<PAGE>   1
 
================================================================================
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
 
                            ------------------------
 
                                   FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
 
                FOR THE QUARTERLY PERIOD ENDED FEBRUARY 28, 1998
 
                                       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                                      77-0182779
       (STATE OR OTHER JURISDICTION OF                       (I.R.S. EMPLOYER
       INCORPORATION OR 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 11,269,000 as of February 28, 1998.
 
     This report consists of 21 pages. The Exhibit Index to this report is
located on page 20.
 
================================================================================
<PAGE>   2
 
                                  VERITY, INC.
 
                                   FORM 10-Q
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                        PAGE
                                                                        ----
<S>       <C>                                                           <C>
PART I:   FINANCIAL INFORMATION
Item 1:   Financial Statements........................................    1
          Condensed Consolidated Balance Sheets as of May 31, 1997
            and February 28, 1998.....................................    1
          Condensed Consolidated Statements of Operations for the
            Three Months Ended February 28, 1997 and 1998 and the Nine
            Months Ended February 28, 1997 and 1998...................    2
          Condensed Consolidated Statements of Cash Flows for the Nine
            Months Ended February 28, 1997 and 1998...................    3
          Notes to Condensed Consolidated Financial Statements........    4
Item 2:   Management's Discussion and Analysis of Financial Condition
            and Results of
            Operations................................................    7
 
PART II:  OTHER INFORMATION
Item 1:   Legal Proceedings...........................................   18
Item 2:   Changes in Securities.......................................   18
Item 3:   Defaults upon Senior Securities.............................   18
Item 4:   Submissions of Matters to a Vote of Security Holders........   18
Item 5:   Other Information...........................................   18
Item 6:   Exhibits and Reports on Form 8-K............................   18
Signatures............................................................   19
</TABLE>
 
                                        i
<PAGE>   3
 
PART I: FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
                                  VERITY, INC.
 
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                              MAY 31,    FEBRUARY 28,
                                                                1997         1998
                                                              --------   ------------
                                                                         (UNAUDITED)
<S>                                                           <C>        <C>
Current assets:
  Cash and cash equivalents.................................  $  2,934     $  3,909
  Short-term investments....................................    15,183       11,663
  Trade accounts receivable, less allowance for doubtful
     accounts of $540 in 1997 and $560 in 1998..............    10,868        9,424
  Prepaid and other current assets..........................     1,694        1,035
                                                              --------     --------
          Total current assets..............................    30,679       26,031
Property and equipment, at cost, net of accumulated
  depreciation and amortization.............................    10,048        8,407
Long-term investments.......................................     7,057            5
Other assets................................................     1,659          629
                                                              --------     --------
          Total assets......................................  $ 49,443     $ 35,072
                                                              ========     ========
 
LIABILITIES
Current liabilities:
  Current portion of long-term debt and capital lease
     obligations............................................  $    617     $    255
  Accounts payable..........................................     4,409        2,877
  Accrued compensation......................................     2,106        3,730
  Other accrued liabilities.................................     1,156        1,703
  Deferred revenue..........................................     3,715        4,831
                                                              --------     --------
          Total current liabilities.........................    12,003       13,396
  Long-term debt and capital lease obligations, net of
     current portion........................................       167           10
                                                              --------     --------
          Total liabilities.................................    12,170       13,406
                                                              ========     ========
 
