<PAGE>   1
 
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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
 
                            ------------------------
 
                                   FORM 10-Q
 
(MARK ONE)
 
     [X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
           EXCHANGE ACT OF 1934
 
                 FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 1998
 
                                       OR
 
     [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
           EXCHANGE ACT OF 1934
 
         FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
 
                        COMMISSION FILE NUMBER: 0-26880
 
                            ------------------------
 
                                  VERITY, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                  DELAWARE                                      77-0182779
       (STATE OR OTHER JURISDICTION OF                       (I.R.S. EMPLOYER
       INCORPORATION OR ORGANIZATION)                       IDENTIFICATION NO.)
</TABLE>
 
                                 894 ROSS DRIVE
                          SUNNYVALE, CALIFORNIA 94089
                                 (408) 541-1500
         (ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
 
                            ------------------------
 
     Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
 
                               YES [X]     NO [ ]
 
     The number of shares outstanding of the Registrant's Common Stock, $0.001
par value, were 11,680,000 as of August 31, 1998.
 
     This report consists of 20 pages. The Exhibit Index to this report is
located on page 19.
 
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<PAGE>   2
 
                                  VERITY, INC.
 
                                   FORM 10-Q
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                       PAGE
                                                                       ----
<S>      <C>                                                           <C>
                       PART I: FINANCIAL INFORMATION
Item 1.  Financial Statements........................................    1
         Condensed Consolidated Balance Sheets as of May 31, 1998 and
           August 31, 1998...........................................    1
         Condensed Consolidated Statements of Operations for the
           Three Months Ended August 31, 1997 and 1998...............    2
         Condensed Consolidated Statements of Cash Flows for the
           Three Months Ended August 31, 1997 and 1998...............    3
         Notes to Condensed Consolidated Financial Statements........    4
Item 2.  Management's Discussion and Analysis of Financial Condition
           and Results of Operations.................................    6
 
                        PART II: OTHER INFORMATION
Item 1.  Legal Proceedings...........................................   17
Item 2.  Changes in Securities.......................................   17
Item 3.  Defaults upon Senior Securities.............................   17
Item 4.  Submission of Matters to a Vote of Security Holders.........   17
Item 5.  Other Information...........................................   17
Item 6.  Exhibits and Reports on Form 8-K............................   17
Signatures...........................................................   18
</TABLE>
 
                                        i
<PAGE>   3
 
                         PART I: FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
                                  VERITY, INC.
 
                     CONDENSED CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                              MAY 31,     AUGUST 31,
                                                                1998         1998
                                                              --------    -----------
                                                                          (UNAUDITED)
<S>                                                           <C>         <C>
Current assets:
  Cash and cash equivalents.................................  $  5,505     $  5,243
  Short-term investments....................................    12,433       18,460
  Trade accounts receivable, less allowance for doubtful
     accounts of $706 in 1998 and $666 in 1999..............    14,488        9,090
  Prepaid and other current assets..........................       878          993
                                                              --------     --------
          Total current assets..............................    33,304       33,786
  Property and equipment, at cost, net of accumulated
     depreciation and amortization..........................     7,567        6,878
  Other assets..............................................       578          502
                                                              --------     --------
          Total assets......................................  $ 41,449     $ 41,166
                                                              ========     ========
 
                                     LIABILITIES
Current liabilities:
  Current portion of long-term debt and capital lease
     obligations............................................  $    149     $     41
  Accounts payable..........................................     3,749        3,520
  Accrued compensation......................................     3,861        3,072
  Other accrued liabilities.................................     1,705        1,831
  Deferred revenue..........................................     7,928        6,663
                                                              --------     --------
          Total current liabilities.........................    17,392       15,127
  Long-term debt and capital lease obligations, net of
     current portion........................................         2            2
                                                              --------     --------
          Total liabilities.................................    17,394       15,129
                                                              --------     --------
 
                                STOCKHOLDERS' EQUITY
Common stock, $0.001 par value:
  Authorized: 30,000,000 shares in 1998 and 1999;
  Issued and outstanding: 11,565,000 shares in 1998 and
     11,680,000 shares in 1999..............................        12           12
Additional paid-in capital..................................    92,212       92,970
Unrealized gain on investments..............................         7            1
Accumulated deficit.........................................   (68,176)     (66,946)
                                                              --------     --------
          Total stockholders' equity........................    24,055       26,037
                                                              --------     --------
          Total liabilities and stockholders' equity........  $ 41,449     $ 41,166
                                                              ========     ========
</TABLE>
 
  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
 
                                        1
<PAGE>   4
 
                                  VERITY, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                              THREE MONTHS ENDED
                                                                  AUGUST 31,
                                                              ------------------
                                                               1997       1998
                                                              -------    -------
                                                                 (UNAUDITED)
<S>                                                           <C>        <C>
Revenues:
  Software products.........................................  $ 3,116    $ 9,889
  Service and other.........................................    2,224      3,331
                                                              -------    -------
          Total revenues....................................    5,340     13,220
                                                              -------    -------
Costs of revenues:
  Software products.........................................      705        437
  Service and other.........................................    1,685      1,082
                                                              -------    -------
          Total costs of revenues...........................    2,390      1,519
                                                              -------    -------
  Gross profit..............................................    2,950     11,701
                                                              -------    -------
Operating expenses:
  Research and development..................................    5,033      3,275
  Marketing and sales.......................................    5,745      5,952
  General and administrative................................    2,152      1,381
                                                              -------    -------
          Total operating expenses..........................   12,930     10,608
                                                              -------    -------
Income (loss) from operations...............................   (9,980)     1,093
Other income, net...........................................      264        287
                                                              -------    -------
Net income (loss) before provision for income taxes.........   (9,716)     1,380
Provision for income taxes..................................       50        150
                                                              -------    -------
Net income (loss)...........................................  $(9,766)   $ 1,230
                                                              =======    =======
Net income (loss) per share -- basic........................  $ (0.89)   $  0.11
                                                              =======    =======
Net income (loss) per share -- diluted......................  $ (0.89)   $  0.10
                                                              =======    =======
Number of shares used in per share calculation -- basic.....   11,033     11,627
                                                              =======    =======
Number of shares used in per share calculation -- diluted...   11,033     12,882
                                                              =======    =======
</TABLE>
 
  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
 
                                        2
<PAGE>   5
 
                                  VERITY, INC.
 
