##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, DC 20549




---

Form 10-Q



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|           |  |                                                                                           
|---------- |  | ------------------------------------------------------------------------------------------
|(Mark One)
|          
|þ          |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR
	15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934 
|           |  | For the quarterly period ended August 31,
	2001                                           
|          
|          
|          
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
	15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934
|           |  | For the transition period from
	               to

	               .                      

Commission File Number: 0-26880

Verity, Inc.

(Exact name of registrant as specified in its
charter)


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

894 Ross Drive

Sunnyvale, California 94089


(408) 541-1500


(Address and telephone number of principal
executive offices)


Indicate by check mark whether registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days.     Yes 
þ
          No 
 o

The number of shares outstanding of the
Registrants Common Stock, $0.001 par value, was 35,368,000
as of September 30, 2001.



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TABLE OF CONTENTS



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



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##### Table of Contents



VERITY, INC.

FORM 10-Q

TABLE OF CONTENTS

|                                |  |                                                                                                      |    |      |    | 
|------------------------------- |  | ---------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                                |  |                                                                                                      |    | Page
|                                |  |                                                                                                      |    |     
|                               
|                               
|                               
|                               
|PART I.  FINANCIAL
	INFORMATION
|                               
|Item  1.                        |  | Financial Statements (Unaudited)                                                                     |    |      |    | 
|                               
|                               
|                               
|                               
|                                |  | Condensed Consolidated Balance Sheets as of
	May 31, 2001 and August 31, 2001                        |    |      | 2  | 
|                               
|                               
|                               
|                               
|                                |  | Condensed Consolidated Statements of Operations
	for the Three Months Ended August 31, 2000 and 2001 |    |      | 3  | 
|                               
|                               
|                               
|                               
|                                |  | Condensed Consolidated Statements of Cash Flows
	for the Three Months Ended August 31, 2000 and 2001 |    |      | 4  | 
|                               
|                               
|                               
|                               
|                                |  | Notes to Condensed Consolidated Financial
	Statements                                                |    |      | 5  | 
|                               
|                               
|                               
|                               
|Item  2.                        |  | Managements Discussion and Analysis of
	Financial Condition and Results of Operations               |    |      | 8  | 
|                               
|                               
|                               
|                               
|Item  3.                        |  | Quantitative and Qualitative Disclosures About
	Market Risk                                          |    |      | 21 | 
|                               
|                               
|                               
|                               
|PART II.  OTHER
	INFORMATION   
|                               
|                               
|                               
|                               
|                               
|Item  1.                        |  | Legal Proceedings                                                                                    |    |      | 22 | 
|                               
|                               
|                               
|                               
|Item  2.                        |  | Changes in Securities and Use of Proceeds                                                            |    |      | 23 | 
|                               
|                               
|                               
|                               
|Item  3.                        |  | Defaults upon Senior Securities                                                                      |    |      | 23 | 
|                               
|                               
|                               
|                               
|Item  4.                        |  | Submission of Matters to a Vote of Security
	Holders                                                 |    |      | 23 | 
|                               
|                               
|                               
|                               
|Item  5.                        |  | Other Information                                                                                    |    |      | 23 | 
|                               
|                               
|                               
|                               
|Item  6.                        |  | Exhibits and Reports on Form 8-K                                                                     |    |      | 23 | 
|                               
|                               
|                               
|                               
|Signature                       |  |                                                                                                      | 24 |     

1



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##### Table of Contents






PART I.     FINANCIAL
INFORMATION




Item 1.     Financial Statements

VERITY, INC.






CONDENSED CONSOLIDATED BALANCE
SHEETS


(In thousands, except per share
data)


|                                   |                                                                                                                           |                                            |         |         |         |  |         |         |         | 
|---------------------------------- | ------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | ------- |  | ------- | ------- | ------- | 
|                                   |                                                                                                                           | August 31,                                 |         | May 31,
|                                   |                                                                                                                           | 2001                                       |         | 2001   
|                                   |                                                                                                                           |                                            |         |        
|                                   |                                                                                                                           |                                           
|                                   |                                                                                                                           | (Unaudited)                               
|                                  
|                                  
|                                  
|                                  
|ASSETS                            
|                                  
|                                  
|                                  
|                                  
|Current assets:                    |                                                                                                                           |                                            |         |         |         |  |         |        
|                                  
|                                  
|                                  
|                                  
|                                   | Cash and cash equivalents                                                                                                 |                                            | $       | 14,401  |         |  | $       | 12,210  |        
|                                  
|                                  
|                                  
|                                  
|                                   | Short-term investments                                                                                                    |                                            |         | 107,313 |         |  |         | 126,687 |        
|                                  
|                                  
|                                  
|                                  
|                                   | Trade accounts receivable, net                                                                                            |                                            |         | 23,161  |         |  |         | 37,741  |        
|                                  
|                                  
|                                  
|                                  
|                                   | Deferred tax assets                                                                                                       |                                            |         | 21,633  |         |  |         | 20,121  |        
|                                  
|                                  
|                                  
|                                  
|                                   | Prepaid and other                                                                                                         |                                            |         | 7,076   |         |  |         | 6,788   |        
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   |                                                                                                                           | Total current assets                       |         |         | 173,584 |  |         |         | 203,547 | 
|                                  
|                                  
|                                  
|                                  
|Property and equipment, net        |                                                                                                                           |                                            | 8,652   |         |         |  | 7,804   |        
|                                  
|                                  
|                                  
|                                  
|Long-term investments              |                                                                                                                           |                                            | 116,186 |         |         |  | 92,248  |        
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   |                                                                                                                           | Total assets                               |         | $       | 298,422 |  |         | $       | 303,599 | 
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        
|Current liabilities:               |                                                                                                                           |                                            |         |         |         |  |         |        
|                                  
|                                  
|                                  
|                                  
|                                   | Accounts payable                                                                                                          |                                            | $       | 7,585   |         |  | $       | 6,790   |        
|                                  
|                                  
|                                  
|                                  
|                                   | Accrued compensation                                                                                                      |                                            |         | 7,690   |         |  |         | 11,799  |        
|                                  
|                                  
|                                  
|                                  
|                                   | Other accrued liabilities                                                                                                 |                                            |         | 2,866   |         |  |         | 3,793   |        
|                                  
|                                  
|                                  
|                                  
|                                   | Deferred revenue                                                                                                          |                                            |         | 14,087  |         |  |         | 17,073  |        
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   |                                                                                                                           | Total current liabilities                  |         |         | 32,228  |  |         |         | 39,455  | 
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   | Commitments and contingencies (Note 6)                                                                                    |                                            |         |         |         |  |         |         |        
|                                  
|                                  
|                                  
|                                  
|Stockholders equity:              |                                                                                                                           |                                            |         |         |         |  |         |        
|                                  
|                                  
|                                  
|                                  
|Preferred stock, $0.001 par value: |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   | Authorized: 2,000,000 shares
        Issued and outstanding: none                                                         |                                            |         |         |         |  |         |         |        
|                                  
|                                  
|                                  
|                                  
|Common stock, $0.001 par value:    |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   | Authorized: 200,000,000 shares                                                                                            |                                            |         |         |         |  |         |         |        
|                                  
|                                  
|                                  
|                                  
|                                   | Issued and outstanding: 35,158,000 shares as of
        May 31, 2001 and
        35,562,000 shares as of August 31, 2001. |                                            |         | 36      |         |  |         | 35      |        
|                                  
|                                  
|                                  
|                                  
|Additional paid-in capital         |                                                                                                                           |                                            | 256,538 |         |         |  | 252,733 |        
|                                  
|                                  
|                                  
|                                  
|Other comprehensive income         |                                                                                                                           |                                            | 1,362   |         |         |  | 652     |        
|                                  
|                                  
|                                  
|                                  
|Retained earnings                  |                                                                                                                           |                                            | 8,258   |         |         |  | 10,724  |        
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   |                                                                                                                           | Total stockholders equity                 |         |         | 266,194 |  |         |         | 264,144 | 
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        
|                                   |                                                                                                                           | Total liabilities and stockholders equity |         | $       | 298,422 |  |         | $       | 303,599 | 
|                                   |                                                                                                                           |                                            |         |         |         |  |         |        

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

2



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##### Table of Contents



VERITY, INC.






CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


(In thousands, except per share
data)


|                                                 |                            |                          |        |        |        |   |        |        |        | 
|------------------------------------------------ | -------------------------- | ------------------------ | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                 |                            |                         
|                                                 |                            | Three Months Ended      
|                                                 |                            | August 31,              
|                                                 |                            |                         
|                                                 |                            | 2001                     |        | 2000  
|                                                 |                            |                          |        |       
|                                                 |                            |                         
|                                                 |                            | (Unaudited)             
|                                                
|                                                
|                                                
|                                                
|Revenues:                                        |                            |                          |        |        |        |   |        |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Software products          |                          | $      | 10,267 |        |   | $      | 22,798 |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Service and other          |                          |        | 9,838  |        |   |        | 8,492  |       
|                                                 |                            |                          |        |        |        |   |        |       
|                                                 |                            | Total revenues           |        |        | 20,105 |   |        |        | 31,290 | 
|                                                 |                            |                          |        |        |        |   |        |       
|Costs of revenues:                               |                            |                          |        |        |        |   |        |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Software products          |                          |        | 542    |        |   |        | 347    |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Service and other          |                          |        | 3,046  |        |   |        | 2,558  |       
|                                                 |                            |                          |        |        |        |   |        |       
|                                                 |                            | Total costs of revenues  |        |        | 3,588  |   |        |        | 2,905  | 
|                                                 |                            |                          |        |        |        |   |        |       
|Gross profit                                     |                            |                          | 16,517 |        |        |   | 28,385 |       
|                                                 |                            |                          |        |        |        |   |        |       
|Operating expenses:                              |                            |                          |        |        |        |   |        |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Research and development   |                          |        | 5,936  |        |   |        | 4,585  |       
|                                                
|                                                
|                                                
|                                                
|                                                 | Marketing and sales        |                          |        | 14,598 |        |   |        | 12,024 |       
|                                                
|                                                
|                                                
|                                                
|                                                 | General and administrative |                          |        | 2,832  |        |   |        | 2,170  |       
|                                                 |                            |                          |        |        |        |   |        |       
|                                                 |                            | Total operating expenses |        |        | 23,366 |   |        |        | 18,779 | 
|                                                 |                            |                          |        |        |        |   |        |       
|Income (loss) from operations                    |                            |                          | (6,849 | )      |        |   | 9,606  |       
|                                                
|                                                
|                                                
|                                                
|Other income, net                                |                            |                          | 2,870  |        |        |   | 2,271  |       
|                                                 |                            |                          |        |        |        |   |        |       
|Income (loss) before provision for income
	taxes |                            |                          | (3,979 | )      |        |   | 11,877 |       
|                                                
|                                                
|                                                
|                                                
|Provision for (benefit from) income taxes        |                            |                          | (1,512 | )      |        |   | 4,632  |       
|                                                 |                            |                          |        |        |        |   |        |       
|Net income (loss)                                |                            | $                        | (2,467 | )      |        | $ | 7,245  |       
|                                                 |                            |                          |        |        |        |   |        |       
|Net income (loss) per
	share  basic             |                            | $                        | (0.07  | )      |        | $ | 0.22   |       
|                                                 |                            |                          |        |        |        |   |        |       
|Net income (loss) per share 
	diluted           |                            | $                        | (0.07  | )      |        | $ | 0.20   |       
|                                                 |                            |                          |        |        |        |   |        |       
|Number of shares  basic                         |                            |                          | 35,362 |        |        |   | 32,369 |       
|                                                 |                            |                          |        |        |        |   |        |       
|Number of shares  diluted                       |                            |                          | 35,362 |        |        |   | 36,916 |       
|                                                 |                            |                          |        |        |        |   |        |       

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

3



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##### Table of Contents



VERITY, INC.






CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS


(In thousands)


|                                                                                   |                                                    |                                                       |        |          |        |   |       |          |         |  
|---------------------------------------------------------------------------------- | -------------------------------------------------- | ----------------------------------------------------- | ------ | -------- | ------ | - | ----- | -------- | ------- | -
|                                                                                   |                                                    |                                                      
|                                                                                   |                                                    | Three Months Ended                                   
|                                                                                   |                                                    | August 31,                                           
|                                                                                   |                                                    |                                                      
|                                                                                   |                                                    | 2001                                                  |        | 2000    
|                                                                                   |                                                    |                                                       |        |         
|                                                                                   |                                                    |                                                      
|                                                                                   |                                                    | (Unaudited)                                          
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Cash flows from operating
	activities:                                             |                                                    |                                                       |        |          |        |   |       |         
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Net income (loss)                                  |                                                       | $      | (2,467   | )      |   | $     | 7,245    |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Adjustments to reconcile net income to net
	cash provided by operating activities: |                                                    |                                                       |        |          |        |   |       |         
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Depreciation and amortization                      |                                                       |        | 1,129    |        |   |       | 625      |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Deferred income taxes                              |                                                       |        |         |        |   |       | 4,321    |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Provision for (recovery of) doubtful accounts      |                                                       |        | (123     | )      |   |       | 6        |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Amortization of discount on securities             |                                                       |        | (100     | )      |   |       | (305     | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Changes in operating assets and
	liabilities:                                      |                                                    |                                                       |        |          |        |   |       |         
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Trade accounts receivable                          |                                                       |        | 15,167   |        |   |       | (2,558   | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Prepaid and other current assets                   |                                                       |        | (1,531   | )      |   |       | (1,296   | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Accounts payable                                   |                                                       |        | 730      |        |   |       | 595      |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Accrued compensation and other accrued liabilities |                                                       |        | (5,197   | )      |   |       | 223      |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Deferred revenue                                   |                                                       |        | (3,022   | )      |   |       | 513      |        
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|                                                                                   |                                                    | Net cash provided by operating activities             |        |          | 4,586  |   |       |          | 9,369   |  
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|Cash flows from investing
	activities:                                             |                                                    |                                                       |        |          |        |   |       |         
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Acquisition of property and equipment              |                                                       |        | (1,981   | )      |   |       | (610     | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Purchases of marketable securities                 |                                                       |        | (148,433 | )      |   |       | (119,468 | )      
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Maturity of marketable securities                  |                                                       |        | 78,651   |        |   |       | 39,900   |        
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Proceeds from sale of marketable securities        |                                                       |        | 65,828   |        |   |       | 57,483   |        
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|                                                                                   |                                                    | Net cash used in investing activities                 |        |          | (5,935 | ) |       |          | (22,695 | )
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|Cash flows from financing
	activities:                                             |                                                    |                                                       |        |          |        |   |       |         
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Proceeds from the sale of common stock, net        |                                                       |        | 3,817    |        |   |       | 12,240   |        
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|                                                                                   |                                                    | Net cash provided by financing activities             |        |          | 3,817  |   |       |          | 12,240  |  
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|Effect of exchange rate changes on cash                                            |                                                    |                                                       | (277   | )        |        |   | (4    | )       
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|                                                                                   |                                                    | Net increase (decrease) in cash and cash
	equivalents |        |          | 2,191  |   |       |          | (1,090  | )
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Cash and cash equivalents, beginning of period                                     |                                                    |                                                       | 12,210 |          |        |   | 7,183 |         
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         
|Cash and cash equivalents, end of period                                           |                                                    | $                                                     | 14,401 |          |        | $ | 6,093 |         
|                                                                                   |                                                    |                                                       |        |          |        |   |       |         

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

4



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##### Table of Contents



VERITY, INC.






NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS


(Information as of August 31, 2001 and
for the three months ended


August 31, 2000 and 2001 and thereafter
is unaudited)


1.     Interim
Financial Data (Unaudited)

The unaudited condensed consolidated financial
statements for Verity, Inc. (the Company or
Verity) as of August 31, 2001 and for the
quarters ended August 31, 2000 and 2001 have been prepared
on the same basis as the audited financial statements and, in
the opinion of management, include all material adjustments,
consisting of normal recurring adjustments, necessary for a fair
presentation of the financial position and results of operations
in accordance with generally accepted accounting principles.
Although certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been omitted
pursuant to the rules and regulations of the Securities and
Exchange Commission, the Company believes the disclosures made
are adequate to make the information presented not misleading.
The accompanying financial statements should be read in
conjunction with the Companys annual financial statements
contained in the Companys Annual Report on Form 10-K
for the year ended May 31, 2001.

The Companys balance sheet as of
May 31, 2001 was derived from the Companys audited
financial statements, but does not include all disclosures
necessary for the presentation to be in accordance with
generally accepted accounting principles.

2.     Computation of
Net Income (Loss) and Earnings Per Share

Basic earnings per share are computed using the
weighted average number of common shares outstanding during the
period. Diluted earnings per share are computed using the
weighted average number of common and common equivalent shares
outstanding during the period. Dilutive common equivalent shares
consist of stock options. All common equivalent shares have been
excluded from the computation of diluted net loss per share for
the three months ended August 31, 2001 because the effect
would be anti-dilutive.

Basic and diluted net income (loss) per
share are calculated as follows for the three months ended
August 31, 2000 and 2001 (in thousands, except per share
data):

|         |                                             |                    |   |        |   |  |   |        | 
|-------- | ------------------------------------------- | ------------------ | - | ------ | - |  | - | ------ | 
|         |                                             |                   
|         |                                             | Three Months Ended
|         |                                             | August 31,        
|         |                                             |                   
|         |                                             | 2001               |   | 2000  
|         |                                             |                    |   |       
|Basic:   |                                             |                    |   |        |   |  |   |       
|        
|        
|        
|        
|         | Weighted-average shares                     |                    |   | 35,362 |   |  |   | 32,369 | 
|         |                                             |                    |   |        |   |  |   |       
|         | Net income (loss)                           |                    | $ | (2,467 | ) |  | $ | 7,245  | 
|         |                                             |                    |   |        |   |  |   |       
|         | Net income (loss) per share                 |                    | $ | (0.07  | ) |  | $ | 0.22   | 
|         |                                             |                    |   |        |   |  |   |       
|Diluted: |                                             |                    |   |        |   |  |   |       
|        
|        
|        
|        
|         | Weighted-average shares                     |                    |   | 35,362 |   |  |   | 32,369 | 
|        
|        
|        
|        
|         | Common equivalent shares from stock options |                    |   |       |   |  |   | 4,547  | 
|         |                                             |                    |   |        |   |  |   |       
|         | Shares used in per share calculation        |                    |   | 35,362 |   |  |   | 36,916 | 
|         |                                             |                    |   |        |   |  |   |       
|         | Net income (loss)                           |                    | $ | (2,467 | ) |  | $ | 7,245  | 
|         |                                             |                    |   |        |   |  |   |       
|         | Net income (loss) per share                 |                    | $ | (0.07  | ) |  | $ | 0.20   | 
|         |                                             |                    |   |        |   |  |   |       

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##### Table of Contents



VERITY, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

3.     Comprehensive
Income

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

4.     Business
Segment

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

|                   |              |                    |   |        |  |  |   |        | 
|------------------ | ------------ | ------------------ | - | ------ |  |  | - | ------ | 
|                   |              |                   
|                   |              | Three Months Ended
|                   |              | August 31,        
|                   |              |                   
|                   |              | 2001               |   | 2000  
|                   |              |                    |   |       
|Revenues:          |              |                    |   |        |  |  |   |       
|                  
|                  
|                  
|                  
|                   | USA          |                    | $ | 17,181 |  |  | $ | 29,459 | 
|                  
|                  
|                  
|                  
|                   | Europe       |                    |   | 2,733  |  |  |   | 1,831  | 
|                  
|                  
|                  
|                  
|                   | ROW          |                    |   | 191    |  |  |   |       | 
|                   |              |                    |   |        |  |  |   |       
|                   | Consolidated |                    | $ | 20,105 |  |  | $ | 31,290 | 
|                   |              |                    |   |        |  |  |   |       
|Long-lived assets: |              |                    |   |        |  |  |   |       
|                  
|                  
|                  
|                  
|                   | USA          |                    | $ | 6,115  |  |  | $ | 3,930  | 
|                  
|                  
|                  
|                  
|                   | Europe       |                    |   | 968    |  |  |   | 546    | 
|                  
|                  
|                  
|                  
|                   | ROW          |                    |   | 1,569  |  |  |   | 462    | 
|                   |              |                    |   |        |  |  |   |       
|                   | Consolidated |                    | $ | 8,652  |  |  | $ | 4,938  | 
|                   |              |                    |   |        |  |  |   |       

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

No single customer accounted for more than 10% of
the Companys revenues for the three months ended
August 31, 2000 and 2001. Revenues derived from sales to
the federal government and its agencies were 6.5% and 6.4% of
the Companys total revenues for the three months ended
August 31, 2000 and 2001, respectively.

5.     Recent
Accounting Pronouncements

SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, as amended by SFAS 137,
Accounting for Derivative Instruments and Hedging
Activities  Deferral of the Effective Date of FASB
Statement No. 133, and SFAS 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities,
became effective for the Company as of June 1, 2001.
SFAS 133 requires that an entity recognize all derivatives
as either assets or liabilities measured at fair value. The
accounting for changes in the fair value of a derivative depends
on the use of the derivative. The adoption of this statement did
not have a material impact on our statement of operations.

6.     Commitments
and Contingencies

In December 1999, a number of complaints were
filed in the United States District Court for Northern District
of California seeking an unspecified amount of damages on behalf
of an alleged class of persons who purchased shares of our
common stock during the period between December 1 and
December 14, 1999. The

6



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##### Table of Contents



VERITY, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

complaints name as defendants Verity and certain
of its directors and officers, asserting that they violated
federal securities laws by misrepresenting Veritys
business and earnings growth, ability to continue to achieve
profitable growth, and failing to disclose certain information
about our business. The complaints were consolidated into a
single action, and in August 2000, the complaint was dismissed
without prejudice with leave to amend. The plaintiffs re-filed
an amended complaint, and Verity filed a motion to dismiss this
amended complaint on October 27, 2000. By order dated
February 13, 2001, the court granted the motion in part and
denied it in part. The court dismissed with prejudice all claims
except a single claim relating to alleged communications with a
securities analyst near the end of Veritys second fiscal
2000 quarter. The court restricted pretrial discovery to the
single remaining claim. On July 24, 2001, council for
plaintiffs agreed to voluntarily dismiss the action with
prejudice, and without an award of costs or fees to any party.
The court ordered the case dismissed on July 27, 2001.

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

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

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

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

The action is currently in the early stages and
no formal discovery has yet been conducted. A case management
conference has been set for October 9, 2001 at which time
the Court will likely enter a scheduling order and set a trial
date.

