<PAGE>   1
 
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                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
 
                                   FORM 10-Q
 
(MARK ONE)
     [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
       SECURITIES EXCHANGE ACT OF 1934
 
       FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 1996
 
                                       OR
 
     [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
       SECURITIES EXCHANGE ACT OF 1934
 
       FOR THE TRANSITION PERIOD FROM ____________ TO ____________
 
       COMMISSION FILE NUMBER: 0-26880
 
                                  VERITY, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
               <S>                               <C>
                         DELAWARE
               (STATE OR OTHER JURISDICTION
                             OF                           77-0182779
                     INCORPORATION OR                  (I.R.S. EMPLOYER
                        ORGANIZATION)                 IDENTIFICATION NO.)
</TABLE>
 
                                 894 ROSS DRIVE
                          SUNNYVALE, CALIFORNIA 94089
                                 (408) 541-1500
         (ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
 
     Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
 
                                YES [X]  NO [ ]
 
     The number of shares outstanding of the Registrant's Common Stock, $0.001
par value, was 10,810,000 as of November 30, 1996.
 
     This report consists of 22 pages. The Exhibit Index to this report is
located on page 19.
 
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<PAGE>   2
 
                                  VERITY, INC.
 
                                   FORM 10-Q
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                                      PAGE NO.
                                                                                      --------
<S>            <C>                                                                    <C>
PART I: FINANCIAL INFORMATION
     Item 1:   Financial Statements...............................................        1
               Condensed Consolidated Balance Sheets as of May 31, 1996 and
               November 30, 1996..................................................        1
               Condensed Consolidated Statements of Operations for the Quarters
               Ended November 30, 1995 and 1996 and the Six Months Ended November
               30, 1995 and 1996..................................................        2
               Condensed Consolidated Statements of Cash Flows for the Six Months
               Ended November 30, 1995 and 1996...................................        3
               Notes to Condensed Consolidated Financial Statements...............        4
     Item 2:   Management's Discussion and Analysis of Financial Condition and
               Results of Operations..............................................        6
PART II: OTHER INFORMATION
     Item 1:   Legal Proceedings..................................................       17
     Item 2:   Changes in Securities..............................................       17
     Item 3:   Defaults upon Senior Securities....................................       17
     Item 4:   Submissions of Matters to a Vote of Security Holders...............       17
     Item 5:   Other Information..................................................       17
     Item 6:   Exhibits and Reports on Form 8-K...................................       17
   Signatures  ...................................................................       18
</TABLE>
 
                                        i
<PAGE>   3
 
PART I:  FINANCIAL INFORMATION
 
ITEM 1:  FINANCIAL STATEMENTS
 
                                  VERITY, INC.
 
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
<TABLE>
<CAPTION>
                                                                                    NOVEMBER 30,
                                                                                        1996
                                                                        MAY 31,     ------------
                                                                         1996
                                                                        -------     (UNAUDITED)
<S>                                                                     <C>         <C>
ASSETS
Current assets:
  Cash and cash equivalents...........................................  $ 2,482       $  3,593
  Short-term investments..............................................   40,899         23,481
  Trade accounts receivable, less allowance for doubtful accounts of
     $389 in 1996 and $491 in 1997....................................    8,822         12,682
  Prepaid and other current assets....................................    1,161          1,644
                                                                        -------     ------------
          Total current assets........................................   53,364         41,400
Property and equipment, at cost, net of accumulated depreciation and
  amortization........................................................    4,744          9,030
Long-term investments.................................................    4,592         12,579
Other assets..........................................................       24            765
                                                                        -------     ------------
          Total assets................................................  $62,724       $ 63,774
                                                                        =======     ==========
 
LIABILITIES
Current liabilities:
  Current portion of long-term debt and capital lease obligations.....  $   426       $    460
  Accounts payable....................................................    3,368          4,108
  Accrued compensation................................................    1,565          1,625
  Other accrued liabilities...........................................      779            729
  Deferred revenue....................................................    3,139          3,434
                                                                        -------     ------------
          Total current liabilities...................................    9,277         10,356
Long-term debt and capital lease obligations, net of current
  portion.............................................................      639            401
                                                                        -------     ------------
          Total liabilities...........................................    9,916         10,757
                                                                        -------     ------------
 
STOCKHOLDERS' EQUITY
Common stock, $.001 par value:
  Authorized: 30,000,000 shares in 1996 and 1997; Issued and
     outstanding 10,735,000 shares in 1996 and 10,810,000 shares in
     1997.............................................................       11             11
  Additional paid-in capital..........................................   87,882         88,815
  Notes receivable from stockholders..................................   (1,225)        (1,089)
  Unrealized gain (loss) on investments...............................     (125)            76
  Accumulated deficit.................................................  (33,735)       (34,796)
                                                                        -------     ------------
          Total stockholders' equity..................................   52,808         53,017
                                                                        -------     ------------
          Total liabilities and stockholders' equity..................  $62,724       $ 63,774
                                                                        =======     ==========
</TABLE>
 
  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
 
                                        1
<PAGE>   4
 
                                  VERITY, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED      SIX MONTHS ENDED
                                                          NOVEMBER 30,           NOVEMBER 30,
                                                       ------------------     -------------------
                                                        1995       1996        1995        1996
                                                       ------     -------     -------     -------
                                                          (UNAUDITED)         (UNAUDITED)
<S>                                                    <C>        <C>         <C>         <C>
Revenues:
  Software products..................................  $5,550     $ 9,726     $ 9,714     $16,955
  Service and other..................................   1,614       1,870       2,985       3,453
                                                       ------     -------     -------     -------
          Total revenues.............................   7,164      11,596      12,699      20,408
                                                       ------     -------     -------     -------
Costs of revenues:
  Software products..................................     499       1,003         652       1,619
  Service and other..................................     679         980       1,335       1,853
                                                       ------     -------     -------     -------
          Total costs of revenues....................   1,178       1,983       1,987       3,472
                                                       ------     -------     -------     -------
Gross profit.........................................   5,986       9,613      10,712      16,936
                                                       ------     -------     -------     -------
Operating expenses:
  Research and development...........................   2,016       3,290       3,795       6,789
  Marketing and sales................................   3,532       5,459       6,070       9,988
  General and administrative.........................     891       1,177       1,624       2,352
                                                       ------     -------     -------     -------
          Total operating expenses...................   6,439       9,926      11,489      19,129
                                                       ------     -------     -------     -------
Loss from operations.................................    (453)       (313)       (777)     (2,193)
Other income, net....................................     115         535           3       1,132
                                                       ------     -------     -------     -------
Net income (loss)....................................  $ (338)    $   222     $  (774)    $(1,061)
                                                       ======     =======     =======     =======
Net income (loss)....................................  $ (338)    $   222     $  (774)    $(1,061)
Accretion to redemption value of mandatorily
  redeemable convertible preferred stock.............    (193)         --        (611)         --
                                                       ------     -------     -------     -------
Net income (loss) applicable to common
  stockholders.......................................  $ (531)    $   222     $(1,385)    $(1,061)
                                                       ======     =======     =======     =======
Net income (loss) per share..........................  $(0.08)    $  0.02     $ (0.27)    $ (0.10)
                                                       ======     =======     =======     =======
Number of shares used in per share calculation.......   6,316      11,421       5,187      10,779
                                                       ======     =======     =======     =======
</TABLE>
 