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              THREE MONTHS ENDED
                                                                  AUGUST 31,
                                                              -------------------
                                                               1997        1998
                                                              -------    --------
                                                                  (UNAUDITED)
<S>                                                           <C>        <C>
Cash flows from operating activities:
  Net income (loss).........................................  $(9,766)   $  1,230
  Adjustments to reconcile net income (loss) to net cash
     provided by (used in) operating activities:
     Depreciation and amortization..........................    1,288         874
     Other..................................................       --         (25)
     Provision for doubtful accounts........................     (130)        363
     Amortization of discount on securities.................      (24)       (134)
     Changes in operating assets and liabilities:
       Trade accounts receivable............................    3,519       5,081
       Prepaid and other current assets.....................       41        (171)
       Accounts payable.....................................   (1,147)       (229)
       Accrued compensation and other accrued liabilities...      328        (635)
       Deferred revenue.....................................      138      (1,198)
                                                              -------    --------
          Net cash provided by (used in) operating
           activities.......................................   (5,753)      5,156
                                                              -------    --------
Cash flows from investing activities:
  Acquisition of property and equipment.....................     (796)       (184)
  Purchases of marketable securities........................   (3,691)    (19,552)
  Maturity of marketable securities.........................    1,400       5,000
  Proceeds from sale of marketable securities...............    9,272       8,652
  Capitalization of software................................     (198)         --
                                                              -------    --------
          Net cash provided by (used in) investing
           activities.......................................    5,987      (6,084)
                                                              -------    --------
Cash flows from financing activities:
  Borrowings under line of credit...........................    1,500          --
  Payments on line of credit................................   (1,500)         --
  Proceeds from stockholders on notes receivable............    1,027          --
  Proceeds from the sale of common stock....................       50         758
  Principal payments on notes payable and capital lease
     obligations............................................     (145)       (109)
                                                              -------    --------
          Net cash provided by financing activities.........      932         649
                                                              -------    --------
Effect of exchange rate changes on cash.....................        1          17
                                                              -------    --------
          Net increase (decrease) in cash and cash
           equivalents......................................    1,167        (262)
Cash and cash equivalents, beginning of period..............    2,934       5,505
                                                              -------    --------
Cash and cash equivalents, end of period....................  $ 4,101    $  5,243
                                                              =======    ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
  ACTIVITIES:
  Acquisition consideration included in accrued
     liabilities............................................  $   200
</TABLE>
 
  The accompanying notes are an integral part of these condensed consolidated
                             financial statements.
 
                                        3
<PAGE>   6
 
                                  VERITY, INC.
 
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
         (INFORMATION AS OF AUGUST 31, 1998 AND FOR THE QUARTERS ENDED
             AUGUST 31, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)
 
 1. INTERIM FINANCIAL DATA (UNAUDITED)
 
     The unaudited financial statements for the quarters ended August 31, 1997
and 1998 have been prepared on the same basis as the audited financial
statements and, in the opinion of management, include all material adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of
the financial position and results of operations in accordance with generally
accepted accounting principles. Although certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to the
rules and regulations of the Securities and Exchange Commission, the Company
believes the disclosures made are adequate to make the information presented not
misleading. It is suggested that the accompanying financial statements be read
in conjunction with the Company's annual financial statements on Form 10-K for
the year ended May 31, 1998.
 
     The Company's balance sheet as of May 31, 1998 was derived from the
Company's audited financial statements, but does not include all disclosures
necessary for the presentation to be in accordance with generally accepted
accounting principles.
 
 2. COMPUTATION OF NET INCOME AND LOSS PER SHARE
 
     The Company has adopted Statement of Financial Accounting Standards No. 128
(SFAS 128), "Earnings Per Share," which requires the dual presentation of basic
and diluted earnings per share. Basic earnings per share are computed using the
weighted average number of common shares outstanding during the period. Diluted
earnings per share are computed using the weighted average number of common and
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of stock options. For the three months ended August
31, 1997, the effects of outstanding stock options were excluded from the
computation of diluted earnings per share because their effect was antidilutive.
Accordingly, no adjustments were required to previously reported earnings per
share amounts.
 
 3. RECENT ACCOUNTING PRONOUNCEMENTS
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive
Income." This statement establishes requirements for disclosure of comprehensive
income and becomes effective for the Company for its fiscal year 1999, with
reclassification of earlier financial statements for comparative purposes.
Comprehensive income generally represents all changes in stockholders' equity
except those resulting from investments or contributions by stockholders. SFAS
130 requires unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income. The Company has adopted
SFAS 130, however, the effects of the adoption were immaterial to all periods
presented.
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments
of an Enterprise and Related Information." This statement establishes standards
for disclosures about operating segments in annual financial statements and
selected information in interim financial reports. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. This statement supersedes statement of Financial Accounting Standards
No. 14, "Financial Reporting for Segments of a Business Enterprise." The new
standard becomes effective for the Company's fiscal year 1999, and requires that
comparative information from earlier years be restated to conform to the
requirements of this standard. The Company is evaluating the requirements of
SFAS 131 and the effects, if any, on the Company's current reporting and
disclosures.
 
                                        4
<PAGE>   7
                                  VERITY, INC.
 
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
         (INFORMATION AS OF AUGUST 31, 1998 AND FOR THE QUARTERS ENDED
             AUGUST 31, 1997 AND 1998 AND THEREAFTER IS UNAUDITED)
 
     During October 1997, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
No. 97-2 (SOP 97-2), "Software Revenue Recognition." This statement delineates
the accounting for software product and maintenance revenues. It supersedes
Statement of Position No. 91-1, "Software Revenue Recognition," and is effective
for transactions entered into in fiscal years beginning after December 15, 1997.
The Company has evaluated the requirements of SOP 97-2 and its current revenue
recognition policy is in compliance with this pronouncement.
 
 4. BANK LINE OF CREDIT
 
     In March 1998, the Company negotiated a $5,000,000 line of credit under an
agreement with a bank, which expires on September 30, 1998. The line of credit
is collateralized by all corporate assets, excluding leased equipment.
Borrowings under the line of credit bear interest at the lender's prime rate
(8.5% at August 31, 1998). The agreement requires the Company to comply with
certain financial covenants and prohibits the assumption of any major debt,
except for equipment leases, without the bank's approval. As of August 31, 1998,
no borrowings were outstanding under the line of credit.
 
     On September 22, 1998, the Company extended the term on its bank line of
credit for an additional two months until November 30, 1998. The Company plans
to renegotiate the agreement upon its expiration on November 30, 1998, but there
is no assurance that such financing will be available on commercially reasonable
terms, or at all.
 
 5. RESTRUCTURING CHARGES
 
     During the quarter ended November 30, 1997, the Company implemented a
worldwide restructuring of its operations, which resulted in workforce
reductions and business consolidations. In connection with the restructuring,
the Company recorded a $3.0 million restructuring charge in the quarter ended
November 30, 1997, of which approximately $1.6 million was related to severance
costs associated with the reduction in the worldwide workforce, approximately
$0.5 million to the termination of certain lease agreements, approximately $0.6
million to the write-off of certain assets and approximately $0.3 million to
other costs associated with the restructuring.
 
     Of the total $3.0 million in restructuring charges, approximately $0.8
million is a current liability at August 31, 1998.
 
 6. SUBSEQUENT EVENTS
 
     On September 24, 1998, the stockholders of the Company approved to amend
the 1995 Stock Option Plan (the "Option Plan") of the Company to increase the
number of shares of Common Stock of the Company authorized for issuance
thereunder from 3,310,836 shares to 4,060,836 shares.
 
                                        5
<PAGE>   8
 
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
OVERVIEW
 
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW IN "RISK FACTORS."
 
     Verity develops, markets and supports knowledge retrieval software products
for application developers, corporate Intranet users and e-commerce sites.
Verity's technology enables organizations to manage text-based information
residing on their networks, making corporate content reusable across Intranets,
the Internet and CD-ROM.
 
     Verity's knowledge retrieval products are designed to primarily index,
search, retrieve, organize and disseminate unstructured information, which
typically constitutes the substantial majority of an enterprise's business
information and does not reside in a traditional relational database. Verity's
products also enable application developers to embed powerful search and
retrieval functionality into their own commercial applications. The Company's
knowledge retrieval and KeyView viewing and filtering products are used within
the Company's own suite of applications and have been embedded by many leading
OEMs, including Lotus, Sybase, SAP and Netscape. Verity has licensed its
technology to key e-commerce vendors, including Adobe Systems, AT&T WorldNet
Services, CNET, Cisco, Compaq, Dow Jones, Ernst & Young, Financial Times,
NewsEDGE Corporation, Informix, NEC, SCO, Siemens Nixdorf, Tandem and
Time-Warner's Pathfinder. Verity's software has been licensed to over 1,000
corporations, government agencies, software developers, online service providers
and Internet publishers worldwide.
 