STOCKHOLDERS' EQUITY
Common stock, $.001 par value:
  Authorized: 30,000,000 shares in 1997 and 1998; Issued and
     outstanding 11,018,000 shares in 1997 and 11,269,000
     shares in 1998.........................................        11           11
Additional paid-in capital..................................    90,012       90,904
Notes receivable from stockholders..........................    (1,090)         (62)
Unrealized gain on investments..............................         6           14
Accumulated deficit.........................................   (51,666)     (69,201)
                                                              --------     --------
          Total stockholders' equity........................    37,273       21,666
                                                              --------     --------
          Total liabilities and stockholders' equity........  $ 49,443     $ 35,072
                                                              ========     ========
</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    NINE MONTHS ENDED
                                                            FEBRUARY 28,         FEBRUARY 28,
                                                         ------------------   -------------------
                                                           1997      1998       1997       1998
                                                         --------   -------   --------   --------
                                                            (UNAUDITED)           (UNAUDITED)
<S>                                                      <C>        <C>       <C>        <C>
Revenues:
  Software products....................................  $  9,181   $ 8,652   $ 26,136   $ 18,434
  Service and other....................................     1,942     2,553      5,395      7,299
                                                         --------   -------   --------   --------
          Total revenues...............................    11,123    11,205     31,531     25,733
                                                         --------   -------   --------   --------
Costs of revenues:
  Software products....................................       585       682      2,204      2,248
  Service and other....................................       918     1,148      2,771      4,127
                                                         --------   -------   --------   --------
          Total costs of revenues......................     1,503     1,830      4,975      6,375
                                                         --------   -------   --------   --------
  Gross profit.........................................     9,620     9,375     26,556     19,358
                                                         --------   -------   --------   --------
Operating expenses:
  Research and development.............................     4,050     3,405     10,839     12,591
  Acquisition of in-process research and development...    10,029        --     10,029         --
  Marketing and sales..................................     5,466     5,530     15,454     17,323
  General and administrative...........................     1,196     1,340      3,548      4,976
  Restructuring charges................................        --        --         --      3,006
                                                         --------   -------   --------   --------
          Total operating expenses.....................    20,741    10,275     39,870     37,896
                                                         --------   -------   --------   --------
Loss from operations...................................   (11,121)     (900)   (13,314)   (18,538)
Other income, net......................................       296       340      1,428      1,153
                                                         --------   -------   --------   --------
Net loss before provision for income taxes.............   (10,825)     (560)   (11,886)   (17,385)
Provision for income taxes.............................        --        50         --        150
                                                         --------   -------   --------   --------
Net loss...............................................  $(10,825)  $  (610)  $(11,886)  $(17,535)
                                                         ========   =======   ========   ========
Net loss per share-basic and diluted...................  $  (1.00)  $ (0.05)  $  (1.10)  $  (1.57)
                                                         ========   =======   ========   ========
Number of shares used in per share calculation-basic
  and diluted..........................................    10,841    11,254     10,800     11,152
                                                         ========   =======   ========   ========
</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>
                                                               NINE MONTHS ENDED
                                                                  FEBRUARY 28,
                                                              --------------------
                                                                1997        1998
                                                              --------    --------
                                                                  (UNAUDITED)
<S>                                                           <C>         <C>
Cash flows from operating activities:
  Net loss..................................................  $(11,886)   $(17,535)
  Adjustments to reconcile net loss to net cash used in
     operating activities:
     Depreciation and amortization..........................     2,732       3,966
     Non-cash restructuring charges.........................        --       1,351
     Provision for doubtful accounts........................       150         (87)
     Amortization of discount on securities.................      (517)        (23)
     Exchange loss..........................................        12          --
     Changes in operating assets and liabilities:
       Trade accounts receivable............................       120       1,532
       Prepaid and other current assets.....................      (719)        589
       Accounts payable.....................................       139      (1,533)
       Accrued compensation and other accrued liabilities...       895         860
       Deferred revenue.....................................       433       1,071
       Write-off in-process research and development........    10,029          --
                                                              --------    --------
          Net cash provided by (used in) operating
            activities......................................     1,388      (9,809)
                                                              --------    --------
Cash flows from investing activities:
  Acquisition of property and equipment.....................    (6,923)     (1,006)
  Purchases of marketable securities........................   (49,272)    (10,596)
  Maturity of marketable securities.........................    33,800       5,000
  Proceeds from sale of marketable securities...............    30,462      16,127
  Investment in preferred stock.............................      (167)         50
  Acquisition of Cognisoft Corporation......................   (10,000)         --
  Capitalization of software................................    (1,035)       (198)
  Increase in other assets..................................       (28)         --
                                                              --------    --------
          Net cash provided by (used in) investing
            activities......................................    (3,163)      9,377
                                                              --------    --------
Cash flows from financing activities:
  Borrowings under line of credit...........................     1,500       1,500
  Payments on line of credit................................    (1,500)     (1,500)
  Proceeds from stockholders on notes receivable............       135       1,028
  Proceeds from the sale of common stock....................     1,093         892
  Principal payments on notes payable and capital lease
     obligations............................................      (125)       (520)
                                                              --------    --------
          Net cash provided by financing activities.........     1,103       1,400
                                                              --------    --------
Effect of exchange rate changes on cash.....................       (65)          7
                                                              --------    --------
          Net increase (decrease) in cash and cash
            equivalents.....................................      (737)        975
Cash and cash equivalents, beginning of period..............     2,482       2,934
                                                              --------    --------
Cash and cash equivalents, end of period....................  $  1,745    $  3,909
                                                              ========    ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid during the period for interest..................  $    153    $     95
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
  ACTIVITIES:
  Assets acquired in Cognisoft acquisition..................  $    548          --
  Liabilities assumed in Cognisoft acquisition..............  $    500          --
  Cognisoft acquisition consideration included in accrued
     liabilities............................................  $     77          --
</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 FEBRUARY 28, 1998 AND FOR THE QUARTERS ENDED
            FEBRUARY 28, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)
 
 1. INTERIM FINANCIAL DATA (UNAUDITED):
 
     The unaudited financial statements for the quarters ended February 28, 1997
and 1998 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. 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, 1997.
 
     The Company's balance sheet as of May 31, 1997 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 LOSS PER SHARE
 
     The Company has adopted Statement of Financial Accounting Standards No. 128
(SFAS No. 128), "Earnings Per Share," which requires the presentation of basic
and diluted net income per share. Basic net income per common share is computed
using the weighted average number of common shares outstanding during the
period. Diluted net income per share is computed using the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. Dilutive common equivalent shares consist of stock options. The Company
has restated all prior period per share data presented as required by SFAS No.
128. No adjustments were required as a result of the revised computations. For
the three months and nine months ended February 28, 1997 and 1998, common
equivalent shares from stock options, warrants and preferred stock are excluded
from the computation since their effect is antidilutive.
 