  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
 
                                        2
<PAGE>   5
 
                                  VERITY, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                                      SIX MONTHS ENDED
                                                                                        NOVEMBER 30,
                                                                                     -------------------
                                                                                      1995        1996
                                                                                     -------     -------
                                                                                         (UNAUDITED)
<S>                                                                                  <C>         <C>
Cash flows from operating activities:
  Net loss.........................................................................  $  (774)    $(1,061)
  Adjustments to reconcile net loss to net cash used in operating activities:
    Depreciation and amortization..................................................      684       1,637
    Provision for doubtful accounts................................................      185         258
    Amortization of discount on securities.........................................       --        (452)
    Common stock issued for services...............................................       60          --
    Equity in loss of investee company.............................................       --          77
    Exchange loss..................................................................                    6
    Changes in operating assets and liabilities:
      Trade accounts receivable....................................................   (3,210)     (4,108)
      Prepaid and other current assets.............................................     (418)       (522)
      Accounts payable.............................................................      619         743
      Accrued compensation and other accrued liabilities...........................      515         (22)
      Deferred revenue.............................................................      904         292
                                                                                     -------     -------
         Net cash used in operating activities.....................................   (1,435)     (3,152)
                                                                                     -------     -------
Cash flows from investing activities:
  Acquisition of property and equipment............................................     (800)     (5,864)
  Purchases of marketable securities...............................................       --     (40,730)
  Maturity of marketable securities................................................       --      31,800
  Proceeds from sale of marketable securities......................................       --      19,483
  Investment in preferred stock....................................................       --        (500)
  Capitalization of software.......................................................       --        (803)
  Increase in other assets.........................................................     (101)         --
                                                                                     -------     -------
         Net cash generated (used) in investing activities.........................     (901)      3,386
                                                                                     -------     -------
Cash flows from financing activities:
  Borrowings under line of credit..................................................      750       1,500
  Payments on line of credit.......................................................   (1,645)     (1,500)
  Proceeds from the sale of mandatorily redeemable convertible preferred stock, net
    of issuance costs..............................................................    3,242          --
  Proceeds from stockholders on notes receivable...................................       --         135
  Proceeds from the sale of common stock...........................................   32,790         933
  Proceeds from issuance of notes payable..........................................      150          --
  Proceeds from sales and lease backs of property and equipment....................      147          --
  Principal payments on notes payable and capital lease obligations................     (786)       (203)
                                                                                     -------     -------
         Net cash provided by financing activities.................................   34,648         865
                                                                                     -------     -------
Effect of exchange rate changes on cash............................................       14          12
                                                                                     -------     -------
         Net increase in cash and cash equivalents.................................   32,326       1,111
Cash and cash equivalents, beginning of period.....................................      324       2,482
                                                                                     -------     -------
Cash and cash equivalents, end of period...........................................  $32,650     $ 3,593
                                                                                     =======     =======
Supplemental disclosure of cash flow information:
  Cash paid during the period for interest.........................................  $   172     $    54
Supplemental schedule of noncash investing and financing activities:
  Accretion to redemption value of mandatorily redeemable convertible preferred
    stock..........................................................................  $   611          --
  Issuance of common stock for notes receivable....................................  $   403          --
  Conversion of mandatorily redeemable convertible preferred stock to common
    stock..........................................................................  $35,922          --
  Common stock issue costs included in other accrued liabilities...................  $   155          --
</TABLE>
 
  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
 
                                        3
<PAGE>   6
 
                                  VERITY, INC.
 
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
        (INFORMATION AS OF NOVEMBER 30, 1996 AND FOR THE QUARTERS ENDED
            NOVEMBER 30, 1995 AND 1996 AND THEREAFTER IS UNAUDITED)
 
1. INTERIM FINANCIAL DATA (UNAUDITED):
 
     The unaudited financial statements for the quarters ended November 30, 1995
and 1996 have been prepared on the same basis as the audited financial
statements and, in the opinion of management, include all 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. It is suggested that the accompanying financial statements be read
in conjunction with the Company's annual financial statements on Form 10-K for
the year ended May 31, 1996.
 
     The Company's balance sheet as of May 31, 1996 was derived from the
Company's audited financial statements but does not include all disclosures
necessary for the presentation to be in accordance with generally accepted
accounting principles.
 
2. COMPUTATION OF NET INCOME AND LOSS PER SHARE
 
     Net income and loss per share is computed using the weighted average number
of shares of common stock outstanding. Common equivalent shares from stock
options, warrants and preferred stock are included in the computation when their
effect is dilutive and excluded from the computation when their effect is
antidilutive, except that, pursuant to the Securities and Exchange Commission
Staff Accounting Bulletins, common and common equivalent shares and mandatorily
redeemable convertible preferred stock, issued at prices below the initial
public offering price during the twelve months immediately preceding the initial
filing date of the Company's initial public offering have been included in the
calculation as if they were outstanding for all periods ending prior to the
effectiveness of the Company's initial public offering using the treasury stock
method and the initial public offering price.
 
3. ACCOUNTING FOR STOCK OPTIONS
 
     During October 1995, the Financial Accounting Standards Board issued
Statement No. 123 (SFAS 123) which establishes a fair value based method of
accounting for stock based compensation plans. While the Company is studying the
impact of the pronouncement, it continues to account for employee stock options
under APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123
will be effective for fiscal years beginning after December 15, 1995.
 
4. BANK LINE OF CREDIT
 
     The Company has available an unsecured $7,500,000 line of credit under an
agreement with a bank which expires on September 30, 1997. Borrowings under the
line of credit bear interest at the lender's prime rate. The agreement requires
the Company to comply with certain financial covenants and prohibits the
assumption of any major debt, except for equipment leases, without the bank's
approval. As of November 30, 1996, no borrowings were outstanding under the line
of credit.
 
5. PREFERRED STOCK PURCHASE RIGHTS PLAN
 
     In September 1996, the Company's Board of Directors adopted a Preferred
Stock Purchase Rights Plan designed to enable all Verity stockholders to realize
the full value of their investment and to provide for fair and equal treatment
for all Verity stockholders in the event that an unsolicited attempt is made to
acquire Verity. Under the plan, stockholders will receive one Right to purchase
one one-hundredth of a share of a new
 
                                        4
<PAGE>   7
 
series of Preferred Stock for each outstanding share of Verity Common Stock held
of record at the close of business on October 2, 1996. The Rights expire on
September 17, 2006.
 
