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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



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FORM 10-Q



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(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, 2003



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



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VERITY, INC.

(Exact name of registrant as specified in its charter)



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



894 Ross Drive

Sunnyvale, California 94089

(408) 541-1500

(Address, including zip code, and telephone number, including area code of principal executive offices)



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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 ̈



Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act).    Yes  x    No ̈



The number of shares outstanding of the Registrants Common Stock,
$0.001 par value, was 37,843,732 as of December 31, 2003.



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##### Table of Contents

VERITY, INC.



FORM 10-Q



TABLE OF CONTENTS



|                              |  |                                                                                                                                                                                                      |  | Page
|----------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|PART I. FINANCIAL INFORMATION |  |                                                                                                                                                                                                     
|                              |  |                                                                                                                                                                                                     
|Item 1.                       |  | Financial Statements (unaudited)                                                                                                                                                                     |  | 3   
|                              |  | Condensed Consolidated Balance Sheets  As of November 30, 2003 and May 31, 2003                                                                                                                     |  | 3   
|                              |  | Condensed Consolidated Statements of Operations  For the Three Month Periods Ended November 30, 2003 and November 30, 2002, and the Six Month Periods Ended November 30, 2003 and November 30, 2002 |  | 4   
|                              |  | Condensed Consolidated Statements of Cash Flows  For the Six Month Periods Ended November 30, 2003 and November 30, 2002                                                                            |  | 5   
|                              |  | Notes to Condensed Consolidated Financial Statements                                                                                                                                                 |  | 6   
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                |  | 15  
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                                                                           |  | 36  
|Item 4.                       |  | Controls and Procedures                                                                                                                                                                              |  | 37  
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                                                                                                                     
|                              |  |                                                                                                                                                                                                     
|Item 1.                       |  | Legal Proceedings                                                                                                                                                                                    |  | 39  
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                                                                                                                            |  | 39  
|Item 3.                       |  | Defaults upon Senior Securities                                                                                                                                                                      |  | 39  
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                                                                                                                  |  | 39  
|Item 5.                       |  | Other Information                                                                                                                                                                                    |  | 39  
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                                                                                                                     |  | 40  
|Signature                     |  | 41                                                                                                                                                                                                  



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##### Table of Contents

PART I. FINANCIAL INFORMATION



Item 1.Financial Statements



VERITY, INC.



CONDENSED
CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data, unaudited)



|                                                                                                                                |  | November 30, 2003 |         | May 31, 2003
|------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ------------
|ASSETS                                                                                                                          |  |                   |         |             
|Current assets:                                                                                                                 |  |                   |         |             
|Cash and cash equivalents                                                                                                       |  | $                 | 78,274  |             
|Short-term investments                                                                                                          |  |                   | 75,988  |             
|Trade accounts receivable, net of allowance for doubtful accounts of $1,479 and $1,540                                          |  |                   | 25,311  |             
|Deferred tax assets                                                                                                             |  |                   | 3,916   |             
|Prepaid and other                                                                                                               |  |                   | 5,523   |             
|                                                                                                                                |  |                   |         |             
|Total current assets                                                                                                            |  |                   | 189,012 |             
|Property and equipment, net                                                                                                     |  |                   | 4,487   |             
|Long-term investments                                                                                                           |  |                   | 95,005  |             
|Deferred tax assets                                                                                                             |  |                   | 18,176  |             
|Intangible assets, net                                                                                                          |  |                   | 10,320  |             
|Goodwill                                                                                                                        |  |                   | 15,145  |             
|Other assets                                                                                                                    |  |                   | 451     |             
|                                                                                                                                |  |                   |         |             
|Total assets                                                                                                                    |  | $                 | 332,596 |             
|                                                                                                                                |  |                   |         |             
|LIABILITIES                                                                                                                     |  |                   |         |             
|Current liabilities:                                                                                                            |  |                   |         |             
|Accounts payable                                                                                                                |  | $                 | 3,956   |             
|Accrued compensation                                                                                                            |  |                   | 8,215   |             
|Income tax payable                                                                                                              |  |                   | 3,541   |             
|Deferred purchase payment                                                                                                       |  |                   | 3,049   |             
|Other accrued liabilities                                                                                                       |  |                   | 699     |             
|Deferred revenue                                                                                                                |  |                   | 19,255  |             
|                                                                                                                                |  |                   |         |             
|Total current liabilities                                                                                                       |  |                   | 38,715  |             
|                                                                                                                                |  |                   |         |             
|Deferred purchase payment                                                                                                       |  |                   |        |             
|                                                                                                                                |  |                   |         |             
|Total liabilities                                                                                                               |  |                   | 38,715  |             
|                                                                                                                                |  |                   |         |             
|STOCKHOLDERS EQUITY                                                                                                            |  |                   |         |             
|Common stock, $0.001 par value:                                                                                                 |  |                   |         |             
|Authorized: 200,000 shares; issued and outstanding: 37,690 shares as of November 30, 2003; and 37,560 shares as of May 31,
2003 |  |                   | 38      |             
|Additional paid-in capital                                                                                                      |  |                   | 262,138 |             
|Other comprehensive income                                                                                                      |  |                   | 2,472   |             
|Retained earnings                                                                                                               |  |                   | 29,233  |             
|                                                                                                                                |  |                   |         |             
|Total stockholders equity                                                                                                      |  |                   | 293,881 |             
|                                                                                                                                |  |                   |         |             
|Total liabilities and stockholders equity                                                                                      |  | $                 | 332,596 |             
|                                                                                                                                |  |                   |         |             



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



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##### Table of Contents

VERITY, INC.



CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data, unaudited)



|                                            |  | Three Months Ended November 30, |        |      | Six Months Ended November 30, |       
|------------------------------------------- |  | ------------------------------- | ------ | ---- | ----------------------------- | ------
|                                            |  | 2003                            |        | 2002 |                               |       
|Revenues:                                   |  |                                 |        |      |                               |       
|Software products                           |  | $                               | 16,227 |      | $                             | 12,949
|Service and other                           |  |                                 | 12,672 |      |                               | 9,942 
|                                            |  |                                 |        |      |                               |       
|Total revenues                              |  |                                 | 28,899 |      |                               | 22,891
|                                            |  |                                 |        |      |                               |       
|Costs of revenues:                          |  |                                 |        |      |                               |       
|Software products                           |  |                                 | 429    |      |                               | 291   
|Service and other                           |  |                                 | 3,288  |      |                               | 3,078 
|Amortization of purchased intangible assets |  |                                 | 645    |      |                               |      
|                                            |  |                                 |        |      |                               |       
|Total costs of revenues                     |  |                                 | 4,362  |      |                               | 3,369 
|                                            |  |                                 |        |      |                               |       
|Gross profit                                |  |                                 | 24,537 |      |                               | 19,522
|                                            |  |                                 |        |      |                               |       
|Operating expenses:                         |  |                                 |        |      |                               |       
|Research and development                    |  |                                 | 4,773  |      |                               | 4,481 
|Marketing and sales                         |  |                                 | 11,687 |      |                               | 9,678 
|General and administrative                  |  |                                 | 2,712  |      |                               | 2,462 
|Restructuring charge                        |  |                                 | 972    |      |                               | 993   
|                                            |  |                                 |        |      |                               |       
|Total operating expenses                    |  |                                 | 20,144 |      |                               | 17,614
|                                            |  |                                 |        |      |                               |       
|Income from operations                      |  |                                 | 4,393  |      |                               | 1,908 
|                                            |  |                                 |        |     
|Interest income, net                        |  |                                 | 1,376  |      |                               | 2,034 
|Other income (loss), net                    |  |                                 | 394    |      |                               | (130  
|                                            |  |                                 |        |      |                               |       
|Income before provision for income taxes    |  |                                 | 6,163  |      |                               | 3,812 
|Provision for income taxes                  |  |                                 | 2,524  |      |                               | 1,449 
|                                            |  |                                 |        |      |                               |       
|Net income                                  |  | $                               | 3,639  |      | $                             | 2,363 
|                                            |  |                                 |        |      |                               |       
|Net income per share  basic                |  | $                               | 0.10   |      | $                             | 0.07  
|                                            |  |                                 |        |      |                               |       
|Net income per share  diluted              |  | $                               | 0.09   |      | $                             | 0.07  
|                                            |  |                                 |        |      |                               |       
|Number of shares  basic                    |  |                                 | 37,579 |      |                               | 34,699
|                                            |  |                                 |        |      |                               |       
|Number of shares  diluted                  |  |                                 | 39,475 |      |                               | 35,766
|                                            |  |                                 |        |      |                               |       



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



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VERITY, INC.



CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, unaudited)



|                                                                                 |  | Six Months Ended November 30, |         
|-------------------------------------------------------------------------------- |  | ----------------------------- | --------
|                                                                                 |  | 2003                          |         
|Cash flows from operating activities:                                            |  |                               |         
|Net income                                                                       |  | $                             | 5,459   
|Adjustments to reconcile net income to net cash provided by operating activities |  |                               |         
|Depreciation and amortization                                                    |  |                               | 3,031   
|Allowance for doubtful accounts                                                  |  |                               |        
|Deferred income taxes                                                            |  |                               |        
|Amortization of premium on securities, net                                       |  |                               | 512     
|Changes in operating assets and liabilities:                                     |  |                               |         
|Trade accounts receivable                                                        |  |                               | (2,515  
|Prepaid and other assets                                                         |  |                               | (713    
|Accounts payable                                                                 |  |                               | (1,623  
|Accrued compensation and other accrued liabilities                               |  |                               | (1,109  
|Deferred revenue                                                                 |  |                               | 270     
|                                                                                 |  |                               |         
|Net cash provided by operating activities                                        |  |                               | 3,312   
|                                                                                 |  |                               |         
|Cash flows from investing activities:                                            |  |                               |         
|Acquisition of property and equipment                                            |  |                               | (1,015  
|Purchases of marketable securities                                               |  |                               | (213,149
|Maturity of marketable securities                                                |  |                               | 89,926  
|Proceeds from sale of marketable securities                                      |  |                               | 115,860 
|                                                                                 |  |                               |         
|Net cash used in investing activities                                            |  |                               | (8,378  
|                                                                                 |  |                               |         
|Cash flows from financing activities:                                            |  |                               |         
|Proceeds from the sale of common stock, net of issuance costs                    |  |                               | 14,498  
|Repurchases of common stock                                                      |  |                               | (17,005 
|                                                                                 |  |                               |         
|Net cash used in financing activities                                            |  |                               | (2,507  
|                                                                                 |  |                               |         
|Effect of exchange rate changes on cash                                          |  |                               | 175     
|                                                                                 |  |                               |         
|Net decrease in cash and cash equivalents                                        |  |                               | (7,398  
|Cash and cash equivalents, beginning of period                                   |  |                               | 85,672  
|                                                                                 |  |                               |         
|Cash and cash equivalents, end of period                                         |  | $                             | 78,274  
|                                                                                 |  |                               |         



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



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VERITY, INC.



NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited)



1. Interim Financial Data



The unaudited condensed consolidated financial statements for Verity, Inc. (the Company or Verity) as of November 30, 2003 and for
the three and six months ended November 30, 2003 and 2002 have been prepared on the same basis as the Companys audited financial statements and, in the opinion of management, include all material adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of the financial position and results of operations in accordance with generally accepted accounting principles. Although certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission, the Company believes the disclosures made are adequate to make the
information presented not misleading. The accompanying financial statements should be read in conjunction with the Companys annual financial statements contained in the Companys Annual Report on Form 10-K for the year ended May 31, 2003.



The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses during the reporting period. Managements estimates, judgments and assumptions are continually evaluated based on available information and experience; however,
actual amounts could differ from those estimates. Certain prior period balances have been reclassified to conform to current period presentation.



The consolidated financial statements include the accounts of Verity, Inc. and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.