     For the three months ended August 31, 1998, total revenues increased 147.6%
over the corresponding fiscal 1997 period, primarily as a result of a 217.4%
increase in software product revenues. Total revenues for the three months ended
August 31, 1998 increased 0.7% from the $13.1 million for the previous three
months ended May 31, 1998. Operating expenses for the three months ended August
31, 1998 decreased primarily as a result of a 47.6% decrease in general and
administrative expenses compared to the previous three months ended May 31,
1998. While it is the Company's goal to increase revenues and generate net
income in future periods, no assurance can be given that the Company's revenues
will increase from quarter to quarter in future periods, or that the Company
will achieve or maintain positive cash flow or profitability.
 
     During the quarter ended November 30, 1997, the Company implemented a
worldwide restructuring of its corporate structure, which resulted in workforce
reductions and business consolidations. In connection with the restructuring,
the Company recorded a $3.0 million restructuring charge in the quarter ended
November 30, 1997, of which approximately $1.6 million was related to severance
costs associated with the reduction in the worldwide workforce, approximately
$0.5 million to the termination of certain lease agreements, approximately $0.6
million to the write-off of certain assets and approximately $0.3 million to
other costs associated with the restructuring. The Company believes that hiring
and retaining qualified individuals at all levels in the Company is essential to
its success, and there can be no assurance that the Company will be successful
in attracting and retaining the necessary personnel. The Company has experienced
significant turnover, including turnover of several senior members of
management. In particular, on July 31, 1997, Mr. Gary J. Sbona was appointed as
the Company's President and Chief Executive Officer, and the Company entered
into an agreement with Regent Pacific Management Corporation, a management firm
of which Mr. Sbona is the Chief Executive Officer. Pursuant to the original
agreement, Regent Pacific agreed to provide management services to the Company,
at a fee of $50,000 per week, including the services of Mr. Sbona as Chief
Executive Officer and President and at least three other Regent Pacific
personnel as part of the Company's management team. The agreement had a one-year
term and could be canceled by the Company after expiration of the initial
26-week period, with a minimum compensation to Regent Pacific of $1.3 million
for that initial period. The agreement requires that the Company indemnify
Regent Pacific and Mr. Sbona for certain liabilities arising out of the
performance of services under the agreement. On April 13,
 
                                        6
<PAGE>   9
 
1998, the Company and Regent Pacific agreed to amend the agreement to provide
that Mr. Sbona and at least four other Regent Pacific personnel would serve as
part of the Company's management team. The amendment also served to extend the
term of the agreement until August 31, 1999, and to extend the noncancelable
period of the agreement until February 28, 1999. In connection with Mr. Sbona's
service as President and CEO of the Company, the Compensation Committee of the
Company's Board also granted to him an option to purchase 350,000 shares of the
Company's common stock at an exercise price of $5.125 per share. The shares
subject to such option will vest on a monthly basis during the 13-month period
ending on February 28, 1999, subject to Mr. Sbona's continued employment as the
Company's President and CEO; provided, however, that the option will vest
entirely upon certain change of control transactions or upon a termination of
Mr. Sbona without cause. The option will also remain exercisable for one year
following the termination of Mr. Sbona's services.
 
     If Company management is unable to effectively manage the Company's
operations, identify opportunities in a timely fashion, and evaluate and manage
the Company's business and competitive position, the Company's results of
operations and financial condition will be materially and adversely affected.
Furthermore, there can be no assurance that the Company will successfully
develop and introduce new products on a timely basis or that its new or recently
introduced products will achieve market acceptance.
 
     On March 11, 1998, the Company announced that it had filed a lawsuit in the
United States District Court for the District of Delaware against Lotus
Development Corporation for copyright infringement, unfair competition, breach
of a 1992 agreement under which Verity licensed certain software to Lotus,
misappropriation of trade secrets, and unjust enrichment and conversion. On June
8, 1998, Verity, Inc. and Lotus Development Corporation announced that they have
concluded a settlement agreement that makes available to Lotus a range of Verity
technologies for use with Lotus products. The settlement agreement resolves
issues that had arisen between the two companies. Accordingly, the Company has
withdrawn its legal action against Lotus Development Corporation by virtue of a
settlement agreement dated June 8, 1998.
 
     The Company's revenues are derived from license fees for its software
products and fees for services complementary to its products, including software
maintenance, consulting and training. Fees for services generally are charged
separately from the license fees for the Company's software products. Effective
for contracts entered into starting June 1, 1998, the Company recognizes
revenues in accordance with the provisions of American Institute of Certified
Public Accountants Statement of Position No. 97-2, "Software Revenue
Recognition." Maintenance revenues from ongoing customer support and product
upgrades are recognized ratably over the term of the applicable maintenance
agreement, which is typically 12 months. Payments for maintenance fees generally
are received in advance and are nonrefundable. Revenues for consulting and
training generally are recognized when the services are performed. Statement of
Position No. 97-2 supersedes Statement of Position No. 91-1, "Software Revenue
Recognition," and is effective for transactions entered into in fiscal years
beginning after December 15, 1997. This statement delineates the accounting for
software product and maintenance revenues. The Company has evaluated the
requirements of SOP 97-2 and its current revenue recognition policy is in
compliance with this pronouncement.
 
                                        7
<PAGE>   10
 
RESULTS OF OPERATIONS
 
     The following table sets forth the percentage of revenues represented by
certain items in the Company's Condensed Consolidated Statements of Operations
for the periods indicated:
 
<TABLE>
<CAPTION>
                                                            THREE MONTHS ENDED
                                                                AUGUST 31,
                                                            -------------------
                                                             1997         1998
                                                            -------      ------
<S>                                                         <C>          <C>
Revenues:
  Software products.......................................    58.4%       74.8%
  Service and other.......................................    41.6        25.2
                                                            ------       -----
          Total revenues..................................   100.0       100.0
                                                            ------       -----
Costs of revenues:
  Software products.......................................    13.2         3.3
  Service and other.......................................    31.6         8.2
                                                            ------       -----
          Total costs of revenues.........................    44.8        11.5
                                                            ------       -----
Gross profit..............................................    55.2        88.5
                                                            ------       -----
Operating expenses:
  Research and development................................    94.2        24.8
  Marketing and sales.....................................   107.6        45.0
  General and administrative..............................    40.3        10.4
                                                            ------       -----
          Total operating expenses........................   242.1        80.2
                                                            ------       -----
Income (loss) from operations.............................  (186.9)        8.3
Interest and other expenses...............................     4.9         2.1
                                                            ------       -----
Income (loss) before provision for income taxes...........  (182.0)       10.4
Provision for income taxes................................     0.9         1.1
                                                            ------       -----
Net income (loss).........................................  (182.9)%       9.3%
                                                            ======       =====
</TABLE>
 
  Revenues
 
     Total revenues increased 147.6% from $5.3 million for the three months
ended August 31, 1997 to $13.2 million for the three months ended August 31,
1998. Total revenues as compared to the three-month period ended August 31, 1997
increased primarily due to increased revenues from licensing of enterprise
products and topic tools products. Software product revenues increased as a
percentage of total revenues from 58.4% for the three months ended August 31,
1997, to 74.8% for the comparable period in fiscal 1999. Conversely, service and
other revenues decreased as a percentage of total revenues from 41.6% for the
three months ended August 31, 1997 to 25.2% for the three months ended August
31, 1998.
 