6. CAPITALIZED SOFTWARE
 
     During the three months ended November 30, 1996, the Company capitalized
approximately $800,000 of software development costs, as required under
generally accepted accounting principles, in connection with the development of
a number of products included in the Company's new SEARCH'97 product line. In
prior periods, the Company had not capitalized any software development costs
since such costs had not been significant.
 
7. PREFERRED STOCK INVESTMENT
 
     In the Fall 1996, the Company made minority equity investments in two
emerging, private software companies and entered into technology licensing
agreements with these companies. The aggregate amounts invested was
approximately $500,000.
 
8. SUBSEQUENT EVENT
 
     On January 10, 1997, the Company entered into an Agreement and Plan of
Reorganization and Merger with Cognisoft Corporation (Cognisoft) providing for
the Company's purchase of Cognisoft for $10 million in cash. Cognisoft, a
startup company located in Bellevue, Washington, is currently developing an
Intranet application that enables corporations to "push" information to users
from multiple data sources. This acquisition will be accounted for using the
purchase method of accounting.
 
                                        5
<PAGE>   8
 
ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
OVERVIEW
 
     Verity develops, markets and supports software tools and applications that
enable individuals, enterprises and publishers to intelligently search, filter
and disseminate textual information residing on enterprise networks, online
services, the Internet, CD-ROM and other electronic media. The Company was
founded in 1988, and, historically, derived the substantial majority of its
revenue from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products.
 
     In early fiscal 1994, Verity retained a new Chief Executive Officer and
replaced several members of its senior management team. Shortly thereafter, the
Company shifted its strategy from the sale of high-priced products requiring
significant customization to leveraging the Company's Topic technology to
develop a number of new, lower-priced products that address the needs of broader
markets. During this period, the Company also focused on building strategic
alliances for the primary purpose of expanding the user base of the Company's
technology rather than generating significant revenues. The objectives of the
Company's strategy are to establish its software as a de facto standard and to
offset lower unit prices for its products with higher sales volumes.
 
     The Company's ongoing implementation of this strategy has involved several
significant actions. During recent years, the Company has reduced significantly
its average unit license fees. Also, during this period, the Company has devoted
significant resources to modify and enhance its core technology to support a
broader set of search and retrieval solutions for use on desktop and
enterprise-wide systems, and over the Internet. Key engineering efforts in this
regard have included the continued enhancement of the functionality of the
Company's Topic search engine and the modification of the Topic software to
facilitate its incorporation in third parties' information management,
publishing and groupware software applications. More recently, the Company's
engineering efforts have focused on the development of new applications of Topic
software for use with CD-ROM, online services and the Internet, together with
the Company's recently announced SEARCH'97 product line. The Company's Topic
technology is deployed within the Company's own suite of applications, and also
as an embedded feature within broadly distributed third-party software
applications, such as Lotus Notes, Adobe Acrobat, Frame FrameViewer and
Documentum Server and WorkSpace. The Company has also licensed its Topic
technology to prominent providers of Internet products and online services,
including Netscape Communications, NetManage, Quarterdeck, AT&T WorldNet
Services, and MCI's Delphi Internet, together with Internet publishers,
including Cisco Systems, Tandem Computer, Compaq Computer and the Financial
Times.
 
     In connection with its new strategy, the Company has also replaced the
majority of its work force and substantially reorganized all of the departments
within the Company. While experiencing significant turnover, the Company
increased the number of research and development personnel from 29 at the
beginning of fiscal 1994 to 91 at November 30, 1996. Given its reduced focus on
offering custom solutions, the Company was able to decrease the number of
personnel involved in its relatively low-margin consulting business from 29 at
the beginning of fiscal 1994 to 15 at November 30, 1996.
 
     Since inception, the Company has incurred significant losses and
substantial negative cash flow. Due in part to the transition, the Company
experienced declining revenues and increased net losses in fiscal years 1993
through 1995. At November 30, 1996, the Company had cumulative operating losses
of $24.7 million, with net losses of $5.8 million, $313,000 and $1.1 million for
fiscal 1995, fiscal 1996 and the six months ended November 30, 1996,
respectively. For the three months ended November 30, 1996, total revenues
increased 62% over the corresponding fiscal 1996 period, primarily as a result
of a 75% increase in software product revenues. Total revenues for the three
months ended November 30, 1996 increased 32% from the $8.8 million
 
                                        6
<PAGE>   9
 
for the previous three months ended August 31, 1996. Operating expenses for the
three months ended November 30, 1996 decreased over the prior three months as a
percentage of revenues, due primarily to higher revenue levels and, with respect
to research and development expense, the capitalization of approximately
$800,000 of software development costs, as required under generally accepted
accounting principles, in connection with the development of a number of
products included in the Company's new SEARCH'97 product line. In prior periods,
the Company had not capitalized any software development costs since such costs
had not been significant. Research and development expenses were $3.3 million,
or 28% of revenues, compared with $2.0 million, or 28% of revenues, for the same
period last year. For the Company's previous quarter ended August 31, 1996,
research and development expenses were $3.5 million, or 40% of revenues. While
it is the Company's goal to increase revenue and generate net income in future
periods, no assurance can be given that the Company's revenues will increase
from quarter to quarter in future periods, or that the Company will achieve
positive cash flow or profitability.
 
     The ongoing implementation of the Company's new strategy has placed, and
may continue to place, a significant strain on the Company's resources,
including its personnel. The Company believes that hiring and retaining
qualified individuals at all levels in the Company is essential to its success,
and there can be no assurance that the Company will be successful in attracting
and retaining the necessary personnel. If Company management is unable to
effectively manage its planned transition, identify opportunities in a timely
fashion, and evaluate and manage the Company's business and competitive
position, the Company's results of operations and financial condition will be
materially and adversely affected. Furthermore, there can be no assurance that
the Company will introduce all of its SEARCH'97 products or other new products
on a timely basis, or that the SEARCH'97 products or other new or recently
introduced products will achieve market acceptance.
 
     The Company's revenues are derived from licenses fees for its software
products and fees for services complementary to its products, including software
maintenance, consulting and training. Fees for services generally are charged
separately from the license fees for the Company's software products. The
Company recognizes revenues in accordance with the provisions of American
Institute of Certified Public Accountants Statement of Position No. 91-1,
Software Revenue Recognition. Accordingly, maintenance revenues from ongoing
customer support and product upgrades are recognized ratably over the term of
the applicable maintenance agreement, which is typically 12 months. Payments for
maintenance fees generally are received in advance and are nonrefundable.
Revenues for consulting and training generally are recognized when the services
are performed.
 