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

7



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##### Table of Contents






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

The following discussion should be read in
conjunction with the consolidated financial statements and
related notes, which appear in our Annual Report on
Form 10-K for the fiscal year ended May 31, 2001. The
following discussion contains forward-looking statements that
involve risks and uncertainties. Our actual results could differ
materially from those anticipated in these forward-looking
statements as a result of certain factors, including those
discussed below and elsewhere in this Quarterly Report on
Form 10-Q, particularly under the heading
 Risk Factors below.

Overview

From 1988 to 1994, we derived substantially all
of our revenues from the license of custom search and retrieval
applications and consulting and other services related to such
applications. In 1995, we began refining and enhancing our core
technology to add functionality and facilitate incorporation of
our technology in a variety of markets. We now offer solutions
and technology that address the business portal market. The
business portal market includes corporate portals used for
sharing information within an enterprise, e-commerce portals for
online selling and market exchange portals for
business-to-business activities. Business portals provide
personalized information to employees, partners, customers and
suppliers. We expect that for the foreseeable future we will
continue to derive the largest portion of our revenues from
licensing our technology for enterprise applications and
business portal solutions.

During fiscal 1997 and early fiscal 1998, we
incurred substantial net losses and our quarterly revenues
fluctuated significantly. In particular, we incurred reduced
revenues on a quarter-to-quarter basis in the first quarter of
fiscal 1997, the third quarter of fiscal 1997 and the first
quarter of fiscal 1998. In this period, we experienced
significant turnover in our workforce, including turnover of
several members of senior management. Under these circumstances,
on July 31, 1997 we retained Mr. Gary J. Sbona as
our president and chief executive officer, and we entered into
an agreement with Regent Pacific Management Corporation, a
management firm of which Mr. Sbona is the chairman and
chief executive officer. Pursuant to this agreement, Regent
Pacific has provided management services for Verity, including
the services of Mr. Sbona as chief executive officer and
other Regent Pacific personnel as part of our management team.

Our restructuring and renewed focus, during
fiscal 1998, contributed to significantly improved results
during the second half of fiscal 1998 and during fiscal years
1999, 2000 and 2001. During the quarterly periods ended
August 31, 1997 to August 31, 1999 and
February 29, 2000 to May 31, 2001, we experienced
increased revenues on a quarterly basis. In addition, during the
thirteen consecutive quarterly periods ended May 31, 2001,
we experienced twelve quarters of record revenues. Due to a
delay in closing three large transactions, revenues for the
quarter ended November 30, 1999 were lower than expected.
While our goal is to increase revenue and generate net income in
future periods, we cannot assure you that our strategy will be
successful, that we will experience the rate of revenue growth
we experienced from August 31, 1997 to May 31, 2001 in
future periods, or that we will continue to maintain positive
cash flow or profitability.

There has been a general downturn in the economy,
which increased during the first quarter of fiscal 2002. This
has caused an increasing number of prospective customers to
cancel, delay or downsize capital spending related business
projects, due to budgetary and worldwide economic pressures
within their businesses. This downturn has negatively impacted
our results for fiscal 2002 revenues. As a result, on
August 9, 2002 we publicly announced that we expected to
report a net loss for the first quarter of fiscal 2002, which
was in fact reported. We are undertaking cost-cutting measures
we deem prudent in this economic environment but expect that
this downturn will continue to have an impact on our financial
results.

Our revenues are derived from license fees for
our software products and fees for services complementary to our
products, including software maintenance, consulting and
training. Fees for services generally are charged separately
from the license fees for our software products. Effective for
contracts entered into starting June 1, 1998, we recognize
revenues in accordance with the provisions of American Institute
of Certified Public Accountants Statement of Position
No. 97-2, Software Revenue Recognition. In
December 1998, AcSEC released provisions of SOP 98-9 that
extend the deferral of certain paragraphs of SOP 97-2.
These paragraphs of SOP 97-2 and SOP 98-9 became
effective for transactions that are entered into fiscal years

8



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##### Table of Contents



beginning after March 15, 1999. We recognize
maintenance revenues from ongoing customer support and product
upgrades ratably over the term of the applicable maintenance
agreement, which is typically twelve months. Generally, we
receive payments for maintenance fees in advance and they are
nonrefundable. We recognize revenues for consulting and training
generally when the services are performed.


For agreements with multiple elements, such as
license, maintenance, training and consulting services, we
allocate revenue to all undelivered elements, usually
maintenance and other services, based on objective evidence of
its fair value, which is specific to us. Any remaining amount is
allocated to the delivered elements and recognized as revenue
when the conditions set forth above are met. We recognize
revenue allocated to maintenance fees for ongoing customer
support and product updates ratably over the period of the
maintenance contract, which is typically twelve months. Payments
for maintenance fees are generally made in advance and are
non-refundable. For revenue allocated to training and consulting
services, we recognize revenue as the related services are
performed.

Results of Operations

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

|                                                 |                            |                          |       |      |       |  |      |      |       | 
|------------------------------------------------ | -------------------------- | ------------------------ | ----- | ---- | ----- |  | ---- | ---- | ----- | 
|                                                 |                            |                         
|                                                 |                            | Three Months Ended      
|                                                 |                            | August 31,              
|                                                 |                            |                         
|                                                 |                            | 2001                     |       | 2000
|                                                 |                            |                          |       |     
|                                                 |                            |                         
|                                                 |                            | (Unaudited)             
|                                                
|                                                
|                                                
|                                                
|Revenues:                                        |                            |                          |       |      |       |  |      |     
|                                                
|                                                
|                                                
|                                                
|                                                 | Software products          |                          |       | 51.1 | %     |  |      | 72.9 | %    
|                                                
|                                                
|                                                
|                                                
|                                                 | Service and other          |                          |       | 48.9 |       |  |      | 27.1 |      
|                                                 |                            |                          |       |      |       |  |      |     
|                                                 |                            | Total revenues           |       |      | 100.0 |  |      |      | 100.0 | 
|                                                 |                            |                          |       |      |       |  |      |     
|Costs of revenues:                               |                            |                          |       |      |       |  |      |     
|                                                
|                                                
|                                                
|                                                
|                                                 | Software products          |                          |       | 2.7  |       |  |      | 1.1  |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Service and other          |                          |       | 15.1 |       |  |      | 8.2  |      
|                                                 |                            |                          |       |      |       |  |      |     
|                                                 |                            | Total costs of revenues  |       |      | 17.8  |  |      |      | 9.3   | 
|                                                 |                            |                          |       |      |       |  |      |     
|Gross profit                                     |                            |                          | 82.2  |      |       |  | 90.7 |     
|                                                 |                            |                          |       |      |       |  |      |     
|Operating expenses:                              |                            |                          |       |      |       |  |      |     
|                                                
|                                                
|                                                
|                                                
|                                                 | Research and development   |                          |       | 29.5 |       |  |      | 14.7 |      
|                                                
|                                                
|                                                
|                                                
|                                                 | Marketing and sales        |                          |       | 72.6 |       |  |      | 38.4 |      
|                                                
|                                                
|                                                
|                                                
|                                                 | General and administrative |                          |       | 14.1 |       |  |      | 6.9  |      
|                                                 |                            |                          |       |      |       |  |      |     
|                                                 |                            | Total operating expenses |       |      | 116.2 |  |      |      | 60.0  | 
|                                                 |                            |                          |       |      |       |  |      |     
|Income (loss) from operations                    |                            |                          | (34.0 | )    |       |  | 30.7 |     
|                                                
|                                                
|                                                
|                                                
|Other income, net                                |                            |                          | 14.2  |      |       |  | 7.3  |     
|                                                 |                            |                          |       |      |       |  |      |     
|Income (loss) before provision for income
	taxes |                            |                          | (19.8 | )    |       |  | 38.0 |     
|                                                
|                                                
|                                                
|                                                
|Provision for (benefit from) income taxes        |                            |                          | (7.5  | )    |       |  | 14.8 |     
|                                                 |                            |                          |       |      |       |  |      |     
|Net income (loss)                                |                            |                          | (12.3 | )%   |       |  | 23.2 | %   
|                                                 |                            |                          |       |      |       |  |      |     



| |         
| | --------
| | Revenues

Our total revenues decreased 35.7% from
$31.3 million for the three months ended August 31,
2000, to $20.1 million for the three months ended
August 31, 2001. The decrease for the three-month period
ended August 31, 2001 was attributable to the impact of the
slowdown in worldwide economic conditions resulting in customers
canceling, delaying and downsizing capital spending, partly
offset by increased service and other revenue derived from our
installed base.