The Companys balance
sheet as of May 31, 2003 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. Accounting for Computation of Net Income (Loss) and Net Income (Loss) Per Share and
Stock-Based Compensation



Basic earnings per share are
computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of common and common equivalent shares outstanding during the period. Dilutive
common equivalent shares consist of in-the-money stock options. In-the-money options are those for which the exercise price is lower than the average market price being used to determine the value. The Companys average
market price for the second quarter in fiscal year 2004 was $14.1832. As of November 30, 2003 and 2002, 10,705,517 and 12,472,342 anti-dilutive weighted shares have been excluded from the common equivalents calculation.



The Company accounts for stock-based employee compensation arrangements under
compensatory plans using the intrinsic value method, which calculates compensation expense based on the difference, if any, on the date of the grant, between the fair value of the Companys stock and the option exercise price.



Generally accepted accounting principles require companies who choose to
account for stock option grants using the intrinsic value method to also determine the fair value of option grants using a stock option pricing model such as the Black-Scholes model and to disclose the impact of fair value accounting in a note to
the



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited)



financial statements. The impact of recognizing the fair value of option grants and stock grants under the Companys employee stock option and stock
purchase plans as an operating expense would have reduced the Companys net income to a net loss, as follows (in thousands, except per share amounts):



|                                                                                             |  | Three Months EndedNovember 30, |         |   | Six Months Ended November 30, |  
|-------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ----------------------------- | -
|                                                                                             |  | 2003                           |         |   | 2002                          |  
|Net income                                                                                   |  |                                |         |   |                               |  
|Net income  as reported                                                                     |  | $                              | 3,639   |   |                               | $
|                                                                                             |  |                                |         |   |                               |  
|Deduct: Total SFAS 123 stock-based employee compensation expense, net of related tax effects |  |                                | (12,324 | ) |                               |  
|                                                                                             |  |                                |         |   |                               |  
|Net loss  pro forma                                                                         |  | $                              | (8,685  | ) |                               | $
|                                                                                             |  |                                |         |   |                               |  
|Earnings per share                                                                           |  |                                |         |   |                               |  
|Net income per share  basic  as reported                                                   |  | $                              | 0.10    |   |                               | $
|                                                                                             |  |                                |         |   |                               |  
|Net loss per share  basic  pro forma                                                       |  | $                              | (0.23   | ) |                               | $
|                                                                                             |  |                                |         |   |                               |  
|Net income per share  diluted  as reported                                                 |  | $                              | 0.09    |   |                               | $
|                                                                                             |  |                                |         |   |                               |  
|Net loss per share  diluted  pro forma                                                     |  | $                              | (0.23   | ) |                               | $
|                                                                                             |  |                                |         |   |                               |  
|Number of shares used in basic  as reported calculation                                     |  |                                | 37,579  |   |                               |  
|                                                                                             |  |                                |         |   |                               |  
|Number of shares used in diluted  as reported calculation                                   |  |                                | 39,475  |   |                               |  
|                                                                                             |  |                                |         |   |                               |  
|Number of shares used in basic and diluted  pro forma calculation                           |  |                                | 37,579  |   |                               |  
|                                                                                             |  |                                |         |   |                               |  



The Company calculated
the fair value of each option grant on the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used for each respective period:



|                        |  | Three Months EndedNovember 30, |  | Six Months EndedNovember 30,
|----------------------- |  | ------------------------------ |  | ----------------------------
|                        |  | 2003                           |  | 2002                        
|Stock Option Plans      |  |                                |  |                             
|Expected volatility     |  | 93%                            |  | 80%                         
|Risk-free interest rate |  | 2.20%                          |  | 2.18%                       
|Expected life           |  | 4.00 years                     |  | 4.29 years                  
|Expected dividend yield |  | 0.00%                          |  | 0.00%                       
|                        |  |                                |  |                             
|Stock Purchase Plan     |  |                                |  |                             
|Expected volatility     |  | 68%                            |  | 90%                         
|Risk-free interest rate |  | 1.38%                          |  | 1.93%                       
|Expected life           |  | 1.00 year                      |  | 1.00 year                   
|Expected dividend yield |  | 0.00%                          |  | 0.00%                       



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited)



3. Investments



As of November 30, 2003 and May 31, 2003, available-for-sale securities consist of the following (in thousands):



|                  |  | November 30, 2003 |         | May 31, 2003                   
|----------------- |  | ----------------- | ------- | -------------------------------
|                  |  | Amortized Cost    |         | Gross Unrealized Gains (Losses)
|Short-term        |  |                   |         |                                
|Corporate         |  | $                 | 38,422  |                                
|Government        |  |                   | 5,000   |                                
|Other             |  |                   | 32,275  |                                
|                  |  |                   |         |                                
|Total short-term  |  | $                 | 75,697  |                                
|                  |  |                   |         |                                
|Long-Term         |  |                   |         |                                
|Corporate         |  | $                 | 9,986   |                                
|Government        |  |                   | 82,925  |                                
|Other             |  |                   | 2,375   |                                
|                  |  |                   |         |                                
|Total long-term   |  |                   | 95,286  |                                
|                  |  |                   |         |                                
|Total investments |  | $                 | 170,983 |                                
|                  |  |                   |         |                                



The maturity of our
long-term investments ranges from one to three years.



4. Deferred Purchase
Payment



On December 17, 2002, the Company completed the
purchase of certain assets and obligations of Inktomi Corporations enterprise search software business. Of the total purchase price, the Company deferred $3.0 million in order to secure Inktomis indemnification obligations under the
Purchase Agreement. On June 17, 2004, the Company is obligated to pay Inktomi an amount equal to the sum of (1) $3.0 million plus (2) simple interest thereon calculated from the December 17, 2002 through the date of payment at an annual rate of
1.5%. The Company has the right to withhold or deduct from the deferred payment amount any sum that may be owed to it by Inktomi pursuant to Inktomis indemnification obligations under the Purchase Agreement. The Company believes the likelihood
of indemnification is remote.



At November 30, 2003, the
deferred purchase payment was categorized as a short-term liability as the payment was due within twelve months of this date. At May 31, 2003, the deferred purchase payment was categorized as a long-term liability as the payment was due greater than
twelve months from this date.



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited)



5. Comprehensive Income



Comprehensive income is defined as the change in equity (net assets) of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources, such as foreign currency translation gains and losses and unrealized gains and losses on available-for-sale securities that are reflected in stockholders equity instead of
net income. The following table sets forth the calculation of comprehensive income (in thousands):



|                                                                    |  | Three Months Ended November 30, |       |   | Six Months Ended November 30,
|------------------------------------------------------------------- |  | ------------------------------- | ----- | - | -----------------------------
|                                                                    |  | 2003                            |       |   | 2002                         
|Net Income                                                          |  | $                               | 3,639 |   |                              
|Foreign currency translations gain                                  |  |                                 | 475   |   |                              
|Unrealized gain (loss) on available-for-sale securities, net of tax |  |                                 | (60   | ) |                              
|                                                                    |  |                                 |       |   |                              
|Comprehensive income                                                |  | $                               | 4,054 |   |                              
|                                                                    |  |                                 |       |   |                              



6. Business Segment



Substantially all of the Companys revenues result from the sale of
the Companys software products and related services. Accordingly, the Company considers itself to be in a single reporting segment, specifically the license, implementation and support of its software. The Companys chief operating
decision-making group reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance.



The Company also has sales and marketing operations located in
the Netherlands, the United Kingdom, France, Germany, South Africa, Mexico, Australia, Japan, a joint investment partnership in Brazil and a development and technical support operation in Canada. Foreign branch and subsidiary revenues consist
primarily of maintenance and consulting services and are being allocated based on foreign branch and subsidiary location. Disclosed in the table below is geographic information for any individual country comprising greater than 10% of the
Companys total revenues or greater than 10% of the Companys long-lived assets. Rest of world (ROW) includes Australia, Brazil, Canada, Japan, Mexico and South Africa.



|               |  | Three Months EndedNovember 30, |        | Six Months Ended November 30,
|-------------- |  | ------------------------------ | ------ | -----------------------------
|               |  | 2003                           |        | 2002                         
|               |  | (in thousands)                
|Revenues:      |  |                                |        |                              
|USA            |  | $                              | 19,539 |                              
|United Kingdom |  |                                | 3,048  |                              
|Other Europe   |  |                                | 4,227  |                              
|ROW            |  |                                | 2,085  |                              
|               |  |                                |        |                              
|Consolidated   |  | $                              | 28,899 |                              
|               |  |                                |        |                              



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited)



|                   |  | November 30, 2003
|------------------ |  | -----------------
|                   |  | (in thousands)   
|Long-lived assets: |  |                  
|USA                |  | $                
|Europe             |  |                  
|Canada             |  |                  
|                   |  |                  
|Other ROW          |  |                  
|                   |  |                  
|Consolidated       |  | $                
|                   |  |                  



Long-lived assets of
geographic areas are those assets used in the Companys operations in each area.



Of the total $9.4 million, $8.7 million, $18.4 million and $16.6 million of revenues outside the U.S. for the three and six month periods ended November 30, 2003 and 2002, respectively, there were $4.8 million, $5.0
million, $9.6 million and $9.3 million of export sales (shipped from the U.S. to non-U.S. locations) and $4.6 million, $3.7 million, $8.8 million and $7.3 million of sales derived from the Companys foreign operations, respectively.



No single customer accounted for more than 10% of the Companys total
revenues for the three and six month periods ended November 30, 2003 and 2002. Revenues derived from sales to the United States government and its agencies were 9.8% and 11.1% of the Companys total revenues for the three month periods ended
November 30, 2003 and 2002, respectively, and 10.6% and 10.1% of the Companys total revenues for the six month periods ended November 30, 2003 and 2002, respectively.



7. Stock Repurchase Program



On June 24, 2003, the Company announced the continuation of its stock repurchase program. The continuation calls for the additional repurchase of
outstanding shares of the Companys common stock up to an aggregate value of $50.0 million. The program will terminate at the end of the fiscal year ending May 31, 2004 unless amended by the Board of Directors. Through November 30, 2003, the
Company repurchased and retired 1,190,987 shares of its common stock through open market transactions, at an aggregate cost of approximately $17.0 million.



8. Restructuring Costs



During each of the periods ended November 30, 2003 and November 30, 2002, the Company executed restructuring efforts designed to reduce costs and to
better align its expense levels with current revenue levels and ensure conservative spending during the current period of economic uncertainty, as described below.



|Restructuring charges: (three and six month periods ended) |  | November 30,2003 |      | November 30,2002
|---------------------------------------------------------- |  | ---------------- | ---- | ----------------
|                                                           |  | (in millions)   
|Severance costs                                            |  | $                | 0.90 |                 
|Legal and other outside services costs                     |  |                  | 0.07 |                 
|Other charges                                              |  |                  | 0.00 |                 
|                                                           |  |                  |      |                 
|Total restructuring charges                                |  | $                | 0.97 |                 
|                                                           |  |                  |      |                 



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited)



With respect to the restructuring executed during the quarter ended November 30, 2003, the Company
implemented this worldwide restructuring plan to focus on reducing expenses and improving efficiency due to continued macro-economic and capital spending issues affecting the software industry. In connection with the restructuring, the Company
recorded in the quarter ended November 30, 2003, a $0.97 million restructuring charge, of which approximately $0.9 million was related to severance costs associated with the reduction in the worldwide workforce by approximately 40 employees and
approximately $0.07 million to legal and other outside services costs associated with the restructuring. The restructuring impacted operations in the U.S., Canada and Europe and was across all functional areas of the company.



|Quarter Ended November 30, 2003 |  | WorkforceReduction |       |   | Legal and Other Outside Services |   |       | Other |  | Total |     
|------------------------------- |  | ------------------ | ----- | - | -------------------------------- | - | ----- | ----- |  | ----- | ----
|                                |  | (in millions)      |      
|Restructuring provision         |  | $                  | 0.90  |   |                                  | $ | 0.07  |       |  | $     | 0.00
|Cash payments                   |  |                    | (0.88 | ) |                                  |   | (0.04 | )     |  |       | 0.00
|                                |  |                    |       |   |                                  |   |       |       |  |       |     
|Balance at November 30, 2003    |  | $                  | 0.02  |   |                                  | $ | 0.03  |       |  | $     | 0.00
|                                |  |                    |       |   |                                  |   |       |       |  |       |     



Of the total $0.97
million restructuring charge, approximately $0.05 million remains unpaid at November 30, 2003. Of the $0.05 million, approximately $0.02 million relates to severance costs to be paid in future quarters and approximately $0.03 million to legal and
other outside services costs associated with the restructuring. The unpaid amount will be paid out over the next two quarters.