                                        7
<PAGE>   10
 
RESULTS OF OPERATIONS
 
     The following table sets forth the percentage of revenues represented by
certain items in the Company's Condensed Consolidated Statements of Operations
for the periods indicated:
 
<TABLE>
<CAPTION>
                                                             THREE MONTHS           SIX MONTHS
                                                                 ENDED                 ENDED
                                                             NOVEMBER 30,          NOVEMBER 30,
                                                            ---------------       ---------------
                                                            1995      1996        1995      1996
                                                            -----     -----       -----     -----
<S>                                                         <C>       <C>         <C>       <C>
Revenues:
  Software products.......................................   77.5%     83.9%       76.5%     83.1%
  Service and other.......................................   22.5      16.1        23.5      16.9
                                                            -----     -----       -----     -----
          Total revenues..................................  100.0     100.0       100.0     100.0
                                                            -----     -----       -----     -----
Costs of revenues:
  Software products.......................................    7.0       8.6         5.1       7.9
  Service and other.......................................    9.4       8.5        10.5       9.1
                                                            -----     -----       -----     -----
          Total costs of revenues.........................   16.4      17.1        15.6      17.0
                                                            -----     -----       -----     -----
Gross profit..............................................   83.6      82.9        84.4      83.0
                                                            -----     -----       -----     -----
Operating expenses:
  Research and development................................   28.2      28.4        29.9      33.3
  Marketing and sales.....................................   49.3      47.1        47.8      48.9
  General and administrative..............................   12.4      10.1        12.8      11.5
                                                            -----     -----       -----     -----
          Total operating expenses........................   89.9      85.6        90.5      93.7
                                                            -----     -----       -----     -----
Loss from operations......................................   (6.3)     (2.7)       (6.1)    (10.7)
Interest and other expenses...............................    1.6       4.6          --       5.5
                                                            -----     -----       -----     -----
Net income (loss).........................................   (4.7)%     1.9%       (6.1)%    (5.2)%
                                                            =====     =====       =====     =====
</TABLE>
 
  REVENUES
 
     Total revenues increased 60.7% from $12.7 million for the six months ended
November 30, 1995 to $20.4 million for the six months ended November 30, 1996.
Total revenues increased 61.9% from $7.2 million for the three months ended
November 30, 1995 to $11.6 million for the three months ended November 30, 1996.
Total revenues for the comparable six months period increased primarily due to
increased revenues from licensing of Internet/publishing products and tools.
Software product revenues increased as a percentage of total revenues from 76.5%
and 77.5% for the six months and three months ended November 30, 1995,
respectively, to 83.1% and 83.9%, respectively, for the comparable periods in
fiscal 1997. Conversely, service and other revenues declined as a percentage of
total revenues from 23.5% and 22.5% for the six months and three months ended
November 30, 1995, respectively, to 16.9% and 16.1%, respectively, for the
comparable periods in fiscal 1997.
 
     Software product revenues.  Software product revenues increased 74.5% from
$9.7 million for the six months ended November 30, 1995 to $17.0 million for the
six months ended November 30, 1996. The increase for the six months ended
November 30, 1996 over the six months ended November 30, 1995 was due
principally to increased revenues from licensing of Internet/publishing products
and tools. Software product revenues increased 75.2% from $5.6 million for the
three months ended November 30, 1995 to $9.7 million for the three months ended
November 30, 1996. The increase for the three months ended November 30, 1996
over the three months ended November 30, 1995 was due principally to increased
revenues from licensing of Internet/publishing products and tools.
 
     Service and other revenues.  Service and other revenues increased 15.7%
from $3.0 million for the six months ended November 30, 1995 to $3.5 million for
the six months ended November 30, 1996. Service and other revenues increased
15.9% from $1.6 million for the three months ended November 30, 1995 to $1.9
 
                                        8
<PAGE>   11
 
million for the three months ended November 30, 1996. Maintenance revenues
increased significantly between the comparable periods, but these increases were
partially offset by reduced consulting and training revenues.
 
     Revenues from foreign operations accounted for 8.9% and 4.2% of total
revenues, respectively, for the six months ended November 30, 1995 and 1996,
with European operations alone accounting for 7.3% and 4.2% of total revenues
for those periods. For the six months ended November 30, 1995 and 1996, export
sales accounted for 20.8% and 22.3% of total revenues, respectively. Revenue
from foreign operations accounted for 8.3% and 4.5%, respectively, for the three
months ended November 30, 1995 and 1996, with European operations alone
accounting for 6.1% and 4.5% of total revenues for those periods. For the three
months ended November 30, 1995 and 1996, export sales accounted for 22.2% and
21.3% of total revenues, respectively. The decreases in revenues from foreign
operations as a percentage of revenues resulted primarily from decreased rest of
world revenues and increased domestic revenues. The Company expects that
revenues derived from foreign operations and export sales will continue to vary
in future periods as a percentage of total revenues.
 
     Licensing and maintenance of software products to Cisco Systems, Inc.
accounted for approximately 19.8% of the Company's revenues for the six months
ended November 30, 1996 and for approximately 32.6% of the Company's revenue for
the three months ended November 30, 1996. Revenues derived from sales to the
federal government and its agencies were 13.9% and 7.5% of the Company's
revenues for the six months periods ended November 30, 1995 and 1996,
respectively and 12.4% and 6.3% of the Company's revenues for the three months
periods ended November 30, 1995 and 1996, respectively. The Company expects 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.  Costs of software products increased 148.3%
from $652,000 for the six months ended November 30, 1995 to $1.6 million for the
six months ended November 30, 1996 representing 6.7% and 9.6%, respectively, of
software product revenues. Costs of software products increased 101.0% from
$499,000 for the three months ended November 30, 1995 to $1.0 million for the
three months ended November 30, 1996 representing 9.0% and 10.3%, respectively,
of the software product revenues. The increase in absolute dollars was
principally related to the higher level of software product sales compared to
the prior year's period. The increase in costs as a percentage of software
product sales was due primarily to the inclusion of licensed software relating
to third party software components included in certain products during the
periods ended November 30, 1996.
 
     Costs of service and other.  Costs of service and other revenues increased
38.8% from $1.3 million for the six months ended November 30, 1995 to $1.9
million for the six months ended November 30, 1996, representing 44.7% and
53.7%, respectively, of service and other revenues. Costs of service and other
revenues increased 44.3% from $679,000 for the three months ended November 30,
1995 to $980,000 for the three months ended November 30, 1996, representing
42.1% and 52.4%, respectively, of service and other revenues. The increase in
absolute dollars was primarily related to the higher level of service revenues
compared to the prior year's period. The increase in costs as a percentage of
service and other revenues was due principally to increases in technical support
and consulting personnel.
 