 3. RECENT ACCOUNTING PRONOUNCEMENTS
 
     In June 1997, the FASB issued SFAS No. 130, "Comprehensive Income." SFAS
No. 130 becomes effective for fiscal years beginning after December 15, 1997 and
requires reclassification of earlier financial statements for comparative
purposes. SFAS No. 130 requires that changes in the amounts of certain items,
including foreign currency translation adjustments and gains and losses on
certain securities be shown in the financial statements. SFAS No. 130 does not
require a specific format for the financial statement in which comprehensive
income is reported, but does require that an amount representing total
comprehensive income be reported in that statement. Management has not yet
determined the effect, if any, of the adoption of SFAS No. 130 on the
consolidated financial statements.
 
     Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." This Statement will change
the way public companies report information about segments of their business in
annual financial statements and requires them to report selected segment
information in their quarterly reports issued to stockholders. It also requires
entity-wide disclosures about the products and services an entity provides, the
material countries in which it holds assets and reports revenues, and its major
customers. The Statement is effective for fiscal years beginning after December
15, 1997. Management has not yet determined the effect, if any, of the adoption
of SFAS No. 131 on the consolidated financial statements.
 
                                        4
<PAGE>   7
                                  VERITY, INC.
 
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
        (INFORMATION AS OF FEBRUARY 28, 1998 AND FOR THE QUARTERS ENDED
            FEBRUARY 28, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)
 
     In October 1997, the Accounting Standards Executive Committee issued
Statement of Position 97-2 (SOP 97-2), "Software Revenue Recognition," which
delineates the accounting for software product and maintenance revenues. SOP
97-2 supersedes the Accounting Standards Executive Committee Statement of
Position 91-1, "Software Revenue Recognition," and is effective for transactions
entered into in fiscal years beginning after December 15, 1997. The Company is
evaluating the requirements of SOP 97-2 and the effects, if any, on the
Company's current revenue recognition policies.
 
 4. BANK LINE OF CREDIT
 
     The Company's unsecured line of credit, which provided for up to $7.5
million in credit, expired on November 29, 1997. The Company obtained a new
secured line of credit with the same bank subsequent to the quarter ended
February 28, 1998. See Note 8 to Condensed Consolidated Financial Statements.
 
 5. CAPITALIZED SOFTWARE
 
     During the three months ended February 28, 1998, the Company did not
capitalize or amortize any software development costs as their amounts were not
material. As of February 28, 1998, the Company does not have any remaining
capitalized software development costs.
 
 6. MANAGEMENT IN TRANSITION
 
     On July 31, 1997, Mr. Gary J. Sbona replaced Mr. Philippe F. Courtot as the
Company's President and Chief Executive Officer, and the Company entered into an
agreement with Regent Pacific Management Corporation, a management firm of which
Mr. Sbona is the Chief Executive Officer. Pursuant to the agreement, Regent
Pacific provides management services to the Company, including the services of
Mr. Sbona as Chief Executive Officer and President and at least three other
Regent Pacific personnel as part of the Company management team. The agreement
had a one year term and could be canceled by the Company after expiration of the
initial 26 week period, with a minimum compensation to Regent Pacific of
$1,300,000 for the initial period.
 
 7. RESTRUCTURING CHARGES
 
     During the quarter ended November 30, 1997, the Company implemented a
worldwide restructuring of its operations which resulted in workforce reductions
and business consolidations. In connection with the restructuring, the Company
recorded a $3.0 million restructuring charge in the quarter ended November 30,
1997, of which approximately $1.6 million was related to severance costs
associated with the reduction in the worldwide workforce, approximately $0.5
million to the termination of certain lease agreements, approximately $0.6
million to the write-off of certain assets and approximately $0.3 million to
other costs associated with the restructuring.
 
     Of the total $3.0 million in restructuring charges, approximately $1.3
million is a current liability at February 28, 1998. Of the $1.3 million, $0.8
million relates to severance costs to be paid out in future quarters, $0.4
million to the termination of certain lease obligations which are scheduled to
be paid out over the remaining life of the lease agreements and $0.1 million to
other costs associated with the restructuring.
 
 8. SUBSEQUENT EVENTS
 
     In March 1998, the Company negotiated a $5 million line of credit under an
agreement with a bank which expires on September 30, 1998. The line of credit is
collateralized by all corporate assets, excluding leased equipment. Borrowings
under the line of credit bear interest at the lender's prime rate (8.5% at
 
                                        5
<PAGE>   8
                                  VERITY, INC.
 
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
        (INFORMATION AS OF FEBRUARY 28, 1998 AND FOR THE QUARTERS ENDED
            FEBRUARY 28, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)
 
February 28, 1998). 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.
 
     On March 11, 1998, the Company announced that it had filed a lawsuit in the
United States District Court for the District of Delaware against Lotus
Development Corporation for copyright infringement, unfair competition, breach
of a 1992 agreement under which Verity licensed certain software to Lotus,
misappropriation of trade secrets, and unjust enrichment and conversion. The
suit alleges breach of a 1992 license agreement between Verity and Lotus in
which Verity licensed certain search software to Lotus. The suit seeks
injunctive relief and damages, among other remedies. The Company also announced
that it has elected to terminate the agreement due to Lotus's breach.
 