With respect to the restructuring executed during the quarter ended November 30, 2002, the Company implemented this worldwide restructuring and recorded a
$0.99 million restructuring charge, of which approximately $0.72 million was related to severance costs associated with the reduction in the worldwide workforce by 50 employees, approximately $0.10 million to legal and other outside services in
connection with the restructuring and approximately $0.17 million to other costs associated with the restructuring. The restructuring impacted operations in the U.S., Canada, the U.K., Germany, France, the Netherlands, Sweden and South Africa.



At November 30, 2003, $0.18 million of the restructuring
executed during the quarter ended November 30, 2002 remains unpaid and is mostly related to a facilities lease and will be paid out ratably over the remaining life of the lease, which terminates in October 2005.



9. Subsequent Event



Regent Pacific Management Corporation (Regent Pacific) has been providing management services to the Company
pursuant to a Retainer Agreement between the Company and Regent Pacific dated July 31, 1997, as amended, (as amended, the Retainer Agreement). In January 2004, the Company and Regent Pacific entered into an amendment to the Retainer
Agreement providing for a 75% reduction in weekly fees payable by the Company under the Retainer Agreement, beginning in March 2004, as well as an extension of the non-cancelable period of the Retainer Agreement from February 28, 2004 to February
28, 2005. As a result of the amendment, the services to be rendered by Regent Pacific to the Company under the Retainer Agreement will be reduced. In addition, pursuant to the amendment, Gary J. Sbona will continue to serve as the Companys
Executive Chairman of the Board, but Stephen W. Young will cease to serve as the Companys Chief Operating Officer effective as of March 1, 2004.



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited)



10. Recent Accounting Pronouncements



In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 143, Accounting for Asset Retirement Obligations. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset. The liability is accreted to its present value each period while the cost is depreciated over its useful life. The Companys adoption of SFAS No. 143 in its fiscal
year 2002 did not have a significant impact on the Companys financial position or results of operations.



In August 2001, the FASB issued SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS No. 121), however it retains the fundamental provisions of SFAS No. 121 for (1) the recognition and measurement of the impairment of
long-lived assets to be held and used and (2) the measurement of long-lived assets to be disposed of by sale. SFAS No. 144 develops a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly
acquired assets and consequently amends Accounting Principles Board Opinion No. 30, Reporting Results of Operations - Reporting the Effects of Disposal of a Division of a Business. Additionally, SFAS No. 144 expands the scope of
discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is
effective for the Companys fiscal year beginning June 1, 2002. The adoption of SFAS No. 144 did not have a significant impact on the Companys financial position or results of operations.



In November 2001, the Emerging Issues Task Force (EITF) of the
FASB reached a consensus on Issue No. 01-09, Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendors Products. EITF No. 01-09 addresses whether consideration from a vendor to a reseller of the
vendors products is an adjustment to the selling prices of the vendors products and, therefore, should be deducted from revenue when recognized in the vendors results of operations, or a cost incurred by the vendor for assets or
services received from the reseller and, therefore, should be an expense when recognized in the vendors results of operations. EITF No. 01-09 is effective for the Company beginning November 1, 2001. The Companys adoption of EITF No.
01-09 did not have a significant impact on the Companys financial position or results of operations.



In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 nullifies the
guidance of the EITF in EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Under EITF Issue No. 94-3, an entity
recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. In SFAS No. 146, the FASB acknowledges that an entitys commitment to a plan does not, by itself, create a present obligation to other parties
that meets the definition of a liability and requires that a liability for a cost that is associated with an exit or disposal activity be recognized when the liability is incurred. It also establishes that fair value is the objective for the initial
measurement of the liability. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Companys adoption of SFAS No. 146 did not have a significant impact on the Companys financial
position or results of operations.



In November 2002, the FASB
issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited



requires that upon issuance of a guarantee, the guarantor must disclose and recognize a liability for the fair value of the obligation it assumes under that
guarantee. The initial recognition and measurement requirement of FIN 45 is effective for guarantees issued or modified after December 31, 2002. As of November 30, 2003, the Companys guarantees that were issued or modified after December 31,
2002 were not material.



The Company enters into standard
indemnification provisions within its software license agreements with its customers and technology partners. Pursuant to these provisions, the Company typically indemnifies, defends and holds harmless the indemnified party for losses suffered or
incurred by the indemnified party in connection with any U.S. patent, copyright or other intellectual property infringement claim by any third party with respect to its products. The term of these indemnification provisions is generally perpetual
any time after execution of the license agreement. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited.



The Company generally warrants that its software products will perform in all
material respects in accordance with its standard published specifications. Historically, costs related to this warranty have not been significant.



The Company has agreements in place with its directors and officers whereby it indemnifies them for certain events or occurrences while the officer and
director is, or was, serving at the Companys request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a
director and officer insurance policy, which may enable it to recover a portion of any future amounts paid.



In November 2002, the EITF reached a consensus on Issue No. 00-21 (Issue 00-21), Revenue Arrangements with Multiple Deliverables.
Issue 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of Issue 00-21 will apply to revenue arrangements entered into in
fiscal periods beginning after June 15, 2003. The adoption of Issue 00-21 did not have a material effect on the Companys consolidated financial position, results of operations or cash flows.



In November 2002 the EITF reached a consensus opinion on EITF No. 02-16,
Accounting by a Customer (including a reseller) for Certain Consideration Received from a Vendor. EITF No. 02-16 requires that cash payments, credits, or equity instruments received, as consideration by a customer from a vendor should be
presumed to be a reduction of cost of sales when recognized by the customer in the income statement. In certain situations, the presumption could be overcome and the consideration recognized either as revenue or a reduction of a specific cost
incurred. The consensus applies prospectively to new or modified arrangements entered into after December 31, 2002. At November 30, 2003, the Company was not a party to transactions contemplated by EITF 02-16.



In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure. SFAS No. 148 amends certain provisions of SFAS No. 123 and is effective for financial statements for fiscal years ending after December 15, 2002. It provides alternative methods
of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires the disclosure of the pro forma effects on an entitys accounting policy with
respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The Company does not currently intend to adopt the fair value based



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VERITY, INC.



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Information as of November 30, 2003 and for the three and six months ended

November 30, 2003 and 2002 is unaudited



method of accounting for stock-based employee compensation and will continue to apply the intrinsic-value based method. The Company has determined the fair
value of option grants using the Black-Scholes stock option pricing model and has provided this pro forma disclosure of the impact of fair value accounting in note 2 to the financial statements, Accounting for Stock-Based Compensation.



In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46). FIN 46 requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable
interest entity should be included in the consolidated financial statements of the entity. FIN 46 is effective February 28, 2004. The Company does not have any interests in variable interest entities.



On April 30, 2003, the FASB issued Statement No. 149 (Statement
149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Statement 149 is intended to result in more consistent reporting of contracts as either freestanding derivative instruments subject to Statement 133 in its
entirety, or as hybrid instruments with debt host contracts and embedded derivative features. In addition, Statement 149 clarifies the definition of a derivative by providing guidance on the meaning of initial net investments related to derivatives.
Statement 149 is effective for contracts entered into or modified after June 30, 2003. The adoption of Statement 149 did not have a material effect on the Companys consolidated financial position, results of operations or cash flows.



On May 15, 2003, the FASB issued Statement No. 150
(Statement 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. Statement 150 establishes standards for classifying and measuring as liabilities certain financial instruments
that embody obligations of the issuer and have characteristics of both liabilities and equity. Statement 150 represents a significant change in practice in the accounting for a number of financial instruments, including mandatorily redeemable equity
instruments and certain equity derivatives that frequently are used in connection with share repurchase programs. The Company does not use such instruments in its share repurchase program. Statement 150 is effective for all financial instruments
created or modified after May 31, 2003, and to other instruments as of September 1, 2003. The adoption of Statement 150 did not have a material effect on the Companys consolidated financial position, results of operations or cash flows.



In July 2003, the EITF reached a consensus on Issue No. 03-05,
Applicability of AICPA SOP 97-2 to Non Software Deliverables in an Arrangement Containing More Than Incidental Software. The consensus opinion in EITF No. 03-05 clarifies the guidance in EITF 00-21 and was reached on July 31, 2003. The
adoption of Issue No. 03-05 did not have a material effect on the Companys consolidated financial position, results of operations or cash flows.



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



The following discussion should be read in conjunction with the consolidated financial statements and related notes, which appear in our Annual Report
on Form 10-K for the fiscal year ended May 31, 2003. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly under the heading Risk Factors below.



Overview



We offer products and technology that address the business portal, e-commerce, and knowledge management markets, which we
define broadly as intellectual capital management. The intellectual capital management market includes enterprise intranets and corporate portals used for sharing information within an enterprise, e-commerce sites for online selling, and extranets
for business-to-business activities. Intellectual capital management solutions provide secure, personalized access to information for employees, partners, customers and suppliers, wherever that information may reside in the enterprise. We expect
that for the foreseeable future we will continue to derive the largest portion of our revenues from licensing our technology for enterprise and e-commerce applications and intellectual capital management solutions.



In December 2002, we completed the acquisition of the enterprise search
assets of Inktomi Corporation, further expanding our product portfolio to include solutions for smaller organizations and departments within larger enterprises. In addition to addressing these markets, the acquired enterprise search software,
re-branded Verity Ultraseek, is in use at a number of larger enterprises for search-only applications as well. We are continuing development and support of the Ultraseek product line, and believe that the larger enterprises in the installed base
represent an upgrade opportunity to our broader intellectual capital management solutions as their needs grow.



Critical Accounting Policies and Estimates



The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and
liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, bad debts, income taxes and intangible assets. We base our estimates on historical experience and on
various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on form 10-K for the fiscal year ended May 31, 2003.



Related Party Transactions



Regent Pacific Management Corporation (Regent Pacific) has been
providing management services to Verity pursuant to a Retainer Agreement between Verity and Regent Pacific dated July 31, 1997, as amended, (as amended, the Retainer Agreement). In January 2004, Verity and Regent Pacific entered into an
amendment to the Retainer Agreement providing for a 75% reduction in weekly fees payable by Verity under the Retainer Agreement, beginning in March 2004, as well as an extension of the non-cancelable period of the Retainer Agreement from February
28, 2004 to February 28, 2005. As a result of the amendment, the services to be rendered by Regent Pacific to Verity under the Retainer Agreement will be reduced. In addition, pursuant to the amendment, Gary J. Sbona will continue to serve as our
Executive Chairman of the Board, but Stephen W. Young will cease to serve as our Chief Operating Officer effective as of March 1, 2004. Messrs. Sbona and Young are both officers of Regent Pacific. As a result of the amendment, we will continue
to incur operating expenses of approximately $162,500 per quarter under this agreement, which will be approximately $487,500 per



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quarter less than we have been incurring since July 1997. These operating expenses will continue to be allocated to all functional areas based on headcount.



