------------------------------------



We develop products primarily in Israel, and also in North America, and sell those products primarily in North America, Israel, Europe and Asia. As a
result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. As substantially all of our sales are currently made in United States dollars, a
strengthening of the United States dollar could make our products less competitive in foreign markets.



We incur expenses denominated in local currencies in Israel, Japan and Europe. As exchange rates vary, these expenses, when translated into United States
dollars, may vary from expectations and adversely affect overall profitability.



Our exposure to market risk for changes in interest rates relates primarily to our cash and cash equivalents. We maintain a conservative investment policy, which intends to ensure the safety and preservation of our
invested funds by limiting default risk, market risk and reinvestment risk. Our cash and cash equivalents as of June 30, 2004, consist primarily of short-term U.S. government securities, demand deposits and money market funds held by institutions in
the United States.



Managements intent and current
practice is to invest funds in excess of current operating requirements in:



| |  | U.S. Treasury Securities
| | - | ------------------------



| |  | Federal Agency Securities (GSEs)
| | - | ---------------------------------



| |  | Commercial Paper
| | - | ----------------



| |  | Corporate Notes/Bonds
| | - | ---------------------



| |  | Certificates of Deposit
| | - | -----------------------



| |  | Time Deposits
| | - | -------------



| |  | Municipal Obligations
| | - | ---------------------



| |  | Money-Market Auction Rate Debt
| | - | ------------------------------



| |  | Money-Market Funds
| | - | ------------------



According to our investment policy the obligor must be rated in the rating category as indicated below by at least two of the Nationally Recognized
Statistical Rating Organizations (NRSROs).



|                  |  |       |  |         |  |           
|----------------- |  | ----- |  | ------- |  | ----------
|                  |  | S & P |  | Moodys |  | Fitch IBCA
|Short Term Rating |  | A-1   |  | P-1     |  | F-1       
|Long Term Rating  |  | A     |  | A       |  | A         



-20-



---

##### Table of Contents

These investments, included in our cash and cash equivalents, are exposed to short-term fluctuations in
interest rates. Should interest rates fall, our cash equivalents may produce less income than expected. Our long-term liabilities, largely composed of deferred revenues, are not subject to interest rate risk. Given the liquid nature of our cash and
cash equivalents and the non-exposed nature of our long-term liabilities, we have concluded that we do not have material market risk exposure due to changes in interest rates.



|Item  4. | Controls and Procedures
|-------- | -----------------------



Under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Chief
Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act, as of the end of the period
covered by this report, and, based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective.



PART II. OTHER INFORMATION



|Item  1. | Legal Proceedings
|-------- | -----------------



None.



|Item  2. | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
|-------- | --------------------------------------------------------------------------------



On February 9, 2004, we exchanged 2,901,191 ordinary shares of Verisity in consideration for Axis shares and granted 123,200
restricted shares to certain Axis key employees in connection with Axis acquisition. The Verisity shares which were part of the merger consideration were issued pursuant to Section 3(a)(10) of the Securities Act. We also issued additional 182,198
ordinary shares as a result of the exercise of share option grants and the purchase of ordinary shares pursuant to our equity incentives plans. The aggregate net consideration received by the Company for the issuance of the ordinary share was
$661,000. Certain of the ordinary shares were issued pursuant to compensatory plans registered by registration statements on Form S-8. Other ordinary shares were issued pursuant to compensatory plans of the Company that are compliant with Rule 701
promulgated under the Securities Act and in reliance on the exemption from the registration requirements of the Securities Act provided by such rule.



|Item  3. | Default Upon Senior Securities
|-------- | ------------------------------



None.



|Item  4. | Submission of Matters to A Vote of Security Holders.
|-------- | ----------------------------------------------------



The 2004 Annual General Meeting of Shareholders of Verisity Ltd. was held at our registered office located at 8-10 HaMelacha Street, Rosh
HaAyin, Israel, on May 27, 2004, at 8:00 a.m. Israeli time to conduct the business described in our proxy statement. The proxy statement was filed with the Securities and Exchange Commission on April 29, 2004. This was a regular annual
meeting. The record date for



-21-



---

##### Table of Contents

determining those shareholders who were entitled to notice of, and to attend and vote at, the meeting and at any
adjournment thereof was April 22, 2004.