                                        6
<PAGE>   9
 
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
       OF OPERATIONS
 
OVERVIEW
 
     HEREIN, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW IN
"RISK FACTORS."
 
     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's core
SEARCH'97 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 Adobe Acrobat, Frame FrameViewer and Documentum Server and
WorkSpace. The Company has also licensed its SEARCH'97 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, Compaq
Computer, the Financial Times and Tandem Computer.
 
     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 1994 and
1995. At February 28, 1998, the Company had cumulative operating losses of $59.5
million, with net losses of $313,000, $17.9 million and $17.5 million for fiscal
1996, fiscal 1997 and the nine months ended February 28, 1998, respectively. For
the three months ended February 28, 1998, total revenues increased 0.7% over the
corresponding fiscal 1997 period, primarily as a result of a 31.5% increase in
service and other revenues. Total revenues for the three months ended February
28, 1998 increased 22.0% from the $9.2 million for the previous three months
ended November 30, 1997. Operating expenses for the three months ended February
28, 1998 decreased in absolute dollars and as a percentage of revenues from the
prior three months, due primarily to $3.0 million of restructuring charges
incurred during the three months ended November 30, 1997. While it is the
Company's goal to increase revenues 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.
 
     During the past few years, the Company has replaced the majority of its
work force and substantially reorganized all of the departments within the
Company. During the quarter ended November 30, 1997, the Company implemented a
worldwide restructuring of its corporate structure which resulted in workforce
reductions and business consolidations. In connection with the restructuring,
the Company recorded a $3.0 million restructuring charge in the quarter ended
November 30, 1997, of which approximately $1.6 million was related to severance
costs associated with the reduction in the worldwide workforce, approximately
$0.5 million to the termination of certain lease agreements, approximately $0.6
million to the write-off of certain assets and approximately $0.3 million to
other costs associated with the restructuring. 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. As noted above, the Company
has experienced significant turnover, including turnover of several senior
members of management. In particular, on July 31, 1997, Mr. Gary J. Sbona was
appointed as the Company's President and Chief Executive Officer, and the
Company entered into an agreement with Regent Pacific Management Corporation
("Regent Pacific"), a management firm of which Mr. Sbona is the Chief Executive
Officer. Pursuant to the agreement, Regent Pacific provides management services
to the Company at a fee of $50,000 per week, including the services of Mr. Sbona
as Chief Executive Officer and President and at least three other Regent Pacific
personnel as part of the Company management team. The original agreement had a
one year term, but could be canceled by the Company after expiration of the
initial 26 week period, with a minimum compensation to Regent Pacific of
$1,300,000 for that initial period. The agreement requires that the Company
indemnify Regent Pacific and Mr. Sbona for certain liabilities arising
 
                                        7
<PAGE>   10
 
out of the performance of services under the agreement. Also, on October 9,
1997, the Company announced the resignation of Donald C. McCauley as Vice
President and Chief Financial Officer.
 
     If Company management is unable to effectively manage the Company's
operations, 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 successfully
develop and introduce new products on a timely basis or that its new or recently
introduced products will achieve market acceptance. See Note 6 to Condensed
Consolidated Financial Statements.
 
     On March 11, 1998, the Company announced that it had filed a lawsuit in the
United States District Court for the District of Delaware against Lotus
Development Corporation for copyright infringement, unfair competition, breach
of a 1992 agreement under which Verity licenses certain software to Lotus,
misappropriation of trade secrets, and unjust enrichment and conversion. The
suit alleges breach of a 1992 license agreement between Verity and Lotus in
which Verity licensed certain search software to Lotus. The suit seeks
injunctive relief and damages, among other remedies. The Company also announced
that it has elected to terminate the agreement due to Lotus's breach. There can
be no assurance that the Company will prevail in its action to recover damages
and obtain injunctive relief, and the Lotus litigation may result in significant
expenses which may have a material adverse effect on the Company's business,
operating results and financial condition.
 
     The Company's revenues are derived from license 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.
 