Results of Operations



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



|                                            |  | Three MonthsEndedNovember 30, |   |  | Six MonthsEndedNovember 30, |  
|------------------------------------------- |  | ----------------------------- | - |  | --------------------------- | -
|                                            |  | 2003                          |   |  | 2002                        |  
|                                            |  | (unaudited)                   |   |  | (unaudited)                 |  
|Revenues:                                   |  |                               |   |  |                             |  
|Software products                           |  | 56.2                          | % |  | 56.6                        | %
|Service and other                           |  | 43.8                          |   |  | 43.4                        |  
|                                            |  |                               |   |  |                             |  
|Total revenues                              |  | 100.0                         |   |  | 100.0                       |  
|                                            |  |                               |   |  |                             |  
|Costs of revenues:                          |  |                               |   |  |                             |  
|Software products                           |  | 1.5                           |   |  | 1.3                         |  
|Service and other                           |  | 11.4                          |   |  | 13.4                        |  
|Amortization of purchased intangible assets |  | 2.2                           |   |  |                            |  
|                                            |  |                               |   |  |                             |  
|Total costs of revenues                     |  | 15.1                          |   |  | 14.7                        |  
|                                            |  |                               |   |  |                             |  
|Gross profit                                |  | 84.9                          |   |  | 85.3                        |  
|                                            |  |                               |   |  |                             |  
|Operating expenses:                         |  |                               |   |  |                             |  
|Research and development                    |  | 16.5                          |   |  | 19.6                        |  
|Marketing and sales                         |  | 40.4                          |   |  | 42.3                        |  
|General and administrative                  |  | 9.4                           |   |  | 10.8                        |  
|Restructuring charge                        |  | 3.4                           |   |  | 4.3                         |  
|                                            |  |                               |   |  |                             |  
|Total operating expenses                    |  | 69.7                          |   |  | 77.0                        |  
|                                            |  |                               |   |  |                             |  
|Income from operations                      |  | 15.2                          |   |  | 8.3                         |  
|Interest income, net                        |  | 4.7                           |   |  | 8.9                         |  
|                                            |  |                               |   |  |                             |  
|Other income (loss), net                    |  | 1.4                           |   |  | (0.5                        | )
|                                            |  |                               |   |  |                             |  
|Income before provision for income taxes    |  | 21.3                          |   |  | 16.7                        |  
|Provision for income taxes                  |  | 8.7                           |   |  | 6.3                         |  
|                                            |  |                               |   |  |                             |  
|Net income                                  |  | 12.6                          | % |  | 10.4                        | %
|                                            |  |                               |   |  |                             |  



Three and Six
Month Periods Ended November 30, 2003 and 2002



Prior
period financials have been reclassified to conform to presentations adopted in fiscal year 2004.



Revenues



Total revenues



|                   |  | November 30,2003             |      | November 30,2002 |   | Change | 
|------------------ |  | ---------------------------- | ---- | ---------------- | - | ------ | 
|                   |  | (dollar amounts in millions) |      |                  |  
|Three months ended |  | $                            | 28.9 |                  | $ | 22.9   | 
|Six months ended   |  | $                            | 55.5 |                  | $ | 44.9   | 



The increase in total
revenues for the three month period ended November 30, 2003, compared with the same period a year ago, was due to a $3.3 million increase in our software product revenues and to a $2.7 million increase in our service and other revenues. The increase
in total revenues for the six month period ended November 30, 2003, compared with the same period a year ago, was due to a $5.1 million increase in our software product revenues and to a $5.5 million increase in our service and other revenues.



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The three and six month periods ended November 30, 2003 results include the addition of our Ultraseek
product, which came from the purchase of assets and assumption of obligations of Inktomi Corporations enterprise search software business (Enterprise) in December 2002. Additionally, the six month period ended November 30, 2003
includes a payment in the first quarter from BroadVision of past royalties in connection with the settlement of outstanding litigation, and was less than 5% of revenues in the six-month period.



Revenues derived from foreign operations accounted for 16.0% and 16.1% of
total revenues for the three month periods ended November 30, 2003 and 2002, respectively, and 15.8% and 16.3% of total revenues for the six month periods ended November 30, 2003 and 2002, respectively. Our export sales consist of products licensed
for delivery outside of the United States. For the three month periods ended November 30, 2003 and 2002, export sales accounted for 16.4% and 21.9% of total revenues, respectively. For the six month periods ended November 30, 2003 and 2002, export
sales accounted for 17.3% and 20.7% of total revenues, respectively.



No single customer accounted for more than 10% of our total revenues for the three and six month periods ended November 30, 2003 and 2002. Revenues derived from sales to the federal government and its agencies were 9.8% and 11.1% of our
total revenues for the three month periods ended November 30, 2003 and 2002, respectively, and 10.6% and 10.1% of our total revenues for the six month periods ended November 30, 2003 and 2002, respectively.



Software product revenues



|                             |  | November 30,2003             |      |   | November 30,2002 |   |      | Change | 
|---------------------------- |  | ---------------------------- | ---- | - | ---------------- | - | ---- | ------ | 
|                             |  | (dollar amounts in millions) |      |   |                  |  
|Three months ended           |  | $                            | 16.2 |   |                  | $ | 12.9 |        | 
|Percentage of total revenues |  |                              | 56.2 | % |                  |   | 56.6 | %      | 
|Six months ended             |  | $                            | 30.4 |   |                  | $ | 25.3 |        | 
|Percentage of total revenues |  |                              | 54.8 | % |                  |   | 56.2 | %      | 



We saw an increase in
demand for our software products in the three and six month periods ended November 30, 2003, compared with the same periods a year ago. The increases in software product revenues in the three and six month periods ended November 30, 2003 were the
result of increased sales to our OEM customers and from the addition of sales of our Ultraseek product, which we did not have prior to our acquisition of Enterprise in December 2002. Software product revenues from our non-Ultraseek products for the
six month period ended November 30, 2003 included the recognition of revenue in the first quarter of past royalties in connection with our confidential settlement with BroadVision relative to our outstanding litigation. This revenue accounted for
less than 5% of total revenues in the six month period.



Service and other revenues



|                             |  | November 30,2003             |      |   | November 30,2002 |   |      | Change | 
|---------------------------- |  | ---------------------------- | ---- | - | ---------------- | - | ---- | ------ | 
|                             |  | (dollar amounts in millions) |      |   |                  |  
|Three months ended           |  | $                            | 12.7 |   |                  | $ | 9.9  |        | 
|Percentage of total revenues |  |                              | 43.8 | % |                  |   | 43.4 | %      | 
|Six months ended             |  | $                            | 25.1 |   |                  | $ | 19.6 |        | 
|Percentage of total revenues |  |                              | 45.2 | % |                  |   | 43.8 | %      | 



Our service and other
revenues consist primarily of fees for software maintenance, consulting and training.



The increase in service and other revenues for the three month period ended November 30, 2003, compared with the same period a year ago, was due to $0.2 million in increased sales of consulting and training services
and to $2.5 million in increased maintenance revenues which results primarily from maintenance contracts



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acquired as part of the Enterprise purchase and increased maintenance contracts associated with our increase in software product revenues. The increase in
service and other revenues for the six month period ended November 30, 2003, compared with the same period a year ago, was due to $0.7 million in increased sales of consulting and training services and to $4.8 million in increased maintenance
revenues which results primarily from maintenance contracts acquired as part of the Enterprise purchase and increased maintenance contracts associated with our increase in software product revenues.



Costs of Revenues



Costs of software products



|                                        |  | November 30, 2003            |     |   | November 30, 2002 |   |     | Change | 
|--------------------------------------- |  | ---------------------------- | --- | - | ----------------- | - | --- | ------ | 
|                                        |  | (dollar amounts in millions) |     |   |                   |  
|Three months ended                      |  | $                            | 0.4 |   |                   | $ | 0.3 |        | 
|Percentage of software product revenues |  |                              | 2.6 | % |                   |   | 2.2 | %      | 
|Six months ended                        |  | $                            | 0.8 |   |                   | $ | 0.7 |        | 
|Percentage of software product revenues |  |                              | 2.5 | % |                   |   | 2.7 | %      | 



Costs of software
products consist primarily of product media, duplication, manuals, packaging materials, shipping expenses, employee compensation expenses, royalties paid to third-party vendors, and in certain instances, licensing of third-party software
incorporated in our products. We believe that costs of software products will increase in absolute dollars in the quarter ending February 29, 2004, primarily as a result of increased royalties paid to third-party software vendors.



The increase in costs of software products in absolute dollars for the three
and six month periods ended November 30, 2003, compared with the same period a year ago, was primarily attributable to a $0.1 million increase in costs of third party software components and from increased costs for manuals and product media
associated with the recent product release of Verity K2 Enterprise 5.0. The increase in costs of software products as a percentage of software product revenues for the three month period ended November 30, 2003, compared with the same period a year
ago, was attributable to the increase in absolute costs, offset in part by the increase in software product revenues. During the three and six month periods ended November 30, 2003 and 2002, we did not capitalize any software development costs.



Costs of service and other



|                                         |  | November 30, 2003            |      |   | November 30, 2002 |   |      | Change | 
|---------------------------------------- |  | ---------------------------- | ---- | - | ----------------- | - | ---- | ------ | 
|                                         |  | (dollar amounts in millions) |      |   |                   |  
|Three months ended                       |  | $                            | 3.3  |   |                   | $ | 3.1  |        | 
|Percentage of service and other revenues |  |                              | 25.9 | % |                   |   | 31.0 | %      | 
|Six months ended                         |  | $                            | 6.7  |   |                   | $ | 5.8  |        | 
|Percentage of service and other revenues |  |                              | 26.6 | % |                   |   | 29.6 | %      | 



Costs of service and
other consists of costs incurred in providing consulting services, customer training, telephone support and product upgrades to customers. Significant cost components include personnel-related and third-party contractor costs, facilities costs,
travel expenses associated with training and consulting implementation services, depreciation expense and corporate overhead allocations. We believe that costs of service and other will decrease slightly in absolute dollars in the quarter ending
February 29, 2004, resulting from modest seasonality associated with the calendar year-end.



The increase in absolute dollars for the three and six month periods ended November 30, 2003, compared with the same period a year ago, was due primarily to a $0.2 million increase in costs associated with the use of
third-party consultants in connection with an increased demand for services, and, in the six month period, to a $0.6 million increase in compensation and other employee related expenses resulting from an approximately 6%



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higher average headcount. The higher average headcount results from the addition of personnel necessary to respond to increased demand for services and in
connection with the Enterprise purchase in December 2002. The decrease as a percentage of service and other revenues, compared with the same periods a year ago, results from higher utilization of personnel resulting from the increase in services
rendered being greater than the increase in personnel.



Amortization of purchased intangible assets



|                             |  | November 30, 2003            |     |   | November 30, 2002 |   |     | Change
|---------------------------- |  | ---------------------------- | --- | - | ----------------- | - | --- | ------
|                             |  | (dollar amounts in millions) |     |   |                  
|Three months ended           |  | $                            | 0.6 |   |                   | $ | 0.0 |       
|Percentage of total revenues |  |                              | 2.2 | % |                   |   | 0.0 | %     
|Six months ended             |  | $                            | 1.3 |   |                   | $ | 0.0 |       
|Percentage of total revenues |  |                              | 2.3 | % |                   |   | 0.0 | %     



During the three and
six month periods ended November 30, 2003, we amortized $0.6 million and $1.3 million, respectively, of the purchased intangible assets in connection with acquired technology, patents and maintenance agreements from our Enterprise purchase. We will
record quarterly amortization expenses of $0.6 million associated with the purchased intangible assets of Enterprise over the estimated useful life of 5 years from the quarter ended February 28, 2003.