9



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##### Table of Contents



Software product revenues.Software product revenues decreased
55.0% from $22.8 million for the three months ended
August 31, 2000 to $10.3 million for the three months
ended August 31, 2001. The decrease for the three months
ended August 31, 2001 in comparison to the same period in
fiscal 2000 was primarily a result of the decline in the economy
and uncertainty surrounding information technology capital
spending.

Service and other revenues.Our service and other revenues consist
primarily of fees for software, maintenance, consulting and
training. Service and other revenues increased 15.9% from
$8.5 million for the three months ended August 31,
2000 to $9.8 million for the three months ended
August 31, 2001. The increase in service and other revenues
for the comparable periods was primarily due to an increase in
maintenance revenue resulting from the renewal of existing
maintenance contracts from prior period software revenue
arrangements and increased consulting revenue due to growth of
customer base.

Service and other revenues from foreign
operations accounted for 6.0% and 16.2% of total revenues for
three months ended August 31, 2000 and 2001, respectively.
Our export sales consist primarily of products licensed for
delivery outside of the United States. For the three months
ended August 31, 2000 and 2001, export sales accounted for
21.1% and 21.6% of total revenues, respectively. We expect that
revenues derived from foreign operations and export sales will
continue to vary in future periods as a percentage of total
revenues.

No single customer accounted for more than 10% of
our revenues for the three months ended August 31, 2000 and
2001. Revenues derived from sales to the federal government and
its agencies were 6.5% and 6.4% of our total revenues for the
three months ended August 31, 2000 and 2001, respectively.
We expect that revenues from such government sales will continue
to vary in future periods as a percentage of revenues.



| |                  
| | -----------------
| | Costs of Revenues

Costs of software products.The cost of our software products
consists primarily of product media, duplication, manuals,
packaging materials, shipping expenses and royalties, and in
certain instances, licensing of third-party software
incorporated in our products. Costs of software products
increased 56.2% from $347,000 for the three months ended
August 31, 2000 to $542,000 for the same comparable period
in fiscal 2002, representing 1.5% and 5.3%, respectively, of the
software product revenues. The increase in absolute dollars and
as a percentage of software product revenues was primarily
attributable to increasing costs of third party software
components. We are currently re-negotiating third party software
contracts. We cannot assure you that such re-negotiations will
be executed in a timely and successful manner, which can have a
material adverse effect on our business, results of operations
and financial condition. In addition, during fiscal 2001 and
2002, we did not capitalize any software development costs since
such costs were not material.

Costs of service and other.Our costs of service and other
revenues consist of costs incurred in providing consulting
services, customer training, telephone support and product
upgrades to customers. Costs of service and other revenues
increased 19.1% from $2.6 million for the three months
ended August 31, 2000 to $3.0 million for the same
comparable period in fiscal 2002, representing 30.1% and 31.0%,
respectively, of service and other revenues during these
periods. The increase in absolute dollars and as a percentage of
service and other revenues during the three months ended
August 31, 2001 as compared to the same period in fiscal
2001 was due to an increase in the staffing of our professional
services organization.



| |                   
| | ------------------
| | Operating Expenses

Research and development.Research and development expenses
increased 29.5% from $4.6 million for the three months
ended August 31, 2000 to $5.9 million for the three
months ended August 31, 2001, representing 14.7% and 29.5%,
respectively, of total revenues for these periods. The increase
in absolute dollars for the three-month period ended
August 31, 2001 was primarily due to an increase in
research and development personnel and outside consulting
services to focus on enhancement of existing products and
development of new products addressing the business portal
market. The increase in research and development expenses as a
percentage of total revenues for the three-month period ended
August 31, 2001, was primarily due to a decrease in
revenues for the quarter, further influenced by an increase in
research and development expenses in absolute dollars. We
believe that research and development expenses may increase in

10



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##### Table of Contents



the future primarily due to the introduction of
new products and other anticipated product development efforts.
Our future research and development expenses may continue to
vary as a percentage of total revenues.


Marketing and sales.Marketing and sales expenses increased
21.4% from $12.0 million for the three months ended
August 31, 2000, to $14.6 million for the three months
ended August 31, 2001, representing 38.4% and 72.6%,
respectively, of total revenues during these periods. The
increase in absolute dollars for the three-month period ended
August 31, 2001, was primarily related to the continued
development of our sales distribution channels in the United
States and Europe. The increase in marketing and sales expenses
as a percentage of total revenues for the three-month period
ended August 31, 2001, was primarily due to a decrease in
revenues for the quarter, further influenced by an increase in
marketing and sales expenses in absolute dollars. We anticipate
that we will continue to make a strong investment in marketing
and sales.

General and administrative.General and administrative expenses
increased 30.5% from $2.2 million in the three months ended
August 31, 2000, to $2.8 million for the three months
ended August 31, 2001, representing 6.9% and 14.1%,
respectively, of total revenues. The increase in absolute
dollars for the three months ended August 31, 2001 was
generally related to the increased costs in professional
services rendered for legal matters and various tax studies. The
increase in general and administrative expenses as a percentage
of total revenues for the three-month period ended
August 31, 2001, was primarily due to a decrease in
revenues for the quarter, further influenced by an increase in
general and administrative expenses in absolute dollars.

Income Taxes

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

Prior to the quarter ended May 31, 2000, we
established a valuation allowance against our deferred tax
assets due to the uncertainty surrounding the realization of
such assets. On a regular basis we assess the realizability of
net deferred tax assets and at May 31, 2000, we assessed
that the realizability of the deferred tax assets was more
likely than not and the entire valuation allowance of
$18.9 million was reversed.

During the quarter ended August 31, 2001, we
assessed the qualification of our research and development
expenses for state and federal research and development tax
credits. We expect the tax savings for fiscal 2002 due to
research and development tax credits to result in a marginally
lower effective tax rate and accordingly applied an effective
tax rate of 38.0% to the result of our quarter ended
August 31, 2001. We will continually reassess the impact of
our research and development expenses on our effective tax rate
in future periods.

Liquidity and Capital Resources

As of August 31, 2001, we had
$237.9 million in cash and cash equivalents and
available-for-sale securities compared to $231.1 million at
May 31, 2001.

Our operating activities provided cash of
$9.4 million and $4.6 million for the three months
ended August 31, 2000 and 2001, respectively. Cash provided
in connection with operating activities for the three months
ended August 31, 2000 was primarily due to our net income,
and an increase in liabilities offset in part by an increase in
accounts receivable and other current assets. Cash provided by
operating activities in the three months ended August 31,
2001 was primarily due to a decrease in accounts receivable,
partially offset by our net loss and a decrease in accrued
compensation and deferred revenue.

Our investing activities used cash of
$22.7 million and $5.9 million for the three months
ended August 31, 2000 and August 31, 2001,
respectively. For the three months ended August 31, 2000
and 2001, cash used by investing activities consisted primarily
of purchases of marketable securities and capital expenditures,
partially offset by proceeds from the sale and maturity of
marketable securities.