                                        8
<PAGE>   11
 
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           NINE MONTHS
                                                             ENDED                 ENDED
                                                         FEBRUARY 28,           FEBRUARY 28,
                                                       -----------------      ----------------
                                                        1997       1998       1997       1998
                                                       ------      -----      -----      -----
<S>                                                    <C>         <C>        <C>        <C>
Revenues:
  Software products..................................    82.5%      77.2%      82.9%      71.6%
  Service and other..................................    17.5       22.8       17.1       28.4
                                                       ------      -----      -----      -----
          Total revenues.............................   100.0      100.0      100.0      100.0
                                                       ------      -----      -----      -----
Costs of revenues:
  Software products..................................     5.3        6.1        7.0        8.8
  Service and other..................................     8.2       10.2        8.8       16.0
                                                       ------      -----      -----      -----
          Total costs of revenues....................    13.5       16.3       15.8       24.8
                                                       ------      -----      -----      -----
Gross profit.........................................    86.5       83.7       84.2       75.2
                                                       ------      -----      -----      -----
Operating expenses:
  Research and development...........................    36.4       30.4       34.4       48.9
  In-process research and development................    90.2         --       31.8         --
  Marketing and sales................................    49.1       49.3       49.0       67.3
  General and administrative.........................    10.8       12.0       11.2       19.3
  Restructuring charge...............................      --         --         --       11.7
                                                       ------      -----      -----      -----
          Total operating expenses...................   186.5       91.7      126.4      147.2
                                                       ------      -----      -----      -----
Loss from operations.................................  (100.0)      (8.0)     (42.2)     (72.0)
Interest and other expenses..........................     2.7        3.0        4.5        4.5
                                                       ------      -----      -----      -----
Loss before provision for income taxes...............   (97.3)      (5.0)     (37.7)     (67.5)
Provision for income taxes...........................      --        0.4         --        0.6
                                                       ------      -----      -----      -----
Net loss.............................................   (97.3)%     (5.4)%    (37.7)%    (68.1)%
                                                       ======      =====      =====      =====
</TABLE>
 
  Revenues
 
     Total revenues decreased 18.4% from $31.5 million for the nine months ended
February 28, 1997 to $25.7 million for the nine months ended February 28, 1998.
Total revenues increased 0.7% from $11.1 million for the three months ended
February 28, 1997 to $11.2 million for the three months ended February 28, 1998.
Total revenues for the comparable nine month period decreased primarily due to
decreased revenues from licensing of enterprise products and Internet/publishing
products. Software product revenues decreased as a percentage of total revenues
from 82.9% and 82.5% for the nine months and three months ended February 28,
1997 respectively, to 71.6% and 77.2%, respectively for the comparable periods
in fiscal 1998. Conversely, service and other revenues increased as a percentage
of total revenues from 17.1% and 17.5% for the nine months and three months
ended February 28, 1997 respectively, to 28.4% and 22.8%, respectively, for the
comparable periods in fiscal 1998.
 
     Software product revenues. Software product revenues decreased 29.5% from
$26.1 million for the nine months ended February 28, 1997 to $18.4 million for
the nine months ended February 28, 1998. The decrease for the nine months ended
February 28, 1998 in comparison to the nine months ended February 28, 1997 was
due principally to decreased revenues from licensing of enterprise products and
Internet/publishing products. Software product revenues decreased 5.8% from $9.2
million for the three months end February 28, 1997 to $8.7 million for the three
months ended February 28, 1998. The decrease for the three months ended February
28, 1998 from the three months ended February 28, 1997 was due principally to
decreased revenues from licensing of enterprise products.
 
                                        9
<PAGE>   12
 
     Service and other revenues. Service and other revenues increased 35.3% from
$5.4 million for the nine months ended February 28, 1997 to $7.3 million for the
nine months ended February 28, 1998. Service and other revenues increased 31.5%
from $1.9 million for the three months ended February 28, 1997 to $2.6 million
for the three months ended February 28, 1998. Maintenance and consulting
revenues increased significantly between the comparable periods, but these
increases were partially offset by reduced training revenues.
 
     Revenues from foreign operations accounted for 4.3% and 6.6% of total
revenues, respectively, for the nine months ended February 28, 1997 and 1998,
with European operations alone accounting for 4.3% and 6.6% of total revenues
for those periods. For the nine months ended February 28, 1997 and 1998, export
sales accounted for 22.2% and 27.5% of total revenues, respectively. Revenues
from foreign operations accounted for 4.4% and 4.8%, respectively, for the three
months ended February 28, 1997 and 1998, with European operations alone
accounting for 4.4% and 4.8% of total revenues for those periods. For the three
months ended February 28, 1997 and 1998, export sales accounted for 21.9% and
30.6% of total revenues, respectively. The increase in revenues from foreign
operations as a percentage of revenues resulted primarily from decreased
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 12.6% of the Company's revenues for the nine months
ended February 28, 1997. For the three months ended February 28, 1997, licensing
and maintenance of software products to Southwestern Bell Telephone accounted
for approximately 13.4% of the Company's revenues. No single customer accounted
for more than 10% of the Company's revenues for the nine months and three months
ended February 28, 1998. Revenues derived from sales to the federal government
and its agencies were 7.1% and 8.9% of the Company's revenues for the nine
months ended February 28, 1997 and 1998, respectively, and 6.3% and 7.1% of the
Company's revenues for the three months ended February 28, 1997 and 1998,
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 2.0% from
$2.20 million for the nine months ended February 28, 1997 to $2.25 million for
the nine months ended February 28, 1998, representing 8.4% and 12.2%,
respectively, of the software product revenues. Costs of software products
increased 16.6% from $585,000 for the three months ended February 28, 1997 to
$682,000 for the three months ended February 28, 1998 representing 6.4% and
7.9%, respectively, of the software product revenues. The increase in absolute
dollars was principally due to the inclusion of licensed software relating to
third party software components included in certain products during the periods
ended February 28, 1998. The increase in costs as a percentage of software
product revenues was primarily related to decreased software product revenues
for the nine months ended February 28, 1998.
 