Operating Expenses



Research and development



|                             |  | November 30, 2003            |      |   | November 30, 2002 |   |      | Change | 
|---------------------------- |  | ---------------------------- | ---- | - | ----------------- | - | ---- | ------ | 
|                             |  | (dollar amounts in millions) |      |   |                   |  
|Three months ended           |  | $                            | 4.8  |   |                   | $ | 4.5  |        | 
|Percentage of total revenues |  |                              | 16.5 | % |                   |   | 19.6 | %      | 
|Six months ended             |  | $                            | 10.2 |   |                   | $ | 9.8  |        | 
|Percentage of total revenues |  |                              | 18.4 | % |                   |   | 21.8 | %      | 



Research and
development expenses consist primarily of employee compensation and benefits, payments to outside contractors, depreciation on equipment used for development and corporate overhead allocations. We believe that research and development is essential
to maintaining our competitive position and we will continue to make significant investments in research and development with the goal of continuing to align research and development expenses with anticipated revenues. We believe that research and
development expenses will increase slightly in absolute dollars in the quarter ending February 29, 2004, primarily resulting from the effect of annual salary increases.



The increases in research and development expenses in absolute dollars for the three and six month periods ended November
30, 2003, compared with the same periods in the prior year, were primarily due to a net $0.3 million and $0.3 million increase, respectively, in bonuses payable, resulting from an accrual in the three month period ended November 30, 2003 compared
with no accrual in the prior year period, combined with a less than $0.1 million and $0.1 million increase, respectively, in compensation costs associated with the effect of annual salary increases in the three and six month periods ended November
30, 2003.



Marketing and sales



|                             |  | November 30, 2003            |      |   | November 30, 2002 |   |      | Change | 
|---------------------------- |  | ---------------------------- | ---- | - | ----------------- | - | ---- | ------ | 
|                             |  | (dollar amounts in millions) |      |   |                   |  
|Three months ended           |  | $                            | 11.7 |   |                   | $ | 9.7  |        | 
|Percentage of total revenues |  |                              | 40.4 | % |                   |   | 42.3 | %      | 
|Six months ended             |  | $                            | 23.8 |   |                   | $ | 20.2 |        | 
|Percentage of total revenues |  |                              | 42.9 | % |                   |   | 45.1 | %      | 



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Marketing and sales expenses consist primarily of employee compensation, including sales commissions and
benefits, tradeshows, outbound marketing and other lead generation activities, public relations, travel expenses associated with our sales staff and corporate overhead allocations. We anticipate that we will continue to make significant investments
in marketing and sales with the goal of continuing to align marketing and sales expenses with anticipated revenues. We believe that marketing and sales expenses will remain approximately flat as a percentage of total revenues in the quarter ending
February 29, 2004.



The increase in marketing and sales
expenses in absolute dollars for the three month period ended November 30, 2003, compared with the same period a year ago, was due to a $0.8 million increase in the use of external sales and marketing professional services, a $0.5 million increase
in sales commissions resulting from the combination of higher revenue and an increased payout rate, a $0.3 million increase in compensation and other employee related expenses resulting from marginally higher average headcount and annual salary
increases, a $0.3 million increase in overall marketing program spending, primarily attributable to the addition of the Enterprise product, and a $0.1 million increase in depreciation expenses.



The increase in marketing and sales expenses in absolute dollars for the six
month period ended November 30, 2003, compared with the same period a year ago, was due to a $1.3 million increase in sales commissions resulting from the combination of higher revenue and an increased payout rate, a $0.9 million increase in
compensation and other employee related expenses resulting from marginally higher average headcount and annual salary increases, a $0.7 million increase in overall marketing program spending, primarily attributable to the addition of the Enterprise
product, a $0.2 million increase in the use of external sales and marketing professional services, and a $0.1 million increase in depreciation expenses.



General and administrative



|                             |  | November 30, 2003            |      |   | November 30, 2002 |   |      | Change | 
|---------------------------- |  | ---------------------------- | ---- | - | ----------------- | - | ---- | ------ | 
|                             |  | (dollar amounts in millions) |      |   |                   |  
|Three months ended           |  | $                            | 2.7  |   |                   | $ | 2.5  |        | 
|Percentage of total revenues |  |                              | 9.4  | % |                   |   | 10.8 | %      | 
|Six months ended             |  | $                            | 5.6  |   |                   | $ | 5.1  |        | 
|Percentage of total revenues |  |                              | 10.1 | % |                   |   | 11.4 | %      | 



General and
administrative expenses consist primarily of personnel costs for finance, legal, human resources and general management, provisions for doubtful accounts, insurance, fees for external professional advisors and corporate overhead allocations. We
believe that general and administrative expenses will remain approximately flat in the quarter ending February 29, 2004.



The increase in general and administrative expenses in absolute dollars for the three month period ended November 30, 2003, compared with the same period
a year ago, was primarily related to a $0.4 million increase in employee related expenses associated with marginally higher headcount, offset in part by a $0.2 million decrease in bad debt expense.



The increase in general and administrative expenses in absolute dollars for
the six month period ended November 30, 2003, compared with the same period a year ago, was primarily related to a $0.7 million increase in employee related expenses associated with marginally higher headcount, a $0.1 million increase in expenses
for outside professional services, a $0.1 million increase in corporate overhead allocations, offset in part by a $0.4 million decrease in bad debt expense.



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Restructuring charge



|                             |  | November 30, 2003            |     |   | November 30, 2002 |   |     | Change | 
|---------------------------- |  | ---------------------------- | --- | - | ----------------- | - | --- | ------ | 
|                             |  | (dollar amounts in millions) |     |   |                   |  
|Three months ended           |  | $                            | 1.0 |   |                   | $ | 1.0 |        | 
|Percentage of total revenues |  |                              | 3.4 | % |                   |   | 4.3 | %      | 
|Six months ended             |  | $                            | 1.0 |   |                   | $ | 1.0 |        | 
|Percentage of total revenues |  |                              | 1.8 | % |                   |   | 2.2 | %      | 



During each of the
periods ended November 30, 2003 and November 30, 2002, we executed restructuring efforts designed to reduce costs and to better align our expense levels with current revenue levels and ensure conservative spending during the current period of
economic uncertainty.



|Restructuring charges:(three and six month periods ended) |  | November 30, 2003 |     | November 30, 2002
|--------------------------------------------------------- |  | ----------------- | --- | -----------------
|                                                          |  | (in millions)    
|Severance costs                                           |  | $                 | 0.9 |                  
|Legal and other outside services costs                    |  |                   | 0.1 |                  
|Other charges                                             |  |                   | 0.0 |                  
|                                                          |  |                   |     |                  
|Total restructuring charges                               |  | $                 | 1.0 |                  
|                                                          |  |                   |     |                  



During the quarter
ended November 30, 2003, we implemented a worldwide restructuring plan to focus on reducing expenses and improving efficiency due to continued macro-economic and capital spending issues affecting the software industry. In connection with the
restructuring, we recorded in the quarter ended November 30, 2003, a $1.0 million restructuring charge, of which approximately $0.9 million was related to severance costs associated with the reduction in the worldwide workforce by approximately 40
employees, and approximately $0.1 million was related to legal and other outside services costs associated with the restructuring. The restructuring impacted operations in the U.S., Canada and Europe and was across all functional areas of the
company.



Of the total $1.0 million restructuring charge,
approximately $0.05 million remains unpaid at November 30, 2003. Of the $0.05 million, approximately $0.01 million relates to severance costs to be paid in future quarters and approximately $0.04 million to costs associated with legal and other
outside services. The unpaid amount will be paid out over the next two quarters.



During the quarter ended November 30, 2002, we implemented a worldwide restructuring and recorded a $1.0 million restructuring charge, of which approximately $0.7 million was related to severance costs associated with
the reduction in the worldwide workforce by 50 employees, approximately $0.1 million to legal and other outside services in connection with the restructuring and approximately $0.2 million to other costs associated with the restructuring. The
restructuring impacted operations in the U.S., Canada and the Netherlands and was concentrated in research and development and, to a lesser extent, sales and marketing. At November 30, 2003, $0.2 million of the restructuring implemented in the
quarter ended November 30, 2002 remains unpaid and is mostly related to a facilities lease and will be paid out ratably over the remaining life of the lease, which terminates in October 2005.



Interest income, net



|                             |  | November 30, 2003            |     |   | November 30, 2002 |   |     | Change | 
|---------------------------- |  | ---------------------------- | --- | - | ----------------- | - | --- | ------ | 
|                             |  | (dollar amounts in millions) |     |   |                   |  
|Three months ended           |  | $                            | 1.4 |   |                   | $ | 2.0 |        | 
|Percentage of total revenues |  |                              | 4.7 | % |                   |   | 8.9 | %      | 
|Six months ended             |  | $                            | 2.8 |   |                   | $ | 4.1 |        | 
|Percentage of total revenues |  |                              | 5.0 | % |                   |   | 9.1 | %      | 



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Interest income, net consists primarily of interest income, net and realized gains (losses) from our
investments in marketable securities.



The decreases in
interest income, net in absolute dollars for the three and six month periods ended November 30, 2003, compared with the same period a year ago, were primarily due to decreasing overall yields on our portfolio of marketable securities caused by the
decreasing interest rate environment, partially mitigated by a slightly higher balance of marketable securities.



Other income (loss), net



|                             |  | November 30,2003             |     |   | November 30,2002 |   |      | Change
|---------------------------- |  | ---------------------------- | --- | - | ---------------- | - | ---- | ------
|                             |  | (dollar amounts in millions) |     |   |                 
|Three months ended           |  | $                            | 0.4 |   |                  | $ | (0.1 | )     
|Percentage of total revenues |  |                              | 1.4 | % |                  |   | 0.5  | %     
|Six months ended             |  | $                            | 0.2 |   |                  | $ | (0.3 | )     
|Percentage of total revenues |  |                              | 0.3 | % |                  |   | 0.6  | %     



Other income (loss),
net consists of gains (losses) on our foreign currency forward contracts.



Income tax provision



|                             |  | November 30, 2003            |     |   | November 30,2002 |   |     | Change | 
|---------------------------- |  | ---------------------------- | --- | - | ---------------- | - | --- | ------ | 
|                             |  | (dollar amounts in millions) |     |   |                  |  
|Three months ended           |  | $                            | 2.5 |   |                  | $ | 1.4 |        | 
|Percentage of total revenues |  |                              | 8.7 | % |                  |   | 6.3 | %      | 
|Six months ended             |  | $                            | 3.6 |   |                  | $ | 2.3 |        | 
|Percentage of total revenues |  |                              | 6.6 | % |                  |   | 5.1 | %      | 



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



We expect tax savings for fiscal 2004 due to research and development tax
credits to decline relative to our historical experience and expect to realize an effective tax rate of 40.0% for the fiscal year. In our first fiscal quarter ended August 31, 2003, we applied an effective tax rate of 38.0%. In order to realize a
40.0% year-to-date effective tax rate, we applied a 40.95% effective tax rate to the results of our quarter ended November 30, 2003. We will continue to reassess the impact of our research and development expenses on our effective tax rate in future
periods. In the comparative periods of fiscal 2003 we applied a 38% effective tax rate.



Liquidity and Capital Resources



|Six month periods ended                   |  | November 30, 2003 |      |   | November 30,2002 |  
|----------------------------------------- |  | ----------------- | ---- | - | ---------------- | -
|                                          |  | (in millions)     |     
|Net cash provided by operating activities |  | $                 | 3.3  |   |                  | $
|Net cash used in investing activities     |  | $                 | (8.4 | ) |                  | $
|Net cash used in financing activities     |  | $                 | (2.5 | ) |                  | $



As of November 30,
2003, we had $249.3 million in cash and cash equivalents and available-for-sale securities compared to $250.7 million at May 31, 2003. At November 30, 2003, our principal sources of liquidity were our cash and cash equivalents and short-term
investments of $154.3 million. As of November 30, 2003, we had no outstanding debt obligations.