  OPERATING EXPENSES
 
     Research and development.  Research and development expenses increased
78.9% from $3.8 million for the six months ended November 30, 1995 to $6.8
million for the six months ended November 30, 1996, representing 29.9% and
33.3%, respectively, of total revenues. Research and development expenses
increased 63.2% from $2.0 million for the three months ended November 30, 1995
to $3.3 million for the three months ended November 30, 1996, representing 28.1%
and 28.4%, respectively, of total revenues. The increase in these costs was
primarily due to a significant increase in headcount of research and development
personnel focused on development of products addressing online,
Internet/publishing, CD-ROM, and groupware applications. In particular, in the
six months ended November 30, 1996, the Company incurred increased staffing
expense relating principally to product development in connection with the
introduction of its new SEARCH'97 product line. During the three months ended
November 30, 1996, the Company capitalized
 
                                        9
<PAGE>   12
 
approximately $800,000 in software development costs, as required under
generally accepted accounting principles. In prior periods, the Company had not
capitalized any software development costs since such costs had not been
significant. The Company intends to continue to allocate substantial resources
to research and development, but research and development expenses may vary as a
percentage of total revenues.
 
     Marketing and sales.  Marketing and sales expenses increased 64.5% from
$6.1 million for the six months ended November 30, 1995 to $10.0 million for the
six months ended November 30, 1996, representing 47.8% and 48.9%, respectively,
of total revenues. Marketing and sales expenses increased 54.6% from $3.5
million in the three months ended November 30, 1995 to $5.5 million for the
three months ended November 30, 1996, representing 49.3% and 47.1%,
respectively, of total revenues. The increase in these costs was primarily
related to the Company's expansion of its marketing and sales organization in
the United States and Europe and promotional costs associated with the launch of
the SEARCH'97 product line. The Company anticipates it will continue to make
significant investments in marketing and sales.
 
     General and administrative.  General and administrative expenses increased
44.8% from $1.6 million in the six months ended November 30, 1995 to $2.4
million for the six months ended November 30, 1996, representing 12.8% and
11.5%, respectively, of total revenues. General and administrative expenses
increased 32.1% from $891,000 in the three months ended November 30, 1995 to
$1.2 million for the three months ended November 30, 1996, representing 12.4%
and 10.2%, respectively, of total revenues. The increase in these costs was
primarily due to increases in personnel and professional service fees required
to support the Company's expanded operations relative to the prior year's
periods.
 
     The Company intends to continue to make significant investments in
marketing and sales and in research and development throughout fiscal 1997,
which could cause operating expenses to increase faster than revenues.
 
  INCOME TAXES
 
     The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
Management evaluates on a quarterly basis the recoverability of the deferred tax
assets and the level of the valuation allowance. At such time as it is
determined that it is more likely than not that deferred tax assets are
realizable, the valuation allowance will be appropriately reduced.
 
                                       10
<PAGE>   13
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Since its inception, the Company has financed its operations primarily
through proceeds of approximately $23.6 million from private sales of Preferred
Stock, proceeds from its initial public offering and secondary public offering
of Common Stock and, to a lesser extent, bank credit lines and capital operating
leases. The Company completed its initial public offering of Common Stock in
October 1995 and realized net proceeds of $32.5 million. In January 1996, the
Company completed its secondary public offering of Common Stock, which generated
net proceeds of $16.5 million. The Company has used a portion of those proceeds
to repay borrowings under its line of credit in the amount of $1.6 million. As
of November 30, 1996, the Company had $39.2 million in cash and cash equivalents
and available-for-sale securities.
 
     The Company's operating activities used cash of $1.4 million and $3.2
million for the six months ended November 30, 1995 and 1996. In the six months
ended November 30, 1995 and November 30, 1996, increases in accounts receivable
were partially offset by depreciation and amortization expense.
 
     The Company's investing activities used cash of $901,000 and generated cash
of $3.4 million for the six months ended November 30, 1995 and 1996,
respectively. In the six months ended November 30, 1995, investing activities
consisted primarily of purchases of property and equipment. For the six months
ended November 30, 1996, cash generated in investing activities consisted
primarily of the proceeds from the sale and maturity of marketable securities
less purchases of marketable securities and property and equipment.
 
     Cash provided by financing activities was $34.6 million and $865,000 for
the six months ended November 30, 1995 and 1996, respectively. In the six months
ended November 30, 1995, financing activities consisted primarily of the sale of
Common Stock in connection with the Company's initial public offering. In the
six months ended November 30, 1996, financing activities consisted primarily of
the sale of Common Stock in connection with the Company's Employee Stock
Purchase Plan.
 
     At November 30, 1996, the Company's principal sources of liquidity were its
cash, cash equivalents, and short-term investments of $27.1 million. The Company
has available an unsecured $7,500,000 line of credit under an agreement with a
bank which expires on September 30, 1997. Borrowings under the line of credit
bear interest at the lender's prime rate. The agreement requires the Company to
comply with certain financial covenants and prohibits the assumption of any
major debt, except for equipment leases, without the bank's approval. At
November 30, 1996, the Company had no outstanding borrowings under the line of
credit.
 
     Capital expenditures, including capital leases, were approximately $800,000
and $5.9 million for the six months ended November 30, 1995 and 1996,
respectively. For the six months ended November 30, 1995, these expenditures
consisted principally of purchases of property and equipment, primarily for
computer hardware and software. In the six months ended November 30, 1996, these
expenditures consisted primarily of leasehold improvements and capital equipment
related to the Company's relocation to a new facility.
 
     The Company believes that its current cash and cash equivalents, its bank
line of credit, its capital leases and funds generated from operations, if any,
will provide adequate liquidity to meet the Company's capital and operating
requirements through at least calendar 1997. Thereafter, or if the Company's
spending plans change, the Company may find it necessary to seek to obtain
additional sources of financing to support its capital needs, but there is no
assurance that such financing will be available on commercially reasonable
terms, or at all.
 
                                       11
<PAGE>   14
 
RISK FACTORS
 
     The following risk factors should be considered carefully in connection
with the Company's business.
 
     History of Losses; Strategic Realignment.  Since inception, the Company has
incurred significant losses and substantial negative cash flow. In the six
months ended November 30, 1996, the Company had a net loss of approximately $1.1
million, and an operating loss of approximately $2.2 million. The Company was
founded in 1988, and historically derived the substantial majority of its
revenues from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products. In early fiscal 1994, the Company shifted its strategy to focus
increasingly on more versatile, lower-priced software applications which require
less specialized consulting. To achieve revenue growth, the Company must, among
other things, increase market acceptance of the Company's technology, achieve
significantly increased sales levels, respond effectively to competitive
developments, continue to attract, retain and motivate qualified persons, and
continue to upgrade its technologies and commercialize products and services
incorporating such technologies. There can be no assurance that the Company's
strategy will be successful or that the Company will experience increased
revenues or become profitable or cash flow positive at any time in the future.
 