     Costs of service and other. Costs of service and other revenues increased
48.9% from $2.8 million for the nine months ended February 28, 1997 to $4.1
million for the nine months ended February 28, 1998, representing 51.4% and
56.5%, respectively, of service and other revenues. Cost of service and other
revenues increased 25.1% from $918,000 for the three months ended February 28,
1997 to $1.1 million for the three months ended February 28, 1998, representing
47.3% and 45.0%, respectively, of service and other revenues. The increase in
absolute dollars was due principally to increases in consulting and technical
support personnel.
 
  Operating expenses
 
     Research and development. Research and development expenses increased 16.2%
from $10.8 million for the nine months ended February 28, 1997 to $12.6 million
for the nine months ended February 28, 1998, representing 34.4% and 48.9%,
respectively, of total revenues. Research and development expenses decreased
15.9% from $4.1 million for the three months ended February 28, 1997 to $3.4
million for the three months ended February 28, 1998, representing 36.4% and
30.4%, respectively, of total revenues. The increase in absolute costs for the
nine months ended February 28, 1998, was primarily due to a significant increase
in
 
                                       10
<PAGE>   13
 
headcount of research and development personnel. In particular, the Company
incurred increased staffing expense relating principally to the recent
acquisition of KeyView. In addition, during the nine months ended February 28,
1997, the Company capitalized approximately $1.0 million of software development
costs in connection with the development of a number of products included in the
Company's SEARCH'97 product line, which when expensed were included in costs of
software products. The increase in costs as a percentage of total revenues was
primarily related to decreased revenues for the nine months ended February 28,
1998. The decrease in absolute costs and as a percentage of total revenues for
the three months ended February 28, 1998, was primarily due to the closure of
the Company's Applications Division (Cognisoft Corporation) and the U.K.
research and development unit (InSite). Future research and development expenses
may vary as a percentage of total revenues.
 
     Marketing and sales. Marketing and sales expenses increased 12.1% from
$15.5 million in the nine months ended February 28, 1997 to $17.3 million for
the nine months ended February 28, 1998, representing 49.0% and 67.3%,
respectively, of total revenues. Marketing and sales expenses increased 1.2%
from $5.47 million for the three months ended February 28, 1997 to $5.53 million
for the three months ended February 28, 1998, representing 49.1% and 49.4%,
respectively, of total revenues. The increase in absolute costs for the nine
months ended February 28, 1998, was primarily related to the Company's expansion
of its sales organization in the United States and Europe. The increase in costs
as a percentage of total revenues was primarily related to decreased revenues
for the nine months ended February 28, 1998. The Company anticipates it will
continue to make significant investments in marketing and sales.
 
     General and administrative. General and administrative expenses increased
40.2% from $3.5 million in the nine months ended February 28, 1997 to $5.0
million for the nine months ended February 28, 1998, representing 11.3% and
19.3%, respectively, of total revenues. General and administrative expenses
increased 12.0% from $1.2 million in the three months ended February 28, 1997 to
$1.3 million for the three months ended February 28, 1998, representing 10.8%
and 12.0%, respectively, of total revenues. The increase in absolute costs was
primarily related to expenses associated with management in transition. See
"Risk Factors -- Management in Transition; Employee Turnover." The increase in
costs as a percentage of total revenues was primarily related to decreased
revenues for the nine months ended February 28, 1998. The Company anticipates
that future general and administrative expenses will increase due to an increase
in legal expenses associated with the lawsuit filed with Lotus Development
Corporation. See Note 8 to Condensed Consolidated Financial Statements.
 
     Restructuring charges. During the quarter ended November 30, 1997, the
Company implemented a worldwide restructuring of its operations which resulted
in workforce reductions and business consolidations. In connection with the
restructuring, the Company recorded a $3.0 million restructuring charge in the
quarter ended November 30, 1997, of which $1.6 million was related to severance
costs associated with the reduction in the worldwide workforce, $0.5 million to
the termination of certain lease agreements, $0.6 million to the write-off of
certain assets and $0.3 million to other costs associated with the
restructuring.
 
     Of the total $3.0 million in restructuring charges, approximately $1.3
million is a current liability at February 28, 1998. Of the $1.3 million, $0.8
million relates to severance costs to be paid out in future quarters, $0.4
million to the termination of certain lease obligations which are scheduled to
be paid out over the remaining life of the lease agreements and $0.1 million to
other costs associated with the restructuring. See Note 7 of Notes to Condensed
Consolidated Financial Statements.
 
  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.
 
                                       11
<PAGE>   14
 
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 February 28, 1998, the Company had $15.6 million in cash and cash equivalents
and available-for-sale securities.
 
     The Company's operating activities generated cash of $1.4 million and used
cash of $9.8 million for the nine months ended February 28, 1997 and 1998,
respectively. In the nine months ended February 28, 1997, cash generated in
operations consisted primarily of the write-off of in-process research and
development and depreciation and amortization expense. For the nine months ended
February 28, 1998, the Company's net loss for the period was partially offset by
depreciation and amortization expense, non-cash restructuring charges and a
decrease in accounts receivable.
 