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Cash provided by operating activities for the six month period ended November 30, 2003 was $3.3 million,
primarily due to our net income of $5.5 million, which reflected among other non-cash charges a charge for depreciation and amortization of $3.5 million, which we add back to reconcile net income to net cash provided by operating activities. Cash
provided by operating activities also included a $0.3 million increase in deferred revenues, but was reduced by a $2.5 million increase in accounts receivable, a $1.6 million decrease in accounts payable, a $1.1 million decrease in accrued
compensation and other accrued liabilities, and a $0.7 million increase in prepaid and other current assets.



Cash used in investing activities for the six month period ended November 30, 2003 was $8.4 million as a result of capital expenditures of $1.0 million
and purchases, net of sales and maturities, of marketable securities of $7.4 million.



Cash used in financing activities for the six month period ended November 30, 2003 was $2.5 million, due to $17.0 million in repurchases of our common stock through our stock repurchase program, partially offset by
$14.5 million in proceeds from the sale of common stock as a result of stock option exercises.



Our principal commitments as of November 30, 2003 consist of obligations under operating leases, totaling $9.2 million over the life of these leases.



Under our operating leases, we have minimum rental payments as follows:



|Fiscal Year Ending May 31, |  | Rental Payments
|-------------------------- |  | ---------------
|2004                       |  | $              
|2005                       |  |                
|2006                       |  |                
|2007                       |  |                
|2008 and thereafter        |  |                
|                           |  |                
|                           |  | $              
|                           |  |                



On December 17, 2002,
we completed the purchase of certain assets and obligations of Inktomi Corporations enterprise search software business. Of the total purchase price, we deferred $3.0 million in order to secure Inktomis indemnification obligations under
the Purchase Agreement. On June 17, 2004, we are obligated to pay Inktomi an amount equal to the sum of (1) $3.0 million plus (2) simple interest thereon calculated from the December 17, 2002 through the date of payment at an annual rate of 1.5%. We
have the right to withhold or deduct from the deferred payment amount any sum that may be owed to us by Inktomi pursuant to Inktomis indemnification obligations under the Purchase Agreement. We believe the likelihood of indemnification is
remote.



On June 24, 2003, we announced the continuation of our
stock repurchase program. The continuation calls for the additional repurchase of outstanding shares of our common stock up to an aggregate value of $50.0 million. The program will terminate at the end of the fiscal year ending May 31, 2004 unless
amended by the Board of Directors. Through November 30, 2003, we repurchased and retired 1,190,987 shares of our common stock through open market transactions, at an aggregate cost of approximately $17.0 million.



We believe that our current cash and cash equivalents, interest income and
cash generated from operations, if any, will provide adequate liquidity to meet our working capital and operating resource expenditure requirements through at least fiscal 2004. If the global economy weakens further, our cash, cash equivalents and
investments balances may decline. As a result, or if our spending plans materially change, we may find it necessary to seek to obtain additional sources of financing to support our capital needs, but we cannot assure you that a financing will be
available on commercially reasonable terms, or at all.



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Recent Accounting Pronouncements



In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 143, Accounting for Asset Retirement Obligations. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset. The liability is accreted to its present value each period while the cost is depreciated over its useful life. The adoption of SFAS No. 143 in our fiscal year 2002 did not
have a significant impact on our financial position or results of operations.



In August 2001, the FASB issued SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of (SFAS No. 121), however it retains the fundamental provisions of SFAS No. 121 for (1) the recognition and measurement of the impairment of long-lived assets to be held and used and (2) the measurement of
long-lived assets to be disposed of by sale. SFAS No. 144 develops a single accounting model for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired assets and consequently amends Accounting Principles
Board Opinion No. 30, Reporting Results of OperationsReporting the Effects of Disposal of a Division of a Business. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with
operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for our fiscal year beginning June 1, 2002. The adoption
of SFAS No. 144 did not have a significant impact on our financial position or results of operations.



In November 2001, the Emerging Issues Task Force (EITF) of the FASB reached a consensus on Issue No. 01-09, Accounting for Consideration
Given by a Vendor to a Customer or a Reseller of the Vendors Products. EITF No. 01-09 addresses whether consideration from a vendor to a reseller of the vendors products is an adjustment to the selling prices of the vendors
products and, therefore, should be deducted from revenue when recognized in the vendors results of operations, or a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be an expense when
recognized in the vendors results of operations. EITF No. 01-09 is effective for us beginning November 1, 2001. The adoption of EITF No. 01-09 did not have a significant impact on our financial position or results of operations.



In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 nullifies the guidance of the EITF in EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring). Under EITF Issue No. 94-3, an entity recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. In SFAS 146, the FASB acknowledges that an entitys commitment
to a plan does not, by itself, create a present obligation to other parties that meets the definition of a liability and requires that a liability for a cost that is associated with an exit or disposal activity be recognized when the liability is
incurred. It also establishes that fair value is the objective for the initial measurement of the liability. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have
a significant impact on our financial position or results of operations.



In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 requires that a liability be recorded in the guarantors balance sheet upon issuance of certain guarantees or indemnifications. In addition, FIN 45 requires disclosures about the guarantees or indemnifications that an
entity has issued, including a reconciliation of changes in the entitys product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees or indemnifications
issued or modified after December 31, 2002, irrespective of the guarantors fiscal year-end. The



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disclosure requirements are effective for financial statements for interim or annual periods issued after December 15, 2002. We have adopted the disclosure
provisions of FIN 45 and evaluated the impact of the measurement provisions on the our financial position and results of operations. As of November 30, 2003, our guarantees that were issued or modified after December 31, 2002 were not material.



We enter into standard indemnification provisions within our
software license agreements with our customers and technology partners. Pursuant to these provisions, we typically indemnify, defend and hold harmless the indemnified party for losses suffered or incurred by the indemnified party in connection with
any U.S. patent, copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification provisions is generally perpetual any time after execution of the license agreement. The
maximum potential amount of future payments that we could be required to make under these indemnification provisions is unlimited.



We generally warrant that our software products will perform in all material respects in accordance with our standard published specifications.
Historically, costs related to this warranty have not been significant.



We have agreements in place with our directors and officers whereby we indemnify them for certain events or occurrences while the officer and director is, or was, serving at our request in such capacity. The maximum potential amount of
future payments we could be required to make under these indemnification agreements is unlimited; however, we have a director and officer insurance policy, which may enable us to recover a portion of any future amounts paid.



In November 2002, the EITF reached a consensus on Issue No. 00-21
(Issue 00-21), Revenue Arrangements with Multiple Deliverables. Issue 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use
assets. The provisions of Issue 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of Issue 00-21 did not have a material effect on our consolidated financial position, results of
operations or cash flows.



In November 2002 the EITF reached a
consensus opinion on EITF No. 02-16, Accounting by a Customer (including a reseller) for Certain Consideration Received from a Vendor. EITF No. 02-16 requires that cash payments, credits, or equity instruments received, as consideration
by a customer from a vendor should be presumed to be a reduction of cost of sales when recognized by the customer in the income statement. In certain situations, the presumption could be overcome and the consideration recognized either as revenue or
a reduction of a specific cost incurred. The consensus applies prospectively to new or modified arrangements entered into after December 31, 2002. At November 30, 2003, we were not a party to any transactions contemplated by EITF 02-16.



In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure. SFAS No. 148 amends certain provisions of SFAS No. 123 and is effective for financial statements for fiscal years ending after December 15, 2002. It provides alternative methods
of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires the disclosure of the pro forma effects on an entitys accounting policy with
respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. We do not currently intend to adopt the fair value based method of accounting for stock-based employee
compensation and will continue to apply the intrinsic-value based method. We have determined the fair value of option grants using the Black-Scholes stock option pricing model and have provided this pro forma disclosure of the impact of fair value
accounting in note 2 to the financial statements, Accounting for Stock-Based Compensation.



In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). FIN 46 requires
that if an entity has a controlling financial interest in a variable interest entity, the



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assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. FIN
46 is effective February 28, 2004. We do not have any interests in variable interest entities.



On April 30, 2003, the FASB issued Statement No. 149 (Statement 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Statement 149 is intended to result in more consistent
reporting of contracts as either freestanding derivative instruments subject to Statement 133 in its entirety, or as hybrid instruments with debt host contracts and embedded derivative features. In addition, Statement 149 clarifies the definition of
a derivative by providing guidance on the meaning of initial net investments related to derivatives. Statement 149 is effective for contracts entered into or modified after June 30, 2003. The adoption of Statement 149 did not have a material effect
on our consolidated financial position, results of operations or cash flows.



On May 15, 2003, the FASB issued Statement No. 150 (Statement 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. Statement 150 establishes
standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. Statement 150 represents a significant change in practice in the
accounting for a number of financial instruments, including mandatorily redeemable equity instruments and certain equity derivatives that frequently are used in connection with share repurchase programs. We do not use such instruments in our share
repurchase program. Statement 150 is effective for all financial instruments created or modified after May 31, 2003, and to other instruments as of September 1, 2003. The adoption of Statement 150 did not have a material effect on our consolidated
financial position, results of operations or cash flows.



In
July 2003, the EITF reached a consensus on Issue No. 03-05, Applicability of AICPA SOP 97-2 to Non Software Deliverables in an Arrangement Containing More Than Incidental Software. The consensus opinion in EITF No. 03-05 clarifies the
guidance in EITF 00-21 and was reached on July 31, 2003. The adoption of Issue No. 03-05 did not have a material effect on our consolidated financial position, results of operations or cash flows.



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RISK FACTORS



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



Risks Related to Our Business



We have sustained quarterly and annual losses in the past and may not be able to maintain profitability



We have incurred net losses in the past and, although we reported net income
in fiscal year 2003 and the first two quarters of fiscal year 2004, we may not be able to maintain profitability. In the future, our revenues may decline, remain flat, or grow at a rate slower than was experienced in the first two quarters of fiscal
year 2004, especially in light of the current economic environment. To achieve revenue growth and maintain fiscal year profitability, we must:



| |  | increase market acceptance of our products;
| | - | -------------------------------------------



| |  | respond effectively to competitive developments;
| | - | ------------------------------------------------



| |  | execute sales despite the recent economic slowdown and resulting decrease in our customers capital spending;
| | - | -------------------------------------------------------------------------------------------------------------



| |  | attract, retain and motivate qualified personnel; and
| | - | -----------------------------------------------------



| |  | upgrade our technologies and commercialize our products and services incorporating these technologies.
| | - | ------------------------------------------------------------------------------------------------------



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



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



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



| |  | the downturn in capital spending by customers;
| | - | ----------------------------------------------



| |  | the size and timing of orders;
| | - | ------------------------------



| |  | changes in the budget or purchasing patterns of customers or potential customers, changes in foreign country exchange rates, or pricing pressures from competitors;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | increased competition in the software and Internet industries;
| | - | --------------------------------------------------------------



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



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



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



| |  | changes in operating expenses and personnel;
| | - | --------------------------------------------



| |  | changes in accounting principles, such as a requirement that stock options be included in compensation, which is widely expected to occur and may become effective as early as 2004
and, which if adopted, would increase our compensation expenses and have a negative effect on our earnings;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the overall trend toward industry consolidation; and
| | - | ----------------------------------------------------



| |  | changes in general economic and geo-political conditions and specific economic conditions in the computer and software industries.
| | - | ----------------------------------------------------------------------------------------------------------------------------------



Any of the factors, some of which are discussed in more detail below, could
materially and adversely impact our operations and financial results, and consequently cause our stock price to fall.



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



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



Demand for our products may be adversely affected if
unfavorable economic and market conditions do not improve or continue to decline



Adverse economic conditions worldwide have contributed to slowdowns in the software information technology spending environment and may continue to impact our business, resulting in reduced demand for our products as
a result of a decrease in capital spending by our customers, increased price competition for our products and higher overhead costs as a percentage of revenues. Decreased demand for our products would result in decreased revenues, which could harm
our operating results and cause the price of our common stock to fall.