     Software product revenues. Software product revenues increased 217.4% from
$3.1 million for the three months ended August 31, 1997 to $9.9 million for the
three months ended August 31, 1998. The increase for the three months ended
August 31, 1998 in comparison to the three months ended August 31, 1997 was due
principally to increased revenues from licensing of enterprise products and
topic tools products.
 
     Service and other revenues. Service and other revenues increased 49.8% from
$2.2 million for the three months ended August 31, 1997 to $3.3 million for the
three months ended August 31, 1998. Maintenance and consulting revenues
increased significantly between the comparable periods, but these increases were
partially offset by reduced training revenues.
 
     Revenues derived from European operations accounted for 10.6% and 5.5%,
respectively, for the three months ended August 31, 1997 and 1998. For the three
months ended August 31, 1997 and 1998, export sales accounted for 21.9% and
22.4% of total revenues, respectively. The decrease in revenues from European
operations as a percentage of total revenues resulted primarily from increased
domestic revenues. The Company expects that revenues derived from European
operations and export sales will continue to vary in future periods as a
percentage of total revenues.
 
                                        8
<PAGE>   11
 
     No single customer accounted for more than 10% of the Company's revenues
for the three months ended August 31, 1997. For the three months ended August
31, 1998, revenues derived from sales to Lotus Development Corporation accounted
for 16.6% of the Company's total revenues. Revenues derived from sales to the
federal government and its agencies were 8.8% and 3.8% of the Company's revenues
for the three months ended August 31, 1997 and 1998, respectively. The Company
expects that revenues from such government sales will continue to vary in future
periods as a percentage of revenues.
 
  Costs of Revenues
 
     Costs of software products. Costs of software products decreased 38.0% from
$705,000 for the three months ended August 31, 1997 to $437,000 for the three
months ended August 31, 1998, representing 22.6% and 4.4%, respectively, of the
software product revenues. In the three months ended August 31, 1997, the
Company incurred amortization expense relating to capitalized software, which
represented a significant part of the software costs. The decrease in absolute
dollars during the periods ended August 31, 1998, was primarily due to the
elimination of the amortization expense related to the capitalized software. The
decrease in costs as a percentage of software product revenues was primarily
related to the increased software product revenues for the three months ended
August 31, 1998.
 
     Costs of service and other. Costs of service and other revenues decreased
35.8% from $1.7 million for the three months ended August 31, 1997 to $1.1
million for the three months ended August 31, 1998, representing 75.8% and
32.5%, respectively, of service and other revenues. The decrease in absolute
dollars was due principally to a decrease in consulting and technical support
personnel.
 
  Operating Expenses
 
     Research and development. Research and development expenses decreased 34.9%
from $5.0 million for the three months ended August 31, 1997 to $3.3 million for
the three months ended August 31, 1998, representing 94.2% and 24.8%,
respectively, of total revenues. The decrease in absolute dollars was primarily
due to a significant decrease in research and development personnel during
fiscal 1999 as a result of a discontinuation of the operations of Insite,
Cognisoft and 64K in fiscal 1998. The decrease in costs as a percentage of total
revenues was primarily related to the increased revenues for the three months
ended August 31, 1998. Future research and development expenses may vary as a
percentage of total revenues. The Company believes that research and development
expenses will increase in the future primarily due to the introduction of new
products to the Company's product line and other anticipated product development
efforts. Future research and development expenses may vary as a percentage of
total revenues.
 
     Marketing and sales. Marketing and sales expenses increased 3.6% from $5.7
million for the three months ended August 31, 1997 to $6.0 million for the three
months ended August 31, 1998, representing 107.6% and 45.0%, respectively, of
total revenues. The increase in absolute costs for the three months ended August
31, 1998, was primarily related to the Company's expansion of its sales
organization in the United States and Europe. The decrease in costs as a
percentage of total revenues was primarily related to the increased revenues for
the three months ended August 31, 1998. The Company anticipates it will continue
to make significant investments in marketing and sales.
 
     General and administrative. General and administrative expenses decreased
35.8% from $2.2 million in the three months ended August 31, 1997 to $1.4
million for the three months ended August 31, 1998, representing 40.3% and
10.4%, respectively, of total revenues. The decrease in absolute costs was
primarily related to decreased expenses associated with management in transition
and personnel. The decrease in costs as a percentage of total revenues was
primarily related to the increased revenues for the three months ended August
31, 1998.
 
     Restructuring charges. During the quarter ended November 30, 1997, the
Company implemented a worldwide restructuring of its corporate structure, which
resulted in workforce reductions and business consolidations. In connection with
the restructuring, the Company recorded a $3.0 million restructuring charge in
the quarter ended November 30, 1997, of which $1.6 million was related to
severance costs associated with the reduction in the worldwide workforce, $0.5
million to the termination of certain lease
 
                                        9
<PAGE>   12
 
agreements, $0.6 million to the write-off of certain assets and $0.3 million to
other costs associated with the restructuring.
 
     Of the total $3.0 million in restructuring charges, approximately $0.8
million is a current liability at August 31, 1998.
 
  Income Taxes
 
     The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
Management evaluates on a quarterly basis the recoverability of the deferred tax
assets and the level of the valuation allowance. At such time as it is
determined that it is more likely than not that deferred tax assets are
realizable, the valuation allowance will be appropriately reduced.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Since its inception, the Company has financed its operations primarily
through proceeds of approximately $23.6 million from private sales of Preferred
Stock, proceeds from its initial public offering and secondary public offering
of Common Stock and, to a lesser extent, bank credit lines and capital operating
leases. The Company completed its initial public offering of Common Stock in
October 1995 and realized net proceeds of $32.5 million. In January 1996, the
Company completed its secondary public offering of Common Stock, which generated
net proceeds of $16.5 million. The Company has used a portion of those proceeds
to repay borrowings under its line of credit in the amount of $1.6 million. As
of August 31, 1998, the Company had $23.7 million in cash and cash equivalents
and available-for-sale securities.
 
     The Company's operating activities used cash of $5.8 million and provided
cash of $5.2 million for the three months ended August 31, 1997 and 1998,
respectively. In the three months ended August 31, 1997, the Company's net loss
for the period offset cash provided by a decrease in accounts receivable and
depreciation and amortization expense. For the three months ended August 31,
1998, the Company's net income, a decrease in accounts receivable, and
depreciation and amortization expense provided cash associated with operating
activities.
 
     The Company's investing activities provided cash of $6.0 million and used
cash of $6.1 million for the three months ended August 31, 1997 and 1998,
respectively. For the three months ended August 31, 1997, cash provided by
investing activities consisted primarily of proceeds from the sale and maturity
of marketable securities partially offset by purchases of marketable securities.
For the three months ended August 31, 1998, cash used by investing activities
consisted primarily of purchases of marketable securities partially offset by
proceeds from the sale and maturity of marketable securities.
 