     The Company's investing activities used cash of $3.2 million and provided
cash of $9.4 million for the nine months ended February 28, 1997 and 1998,
respectively. For the nine months ended February 28, 1997 cash used in investing
activities consisted primarily of purchases of marketable securities and the
acquisition of Cognisoft Corporation less proceeds from the sale and maturity of
marketable securities. For the nine months ended February 28, 1998, cash
provided by investing activities consisted primarily of proceeds from the sale
and maturity of marketable securities partially offset by purchases of
marketable securities and purchases of property and equipment.
 
     Cash provided by financing activities was $1.1 million and $1.4 million for
the nine months ended February 28, 1997 and 1998, respectively. In the nine
months ended February 28, 1997 and 1998, financing activities consisted
primarily of proceeds from the sale of Common Stock in connection with the
Company's Employee Stock Purchase Plan and proceeds from stockholders on notes
receivable.
 
     At February 28, 1998, the Company's principal sources of liquidity were its
cash, cash equivalents, and short-term investments of $15.6 million. The
Company's unsecured line of credit, which provided for up to $7.5 million in
credit, expired on November 29, 1997. In March 1998, the Company obtained a $5
million line of credit under an agreement with the same bank which expires on
September 30, 1998. The line of credit is collateralized by all corporate
assets, excluding leased equipment. 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
February 28, 1998, no borrowings were outstanding under the new line of credit.
See Note 8 of Notes to Condensed Consolidated Financial Statements.
 
     Capital expenditures, including capital leases, were approximately $6.9
million and $1.0 million for the nine months ended February 28, 1997 and 1998,
respectively. For the nine months ended February 28, 1997, these expenditures
consisted primarily of leasehold improvements and capital equipment related to
the Company's relocation to a new facility. In the nine months ended February
28, 1998, these expenditures consisted principally of purchases of property and
equipment, primarily for computer hardware and software.
 
     The Company believes that its current cash and cash equivalents and funds
generated from operations, if any, will provide adequate liquidity to meet the
Company's capital and operating requirements through at least calendar 1998.
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.
 
                                       12
<PAGE>   15
 
RISK FACTORS
 
     The Company operates in a rapidly changing environment that involves
numerous risks, a number of which are beyond the Company's control. The
following discussion highlights some of those risks. A comprehensive summary of
the risks can be found in the Company's Annual Report on Form 10-K for the
fiscal year ended May 31, 1997 and the Company's definitive Proxy Statement on
Schedule 14A as filed on September 15, 1997.
 
     History of Losses; Strategic Realignment. Since inception, the Company has
incurred significant losses and substantial negative cash flow. In the nine
months ended February 28, 1998, the Company had a net loss of approximately
$17.5 million, and an operating loss of approximately $18.5 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 in Transition; Employee Turnover. 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 SEARCH'97
suite of products, including its Agent Server products, 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. 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. As noted above, the Company has experienced significant turnover,
including turnover of several senior members of management. In particular, on
July 31, 1997, Mr. Gary J. Sbona was appointed as the Company's President and
Chief Executive Officer, and the Company entered into an agreement with Regent
Pacific Management Corporation, a management firm of which Mr. Sbona is the
Chief Executive Officer. Pursuant to the agreement, Regent Pacific will provide
management services to the Company at a fee of $50,000 per week, including the
services of Mr. Sbona as Chief Executive Officer and President and at least
three other Regent Pacific personnel as part of the Company management team. The
agreement had a one year term, but could be canceled by the Company after
expiration of the initial 26 week period, with a minimum compensation to Regent
Pacific of $1,300,000 for that initial period. If Company management is unable
to effectively manage the Company's operations,
 
                                       13
<PAGE>   16
 
identify opportunities in a timely fashion, and evaluate and manage the
Company's business and competitive position, 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; technological 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.
 
     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 have in the past, and may in the future, also
result in volatility in the price of the shares of the Company's Common Stock.
 
     Litigation. On March 11, 1998, the Company announced that it had filed a
lawsuit in the United States strict Court for the District of Delaware against
Lotus Development Corporation for copyright infringement, unfair competition,
breach of a 1992 agreement under which the Company licensed certain software to
Lotus, misappropriation of trade secrets, and unjust enrichment and conversion.
The suit seeks injunctive relief and damages, among other remedies. The Company
also announced that it has elected to terminate the agreement due to Lotus's
breach. There can be no assurance that the Company will prevail in its action to
recover damages and obtain injunctive relief, and the Lotus litigation may
result in significant expenses which may have a material adverse effect on the
Company's business, operating results and financial condition.
 
     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.
There is no assurance that such products will be developed and released on a
timely basis, or that such products will achieve market acceptance.
 