11



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##### Table of Contents



Cash provided by financing activities was
$12.2 million and $3.8 million for the three months
ended August 31, 2000 and 2001, respectively. Cash provided
by financing activities for the three months ended
August 31, 2000 and 2001 was from the sale of common stock
as a result of stock options exercised.

At August 31, 2001, our principal sources of
liquidity were our cash and cash equivalents and short-term
investments of $121.7 million. As of August 31, 2001,
we had no outstanding debt obligations.

Capital expenditures were approximately
$0.6 million and $2.0 million for the three months
ended August 31, 2000 and 2001, respectively. For the three
months ended August 31, 2000 and 2001, these expenditures
consisted principally of purchases of property and equipment,
primarily for computer hardware and software. The increase in
capital expenditures for the three months ended August 31,
2001 was principally due to the purchase of additional property
and equipment to support our current infrastructure.

We believe that our current cash and cash
equivalents and our funds generated from operations, if any,
will provide adequate liquidity to meet our capital and
operating requirements through at least fiscal 2003. Thereafter,
or if our spending plans change, we may find it necessary to
seek to obtain additional sources of financing to support our
capital needs, but we cannot assure you that such financing will
be available on commercially reasonable terms, or at all.

Recent Accounting Pronouncements

SFAS 133, Accounting for Derivative Instruments
and Hedging Activities, as amended by SFAS 137, Accounting
for Derivative Instruments and Hedging Activities 
Deferral of the Effective Date of FASB Statement No. 133,
and SFAS 138, Accounting for Certain Derivative Instruments
and Certain Hedging Activities, became effective for the Company
as of June 1, 2001. SFAS 133 requires that an entity
recognize all derivatives as either assets or liabilities
measured at fair value. The accounting for changes in the fair
value of a derivative depends on the use of the derivative. The
adoption of this statement did not have a material impact on our
statement of operations.

Impact of European Monetary
Conversion

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

RISK FACTORS

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

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Risks Related to Our Business



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

We sustained a loss for the three months ended
August 31, 2001. Despite our financial performance in the
three years prior to the last quarter, we have in the past also
incurred significant losses and substantial negative cash flow.
In the future, our revenues may decline, remain flat, or grow at
a rate slower than was experienced in periods prior to last
quarter and, on a quarter-to-quarter basis, our net sales may
decline, remain flat or grow at a significantly lower rate than
our recent historical quarterly growth rate, especially in light
of the recent economic slowdown. To achieve revenue growth, we
must:



| |   |                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------
| |  | increase market acceptance of our products;                                                           
|
| |  | respond effectively to competitive developments;                                                      
|
| |  | attract, retain and motivate qualified personnel;
	and                                                
|
| |  | upgrade our technologies and commercialize our
	products and services incorporating such technologies.

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



| |                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------
| | Our revenues and operating results may
	fluctuate in future periods, which could adversely affect our
	stock price

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



| |   |                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the downturn in capital spending by customers as
	a result of the recent economic slowdown;                                                                                             
|
| |  | the size and timing of orders;                                                                                                                                                          
|
| |  | changes in the budget or purchasing patterns of
	corporations and government agencies, foreign country exchange
	rates, or pricing pressures from competitors;                          
|
| |  | increased competition in the software and
	Internet industries;                                                                                                                         
|
| |  | the introduction and market acceptance of new
	technologies and standards in search and retrieval, Internet,
	document management, database, networking, and communications
	technology;
|
| |  | variations in sales channels, product costs, the
	mix of products sold, or the success of quality control measures;                                                                     
|
| |  | the integration of people, operations, and
	products from acquired businesses and technologies;                                                                                         
|
| |  | changes in operating expenses and personnel;                                                                                                                                            
|
| |  | the overall trend toward industry consolidation;
	and                                                                                                                                   
|
| |  | changes in general economic conditions and
	specific economic conditions in the computer and software
	industries.                                                                      

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



| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | The size and timing of large orders may
	materially affect our quarterly operating results

The size and timing of individual orders may
cause our operating results to fluctuate. The dollar amounts of
large orders for our products have been increasing, and
therefore the operating results for a quarter could be

13



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




| |                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------
| | Our expenditures are tied to anticipated
	revenues, and therefore imprecise forecasts may result in poor
	operating results

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



| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | We have been sued, and are at risk of
	future securities class action litigation, due to our past and
	expected stock price volatility

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



| |                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------
| | We must successfully introduce new products
	or our customers will purchase our competitors products and our
	business will be adversely affected

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

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

14



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



| |                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We face intense competition from companies
	with significantly greater financial, technical, and marketing
	resources, which could adversely affect our ability to maintain
	or increase sales of our products

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

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



| |                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | We rely on Regent Pacific Management
	Corporation for the management of Verity, and the loss of these
	services could adversely affect our business

Regent Pacific Management Corporation, a
management firm of which Gary J. Sbona is chief executive
officer, provides management services for our company. The
management services provided under our agreement with Regent
Pacific include the services of Mr. Sbona, as chairman of
the board and chief executive officer, and other Regent Pacific
personnel as part of Veritys management team. Gary J.
Sbona is also deemed an employee of our company under common
law. On March 12, 2001 we extended our agreement with
Regent Pacific Management Corporation through August 31,
2002. This is the fourth amendment to the retainer agreement
between Regent Pacific Management Corporation and Verity, Inc.
since the original agreement dated July 31, 1997. Under
this amended agreement, Regent Pacific continues to provide the
services of Gary J. Sbona as Chairman and Chief Executive
Officer of Verity, and continues to provide additional Regent
Pacific management services to our company. The agreement
provides us with an option to further extend the term of this
agreement through February 2003. This agreement may be cancelled
at the option of the board after February 2003. If the agreement
with Regent Pacific were canceled or not renewed, the loss of
the Regent Pacific personnel could have a material adverse
effect on our operations, especially during the transition phase
to a new management. Similarly, if any adverse change in
Veritys relationship with Regent Pacific occurs, it could
hinder managements ability to direct our business and
materially and adversely affect our results of operations and
financial condition.

15



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| |                                                                          
| | -------------------------------------------------------------------------
| | Our business may suffer due to risks
	associated with international sales

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



| |   |                                                                       
| | - | ----------------------------------------------------------------------
| |  | difficulties in complying with regulatory
	requirements and standards;
|
| |  | tariffs and other trade barriers;                                     
|
| |  | costs and risks of localizing products for
	foreign countries;        
|
| |  | reliance on third parties to distribute our
	products;                
|
| |  | longer accounts receivable payment cycles;                            
|
| |  | potentially adverse tax consequences;                                 
|
| |  | limits on repatriation of earnings; and                               
|
| |  | burdens of complying with a wide variety of
	foreign laws.            