The proposals voted on
at the meeting, each of which were approved, are summarized below and are more fully described in the proxy statement. A table showing the votes for, against, and abstaining for each proposal follows this list. With respect to the election of
directors, shareholders were permitted to vote for the nominee or to withhold their vote for the nominee. Shareholders could vote for, against, or abstain from voting for each of the other proposals. Votes were cast representing 20,565,857 shares
out of 23,569,749 outstanding shares. This represents 87.3% participation. The shareholders approved the following proposals:



1. To elect Yoav Hollander as our Class III director to hold office for a term that expires in 2007 at the third Annual General Meeting
that follows the upcoming 2004 Annual General Meeting and until his successor shall be elected and qualified;



2. To elect Tali Aben, Douglas Norby and Uzi Sasson as our external directors to hold office for a term that expires in 2007 at the third
Annual General Meeting that follows the upcoming 2004 Annual General Meeting and until each of their successor(s) shall be elected and qualified;



3. To approve the grant of an option to purchase 50,000 ordinary shares to Moshe Gavrielov, our director and Chief Executive Officer,
under the Verisity Ltd. 2000 U.S. Share Incentive Plan, as amended, with an exercise price equal to the fair market value of our ordinary shares as of the close of business on the date of the upcoming 2004 Annual General Meeting;



4. To approve the grant of an option to purchase 30,000
ordinary shares to Yoav Hollander, our director and Chief Technology Officer, under the Verisity Ltd. 2000 Israeli Share Option Plan, as amended, with an exercise price equal to the fair market value of our ordinary shares as of the close of
business on the date of the upcoming 2004 Annual General Meeting;



5. To approve the grant of an option to purchase 20,000 ordinary shares to Michael McNamara, our director and Senior Vice President of Simulation, under the Verisity Ltd. 2000 U.S. Share Incentive Plan, as amended,
with an exercise price equal to the fair market value of our ordinary shares as of the close of business on the date of the upcoming 2004 Annual General Meeting;



6. To approve the 2003 bonuses of our executive officers who also serve as members of our Board of
Directors;



7. To approve the 2004 base
salaries of our executive officers who also serve as members of our Board of Directors;



8. To approve compensation for the non-employee members of our Board of Directors, including external directors;



9. To approve insurance coverage for and indemnification
agreements between Verisity Ltd. and each of our new external directors Douglas Norby and Uzi Sasson;



10. To approve grant of an option to purchase 50,000 ordinary shares under the Verisity Ltd. 2000 U.S. Share Incentive Plan, as amended,
to each of our non-employee directors, including Douglas Fairbairn and Zohar Zisapel plus, if elected, external directors Tali Aben, Douglas Norby and Uzi Sasson;



11. To approve an increase in the number of ordinary shares available for issuance under the Verisity Ltd.
2000 U.S. Share Incentive Plan, as amended, by 825,000 shares and to approve an increase in the number of ordinary shares available for issuance under the Verisity Ltd. 2000 Israeli Share Option Plan, as amended, by 325,000 shares;



-22-



---

##### Table of Contents

12. To approve an increase in the number of ordinary shares available for issuance under
the Verisity Ltd. 2000 Employee Share Purchase Plan, as amended, by 300,000 shares; and



13. To approve the selection of Ernst & Young LLP as our independent auditors with Messrs. Kost Forer Gabbay & Kasierer, a member
of Ernst & Young International, as our Israeli statutory independent auditors for the fiscal year ending December 31, 2004.