Changes in effective tax rates could affect our results



Our future effective tax rates could be adversely affected by changes in the valuation of our deferred tax assets and liabilities, and changes in U.S. or foreign tax laws or interpretations thereof.



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



The size and timing of individual orders may
cause our operating results to fluctuate significantly. Our operating results for a quarter could be materially and adversely affected if one or more large orders are either not received or are delayed or deferred by customers. A significant portion
of our revenues in recent quarters has been derived from these relatively large sales to a limited number of customers, and we currently anticipate that future quarters will continue to reflect this trend. Sales cycles for these customers can be up
to nine months or longer. In addition, customer order deferrals in anticipation of new products may cause our operating results to fluctuate. Like many software companies, we have generally recognized a substantial portion of our revenues in



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the last month of each quarter, with these revenues concentrated in the last weeks of the quarter. Accordingly, the cancellation or deferral of even a small
number of purchases of our products could harm our business in any particular quarter. In addition, to the extent that the significant sales occur earlier than expected, operating results for subsequent quarters may fail to keep pace or even
decline.



Our sales cycle is lengthy and unpredictable



Any delay in sales of our products and services could
cause our quarterly revenue and operating results to fluctuate. The typical sales cycle of our products is lengthy, generally between six to eighteen months, unpredictable, and involves significant investment decisions by prospective customers, as
well as our education of potential customers regarding the use and benefits of our products. Our customers spend a substantial amount of time before purchasing our products in performing internal reviews and obtaining capital expenditure approvals.
We believe our sales cycle lengthened in 2002 and 2003 as a result of macro-economic factors and we cannot be certain that this cycle will not continue to lengthen in the future.



Our business may suffer due to risks associated with international sales



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



| |  | difficulties in complying with regulatory requirements and standards;
| | - | ---------------------------------------------------------------------



| |  | tariffs and other trade barriers;
| | - | ---------------------------------



| |  | costs and risks of localizing products for foreign countries;
| | - | -------------------------------------------------------------



| |  | reliance on third parties to distribute our products;
| | - | -----------------------------------------------------



| |  | longer accounts receivable payment cycles;
| | - | ------------------------------------------



| |  | potentially adverse tax consequences;
| | - | -------------------------------------



| |  | limits on repatriation of earnings; and
| | - | ---------------------------------------



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



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



Service and other revenues derived from foreign operations accounted for 15.8% and 15.0% of total revenues for the six month period ended November 30,
2003, and fiscal year 2003, respectively. Our export sales consist primarily of products licensed for delivery outside of the United States. For the six month period ended November 30, 2003 and fiscal year 2003, export sales accounted for 17.3% and
22.4% of total revenues, respectively. We expect that revenues derived from foreign operations and export sales will continue to account



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for a significant percentage of our revenues for the foreseeable future. These revenues may fluctuate significantly as a percentage of revenues from period
to period. In addition, a portion of these revenues was derived from sales to foreign government agencies, which may be subject to risks similar to those described immediately below.



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



Revenues derived from sales to the U.S. federal and state governments and their agencies were 10.6% and 9.8% of total revenues for the six month period ended November 30, 2003 and fiscal year 2003, respectively.
Future reductions in government spending on information technologies could harm our operating results. In recent years, budgets of many governments and/or their agencies have been reduced, causing certain customers and potential customers of our
products to re-evaluate their needs. These budget reductions are expected to continue over at least the next several years.



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



We must successfully introduce new products or our customers will purchase our competitors products



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



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



If we are unable to enhance our existing products to conform to evolving industry standards in our rapidly changing markets, our products may become obsolete



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



The life cycles of our products are difficult to estimate. Our future success will depend upon our ability to 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 HTML and XML, and address increasingly sophisticated customer needs. We cannot assure you
that we will not experience difficulties that could delay or prevent the successful development, introduction and marketing of new products, or that new products and product enhancements will meet the requirements of the marketplace and achieve
market acceptance.



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



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



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



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



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



Some of the technology used by our products is licensed from third parties, generally on a nonexclusive basis. We believe that there are alternative
sources for each of the material components of technology we license from third parties. However, the termination of any of these licenses, or the failure of the third-party licensors to adequately maintain or update their products, could result in
delay in our ability to ship these products while we seek to implement technology offered by alternative sources. Any required replacement licenses could prove costly. Also, any delay, to the extent it becomes extended or occurs at or near the end
of a fiscal quarter, could harm our quarterly results of operations. While it may be necessary or desirable in the future to obtain other licenses relating to one or more of our products or relating to current or future technologies, we cannot
assure you that we will be able to do so on commercially reasonable terms or at all.



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



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



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



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



Third parties may assert that our products infringe their proprietary rights, or may assert claims for indemnification resulting from infringement claims against us. Any such claims may cause us to delay or cancel
shipment of our products, which could harm our business. In addition, irrespective of the validity or the successful assertion of claims, we could incur significant costs in defending against claims. To date, no third party has asserted such claims
against us.



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



In the past, securities class action litigation has often been brought against companies following a decline in the market price of their securities. For
example, in December 1999 our stock price dramatically declined and a number of lawsuits were filed against us. Because we expect our stock price to continue to fluctuate significantly, we may be the target of similar litigation in the future.
Securities litigation could result in substantial costs and divert managements attention and resources, and could seriously harm our business.



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



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



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



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



The information retrieval, classification and recommendation software markets are intensely competitive and we cannot assure you that we will maintain our current position or market share. A number of companies offer
competitive products addressing these markets. In the enterprise market, we compete with Autonomy, Convera, Endeca, FAST, Google, Hummingbird, iPhrase, Mercado, Microsoft, Open Text and Thunderstone, among others. Plumtree is on occasion a
competitor, but is viewed primarily as our partner and customer. In the Internet/publishing market, we compete with Autonomy, Convera, Dataware, FAST, iPhrase, Lotus and



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Microsoft, among others. We also compete indirectly with database vendors, such as Oracle, that offer information search and retrieval capabilities with
their core database products, as well as with ERP (Enterprise Resource Planning) vendors, such as SAP, that offer these capabilities as part of their overall solution.



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



Our recent acquisition of the Inktomi enterprise search software assets and other
potential acquisitions may have unexpected consequences or impose additional costs on us



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



| |  | difficulties in integration of the operations, technologies, products and personnel of the acquired companies;
| | - | --------------------------------------------------------------------------------------------------------------



| |  | the risk of diverting managements attention from normal daily operations of the business;
| | - | ------------------------------------------------------------------------------------------



| |  | accounting consequences, including changes in purchased research and development expenses, resulting in variability in our quarterly earnings;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  | potential difficulties in completing projects associated with purchased in-process research and development;
| | - | ------------------------------------------------------------------------------------------------------------



| |  | risks of entering markets in which we have no or limited direct prior experience and where competitors in these markets have stronger market positions;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the potential loss of key employees of the acquired company;
| | - | ------------------------------------------------------------



| |  | the assumption of known and potentially unknown liabilities of the acquired company;
| | - | ------------------------------------------------------------------------------------



| |  | we may find that the acquired company or assets do not further our business strategy or that we paid more than what the company or assets are worth;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we may have product liability associated with the sale of the acquired companys products;
| | - | ------------------------------------------------------------------------------------------



| |  | we may have difficulty maintaining uniform standards, controls, procedures and policies;
| | - | ----------------------------------------------------------------------------------------



| |  | our relationship with current and new employees and clients could be impaired;
| | - | ------------------------------------------------------------------------------



| |  | the acquisition may result in litigation from terminated employees or third parties who believe a claim against us would be valuable to pursue;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  | our due diligence process may fail to identify significant issues with product quality, product architecture and legal contingencies, among other matters; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | insufficient revenues to offset increased expenses associated with acquisitions.
| | - | --------------------------------------------------------------------------------



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Acquisitions may also cause us to:



| |  | issue common stock that would dilute our current stockholders percentage ownership;
| | - | ------------------------------------------------------------------------------------



| |  | record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | incur amortization expenses related to certain intangible assets; or
| | - | --------------------------------------------------------------------



| |  | incur large and immediate write-offs.
| | - | -------------------------------------



We cannot assure you that our acquisition of Inktomis enterprise search software assets and future acquisitions will be successful and will not
adversely affect our business. We must also maintain our ability to manage any growth effectively. Failure to manage growth effectively and successfully integrate acquisitions we make could harm our business.



If we account for employee stock option and employee stock purchase plans using the
fair value method, it could significantly reduce our net income and earnings per share



There has been ongoing public debate whether employee stock option and employee stock purchase plans shares should be treated as a compensation expense
and, if so, how to properly value such charges. If we elected or were required to record an expense for our stock-based compensation plans using the fair value method, we could have significant accounting charges. For example, in the second quarter
of fiscal year 2004, had we accounted for stock-based compensation plans using the fair-value method prescribed in FASB Statement No. 123 as amended by Statement 148, earnings per share would have been reduced by $0.32 per share and we would have
reported a $0.23 loss per share. Although we are not currently required to record any compensation expense using the fair value method in connection with option grants to employees that have an exercise price at or above fair market value at the
grant date and for shares issued under our employee stock purchase plan, it is possible that future laws or regulations will require us to treat all stock-based compensation as an expense using the fair value method. See Note 2 to Consolidated
Financial Statements for a more detailed presentation of accounting for stock-based compensation plans.



Risks Related to Our Industry



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



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



The business of many
of our customers, and consequently our ability to sell our products, would be seriously harmed if:



| |  | use of the Internet, the Web and other online services does not continue to increase or increases more slowly than expected;
| | - | ----------------------------------------------------------------------------------------------------------------------------



| |  | the infrastructure for the Internet, the Web and other online services does not effectively support expansion that may occur; or
| | - | --------------------------------------------------------------------------------------------------------------------------------



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



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



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



| |  | potentially inadequate development of the necessary communication and network infrastructure, particularly if rapid growth of the Internet continues;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | delayed development of enabling technologies and performance improvements;
| | - | --------------------------------------------------------------------------



| |  | delayed development or adoption of new standards and protocols; and
| | - | -------------------------------------------------------------------



| |  | increased governmental regulation.
| | - | ----------------------------------



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



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



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



Security risks expose us to additional costs and to litigation



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



Risks Related to Ownership of Our Common Stock



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



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



| |  | future announcements concerning us or our competitors;
| | - | ------------------------------------------------------



| |  | quarterly variations in operating results;
| | - | ------------------------------------------



| |  | announcements of technological innovations;
| | - | -------------------------------------------



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



| |  | announcements of acquisitions by us or competitors;
| | - | ---------------------------------------------------



| |  | litigation involving proprietary rights or other matters; and
| | - | -------------------------------------------------------------



| |  | changes in earnings estimates by analysts or other factors.
| | - | -----------------------------------------------------------



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



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



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



| |  | establishment of a classified board of directors such that not all members of the board may be elected at one time;
| | - | -------------------------------------------------------------------------------------------------------------------



| |  | the ability of the board of directors to issue, without stockholder approval, up to 1,999,995 shares of preferred stock to increase the number of outstanding shares and thwart a
takeover attempt;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | no provision for cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | limitations on who may call special meetings of stockholders;
| | - | -------------------------------------------------------------



| |  | prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  | advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Item 3.Quantitative and Qualitative Disclosures About Market Risk



Interest Rate Risk.The primary objective of our investment activities is to preserve the principal while at the same time maximize yields without
significantly increasing our risk. To achieve this objective, we maintain our portfolio of cash equivalents and investments in a variety of securities, including both government and corporate obligations and money market funds. As of November 30,
2003, approximately 62% of our portfolio matures in one year or less, with the remainder maturing in less than three years. We do not use derivative financial instruments in our investment portfolio. We place our investments with high credit quality
issuers and, by policy, limit the amount of credit exposure to any one issuer.