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

Service and other revenues derived from foreign
operations accounted for 6.4%, 6.7%, 6.3%, and 16.2% of total
revenues, respectively, in fiscal 1999, 2000, 2001, and the
quarter ended August 31, 2001, respectively. Our export
sales consist primarily of products licensed for delivery
outside of the United States. In fiscal years 1999, 2000,
2001, and the quarter ended August 31, 2001, export sales
accounted for 27.1%, 19.0%, 26.0%, and 21.6% of total revenues,
respectively. We expect that revenues derived from foreign
operations and export sales will continue to account for a
significant percentage of our revenues for the foreseeable
future. These revenues may fluctuate significantly as a
percentage of revenues from period to period. In addition, a
portion of these revenues was derived from sales to foreign
government agencies, which may be subject to risks similar to
those described immediately below. See Note 4 of Notes to
Condensed Consolidated Financial Statements under Part 1,
Item 1 of this Quarterly Report on Form 10-Q for a
discussion of our international revenues, income from operations
and long-lived assets by geographic region.



| |                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A significant portion of our revenues is
	derived from sales to the federal government, which are subject
	to budget cuts and, consequently, the potential loss of revenues
	upon which we have historically relied

Revenues derived from sales to the federal and
state governments and their agencies were 8.1%, 7.8%, 7.4%, and
6.4% of total revenues in fiscal years 1999, 2000, 2001, and the
quarter ended August 31, 2001, respectively. Future
reductions in United States spending on information technologies
could have a material adverse effect on our operating results.
Sales to government agencies declined as a percentage of
revenues during these periods, and may decline in the future. In
recent years, budgets of many government agencies have been
reduced, causing certain customers and potential customers of
our products to re-evaluate their needs. These budget reductions
are expected to continue over at least the next several years.

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



| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to enhance our existing
	products and develop new products to respond to our rapidly
	changing markets, our products may become obsolete

The computer software industry is subject to
rapid technological change, changing customer requirements,
frequent new product introductions, and evolving industry
standards that may render existing products and services
obsolete. As a result, our position in our existing markets or
other markets that we may enter could be eroded rapidly by
product advancements by competitors. If we are unable to develop
and introduce products in a timely manner in response to
changing market conditions or customer requirements, our
financial condition and results of operations would be
materially and adversely affected.

The life cycles of our products are difficult to
estimate. Our future success will depend upon our ability to
enhance existing products and to develop new products on a
timely basis. In addition, our products must keep pace with
technological developments, conform to evolving industry
standards, particularly client/server and Internet communication
and security protocols, as well as publishing formats such as
Hypertext Markup Language, or HTML, and Extensible Markup
Language, or XML, and address increasingly sophisticated
customer needs. We cannot assure you that we will not experience
difficulties that could delay or prevent the successful
development, introduction and marketing of new products, or that
new products and product enhancements will meet the requirements
of the marketplace and achieve market acceptance.

We strive to achieve compatibility between our
products and the text publication formats we believe are or will
become popular and widely adopted. We invest substantial
resources in development efforts aimed at achieving such
compatibility. Any failure by us to anticipate or respond
adequately to technology or market developments could result in
a loss of competitiveness or revenue. For instance, to date we
have focused our efforts on integration with the Adobe PDF and
Lotus Notes environments and, more recently, the Microsoft
Exchange environment. Should any of these products or
technologies lose or fail to achieve acceptance in the
marketplace or be replaced by other products or technologies,
our business could be materially and adversely affected.

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



| |                                                                                                               
| | --------------------------------------------------------------------------------------------------------------
| | Our software products are complex and may
	contain errors that could damage our reputation and decrease
	sales

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

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| |                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------
| | If we lose key personnel, or are unable to
	attract additional qualified personnel, our ability to conduct
	and grow our business will be impaired

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

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



| |                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our ability to compete successfully will
	depend, in part, on our ability to protect our intellectual
	property rights, which we may not be able to
	protect

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

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



| |                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------
| | Our products employ technology that may
	infringe on the proprietary rights of third parties, which may
	expose us to litigation

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



| |                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We are dependent on proprietary technology
	licensed from third parties, the loss of which could delay
	shipments of products incorporating this technology and could be
	costly

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

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fiscal quarter, could result in a material
adverse effect on our quarterly results of operations. While it
may be necessary or desirable in the future to obtain other
licenses relating to one or more of our products or relating to
current or future technologies, we cannot assure you that we
will be able to do so on commercially reasonable terms or at all.




| |                                                                                          
| | -----------------------------------------------------------------------------------------
| | Potential acquisitions may have unexpected
	consequences or impose additional costs on us

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



| |   |                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties in integration of the operations,
	technologies, and products of the acquired companies;                                                   
|
| |  | the risk of diverting managements attention
	from normal daily operations of the business;                                                             
|
| |  | accounting consequences, including changes in
	purchased research and development expenses, resulting in
	variability in our quarterly earnings;        
|
| |  | potential difficulties in completing projects
	associated with purchased in-process research and development;                                           
|
| |  | risks of entering markets in which we have no or
	limited direct prior experience and where competitors in such
	markets have stronger market positions;
|
| |  | the potential loss of key employees of the
	acquired company; and                                                                                       
|
| |  | the assumption of unforeseen liabilities of the
	acquired company.                                                                                      

We cannot assure you that our future acquisitions
will be successful and will not adversely affect our financial
condition or results of operations. We must also maintain our
ability to manage any such growth effectively. Failure to manage
growth effectively and successfully integrate acquisitions we
make could harm our business and operating results.

Risks Related to Our Industry



| |                                                                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We depend on increasing use of the
	Internet, intranets, extranets and portals and on the growth of
	electronic commerce. If the use of the Internet, intranets,
	extranets and portals and electronic commerce do not grow as
	anticipated, our business will be seriously harmed

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

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



| |   |                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------
| |  | use of the Internet, the Web and other online
	services does not continue to increase or increases more slowly
	than expected;    
|
| |  | the infrastructure for the Internet, the Web and
	other online services does not effectively support expansion
	that may occur; or

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



| |                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------
| | Capacity constraints may restrict the use
	of the Internet as a commercial marketplace, which would
	restrict our growth

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



| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | potentially inadequate development of the
	necessary communication and network infrastructure, particularly
	if rapid growth of the Internet continues;
|
| |  | delayed development of enabling technologies and
	performance improvements;                                                                            
|
| |  | delays in the development or adoption of new
	standards and protocols; and                                                                             
|
| |  | increased governmental regulation.                                                                                                                     

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



| |                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Security risks and concerns may deter the
	use of the Internet for conducting electronic commerce, which
	would adversely affect the demand for our products

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



| |                                                                
| | ---------------------------------------------------------------
| | Security risks expose us to additional
	costs and to litigation

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

Risks Related to Ownership of Our Common
Stock



| |                                                                                                      
| | -----------------------------------------------------------------------------------------------------
| | The market price of our common stock will
	fluctuate and you may lose all or part of your
	investment

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



| |   |                                                                                               
| | - | ----------------------------------------------------------------------------------------------
| |  | future announcements concerning Verity or its
	competitors;                                   
|
| |  | quarterly variations in operating results;                                                    
|
| |  | announcements of technological innovations;                                                   
|
| |  | the introduction of new products or changes in
	product pricing policies by us or competitors;

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| |   |                                                                    
| | - | -------------------------------------------------------------------
| |  | proprietary rights or other litigation; and                        
|
| |  | changes in earnings estimates by analysts or
        other factors.

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



| |                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have implemented certain anti-takeover
        provisions that may prevent or delay an acquisition of Verity
        that might be beneficial to our stockholders

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



| |   |                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | establishment of a classified board of directors
        such that not all members of the board may be elected at one
        time;                                                                                      
|
| |  | the ability of the board of directors to issue
        without stockholder approval up to 2,000,000 shares of preferred
        stock to increase the number of outstanding shares and thwart a
        takeover attempt;
|
| |  | no provision for cumulative voting in the
        election of directors, which would otherwise allow less than a
        majority of stockholders to elect director candidates;                                          
|
| |  | limitations on who may call special meetings of
        stockholders;                                                                                                                                                    
|
| |  | prohibiting stockholder action by written
        consent, thereby requiring all stockholder actions to be taken
        at a meeting of our stockholders; and                                                           
|
| |  | establishing advance notice requirements for
        nominations for election to the board of directors or for
        proposing matters that can be acted upon by stockholders at
        stockholder meetings.         