|         |  |                     |  |                |  |               |  |                
|-------- |  | ------------------- |  | -------------- |  | ------------- |  | ---------------
|         |  | TABLE OF VOTES CAST |  |               
|Proposal |  | Votes for           |  | Votes withheld |  | Votes against |  | Votes abstained
|1.       |  | 19,742,234          |  | 823,623        |  |               |  |                
|2.       |  | 19,742,234          |  | 823,623        |  |               |  |                
|3.       |  | 9,460,943           |  |                |  | 7,869,156     |  | 18,107         
|4.       |  | 9,477,478           |  |                |  | 7,852,766     |  | 17,962         
|5.       |  | 9,503,187           |  |                |  | 7,827,282     |  | 17,737         
|6.       |  | 19,684,392          |  |                |  | 822,930       |  | 58,535         
|7.       |  | 20,076,888          |  |                |  | 432,994       |  | 55,975         
|8.       |  | 19,792,426          |  |                |  | 717,192       |  | 56,239         
|9.       |  | 14,291,282          |  |                |  | 5,802,338     |  | 472,237        
|10.      |  | 9,190,051           |  |                |  | 8,111,819     |  | 46,336         
|11.      |  | 8,929,683           |  |                |  | 8,011,982     |  | 406,541        
|12.      |  | 16,028,224          |  |                |  | 1,264,058     |  | 55,924         
|13.      |  | 19,540,157          |  |                |  | 648,991       |  | 376,709        



-23-



---

##### Table of Contents

|Item 5. | Other Information
|------- | -----------------



None.



|Item 6. | Exhibits and Reports on Form 8-K
|------- | --------------------------------



| | (a) | See Exhibit Index on Page 27.
| | --- | -----------------------------



| | (b) | Report on Form 8-K filed in the first quarter of 2004.
| | --- | ------------------------------------------------------



On April 2, 2004, we filed a current report on Form 8-K to announce preliminary first quarter results and webcast.



On April 22, 2004, we filed a current report on Form 8-K/A to amend the
current report on Form 8-K that was filed on February 24, 2004, in connection with the acquisition of Axis Systems Inc.



On April 27, 2004, we filed a current report on Form 8-K to disclose the results of operations and financial information for the quarter ended March 31,
2004 and forward-looking statements relating to 2004 and the second quarter of 2004 as presented in a press release of April 26, 2004.



On April 29, 2004, we filed a current report on Form 8-K to disclose the transcript of the conference call relating to the financial results for the
quarter ended March, 31, 2004 that was held on April 26, 2004.



-24-



---

##### Table of Contents

SIGNATURES



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



|      |  |                |  |                            |  |     |  |                                                                                                                                  
|----- |  | -------------- |  | -------------------------- |  | --- |  | ---------------------------------------------------------------------------------------------------------------------------------
|      |  |                |  | VERISITY LTD. (Registrant)
|      |  |                |  |                           
|Date: |  | August 6, 2004 |  |                            |  | By: |  | /s/    Charles G. Alvarez                                                                                                        
|      |  |                |  |                            |  |     |  | Charles G. Alvarez Senior Vice President of Finance
and Administration and Chief Financial Officer (Principal
Accounting Officer)