     Cash provided by financing activities was $932,000 and $649,000 for the
three months ended August 31, 1997 and 1998, respectively. In the three months
ended August 31, 1997, financing activities consisted primarily of proceeds from
the sale of Common Stock in connection with the proceeds from stockholders on
notes receivable. In the three months ended August 31, 1998, financing
activities consisted primarily of proceeds from the sale of Common Stock.
 
     At August 31, 1998, the Company's principal sources of liquidity were its
cash, cash equivalents, and short-term investments of $23.7 million. In March
1998, the Company obtained a $5.0 million line of credit under an agreement with
a bank, which expires on September 30, 1998. The line of credit is
collateralized by all corporate assets, excluding leased equipment. Borrowings
under the line of credit bear interest at the lender's prime rate. The agreement
requires the Company to comply with certain financial covenants and prohibits
the assumption of any major debt, except for equipment leases, without the
bank's approval. The agreement was extended until November 30, 1998. As of
August 31, 1998, no borrowings were outstanding under the line of credit. See
Note 4 of Notes to Condensed Consolidated Financial Statements.
 
     Capital expenditures, including capital leases, were approximately $796,000
and $184,000 for the three months ended August 31, 1997 and 1998, respectively.
For the three months ended August 31, 1997 and 1998, these expenditures
consisted principally of purchases of property and equipment, primarily for
computer hardware and software.
 
                                       10
<PAGE>   13
 
     The Company believes that its current cash and cash equivalents, its bank
line of credit and its funds generated from operations, if any, will provide
adequate liquidity to meet the Company's capital and operating requirements
through at least fiscal 1999. Thereafter, or if the Company's spending plans
change, the Company may find it necessary to seek to obtain additional sources
of financing to support its capital needs, but there is no assurance that such
financing will be available on commercially reasonable terms, or at all.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive
Income." This statement establishes requirements for disclosure of comprehensive
income and becomes effective for the Company for its fiscal year 1999, with
reclassification of earlier financial statements for comparative purposes.
Comprehensive income generally represents all changes in stockholders' equity
except those resulting from investments or contributions by stockholders. SFAS
130 requires unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income. The Company has adopted
SFAS 130, however, the effects of the adoption were immaterial to all periods
presented.
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments
of an Enterprise and Related Information." This statement establishes standards
for disclosures about operating segments in annual financial statements and
selected information in interim financial reports. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. This statement supersedes statement of Financial Accounting Standards
No. 14, "Financial Reporting for Segments of a Business Enterprise." The new
standard becomes effective for the Company's fiscal year 1999, and requires that
comparative information from earlier years be restated to conform to the
requirements of this standard. The Company is evaluating the requirements of
SFAS 131 and the effects, if any, on the Company's current reporting and
disclosures.
 
     During October 1997, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
No. 97-2 (SOP 97-2), "Software Revenue Recognition." This statement delineates
the accounting for software product and maintenance revenues. It supersedes
Statement of Position No. 91-1, "Software Revenue Recognition," and is effective
for transactions entered into in fiscal years beginning after December 15, 1997.
The Company has evaluated the requirements of SOP 97-2 and its current revenue
recognition policy is in compliance with this pronouncement.
 
YEAR 2000 COMPLIANCE
 
     Many currently installed computer systems are not capable of distinguishing
21st century dates from 20th century dates. As a result, in less than two years,
computer systems or applications used by many companies in a wide variety of
industries will experience operating difficulties unless the systems or
applications are modified to process information related to the century change
adequately. Significant uncertainty exists in the software and other industries
concerning the scope and magnitude of problems associated with the century
change. To the extent Year 2000 issues cause significant delay in, or
cancellation of, decisions to purchase the Company's products or product
support, due to the relocation of resources to address Year 2000 issues or
otherwise, the Company's business, results of operations and financial condition
could be materially and adversely affected.
 
  Products
 
     Based on the Company's recent assessment of Year 2000 issues, the Company
has determined that the current versions of its products are "Year 2000
compliant." In spite of the fact that the Company has not been a party to any
litigation or any proceedings to date involving its products or services related
to Year 2000 compliance issues, there can be no assurance that the Company will
not in the future be required to defend its products or services in such
proceedings, or to negotiate the resolution of claims based on Year 2000 issues.
The costs of defending and resolving Year 2000-related disputes, and any
liability of the Company for Year
 
                                       11
<PAGE>   14
 
2000-related damages, including consequential damages, could have a material
adverse effect on the Company's business, results of operations and financial
condition.
 
  Operations
 
     The Company is reviewing its internal management information and other
systems in order to identify and modify those products, services or systems that
are not Year 2000 compliant. The total cost of these Year 2000 compliance
activities has not been material to date. There can be no assurance that the
Company will identify and remedy all significant Year 2000 problems in a timely
fashion, that remedial efforts in this regard will not involve significant time
and expense, or that such problems will not have a material adverse effect on
the Company's business, results of operations and financial condition. The
Company faces additional risk to the extent that suppliers of products, services
and systems purchased by the Company and others with whom the Company transacts
business are not Year 2000 compliant. In the event that any such third parties
can not provide the Company with products, services or systems that are Year
2000 compliant on a timely basis, or in the event Year 2000 issues prevent such
third parties from delivering products, services or systems required by the
Company on a timely basis, the Company's business, results of operations and
financial condition could be materially and adversely affected.
 
RISK FACTORS
 
     The Company operates in a rapidly changing environment that involves
numerous risks, a number of which are beyond the Company's control. The
following discussion highlights some of those risks. A comprehensive summary of
the risks can be found in the Company's Annual Report on Form 10-K for the
fiscal year ended May 31, 1998 and the Company's definitive Proxy Statement on
Schedule 14A as filed on August 27, 1998.
 
     History of Losses; Strategic Realignment. Since inception, the Company has
incurred significant losses and substantial negative cash flow. The Company was
founded in 1988, and historically derived the substantial majority of its
revenues from the licensing of high-priced, custom search and retrieval
applications for use almost entirely by large organizations and government
agencies. During these years, the Company also generated a substantial portion
of its revenues by providing the consulting services required to support these
products. In early fiscal 1994, the Company shifted its strategy to focus
increasingly on more versatile, lower-priced software applications, which
require less specialized consulting. To achieve revenue growth, the Company
must, among other things, increase market acceptance of the Company's
technology, achieve significantly increased sales levels, respond effectively to
competitive developments, continue to attract, retain and motivate qualified
persons, and continue to upgrade its technologies and commercialize products and
services incorporating such technologies. There can be no assurance that the
Company's strategy will be successful or that the Company will experience
increased revenues or become profitable or cash flow positive at any time in the
future.
 
     Management in Transition; Employee Turnover. The Company is experiencing a
period of transition and new product introductions that have placed, and will
continue to place, a significant strain on its resources, including personnel.
During the past few years, management and other personnel have focused on
modifying and enhancing the Company's core technology to support a broader set
of search and retrieval solutions for use on desktop and enterprise-wide
systems, and over online services, the Internet and on CD-ROM. In order for the
Company's strategy to succeed, the Company must, among other things, leverage
its core technology to develop new product offerings by the Company and by its
original equipment manufacturer ("OEM") customers that address the needs of
these new markets. Many of the Company's products are still being developed or
have only recently been introduced, and there is no assurance that such products
will be successfully completed on a timely basis, will achieve market acceptance
or will generate significant revenues. Projects relating to these efforts,
including Verity's suite of products, continued enhancement of the functionality
of the Company's search engine and related products, and technical integration
of the Company's products with the products of the Company's strategic partners,
when added to the day-to-day activities of the Company, will continue to strain
the Company's resources and personnel.
 