     Management of Transition.  The Company is experiencing a period of
transition and new product introductions that have placed, and will continue to
place, a significant strain on its resources, including personnel. During the
past few years, management and other personnel have focused on modifying and
enhancing the Company's core technology to support a broader set of search and
retrieval solutions for use on desktop and enterprise-wide systems, and over
online services, the Internet and on CD-ROM. In order for the Company's strategy
to succeed, the Company must, among other things, leverage its core technology
to develop new product offerings by the Company and by its original equipment
manufacturer ("OEM") customers that address the needs of these new markets. Many
of the Company's products are still being developed or have only recently been
introduced, and there is no assurance that such products will be successfully
completed on a timely basis, will achieve market acceptance or will generate
significant revenues. Projects relating to these efforts, including the
development and commercial deployment of the Company's next generation SEARCH'97
suite of products, its Agent Server products and its groupware products for
Microsoft Exchange, continued enhancement of the functionality of the Company's
search engine, and technical integration of the Company's products with the
products of the Company's strategic partners, when added to the day-to-day
activities of the Company, will continue to strain the Company's resources and
personnel.
 
     In connection with its strategy, the Company has also replaced the majority
of its work force and substantially reorganized all of the departments within
the Company. While experiencing substantial turnover, the Company increased the
number of research and development personnel from 29 at the beginning of fiscal
1994 to 91 at November 30, 1996. During the same period, the Company decreased
the number of consulting personnel from 29 at the beginning of fiscal 1994 to 15
at November 30, 1996. Continuity of personnel can be an important factor in the
successful completion of the Company's development projects, and ongoing
turnover in the Company's research and development personnel could materially
and adversely impact the Company's development and marketing efforts. The
Company believes that hiring and retaining qualified individuals at all levels
in the Company is essential to its success, and there can be no assurance that
the Company will be successful in attracting and retaining the necessary
personnel. If Company management is unable to effectively manage its planned
transition or any subsequent growth, identify opportunities in a timely fashion,
and evaluate and manage the Company's business and competitive position, then
its results of operations and financial condition will be materially and
adversely affected.
 
     Fluctuations in Operating Results.  The Company's quarterly operating
results have varied and are expected to vary significantly in the future. These
fluctuations may be caused by many factors, including, among others, the size
and timing of individual orders; customer order deferrals in anticipation of new
products; changes in the budgets or purchasing patterns of government agencies;
timing of introduction or enhancement of products by the Company or its
competitors; market acceptance of new products; technologi-
 
                                       12
<PAGE>   15
 
cal changes in search and retrieval, database, networking, or communications
technology; competitive pricing pressures; changes in the Company's operating
expenses; personnel changes; foreign currency exchange rates; mix of products
sold; quality control of products sold; and general economic conditions.
 
     A significant portion of the Company's revenues in recent quarters has been
derived from relatively large sales to a limited number of customers, and the
Company currently anticipates that future quarters will continue to reflect this
trend. Sales cycles for these customers can be up to six months or longer. In
addition, like many software companies, the Company has generally recognized a
substantial portion of its 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 the Company's
products could have a material adverse effect on the Company's business, results
of operations and financial condition in any particular quarter. To the extent
that significant sales occur earlier than expected, operating results for
subsequent quarters may fail to keep pace or even decline.
 
     Product revenues are also difficult to forecast because the market for
search and retrieval software is uncertain and evolving. Because the Company
generally ships software products within a short period after receipt of an
order, the Company typically does 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 the Company's revenues are derived
from royalties based upon sales by third-party vendors of products incorporating
the Company's technology. These revenues may be subject to extreme fluctuation
and are difficult for the Company to predict. The Company's expense levels are
based, in part, on its expectations as to future revenues and to a large extent
are fixed. Therefore, the Company 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 the Company's expectations or any material
delay of customer orders would have an almost immediate adverse affect on the
Company's operating results and on the Company's ability to achieve
profitability.
 
     The Company's revenues, and particularly its software products revenues,
increased significantly in fiscal 1997 over fiscal 1996. Due to the evolving
nature of the markets for the Company's products and other factors, however,
there can be no assurance that the Company's revenues will continue to increase
significantly or at all in future periods.
 
     As a result of the foregoing and other factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Fluctuations in operating results may also result in volatility in the price of
the shares of the Company's Common Stock.
 
     Developing Market; Unproven Acceptance of the Company's Products.  The
Company has recently introduced or announced several products addressing a
market which has only recently begun to develop, is rapidly evolving and is
characterized by an increasing number of market entrants who have introduced or
developed products and services addressing search and retrieval requirements
over private and public networks, CD-ROM, online services and the Internet.
While the Company has commenced commercial shipment of several of its SEARCH'97
products, there is no assurance that such products will achieve market
acceptance or that future products will be developed and released on a timely
basis.
 
     As is typical in the case of a new and evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty. The software industry addressing the information
management requirements of networked systems, CD-ROM, online services and the
Internet is young and has few proven products. Moreover, critical issues
concerning the commercial use of online services and the Internet (including
security, reliability, cost, ease of use and access, and quality of service)
remain unresolved and may impact the growth of the Internet and online markets,
together with the software standards and electronic media employed in such
markets.
 
     The Company's future operating results will depend in substantial part upon
its ability to increase the installed base of its intelligent search and
filtering technology and to begin to generate significant product revenues from
its products, its SEARCH'97 products and other products addressing the
information retrieval
 
                                       13
<PAGE>   16
 
requirements of individuals and corporations from data sources within an
enterprise and on CD-ROM, online services and the Internet. The Company's future
operating results will also depend upon its ability to successfully market its
technology to online and Internet publishers who use such technology to index
their published information in the format used by Verity. To the extent that
such publishers do not adopt the Company's technology for indexing their
published information, users will be unable to search such information using the
Company's search and retrieval products, which in turn will limit the demand for
the Company's products.
 
     Because the market for certain of the Company's products and services is
new and evolving, it is difficult to assess or predict with any assurance the
growth rate, if any, and size of this market. There can be no assurance that the
market for the Company's products and services will develop, or that the
Company's products or services will achieve market acceptance. If the market
fails to develop, develops more slowly than expected or becomes saturated with
competitors, or if the Company's products do not achieve significant market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected.
 
     A significant element of the Company's strategy is to embed its technology
in products offered by the Company's OEM customers. Many of the markets for such
products are also new and evolving and, therefore, subject to the same risks
faced by the Company in the markets for its own products. In addition,
consolidation in the industries served by the Company could, and acquisition or
development by any of the Company's significant customers of technology
competitive with the Company's would, materially and adversely affect the
Company's business and prospects.
 