-25-



---

##### Table of Contents

|         |  |                                                                                                                                                                                              
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number   |  | Description                                                                                                                                                                                  
|2.1(6)   |  | Agreement and Plan of Merger, dated as December 11, 2003 among Verisity Ltd., Atlas Acquisition Corp., Summit Ventures V1-A,L.P. and Axis Systems Inc.                                       
|3.1(1)   |  | Articles of Association, as amended.                                                                                                                                                         
|3.2(1)   |  | Amendment to the Articles of Association                                                                                                                                                     
|3.3(7)   |  | Form of Amended and Restated Articles of Association.                                                                                                                                        
|3.4(1)   |  | Memorandum of Association, as amended.                                                                                                                                                       
|4.1(1)   |  | Form of Share Certificate.                                                                                                                                                                   
|4.3(1)   |  | Warrant to Purchase up to an aggregate of 45,618 Series D Preferred Shares.                                                                                                                  
|10.2(1)  |  | Amended and Restated Loan and Security Agreement by and between Silicon Valley Bank and Verisity Design, Inc., dated as of December 31, 1998.                                                
|10.3(1)  |  | Unconditional Guaranty (Verisity Ltd.) dated as of December 31, 1998.                                                                                                                        
|10.5(1)  |  | Rental Agreement by and between Verisity Design, EURL and IOM Business Center GmbH, dated as of October 1, 1999.                                                                             
|10.6(1)  |  | Rental Agreement by and between Verisity Design, EURL and IOM Business Center GmbH, dated May 8, 2000.                                                                                       
|10.7(1)  |  | License by and between Chancery Court Business Center Ltd. And Verisity Design, EURL, effective as of August 1, 2000.                                                                        
|10.8(1)  |  | Office Services Agreement by and between Verisity Design, EURL and Vantas, effective as of November 1, 1999.                                                                                 
|10.9(1)  |  | Domiciliation Agreement by and between Verisity Design, EURL and BURO Club, dated May 11, 1999.                                                                                            
|10.10    |  | East Evelyn Lease by and between SFERS Real Estate Corp. U, a Delaware corporation and Verisity Design, Inc., dated April 14, 2004.                                                          
|10.12(2) |  | Lease Agreement dated as of November 28, 2000, by and between W9/TIB Real Estate Limited Partnership and Verisity Design, Inc.                                                               
|10.13(1) |  | Office Service Agreement effective as of October 1, 2000 by and between Austin Mopac d/b/a/ Vantos and Verisity Design, Inc.                                                                 
|10.14(1) |  | Office Service Agreement dated as of November 8, 1999 by and between Plano Executive Suite, Inc. d/b/a HQ Plano, Managing Partner and Verisity Design, Inc.                                  
|10.16(1) |  | International Distributor Agreement by and between Verisity Design, Inc. and Cybertec Yugen Kaisha, effective as of January 1, 1999.                                                         
|10.17(1) |  | International Distributor Agreement by and between Verisity Design, Inc. and Davan Tech Company, Ltd., dated as of November 10, 1999.                                                        
|10.18(1) |  | Employment Agreement effective as of October 26, 1999 by and between Verisity Design, Inc. and Michael McNamara.                                                                             
|10.19(1) |  | Employment Agreement effective as of March 23, 1998 by and among Verisity Ltd., Verisity Design, Inc. and Moshe Gavrielov.                                                                   
|10.21(1) |  | Form Software License Agreement.                                                                                                                                                             
|10.24(1) |  | Stock Option Agreement effective as of December 1, 1999 by and between Verisity Ltd. and Moshe Gavrielov.                                                                                    
|10.25    |  | 2000 U.S. Share Incentive Plan, Amended and Restated dated May 27, 2004.                                                                                                                     
|10.26(1) |  | Verisity Ltd. 1999 Israeli Share Option Plan and form of Option Agreement for 1999 Israeli Share Option Plan.                                                                                
|10.27(1) |  | Verisity Ltd. 1999 Share Incentive Plan and form of Option Agreement for 1999 Share Incentive Plan.                                                                                          
|10.28(1) |  | Sub-Plan for the Issuance of Options to the Companys Employees created within the framework of the 1997 Israel Share and Option Incentive Plan and form of Option Agreement for
Sub-Plan.   
|10.29(1) |  | 1997 Israel Share and Stock Option Incentive Plan.                                                                                                                                           
|10.30(1) |  | 1996 U.S. Stock Option Plan, as amended October 1999, form of Option Agreement for 1996 U.S. Stock Option Plan and form of Amended Option Agreement.                                         
|10.31(1) |  | Verisity Ltd. 2000 Employee Share Purchase Plan.                                                                                                                                             
|10.32(1) |  | Amendment to Amended and Restated Investor Rights Agreement dated as of July 21, 1999 by and among Verisity Ltd., Yoav Hollander, Avishai Silvershatz, Moshe Gavrielov and certain
investors.