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






Item 3.     Quantitative and Qualitative Disclosures about Market
Risk


Interest Rate Risk.The primary objective of our
investment activities is to preserve the principal while at the
same time maximizing yields without significantly increasing the
risk. To achieve this objective, we maintain our portfolio of
cash equivalents and investments in a variety of securities,
including both government and corporate obligations and money
market funds. As of August 31, 2001, approximately 48% of
our portfolio matures in one year or less, with the remainder
maturing in less than three years. We do not use derivative
financial instruments in our investment portfolio. We place our
investments with high credit quality issuers and, by policy,
limit the amount of credit exposure to any one issuer.

The following table presents the amounts of our
cash equivalents and investments that are subject to interest
rate risk by year of expected maturity and average interest
rates as of August 31, 2001:

|                       |  |                |        |        |  |        |        |        |  |       |        |            |  |   |       |   |  |   |         |  |  |   |         | 
|---------------------- |  | -------------- | ------ | ------ |  | ------ | ------ | ------ |  | ----- | ------ | ---------- |  | - | ----- | - |  | - | ------- |  |  | - | ------- | 
|                       |  | FY2002         |        | FY2003 |  | FY2004 |        | FY2005 |  | Total |        | Fair Value
|                       |  |                |        |        |  |        |        |        |  |       |        |           
|                       |  |               
|                       |  | (In thousands)
|                      
|                      
|                      
|                      
|Cash equivalents       |  | $              | 14,401 |        |  |        |       |        |  |       |       |            |  |   |      |   |  | $ | 14,401  |  |  | $ | 14,401  | 
|                      
|                      
|                      
|                      
|Average interest rate  |  |                | 3.2    | %      |  |        |        |        |  |       |        |            |  |   |       |   |  |   |         |  |  |   |         | 
|                      
|                      
|                      
|                      
|Short-term investments |  | $              | 97,340 |        |  | $      | 9,973  |        |  |       |       |            |  |   |      |   |  | $ | 107,313 |  |  | $ | 107,313 | 
|                      
|                      
|                      
|                      
|Average interest rate  |  |                | 4.7    | %      |  |        | 4.7    | %      |  |       |        |            |  |   |       |   |  |   |         |  |  |   |         | 
|                      
|                      
|                      
|                      
|Long-term investments  |  |                |       |        |  | $      | 79,736 |        |  | $     | 31,373 |            |  | $ | 5,077 |   |  | $ | 116,186 |  |  | $ | 116,186 | 
|                      
|                      
|                      
|                      
|Average interest rates |  |                |       |        |  |        | 5.2    | %      |  |       | 5.6    | %          |  |   | 5.3   | % |  |   |         |  |  |   |         | 

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Foreign Currency Risk.We transact business in various
foreign currencies, including the Euro, the British pound, the
French franc, the German mark, the Dutch guilder, the Canadian
dollar, the Australian dollar, the Swedish krona, the South
African rand, the Mexican peso and the Brazilian real. Certain
of these countries have converted to the Euro effective
June 01, 2001. We have established a foreign currency
hedging program utilizing foreign currency forward exchange
contracts to hedge certain sales contracts denominated in
foreign currency. Under this program, fluctuations in foreign
currencies during the period from the signing of the contract
until payment are partially offset by realized gains and losses
on the hedging instruments. The goal of this hedging program is
to lock in exchange rates on our sales contracts denominated in
foreign currencies. The notional amount of hedged contracts and
the estimated fair value are not material.




PART II.     OTHER
INFORMATION




Item 1.     Legal Proceedings

In December 1999, a number of complaints were
filed in the United States District Court for Northern District
of California seeking an unspecified amount of damages on behalf
of an alleged class of persons who purchased shares of our
common stock during the period between December 1 and
December 14, 1999. The complaints name as defendants Verity
and certain of its directors and officers, asserting that they
violated federal securities laws by misrepresenting
Veritys business and earnings growth ability to continue
to achieve profitable growth, and failing to disclose certain
information about our business. The complaints were consolidated
into a single action, and in August 2000, the complaint was
dismissed without prejudice with leave to amend. The plaintiffs
re-filed an amended complaint, and Verity filed a motion to
dismiss this amended complaint on October 27, 2000. By
order dated February 13, 2001, the court granted the motion
in part and denied it in part. The court dismissed with
prejudice all claims except a single claim relating to alleged
communications with a securities analyst near the end of
Veritys second fiscal 2000 quarter. On July 24, 2001,
council for plaintiffs agreed to voluntarily dismiss the action
with prejudice, and without an award of costs or fees to any
party. The court ordered the case dismissed on July 27,
2001.

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

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

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

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

The action is currently in the early stages and
no formal discovery has yet been conducted. A case management
conference has been set for October 9, 2001 at which time
the Court will likely enter a scheduling order and set a trial
date.




Item 2.     Changes in Securities and Use of Proceeds

Not Applicable.




Item 3.     Defaults upon Senior Securities

Not Applicable.




Item 4.     Submission of Matters to a Vote of Security
Holders

Not Applicable.




Item 5.     Other Information

Not Applicable.




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

A.     Exhibits
  See Exhibit Index

B.     Reports on
Form 8-K

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

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SIGNATURE

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



| |             
| | ------------
| | VERITY, INC.



| |     |                   
| | --- | ------------------
| | By: | /s/ TODD K. YAMAMI

| |                                                 
| | ------------------------------------------------
| |                                                 
| | Todd K. Yamami                                  
| | Vice President & Chief Financial
        Officer
| | (Principal Financial Officer)                   

Dated:  October 3, 2001

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INDEX TO EXHIBITS

|        |      |  |  |                         |  |                                                                                                                     
|------- | ---- |  |  | ----------------------- |  | --------------------------------------------------------------------------------------------------------------------
|Exhibit |      |  |  |                        
|Number  |      |  |  | Description of Document
|        |      |  |  |                        
|        | 3.1  |  |  |                        |  | Restated Certificate of Incorporation of the
        Company.(1)                                                    
|        | 3.2  |  |  |                        |  | By-Laws.(1)                                                                                                         
|        | 3.4  |  |  |                        |  | Certificate of Designation, Preferences and
        Rights of Series A Preferred Stock.(2)                          
|        | 4.1  |  |  |                        |  | Amended and Restated Rights Agreement dated
        August 1, 1995, as amended.(3)                                  
|        | 4.2  |  |  |                        |  | Form of Rights Agreement between Verity, Inc. and
        First National Bank of Boston dated September 18, 1996.(4)
|        | 4.3  |  |  |                        |  | First Amendment to Rights Agreement dated as of
        July 23, 1999 among Verity, Inc. and BankBoston, N.A.(5)    
|        | 10.5 |  |  |                        |  | 1996 Non-Statutory Stock Incentive Plan, as
        amended.(6)                                                     



---



|    |                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference from the exhibits with
        corresponding numbers from the Companys Form 10-Q for
        the quarter ended November  30, 2000.                                  
|   
|(2) | Incorporated by reference from the exhibits with
        corresponding numbers from the Companys Form 10-Q for
        the quarter ended August 31, 1996.                                     
|   
|(3) | Incorporated by reference from the exhibits with
        corresponding numbers from the Companys Registration
        Statement (No. 33-96228), declared effective on
        October 5, 1995.
|   
|(4) | Incorporated by reference from
        Exhibit No. 1 to the Companys Form 8-K as
        filed with the Securities and Exchange Commission on
        October 10, 1996.                       
|   
|(5) | Incorporated by reference to Exhibit 99.2
        from the Companys Current Report on Form 8-K filed on
        July 29, 1999.                                                                
|   
|(6) | Incorporated by reference to Exhibit 99.1
        from the Companys Registration Statement
        (No. 333-68586) filed on August 29, 2001.                                                  

25