     Dependence on International Operations.  In fiscal 1995, fiscal 1996 and
the six months ended November 30, 1996, revenues derived from foreign operations
accounted for approximately 14.3%, 6.6% and 4.2% of the Company's total
revenues, respectively, with European operations alone accounting for 11.9%,
5.6% and 4.2% of revenues for these periods. The Company's export sales
accounted for 24.1%, 19.1% and 22.3% of revenues in fiscal 1995, fiscal 1996,
and the six months ended November 30, 1996, respectively. Accordingly, on a
combined basis, foreign operations and export sales accounted for approximately
38.4%, 25.7% and 26.5% of revenues in fiscal 1995, fiscal 1996 and the six
months ended November 30, 1996, respectively. The Company expects that revenues
derived from foreign operations and export sales will continue to account for a
significant percentage of the Company's revenues for the foreseeable future;
however, these revenues may fluctuate significantly as a percentage of revenues
from period to period. Certain of these revenues have been derived from sales to
foreign government agencies which may be subject to risks similar to those
described below.
 
     There are a number of risks inherent in the Company's international
business activities, including unexpected changes in regulatory requirements,
tariffs and other trade barriers, costs and risks of localizing products for
foreign countries, longer accounts receivable payment cycles, potentially
adverse tax consequences, limits on repatriation of earnings and the burdens of
complying with a wide variety of foreign laws. Additionally, the Company does
not engage in 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, such 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 the Company's results of operations. The
financial stability of foreign markets could also affect the Company's
international sales. In addition, revenues of the Company earned in various
countries where the Company does business may be subject to taxation by more
than one jurisdiction, thereby adversely affecting the Company's earnings. There
can be no assurance that such factors will not have an adverse effect on the
revenues from the Company's future international sales and, consequently, the
Company's results of operations.
 
                                       14
<PAGE>   17
 
     Dependence on United States Government and the Risk of Contract
Termination.  Agencies of the United States government have accounted for a
significant portion of the Company's revenues. Specifically, these agencies
accounted for approximately 25.5%, 10.5% and 7.5% of revenues in fiscal 1995,
fiscal 1996 and the six months ended November 30, 1996, respectively. 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
the Company's products to re-evaluate their needs. Such budget reductions are
expected to continue over at least the next several years. Future reductions in
United States spending on information technologies could have a material adverse
effect on the Company's operating results.
 
     Almost all of the Company's government contracts contain termination
clauses which permit contract termination upon the Company's default or for
convenience of the other contracting party. There can be no assurance such
cancellations will not occur in the future, and any such termination could
adversely affect the Company's operating results.
 
     Technological Change; Market Acceptance of Evolving
Standards.  Historically, the Company has derived substantially all of its
revenues from the license of custom search and retrieval applications and
consulting and other services related to such applications. Recently, the
Company has refined and enhanced its core technology to add functionality and
facilitate incorporation of the Company's technology in a variety of
applications addressing the desktop, CD-ROM, enterprise, online and Internet
markets. Nevertheless, the Company expects that for the foreseeable future it
will continue to derive the largest portion of its revenues from licensing its
technology for enterprise applications.
 
     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, the Company's position in its existing markets or other markets that it
may enter could be eroded rapidly by product advancements by competitors. The
life cycles of the Company's products are difficult to estimate. The Company's
future success will depend, in part, upon its ability to enhance existing
products and to develop new products on a timely basis. In addition, its
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 ("HTML"), and address increasingly sophisticated customer needs. There
can be no assurance that the Company 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. If the Company is
unable to develop and introduce products in a timely manner in response to
changing market conditions or customer requirements, the Company's financial
condition and results of operations would be materially and adversely affected.
 
     In addition, a significant strategy of the Company is to achieve
compatibility between the Company's products and the text publication formats
the Company believes are or will become popular and widely adopted. The Company
invests substantial resources in development efforts aimed at achieving such
compatibility. Any failure by the Company to anticipate or respond adequately to
technology or market developments could result in a loss of competitiveness or
revenue. For instance, to date the Company has focused its efforts on
integration with the Adobe PDF, Netscape 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, the Company's business could be
materially adversely affected.
 
     Because one of the Company's strategies is to embed its basic search engine
in key OEM application products, the Company's sales of its intelligent search
and filtering products depend in part on its ability to maintain compatibility
with these OEM applications. There is no assurance that the Company will be able
to maintain compatibility with these vendors' products or continue to be the
search technology of choice for such OEMs, and the failure to maintain
compatibility with or be selected by such OEMs would materially adversely affect
the Company's sales. Further, the failure of the products of the Company's key
OEM partners to achieve market acceptance could have a material adverse effect
on the Company's results of operations.
 
                                       15
<PAGE>   18
 
     Software products as complex as those offered by the Company may contain
errors that may be detected at any point in the products' life cycles. The
Company has in the past discovered software errors in certain of its products
and has experienced delays in shipment of products during the period required to
correct these errors. There can be no assurance that, despite testing and
quality assurance efforts by the Company and by current and potential customers,
errors will not be found, resulting in loss of or delay in market acceptance and
sales, diversion of development resources, injury to the Company's reputation,
or increased service and warranty costs, any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition. Although the Company generally attempts to limit by contract its
exposure to incidental and consequential damages, and to cap the Company's
liabilities under the contract, if a court failed to enforce the liability
limiting provisions of the Company's contracts for any reason, or if liabilities
arose which were not effectively limited, the Company's operating results could
be materially and adversely affected.
 
                                       16
<PAGE>   19
 
PART II:  OTHER INFORMATION
 
ITEM 1:  LEGAL PROCEEDINGS:
 
     Not Applicable.
 
ITEM 2:  CHANGES IN SECURITIES:
 
     Not Applicable.
 
ITEM 3:  DEFAULTS UPON SENIOR SECURITIES:
 
     Not Applicable.
 
ITEM 4:  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
 
     The Company's Annual Meeting of Stockholders was held on September 16,
1996. Proxies for the meeting were solicited pursuant to Regulation 14A. At the
meeting, management's nominees for two directors and three proposals were
submitted to the stockholders of the Company. Management's nominees for director
were elected by the following votes:
 
<TABLE>
<CAPTION>
                                                                         SHARES
                                                                 ----------------------
                               NOMINEES                          VOTING FOR    WITHHELD
        -------------------------------------------------------  ----------    --------
        <S>                                                      <C>           <C>
        Steven M. Krausz.......................................   8,202,541     81,893
        Charles P. Waite, Jr...................................   8,202,614     81,820
</TABLE>
 
Philippe F. Courtot and Steven A. MacDonald continued to serve as directors of
the Company after the annual meeting and will continue to serve until the Annual
Meeting of Stockholders to be held in 1998 and 1997, respectively.
 