-26-



---

##### Table of Contents

|         |  |                                                                                                                                                                                                                                                            
|-------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number   |  | Description                                                                                                                                                                                                                                                
|10.33(1) |  | Amended and Restated Investors Rights Agreement dated as of February 26, 1999 by and among Verisity Ltd., Yoav Hollander, Avishai Silvershatz, Moshe Gavrielov and certain
investors.                                                                      
|10.34(1) |  | Technology Exchange Agreement, Addendum to Software License and Volume Purchase Agreement effective as of January 1, 2000 by and between LSI Logic Corporation and Verisity Design,
Inc.                                                                   
|10.35(1) |  | Software License and Volume Purchase Agreement effective as of December 11, 1998 by and between Verisity Design, Inc. and LSI Logic Corporation.                                                                                                           
|10.36(1) |  | Software License Agreement by and between Intel Corporation and Verisity Design, Inc., effective as of January 18, 1999.                                                                                                                                   
|10.37(1) |  | Amendment No. 1 to Software and Related Services Agreement, effective as of May 5, 2000 and Intel Corporation Purchase Agreement, Software and Related Services, by and between Intel
Corporation and Verisity Design, Inc., effective as of June 21, 1999.
|10.38(1) |  | Verisity Ltd. 2000 Israeli Share Option Plan and form of Option Agreement for 2000 Israeli Share Option Plan.                                                                                                                                              
|10.39(1) |  | Verisity Ltd. 2000 Directed Share Plan.                                                                                                                                                                                                                    
|10.40(1) |  | International Representative Agreement between Verisity Design, EURL and Integrated Systems Scandinavia EDA AB, effective as of June 15, 2000.                                                                                                             
|10.41(1) |  | First Amendment to Verisity Ltd. 1999 Israeli Share Option Plan.                                                                                                                                                                                           
|10.42(1) |  | First Amendment to Verisity Ltd. 2000 Employee Share Purchase Plan.                                                                                                                                                                                        
|10.43(2) |  | Sublease Agreement dated as of February 20, 2002, between Lakewood Property Trust, I/O of Austin Inc. and Verisity Design, Inc.                                                                                                                            
|10.44(3) |  | Lease Agreement dated as of October 14, 2002 by and between Luki, Construction and Development Ltd. and Verisity Ltd.                                                                                                                                      
|10.45    |  | Verisity Ltd. 2000 Employee Share Purchase Plan Amended and Restated May 27, 2004.                                                                                                                                                                         
|10.46    |  | Verisity Ltd. 2000 Israeli Share Option Plan, May 2004 amendment.                                                                                                                                                                                          
|21.1(7)  |  | List of subsidiaries.                                                                                                                                                                                                                                      
|31.1     |  | Certification of Chief Executive Officer under Section 302(a) of the Sarbanes-Oxley Act of 2002.                                                                                                                                                           
|31.2     |  | Certification of Chief Financial Officer under Section 302(a) of the Sarbanes-Oxley Act of 2002.                                                                                                                                                           
|32.1     |  | Certification of Chief Executive Officer pursuant to 18.U.S.C. Section 1350 for the current period, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                  
|32.2     |  | Certification of Chief Financial Officer pursuant to 18.U.S.C. Section 1350 for the current period, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                  

---

|(1) | Incorporated by reference from the like-numbered exhibit filed with the Registrants registration statement on Form S-1 (No. 333-45440) filed on September 8, 2000, as
subsequently amended.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference from the like-numbered exhibit filed with the annual report on Form 10-K (No. 000-32417) filed on March 26, 2002.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference from the like-numbered exhibit filed with the annual report on Form 10-K (No. 000-32417) filed on March 21, 2003.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference from the like-numbered exhibit filed with the quarterly report on Form 10-Q (No. 000-32417) filed on May 13, 2003.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference from the like-numbered exhibit filed with the quarterly report on Form 10-Q (No. 000-32417) filed on November 10, 2003.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference from the like-numbered exhibit filed with the current report on Form 8-K (No. 000-32417) filed on December 12, 2003.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Incorporated by reference from the like-numbered exhibit filed with the annual report on Form 10-K (No. 000-32417) filed on March 12, 2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------



-27-