The following table presents the amounts of our cash, cash equivalents and investments that are subject to interest rate risk by year of expected maturity and average interest rates as of November 30, 2003:



|                          |  | FY2004                 |        |   | FY2005 |   |        | FY2006 |  |   | FY2007 |   |  | Total |        |   | Fair Value |  
|------------------------- |  | ---------------------- | ------ | - | ------ | - | ------ | ------ |  | - | ------ | - |  | ----- | ------ | - | ---------- | -
|                          |  | (Dollars in thousands) |       
|Cash and cash equivalents |  | $                      | 78,274 |   |        |   |       |        |  |   |       |   |  |       |       |   |            | $
|Average interest rate     |  |                        | 1.2    | % |        |   |       |        |  |   |       |   |  |       |       |   |            |  
|Fixed-rate securities     |  | $                      | 33,196 |   |        | $ | 28,057 |        |  | $ | 44,640 |   |  | $     | 32,825 |   |            | $
|Average interest rate     |  |                        | 4.4    | % |        |   | 2.5    | %      |  |   | 2.3    | % |  |       | 2.5    | % |            |  
|Variable-rate securities  |  | $                      | 32,275 |   |        |   |       |        |  |   |       |   |  |       |       |   |            | $
|Average interest rates    |  |                        | 1.2    | % |        |   |       |        |  |   |       |   |  |       |       |   |            |  



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This compares to our cash equivalents and investments that were subject to interest rate risk by year of
expected maturity and average interest rates as of May 31, 2003 as follows:



|                          |  | FY2004                 |        |   | FY2005 |   |        | FY2006 |  |   | Total  |   |  | Fair Value |        
|------------------------- |  | ---------------------- | ------ | - | ------ | - | ------ | ------ |  | - | ------ | - |  | ---------- | -------
|                          |  | (Dollars in thousands) |       
|Cash and cash equivalents |  | $                      | 85,672 |   |        |   |       |        |  |   |       |   |  | $          | 85,672 
|Average interest rate     |  |                        | 1.1    | % |        |   |       |        |  |   |       |   |  |            | 1.1    
|Fixed-rate securities     |  | $                      | 50,393 |   |        | $ | 69,966 |        |  | $ | 42,113 |   |  | $          | 162,472
|Average interest rate     |  |                        | 4.3    | % |        |   | 2.5    | %      |  |   | 2.9    | % |  |            | 3.2    
|Variable-rate securities  |  | $                      | 2,600  |   |        |   |       |        |  |   |       |   |  | $          | 2,600  
|Average interest rates    |  |                        | 1.4    | % |        |   |       |        |  |   |       |   |  |            | 1.4    



The total dollar value
of our portfolio decreased by only $1.5 million from May 31, 2003 to November 30, 2003. However, between these dates, the composition of our portfolio changed significantly, as follows:



| |  | our combined cash equivalents and variable rate investments increased by $22.3 million, while our fixed-rate securities decreased by $23.8 million; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | although the weighted average maturity of our portfolio remained within our target levels, the composition of our portfolio changed significantly in that we increased the amounts
both of securities with maturities within 12 months and securities with maturities in excess of 24 months, which increases were offset by a $7.4 million decrease in cash and cash equivalents , the $1.5 million decrease in the overall value of the
portfolio, and the remainder being the decrease in the amount of securities with maturities between 12 months and 24 months.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As a result of the decrease in the amount of fixed-rate securities, the amount of interest we earn on our portfolio as of November 30, 2003 will be more
responsive to interest rate fluctuations as compared to May 30, 2003, but the value of the portfolio will be less responsive to interest rate fluctuations.



Foreign Currency Risk.We transact business in various foreign currencies, including the Euro, the British pound, the Canadian dollar, the
Australian dollar, the Swedish krona, the South African rand, the Mexican peso, the Brazilian real, the Japanese yen and the Singaporean dollar. We have established a foreign currency hedging program utilizing foreign currency forward exchange
contracts to offset the risk associated with the effects of certain foreign currency transaction exposures. Under this program, increases or decreases in our foreign currency transactions are in part offset by gains and losses on the forward
contracts, so as to mitigate the possibility of foreign currency transaction gains and losses. These foreign currency transactions typically arise from intercompany transactions.



Our forward contracts generally have terms of 90 days or less. We do not use forward contracts for trading purposes. All
foreign currency transactions and all outstanding forward contracts (non equity hedges) are marked to market at the end of the period with any changes in market value included in Other income (loss), net. Our ultimate realized gain or loss with
respect to currency fluctuations will depend on the currency exchange rates and other factors in effect as the contracts mature. Net foreign exchange transaction gain included in Other income, net in the accompanying consolidated of operations was
$174,000 in the six month period ended November 30, 2003. The fair value of the foreign currency exchange contracts was not material to our consolidated financial statements.



Item 4.Controls and Procedures



Limitations on the Effectiveness of Controls. Our management, including the Chief Executive Officer and Chief Financial Officer, believes that our disclosure controls and procedures and our internal control
over financial reporting will provide reasonable assurance that all errors will be detected, but does not expect that our disclosure controls and procedures or our internal control over financial reporting will provide absolute assurance



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that all errors will be detected. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Verity have been detected.
These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.



Evaluation of Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of management,
including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of November 30, 2003. Based on that evaluation, our management, including the Chief
Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of November 30, 2003, to provide reasonable assurance that the information required to be disclosed by us in this Quarterly Report
on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and Form 10-Q.



Changes in Internal Control over Financial Reporting. During the three month period ended November 30, 2003, there
were no changes in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II. OTHER INFORMATION



Item 1.Legal Proceedings



Not Applicable.



Item 2.Changes in Securities and Use of Proceeds



Not Applicable.



Item 3.Defaults upon Senior Securities



Not Applicable.



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



The Companys Annual Meeting of Stockholders was held on October 23, 2003. Proxies for the meeting were solicited pursuant to Regulation 14A. At the
meeting, managements nominees for two director positions to serve until the Companys 2006 annual meeting of stockholders were submitted to the stockholders of the Company. Managements nominees for director were elected by the
following vote:



|                       |  | Shares    
|---------------------- |  | ----------
|Nominee                |  | Voting For
|Anthony J. Bettencourt |  | 34,083,680
|Stephen A. MacDonald.  |  | 28,726,483



Gary J. Sbona, Steven
M. Krausz, Charles P. Waite, Jr., Stephen A. MacDonald, Victor A. Cohn, John G. Schwarz, Karl C. Powell and Anthony J. Bettencourt continued to serve as directors of the Company after the annual meeting. Mr. Sbona will continue to serve as the
Executive Chairman of the Board, and Mr. Powell and Mr. Schwarz will continue to serve as directors until the Annual Meeting of Stockholders to be held in 2004. Mr. Krausz, Mr. Cohn and Mr. Waite will continue to serve until the Annual Meeting of
Stockholders to be held in 2005. Mr. Bettencourt and Mr. MacDonald will continue to serve until the Annual Meeting of Stockholders to be held in 2006.



A previous proposal to ratify the selection of PricewaterhouseCoopers LLP as independent auditors of the Company for its fiscal year ending May 31, 2004
was withdrawn.



Item 5.Other Information



Regent Pacific Management Corporation (Regent Pacific) has been providing management services to Verity pursuant to a Retainer Agreement between Verity and Regent Pacific dated July 31, 1997, as amended,
(as amended, the Retainer Agreement). In January 2004, Verity and Regent Pacific entered into an amendment to the Retainer Agreement providing for a 75% reduction in weekly fees payable by Verity under the Retainer Agreement, beginning
in March 2004, as well as an extension of the non-cancelable period of the Retainer Agreement from February 28, 2004 to February 28, 2005. As a result of the amendment, the services to be rendered by Regent Pacific to Verity under the Retainer
Agreement will be reduced. In addition, pursuant to the amendment, Gary J. Sbona will continue to serve as our Executive Chairman of the Board, but Stephen W. Young will cease to serve as our Chief Operating Officer effective as of March 1, 2004.



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Item 6.Exhibits and Reports on Form 8-K



A. Exhibits  See Exhibit Index following the signature page to this report, which is incorporated by reference here.



B. Reports on Form 8-K



We filed four report on Form 8-K during the quarter covered by this report.



|Date               |  | Item Reported On                                                                                                                                                                                                          
|------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|September 10, 2003 |  | We reported under Item 12 a press release we issued on September 10, 2003, announcing financial results for fiscal quarter ended August 31, 2003.                                                                         
|                   | 
|October 23, 2003   |  | We reported on Item 9 that PricewaterhouseCoopers LLP has ceased to be our independent public accountants.                                                                                                                
|                   | 
|October 29, 2003   |  | We reported on Item 4 the engagement of KPMG LLP to serve as our principal auditors, replacing PricewaterhouseCoopers LLP.                                                                                                
|                   | 
|October 31, 2003   |  | We reported an amendment to the Form 8-K filed on October 29, 2003, relating to the change of independent public accountants, to change the ending date of the interim period
referred to in the last paragraph of Item 4.



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SIGNATURE



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



VERITY, INC.(Registrant)By:

/s/    STEVEN R.
SPRINGSTEELSteven R. Springsteel Senior Vice President of Finance and Administration and Chief Financial
Officer




Dated: January 9, 2004



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##### Table of Contents

INDEX TO EXHIBITS



|Exhibit Number |  | Description of Document                                                                                                                                                                                                                       
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1            |  | Asset Purchase Agreement among Inktomi Corporation, Quiver, Inc., Ultraseek Corporation, Quiver Ltd. and the Company, dated November 13, 2002. (1)                                                                                            
|               | 
|2.2            |  | Amendment No. 1 to Asset Purchase Agreement among Inktomi Corporation, Inktomi Quiver Corporation, Ultraseek Corporation, Quiver Ltd. and the Company, dated December 17, 2002,
amending Asset Purchase Agreement dated November 13, 2002. (1)
|               | 
|3.1            |  | Restated Certificate of Incorporation of the Company. (2)                                                                                                                                                                                     
|               | 
|3.2            |  | By-Laws. (2)                                                                                                                                                                                                                                  
|               | 
|4.1            |  | Amended and Restated Rights Agreement dated August 1, 1995, as amended. (3)                                                                                                                                                                   
|               | 
|4.2            |  | Form of Rights Agreement between Verity, Inc. and First National Bank of Boston dated September 18, 1996. (4)                                                                                                                                 
|               | 
|4.3            |  | First Amendment to Rights Agreement dated as of July 23, 1999 among Verity, Inc. and BankBoston, N.A. (5)                                                                                                                                     
|               | 
|10.41          |  | Seventh Amendment to Retainer Agreement between Regent Pacific Management Corporation and Verity, Inc. dated January 9, 2004.                                                                                                                 
|               | 
|31.1           |  | Certification of Anthony J. Bettencourt.                                                                                                                                                                                                      
|               | 
|31.2           |  | Certification of Steven R. Springsteel.                                                                                                                                                                                                       
|               | 
|32             |  | Certification of Chief Executive Officer and Chief Financial Officer.                                                                                                                                                                         

---

|(1) | Incorporated by reference from the exhibits with corresponding numbers from the Companys Form 8-K filed with the Securities and Exchange Commission on December 20, 2002
(Commission No. 000-26880).
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference from the exhibits with corresponding numbers from the Companys Form 10-Q for the quarter ended November 30, 2000 with the Securities and Exchange
Commission on January 10, 2001. (Commission No. 000-26880).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference from the exhibits with corresponding numbers from the Companys Registration Statement (No. 33-96228), declared effective on October 5, 1995.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference from Exhibit No. 1 to the Companys Form 8-K as filed with the Securities and Exchange Commission on October 10, 1996 (Commission No. 000-26880).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference to Exhibit 99.2 from the Companys Report on Form 8-K filed with the Securities and Exchange Commission on July 29, 1999 (Commission No. 000-26880).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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