                                       12
<PAGE>   15
 
     In connection with its strategy, the Company has also replaced the majority
of its work force and substantially reorganized all of the departments within
the Company. Continuity of personnel can be an important factor in the
successful completion of the Company's development projects, and ongoing
turnover in the Company's research and development personnel could materially
and adversely impact the Company's development and marketing efforts. The
Company believes that hiring and retaining qualified individuals at all levels
in the Company is essential to its success, and there can be no assurance that
the Company will be successful in attracting and retaining the necessary
personnel. As noted above, the Company has experienced significant turnover,
including turnover of several senior members of management. In particular, on
July 31, 1997, Mr. Gary J. Sbona was appointed as the Company's President and
Chief Executive Officer, and the Company entered into an agreement with Regent
Pacific Management Corporation, a management firm of which Mr. Sbona is the
Chief Executive Officer. Pursuant to the original agreement, Regent Pacific
agreed to provide management services to the Company, including the services of
Mr. Sbona as Chief Executive Officer and President and at least three other
Regent Pacific personnel as part of the Company management team. The agreement
had a one-year term and could be canceled by the Company after expiration of the
initial 26-week period, with a minimum compensation to Regent Pacific of $1.3
million for that initial period. On April 13, 1998, the Company and Regent
Pacific agreed to amend the agreement to provide that Mr. Sbona and at least
four other Regent Pacific personnel would serve as part of the Company's
management team. The amendment also served to extend the term of the agreement
until August 31, 1999, and to extend the noncancelable period of the agreement
until February 28, 1999. In connection with Mr. Sbona's service as President and
CEO of the Company, the Compensation Committee of the Company's Board also
granted to him an option to purchase 350,000 shares of the Company's common
stock at an exercise price of $5.125 per share. The shares subject to such
option will vest on a monthly basis during the 13-month period ending on
February 28, 1999, subject to Mr. Sbona's continued employment as the Company's
President and CEO; provided, however, that the option will vest entirely upon
certain change of control transactions or upon a termination of Mr. Sbona
without cause. The option will also remain exercisable for one year following
the termination of Mr. Sbona's services. If Company management is unable to
effectively manage the Company's operations, identify opportunities in a timely
fashion, and evaluate and manage the Company's business and competitive
position, results of operations and financial condition will be materially and
adversely affected.
 
     Fluctuations in Operating Results. The Company's quarterly operating
results have varied and are expected to vary significantly in the future. These
fluctuations may be caused by many factors, including, among others, the size
and timing of individual orders; customer order deferrals in anticipation of new
products; changes in the budgets or purchasing patterns of government agencies;
timing of introduction or enhancement of products by the Company or its
competitors; market acceptance of new products; technological changes in search
and retrieval, database, networking, or communications technology; competitive
pricing pressures; changes in the Company's operating expenses; personnel
changes; foreign currency exchange rates; mix of products sold; quality control
of products sold; and general economic conditions.
 
     A significant portion of the Company's revenues in recent quarters have
been derived from relatively large sales to a limited number of customers, and
the Company currently anticipates that future quarters will continue to reflect
this trend. Sales cycles for these customers can be up to six months or longer.
In addition, like many software companies, the Company has generally recognized
a substantial portion of its revenues in the last month of each quarter, with
these revenues concentrated in the last weeks of the quarter. Accordingly, the
cancellation or deferral of even a small number of purchases of the Company's
products could have a material adverse effect on the Company's business, results
of operations and financial condition in any particular quarter. To the extent
that significant sales occur earlier than expected, operating results for
subsequent quarters may fail to keep pace or even decline.
 
     Product revenues are also difficult to forecast because the market for
search and retrieval software is uncertain and evolving. Because the Company
generally ships software products within a short period after receipt of an
order, the Company typically does not have a material backlog of unfilled
orders, and revenues in any quarter are substantially dependent on orders booked
in that quarter. In addition, a portion of the Company's revenues is derived
from royalties based upon sales by third-party vendors of products incorporating
the Company's technology. These revenues may be subject to extreme fluctuation
and are difficult for the
 
                                       13
<PAGE>   16
 
Company to predict. The Company's expense levels are based, in part, on its
expectations as to future revenues and to a large extent are fixed. Therefore,
the Company may be unable to adjust spending in a timely manner to compensate
for any unexpected revenue shortfall. Any significant shortfall of demand in
relation to the Company's expectations or any material delay of customer orders
would have an almost immediate adverse affect on the Company's operating results
and on the Company's ability to achieve profitability.
 
     As a result of the foregoing and other factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
Fluctuations in operating results have in the past, and may in the future, also
result in volatility in the price of the shares of the Company's Common Stock.
 
     Litigation. On March 11, 1998, the Company announced that it had filed a
lawsuit in the United States District Court for the District of Delaware against
Lotus Development Corporation for copyright infringement, unfair competition,
breach of a 1992 agreement under which Verity licensed certain software to
Lotus, misappropriation of trade secrets and unjust enrichment and conversion.
On June 8, 1998, Verity, Inc. and Lotus Development Corporation announced that
they have concluded a settlement agreement that makes available to Lotus a range
of Verity technologies for use with Lotus products. The settlement agreement
resolves issues that had arisen between the two companies. Accordingly, the
Company has withdrawn its legal action against Lotus Development Corporation by
virtue of a settlement agreement dated June 8, 1998.
 
     Developing Market; Unproven Acceptance of the Company's Products. The
Company's development efforts are focused on expanding Verity's suite of
products, designing enhancements to the Company's core technology, and
addressing additional technical challenges inherent in developing new
applications for enterprise, e-commerce, OEM and sophisticated CD-ROM publishing
markets. The Company plans to undertake development of further enhancements of
the search performance, scalability, functionality and deployability of its
products. There is no assurance that such products will be developed and
released on a timely basis, or that such products will achieve market
acceptance.
 
     As is typical in the case of a new and evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty. The software industry addressing the information
management requirements of networked systems, CD-ROM, online services and the
Internet is young and has few proven products. Moreover, critical issues
concerning the commercial use of online services and the Internet (including
security, reliability, cost, ease of use and access, and quality of service)
remain unresolved and may impact the growth of the Internet and online markets,
together with the software standards and electronic media employed in such
markets.
 
     The Company's future operating results will depend in substantial part upon
its ability to increase the installed base of its intelligent search and
filtering technology and to begin to generate significant product revenues from
its CD Publisher, Information Server, Agent Server, KeyView products and other
products addressing the information retrieval and viewing requirements of
individuals and corporations from data sources within an enterprise and on
CD-ROM, online services and the Internet. The Company's future operating results
will also depend upon its ability to successfully market its technology to
online and Internet publishers who use such technology to index their published
information in the format used by Verity. To the extent that such publishers do
not adopt the Company's technology for indexing their published information,
users will be unable to search such information using the Company's search and
retrieval products, which in turn will limit the demand for the Company's
products.
 
     Because the market for certain of the Company's products and services is
new and evolving, it is difficult to assess or predict with any assurance the
growth rate, if any, and size of this market. There can be no assurance that the
market for the Company's products and services will develop, or that the
Company's products or services will achieve market acceptance. If the market
fails to develop, develops more slowly than expected or becomes saturated with
competitors, or if the Company's products do not achieve significant market
acceptance, the Company's business, operating results and financial condition
will be materially and adversely affected.
 