                                       14
<PAGE>   17
 
     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 SEARCH'97 CD Publisher, SEARCH'97 Information Server, SEARCH'97 Agent
Server, KeyView products and other products addressing the information retrieval
and viewing 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 SEARCH'97
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. Revenues from foreign operations
accounted for 4.3% and 6.6% of total revenues, respectively, for the nine months
ended February 28, 1997 and 1998, with European operations alone accounting for
4.3% and 6.6% of total revenues for those periods. For the nine months ended
February 28, 1997 and 1998, export sales accounted for 22.2% and 27.5% of total
revenues, respectively. Revenues from foreign operations accounted for 4.4% and
4.8%, respectively, for the three months ended February 28, 1997 and 1998, with
European operations alone accounting for 4.4% and 4.8% of total revenues for
those periods. For the three months ended February 28, 1997 and 1998, export
sales accounted for 21.9% and 30.6% of total revenues, respectively. The
increase in revenues from foreign operations as a percentage of revenues
resulted primarily from decreased 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. 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
 
                                       15
<PAGE>   18
 
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.
 
     Dependence on United States Government and the Risk of Contract
Termination. Revenues derived from sales to the federal government and its
agencies were 7.1% and 8.9% of the Company's revenues for the nine months ended
February 28, 1997 and 1998, respectively and 6.3% and 7.1% of the Company's
revenues for the three months ended February 28, 1997 and 1998, respectively.
The Company expects that revenues from such government sales will continue to
vary in future periods as a percentage of revenues.
 
     Agencies of the United States government have accounted for a significant
portion of the Company's revenues. Specifically, these agencies accounted for
approximately 10.5%, 9.5% and 8.9% of revenues in fiscal 1996, fiscal 1997 and
the nine months ended February 28, 1998, respectively. Sales to government
agencies fluctuated 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
 
                                       16
<PAGE>   19
 
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 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.
 
     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.
 
                                       17
<PAGE>   20
 
                           PART II: OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
     On March 11, 1998, the Company announced that it had filed a lawsuit in the
United States District Court for the District of Delaware against Lotus
Development Corporation for copyright infringement, unfair competition, breach
of a 1992 agreement under which Verity licensed certain software to Lotus,
misappropriation of trade secrets, and unjust enrichment and conversion. The
suit alleges breach of a 1992 license agreement between Verity and Lotus in
which Verity licensed certain search software to Lotus. The suit seeks
injunctive relief and damages, among other remedies. The Company also announced
that it has elected to terminate the agreement due to Lotus's breach.
 
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
 
     Not Applicable
 
ITEM 5. OTHER INFORMATION
 
     Not Applicable.
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
     A.  Exhibits -- See Exhibit Index
 
     B.  Form 8-K
 
                                       18
<PAGE>   21
 
                                   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/ JAMES E. TICEHURST
                                            ------------------------------------
                                            James E. Ticehurst
                                            Vice President, Administration and
                                              Controller
                                            (Principal Financial Officer)
Dated: April 14, 1998
 
                                       19
<PAGE>   22
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT                                                                 SEQUENTIAL
NUMBER                      DESCRIPTION OF DOCUMENT                      PAGE NO.
-------                     -----------------------                     ----------
<S>       <C>                                                           <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)..........
 2.2      Agreement and Plan of Reorganization dated January 10, 1997
          among Verity, Inc., Cognisoft Acquisition Corporation and
          Cognisoft Corporation, and certain shareholders of
          Cognisoft.(7)...............................................
 2.3      Form of Stock Purchase Agreement dated as of May 31, 1997
          among Verity, 64K and certain shareholders of 64K.(8).......
 2.4      Agreement for Purchase and Sale of Assets dated as of May
          30, 1997 among FTP US, FTP Canada, Verity US and Verity
          Canada.(9)..................................................
 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)................................................
10.7      Series G Preferred Stock Purchase Agreement dated August 29,
          1994.(2)....................................................
10.8      Series H Preferred Stock Purchase Agreement dated August 1,
          1995.(2)....................................................
10.18     Lease Agreement between Ross Drive Investors and the Company
          dated January 22, 1996.(3)..................................
10.19     Retainer Agreement between Regent Pacific Management
          Corporation and Verity, Inc. dated July 13, 1997.(10).......
10.20     Confidential Severance Option Agreement between Verity, Inc.
          and Richard Lo dated August 20, 1997.(10)...................
10.21     Employment Agreement between Anthony J. Bettencourt and the
          Company dated August 28, 1997.(11)..........................
10.22     Security and Loan Agreement between Imperial Bank and the
          Company dated November 30, 1997.............................
27.1      Financial Data Schedule.....................................
</TABLE>
 
---------------
 (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.
 
                                       20
<PAGE>   23
 
 (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.
 
 (8) Relating to the 64K acquisition, incorporated by reference from Exhibit No.
     2.1 to the Company's report on Form 8-K as filed with the Securities and
     Exchange Commission on June 13, 1997.
 
 (9) Relating to the KeyView acquisition, incorporated by reference from Exhibit
     No. 2.1 to the Company's report on Form 8-K as filed with the Securities
     and Exchange Commission on June 13, 1997.
 
(10) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-K for the year ended May 31, 1997.
 
(11) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended August 31, 1997.
 
                                       21