     A second proposal to amend the 1995 Stock Option Plan of the Company to
increase the number of shares of Common Stock of the Company authorized for
issuance thereunder from 2,910,836 shares to 3,310,836 shares and to make
certain other amendments to the Plan, was submitted to a vote of the
stockholders of the Company. The proposal was approved by the following vote:
 
<TABLE>
<CAPTION>
FOR THE PROPOSAL     AGAINST THE PROPOSAL     ABSTENTIONS     BROKER NON-VOTES
----------------     --------------------     -----------     ----------------
<S>                  <C>                      <C>             <C>
    7,216,038               915,741              3,100             149,555
</TABLE>
 
     A third proposal to amend the 1995 Employee Stock Purchase Plan of the
Company to increase the number of shares of Common Stock of the Company
authorized for issuance thereunder from 250,000 shares to 500,000 shares, was
submitted to a vote of the stockholders of the Company. The proposal was
approved by the following vote:
 
<TABLE>
<CAPTION>
FOR THE PROPOSAL     AGAINST THE PROPOSAL     ABSTENTIONS     BROKER NON-VOTES
----------------     --------------------     -----------     ----------------
<S>                  <C>                      <C>             <C>
    7,987,423               146,981                475             149,555
</TABLE>
 
     A final proposal to ratify the appointment of Coopers & Lybrand LLP as the
Company's independent public accountants for the year ending May 31, 1997 was
also submitted to a vote of the stockholders of the Company. The proposal was
approved by the following vote:
 
<TABLE>
<CAPTION>
FOR THE PROPOSAL     AGAINST THE PROPOSAL     ABSTENTIONS     BROKER NON-VOTES
----------------     --------------------     -----------     ----------------
<S>                  <C>                      <C>             <C>
    8,280,606                 3,453                375                   0
</TABLE>
 
ITEM 5:  OTHER INFORMATION:
 
     Not Applicable.
 
ITEM 6:  EXHIBITS AND REPORTS ON FORM 8-K:
 
     A. Exhibits -- See Exhibit Index
 
     B. Form 8-K
 
     On October 10, 1996, the Company filed a Form 8-K with the Securities and
Exchange Commission relating to the Company's adoption of a shareholder rights
plan on September 18, 1996. See Note 5 to Notes to Condensed Consolidated
Financial Statements.
 
                                       17
<PAGE>   20
 
                                   SIGNATURES
 
     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/ DONALD C. MCCAULEY
 
                                            ------------------------------------
                                            Donald C. McCauley
                                            Chief Financial Officer
                                            (Principal Financial and Accounting
                                            Officer)
 
Dated: January 15, 1997
 
                                       18
<PAGE>   21
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                              DESCRIPTION OF DOCUMENT
-------     -----------------------------------------------------------------------
<C>         <S>                                                                        <C>
    2.1     Form of Agreement and Plan of Merger between Verity, Inc., a California
            corporation, and Verity Delaware Corporation, a Delaware corporation,
            filed September 22, 1995.(1)...........................................
    3.1     Certificate of Incorporation of the Company.(1)........................
    3.2     By-Laws.(1)............................................................
    3.3     Certificate of Retirement of Series of Preferred Stock.(7).............
    3.4     Certificate of Designation, Preferences and Rights of Series A
            Preferred Stock.(7)....................................................
    4.1     Amended and Restated Rights Agreement dated August 1, 1995, as
            amended.(1)............................................................
    4.2     Form of Rights Agreement between Verity, Inc. and First National Bank
            of Boston dated September 18, 1996.(6).................................
   10.1     Form of Indemnification Agreement for directors and officers.(1).......
   10.2     Amended and Restated 1995 Stock Option Plan and forms of agreements
            thereunder.(7).........................................................
   10.3     1995 Employee Stock Purchase Plan.(1),(4)..............................
   10.4     1995 Outside Directors Stock Option Plan and forms of agreement
            thereunder.(1),(4).....................................................
   10.5     Employment Agreement between Philippe F. Courtot and the Company dated
            July 15, 1993, together with related Amended and Restated Stock
            Purchase Agreement dated as of June 1, 1995.(1),(4)....................
   10.6     Security and Loan Agreement between Imperial Bank and the Company dated
            April 7, 1994, as amended.(2)..........................................
   10.7     Series G Preferred Stock Purchase Agreement dated August 29,
            1994.(2)...............................................................
   10.8     Series H Preferred Stock Purchase Agreement dated August 1, 1995.(2)...
   10.9     Sublease Agreement between Booz-Allen & Hamilton, Inc. and the Company
            dated April 1, 1988, as amended.(1)....................................
  10.10     Lease Agreement between The Trustees of the Roman Catholic Church of
            the Archdiocese of Canberra and Goulburn and the Company dated July 1,
            1993 (Australia).(1)...................................................
  10.11     Lease Agreement between Peel Investments (North) Limited and the
            Company dated 1994 (England).(1).......................................
  10.12     Lease Agreement between Le Centre D'Affaires Perinord and the Company
            dated November 26, 1992 (France).(1)...................................
  10.13     Lease Agreement between Oskam Vastgoed De Meern B.V. and the Company
            dated September 1, 1990 (The Netherlands).(1)..........................
  10.14     OEM Software Development and Run Time License Agreement between Adobe
            Systems, Inc. and the Company dated July 29, 1994, as
            amended.(1),(5)........................................................
  10.15     License Agreement between Frame Technology Corporation and the Company
            dated May 29, 1992.(1),(5).............................................
  10.16     OEM Development and License Agreement between the Company and Delphi
            Internet Services Corporation dated as of August 23, 1995.(1),(5)......
  10.18     Lease Agreement between Ross Drive Investors and the Company dated
            January 22, 1996.(3)...................................................
   11.1     Statement of computation of net income and loss per share..............
   27.1     Financial Data Schedule................................................
</TABLE>
 
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<PAGE>   22
 
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(1) Incorporated by reference from the exhibits with corresponding numbers from
    the Company's Registration Statement (No. 33-96228), declared effective on
    October 5, 1995.
 
(2) Incorporated by reference from the exhibits with corresponding numbers from
    the Company's Registration Statement (No. 33-80567), declared effective on
    January 17, 1996.
 
(3) Incorporated by reference from the exhibits with corresponding numbers from
    the Company's Form 10-Q for the quarter ended February 29, 1996.
 
(4) Management contract or compensatory plan covering executive officers and
    directors of the Company.
 
(5) Confidential Treatment has been granted for portions of these exhibits.
 
(6) Incorporated by reference from exhibit no. 1 from the Company's Form 8-K as
    filed with the Securities and Exchange Commission on October 10, 1996.
 
(7) Incorporated by reference from the exhibits with corresponding numbers from
    the Company's Form 10-Q for the quarter ended August 31, 1996.
 
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