                                       14
<PAGE>   17
 
     A significant element of the Company's strategy is to embed Verity's
technology in products offered by the Company's OEM customers. Many of the
markets for such products are also new and evolving and, therefore, subject to
the same risks faced by the Company in the markets for its own products. In
addition, consolidation in the industries served by the Company could, and
acquisition or development by any of the Company's significant customers of
technology competitive with the Company's would, materially and adversely affect
the Company's business and prospects.
 
     Dependence on International Operations. Revenues derived from European
operations accounted for 10.6% and 5.5%, respectively, for the three months
ended August 31, 1997 and 1998. For the three months ended August 31, 1997 and
1998, export sales accounted for 21.9% and 22.4% of total revenues,
respectively. The decrease in revenues from European operations as a percentage
of total revenues resulted primarily from the increased domestic revenues. The
Company expects that revenues derived from European operations and export sales
will continue to account for a significant percentage of the Company's revenues
for the foreseeable future; however, these revenues may fluctuate significantly
as a percentage of revenues from period to period. Certain of these revenues
have been derived from sales to foreign government agencies, which may be
subject to risks similar to those described below.
 
     There are a number of risks inherent in the Company's international
business activities, including unexpected changes in regulatory requirements,
tariffs and other trade barriers, costs and risks of localizing products for
foreign countries, longer accounts receivable payment cycles, potentially
adverse tax consequences, limits on repatriation of earnings and the burdens of
complying with a wide variety of foreign laws. Additionally, the Company does
not engage in hedging activities to protect against the risk of currency
fluctuations. Fluctuations in currency exchange rates could cause sales
denominated in U.S. dollars to become relatively more expensive to customers in
a particular country, leading to a reduction in sales or profitability in that
country. Also, such fluctuations could cause sales denominated in foreign
currencies to affect a reduction in the current U.S. dollar revenues derived
from sales in a particular country. Furthermore, future international activity
may result in increased foreign currency denominated sales and, in such event,
gains and losses on the conversion to U.S. dollars of accounts receivable and
accounts payable arising from international operations may contribute
significantly to fluctuations in the Company's results of operations. The
financial stability of foreign markets could also affect the Company's
international sales. In addition, revenues of the Company earned in various
countries where the Company does business may be subject to taxation by more
than one jurisdiction, thereby adversely affecting the Company's earnings. There
can be no assurance that such factors will not have an adverse effect on the
revenues from the Company's future international sales and, consequently, the
Company's results of operations.
 
     Dependence on United States Government and the Risk of Contract
Termination. Agencies of the United States government have accounted for a
significant portion of the Company's revenues. Specifically, these agencies
accounted for approximately 8.8% and 3.8% of revenues for the three months ended
August 31, 1997 and 1998, respectively. Sales to government agencies fluctuated
as a percentage of revenues during these periods, and may decline in the future.
In recent years, budgets of many government agencies have been reduced, causing
certain customers and potential customers of the Company's products to
re-evaluate their needs. Such budget reductions are expected to continue over at
least the next several years. Future reductions in United States spending on
information technologies could have a material adverse effect on the Company's
operating results.
 
     Almost all of the Company's government contracts contain termination
clauses, which permit contract termination upon the Company's default or for
convenience of the other contracting party. There can be no assurance such
cancellations will not occur in the future, and any such termination could
adversely affect the Company's operating results.
 
     Technological Change; Market Acceptance of Evolving
Standards. Historically, the Company has derived substantially all of its
revenues from the license of custom search and retrieval applications and
consulting and other services related to such applications. Recently, the
Company has refined and enhanced its core technology to add functionality and
facilitate incorporation of the Company's technology in a variety of
applications addressing the desktop, CD-ROM, enterprise, online and Internet
markets. Nevertheless, the
 
                                       15
<PAGE>   18
 
Company expects that for the foreseeable future it will continue to derive the
largest portion of its revenues from licensing its technology for enterprise
applications.
 
     The computer software industry is subject to rapid technological change,
changing customer requirements, frequent new product introductions and evolving
industry standards that may render existing products and services obsolete. As a
result, the Company's position in its existing markets or other markets that it
may enter could be eroded rapidly by product advancements by competitors. The
life cycles of the Company's products are difficult to estimate. The Company's
future success will depend, in part, upon its ability to enhance existing
products and to develop new products on a timely basis. In addition, its
products must keep pace with technological developments, conform to evolving
industry standards, particularly client/server and Internet communication and
security protocols, as well as publishing formats such as Hypertext Markup
Language ("HTML"), and address increasingly sophisticated customer needs. There
can be no assurance that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of new
products, or that new products and product enhancements will meet the
requirements of the marketplace and achieve market acceptance. If the Company is
unable to develop and introduce products in a timely manner in response to
changing market conditions or customer requirements, the Company's financial
condition and results of operations would be materially and adversely affected.
 
     In addition, a significant strategy of the Company is to achieve
compatibility between the Company's products and the text publication formats
the Company believes are or will become popular and widely adopted. The Company
invests substantial resources in development efforts aimed at achieving such
compatibility. Any failure by the Company to anticipate or respond adequately to
technology or market developments could result in a loss of competitiveness or
revenue. For instance, to date the Company has focused its efforts on
integration with the Adobe PDF and Lotus Notes environments and, more recently,
the Microsoft Exchange environment. Should any of these products or technologies
lose or fail to achieve acceptance in the marketplace or be replaced by other
products or technologies, the Company's business could be materially and
adversely affected.
 
     Because one of the Company's strategies is to embed its basic search engine
in key OEM application products, the Company's sales of its intelligent search
and filtering products depend in part on its ability to maintain compatibility
with these OEM applications. There is no assurance that the Company will be able
to maintain compatibility with these vendors' products or continue to be the
search technology of choice for such OEMs, and the failure to maintain
compatibility with or be selected by such OEMs would materially and adversely
affect the Company's sales. Further, the failure of the products of the
Company's key OEM partners to achieve market acceptance could have a material
adverse effect on the Company's results of operations.
 
     Software products as complex as those offered by the Company may contain
errors that may be detected at any point in the products' life cycles. The
Company has in the past discovered software errors in certain of its products
and has experienced delays in shipment of products during the period required to
correct these errors. There can be no assurance that, despite testing and
quality assurance efforts by the Company and by current and potential customers,
errors will not be found, resulting in loss of or delay in market acceptance and
sales, diversion of development resources, injury to the Company's reputation,
or increased service and warranty costs, any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition. Although the Company generally attempts to limit by contract its
exposure to incidental and consequential damages, and to cap the Company's
liabilities under the contract, if a court failed to enforce the liability
limiting provisions of the Company's contracts for any reason, or if liabilities
arose which were not effectively limited, the Company's operating results could
be materially and adversely affected.
 
                                       16
<PAGE>   19
 
                           PART II: OTHER INFORMATION
 
ITEM 1. LEGAL PROCEEDINGS
 
     On March 11, 1998, the Company announced that it had filed a lawsuit in the
United States District Court for the District of Delaware against Lotus
Development Corporation for copyright infringement, unfair competition, breach
of a 1992 agreement under which Verity licensed certain software to Lotus,
misappropriation of trade secrets, and unjust enrichment and conversion. On June
8, 1998, Verity, Inc. and Lotus Development Corporation announced that they have
concluded a settlement agreement that makes available to Lotus a range of Verity
technologies for use with Lotus products. The settlement agreement resolves
issues that had arisen between the two companies. Accordingly, the Company has
withdrawn its legal action against Lotus Development Corporation by virtue of a
settlement agreement dated June 8, 1998.
 
ITEM 2. CHANGES IN SECURITIES
 
     Not Applicable.
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
     Not Applicable.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     The Company's Annual Meeting of Stockholders was held on September 24,
1998. Proxies for the meeting were solicited pursuant to Regulation 14A. At the
meeting, management's nominee for director and three proposals were submitted to
the stockholders of the Company. Management's nominee for director was elected
by the following vote:
 
<TABLE>
<CAPTION>
                                                         SHARES
                                                 ----------------------
                    NOMINEE                      VOTING FOR    WITHHELD
                    -------                      ----------    --------
<S>                                              <C>           <C>
Gary J. Sbona..................................  9,456,089     107,864
</TABLE>
 
     Steven M. Krausz, Charles P. Waite, Jr. and Stephen A. MacDonald continued
to serve as directors of the Company after the annual meeting. Mr. Krausz and
Mr. Waite will continue to serve until the Annual Meeting of Stockholders to be
held in 1999, and Mr. MacDonald will continue to serve until the Annual Meeting
of Stockholders to be held in 2000.
 
     A second proposal to amend the 1995 Stock Option Plan (the "Option Plan")
of the Company to increase the number of shares of Common Stock of the Company
authorized for issuance thereunder from 3,310,836 shares to 4,060,836 shares,
was submitted to a vote of the stockholders of the Company. The proposal was
approved by the following vote:
 
<TABLE>
<CAPTION>
FOR THE PROPOSAL   AGAINST THE PROPOSAL   ABSTENTIONS   BROKER NON-VOTES
----------------   --------------------   -----------   ----------------
<S>                <C>                    <C>           <C>
  2,431,021             1,241,356           38,058         5,853,518
</TABLE>
 
     A final proposal to ratify the selection of PricewaterhouseCoopers LLP as
independent accountants of the Company for its fiscal year ending May 31, 1999
was also submitted to a vote of the stockholders of the Company. The proposal
was approved by the following vote:
 
<TABLE>
<CAPTION>
FOR THE PROPOSAL   AGAINST THE PROPOSAL   ABSTENTIONS   BROKER NON-VOTES
----------------   --------------------   -----------   ----------------
<S>                <C>                    <C>           <C>
  9,548,340               4,905             10,708             0
</TABLE>
 
ITEM 5. OTHER INFORMATION
 
     Not Applicable.
 
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 
     A. Exhibits -- See Exhibit Index
 
     B. Reports on Form 8-K
 
          None.
 
                                       17
<PAGE>   20
 
                                   SIGNATURES
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
 
                                          VERITY, INC.
 
                                          By:    /s/ JAMES E. TICEHURST
 
                                            ------------------------------------
                                                     James E. Ticehurst
                                             Vice President, Administration and
                                                          Controller
                                               (Principal Financial Officer)
 
Dated: October 6, 1998
 
                                       18
<PAGE>   21
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT                                                                  SEQUENTIAL
NUMBER                       DESCRIPTION OF DOCUMENT                      PAGE NO.
-------                      -----------------------                     ----------
<C>        <S>                                                           <C>
 2.1       Form of Agreement and Plan of Merger between Verity, Inc., a
           California corporation, and Verity Delaware Corporation, a
           Delaware corporation, filed September 22, 1995.(1)..........
 2.2       Agreement and Plan of Reorganization dated January 10, 1997
           among Verity, Inc., Cognisoft Acquisition Corporation and
           Cognisoft Corporation, and certain shareholders of
           Cognisoft.(7)...............................................
 2.3       Form of Stock Purchase Agreement dated as of May 31, 1997
           among Verity, 64k and certain shareholders of 64k.(8).......
 2.4       Agreement for Purchase and Sale of Assets dated as of May
           30, 1997 among FTP US, FTP Canada, Verity US and Verity
           Canada.(9)..................................................
 3.1       Certificate of Incorporation of the Company.(1).............
 3.2       By-Laws.(1).................................................
 3.3       Certificate of Retirement of Series of Preferred
           Stock.(7)...................................................
 3.4       Certificate of Designation, Preferences and Rights of Series
           A Preferred Stock.(7).......................................
 4.1       Amended and Restated Rights Agreement dated August 1, 1995,
           as amended.(1)..............................................
 4.2       Form of Rights Agreement between Verity, Inc. and First
           National Bank of Boston dated September 18, 1996.(6)........
10.1       Form of Indemnification Agreement for directors and
           officers.(1)................................................
10.2       Amended and Restated 1995 Stock Option Plan and forms of
           agreements thereunder.(7)...................................
10.3       1995 Employee Stock Purchase Plan.(1),(4)...................
10.4       1995 Outside Directors Stock Option Plan and forms of
           agreement thereunder.(1),(4)................................
10.5       Employment Agreement between Philippe F. Courtot and the
           Company dated July 15,1993, together with related Amended
           and Restated Stock Purchase Agreement dated as of June 1,
           1995.(1),(4)................................................
10.7       Series G Preferred Stock Purchase Agreement dated August 29,
           1994.(2)....................................................
10.8       Series H Preferred Stock Purchase Agreement dated August 1,
           1995.(2)....................................................
10.18      Lease Agreement between Ross Drive Investors and the Company
           dated January 22, 1996.(3)..................................
10.19      Retainer Agreement between Regent Pacific Management
           Corporation and Verity, Inc. dated July 13, 1997.(10).......
10.20      Confidential Severance Option Agreement between Verity, Inc.
           and Richard Lo dated August 20, 1997.(10)...................
10.21      Employment Agreement between Anthony J. Bettencourt and the
           Company dated August 28, 1997.(11)..........................
10.22      Security and Loan Agreement between Imperial Bank and the
           Company dated November 30, 1997.(12)........................
10.23      Amendment to Retainer Agreement between Regent Pacific
           Management Corporation and Verity, Inc. dated February 1,
           1998.(13)...................................................
27.1       Financial Data Schedule.....................................
</TABLE>
 
                                       19
<PAGE>   22
 
---------------
 (1) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Registration Statement (No. 33-96228), declared effective on
     October 5, 1995.
 
 (2) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Registration Statement (No. 33-80567), declared effective on
     January 17, 1996.
 
 (3) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended February 29, 1996.
 
 (4) Management contract or compensatory plan covering executive officers and
     directors of the Company.
 
 (5) Confidential Treatment has been granted for portions of these exhibits.
 
 (6) Incorporated by reference from exhibit no. 1 from the Company's Form 8-K as
     filed with the Securities and Exchange Commission on October 10, 1996.
 
 (7) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended August 31, 1996.
 
 (8) Relating to the 64k acquisition, incorporated by reference from Exhibit No.
     2.1 to the Company's report on Form 8-K as filed with the Securities and
     Exchange Commission on June 13, 1997.
 
 (9) Relating to the KeyView acquisition, incorporated by reference from Exhibit
     No. 2.1 to the Company's report on Form 8-K as filed with the Securities
     and Exchange Commission on June 13, 1997.
 
(10) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-K for the year ended May 31, 1997.
 
(11) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended August 31, 1997.
 
(12) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended February 28, 1998.
 
(13) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-K for the year ended May 31, 1998.
 
                                       20