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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K/A

Amendment No. 1



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FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934



(MARK ONE)

|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------



For the Fiscal Year Ended May 31, 2004



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     
|(Address of principal executive offices) |  | (Zip code)



Registrants
telephone number, including area code: (408) 541-1500



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Securities registered pursuant to Section 12(b) of the Act: None



Securities registered pursuant to section 12(g) of the Act:



Common Stock, $0.001 Par Value

(Title of class)



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Indicate by check mark whether the 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 if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. ̈



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



The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of the Common Stock on November 28, 2003, as reported on Nasdaq National Market was approximately $409,852,608. Excludes approximately 9,148,872 shares of Common Stock held collectively by the executive
officers and directors of the registrant and by each person who owned 5% or more of the outstanding Common Stock as of such date. Exclusion of shares held by any person should not be construed to indicate that a determination has been made that such
person is an affiliate of the registrant.



The number of shares
of the registrants Common Stock outstanding on July 31, 2004 was 37,103,274.



DOCUMENTS INCORPORATED BY REFERENCE



The information required by Part III of this report, to the extent not set forth herein, is incorporated by reference from the Registrants definitive proxy statement relating to the annual meeting of
stockholders to be held September 30, 2004, which definitive proxy statement was filed with the Securities and Exchange Commission within 120 days after the fiscal year to which this Report relates.



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EXPLANATORY NOTE



We are amending our Annual Report on Form 10-K for the year ended May 31, 2004, filed on August 13, 2004 (the
Original Form 10-K) to reclassify auction rate securities previously categorized as cash and cash equivalents as short-term investments in our consolidated balance sheets as of May 31, 2004 and 2003, record the impact created by these
reclassifications in our consolidated statements of cashflows for the years ended May 31, 2004, 2003 and 2002 and amend the related disclosures impacted by these reclassifications.



During our third fiscal quarter of 2005, we determined to categorize auction rate securities as short-term investments
rather than as cash and cash equivalents. We reflected the reclassification in our Quarterly Report on Form 10-Q filed for the period ended February 28, 2005, and are amending our Original Form 10-K to reflect this reclassification.



Additionally, we have included two other balance sheet
reclassifications for items categorized as other assets and other accrued liabilities which we have concluded should be presented as long-term. We have also revised cashflows from investing activities to remove purchases, sales and maturities of
financial instruments that which we have concluded were transactions in cash and cash equivalents rather than in investments.



Except as discussed above, we have not modified or updated disclosures presented in the Original Form 10-K, except as required to reflect the effects of
these reclassifications and revisions, in this Form 10-K/A, other than to delete forward-looking statements that have been superseded by subsequent events. Accordingly, this Form 10-K/A does not reflect events occurring after the filing of our
Original Form 10-K or modify or update those disclosures affected by subsequent events. Information not affected by the reclassification and revisions referred to above is unchanged and reflects the disclosures made at the time of the filing of the
Original Form 10-K. References to the Annual Report on Form 10-K herein and in the Original Form 10-K shall refer to the Annual Report on Form 10-K for the year ended May 31, 2004, as amended by this Amendment No. 1 thereto.



This Annual Report on Form 10-K/A should be read in conjunction with our
filings made with the Securities and Exchange Commission subsequent to the filing of our Original Form 10-K, including any amendments to those filings. The following items have been amended as a result of the reclassification and revisions:



| |  |  | Part II - Item 6. Selected Consolidated Financial Data;
| | - |  | -------------------------------------------------------



| |  |  | Part II - Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | Part II - Item 7A. Quantitative and Qualitative Disclosure About Market Risk;
| | - |  | -----------------------------------------------------------------------------



| |  |  | Part II - Item 8. Financial Statement and Supplementary Data;
| | - |  | -------------------------------------------------------------



| |  |  | Part IV - Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
| | - |  | -----------------------------------------------------------------------------------



Please refer to Note 2 to the accompanying consolidated financial statements for additional information on the reclassification.



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PART II



Item 6.Selected Consolidated Financial Data



The table below presents portions of our consolidated financial statements and is not complete. You should read the following selected financial data in
conjunction with our Consolidated Financial Statements and the Notes to these financial statements and with Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Annual
Report on Form 10-K. The historical results presented below are not necessarily indicative of the results to be expected for any future fiscal year.



|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|-------------------------------------------------------- |  | ------------------------------------- | ------- | ---- | - | ------- |  | - | ------- | - | ---- | - | ------- |  | - | ------- | -
|                                                         |  | Fiscal Year Ended May 31,             |        
|                                                         |  | 2004                                  |         | 2003 |   | 2002    |  |   | 2001    |   | 2000 |  
|                                                         |  | (in thousands, except per share data) |        
|Consolidated Statements of Operations Data:              |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Revenues:                                                |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Software products                                        |  | $                                     | 71,999  |      | $ | 57,529  |  | $ | 55,859  |   |      | $ | 108,705 |  | $ | 69,655  |  
|Service and other                                        |  |                                       | 52,311  |      |   | 44,421  |  |   | 37,906  |   |      |   | 36,330  |  |   | 26,445  |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Total revenues                                           |  |                                       | 124,310 |      |   | 101,950 |  |   | 93,765  |   |      |   | 145,035 |  |   | 96,100  |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Costs of revenues:                                       |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Software products                                        |  |                                       | 2,270   |      |   | 1,210   |  |   | 2,289   |   |      |   | 1,675   |  |   | 911     |  
|Service and other                                        |  |                                       | 14,467  |      |   | 12,510  |  |   | 11,469  |   |      |   | 12,141  |  |   | 8,756   |  
|Amortization of purchased intangible assets              |  |                                       | 3,456   |      |   | 1,290   |  |   |        |   |      |   |        |  |   |        |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Total costs of revenues                                  |  |                                       | 20,193  |      |   | 15,010  |  |   | 13,758  |   |      |   | 13,816  |  |   | 9,667   |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Gross profit                                             |  |                                       | 104,117 |      |   | 86,940  |  |   | 80,007  |   |      |   | 131,219 |  |   | 86,433  |  
|Operating expenses:                                      |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Research and development                                 |  |                                       | 20,211  |      |   | 20,144  |  |   | 21,725  |   |      |   | 20,257  |  |   | 14,538  |  
|Marketing and sales                                      |  |                                       | 50,006  |      |   | 42,310  |  |   | 51,399  |   |      |   | 57,543  |  |   | 39,603  |  
|General and administrative                               |  |                                       | 12,057  |      |   | 10,736  |  |   | 11,917  |   |      |   | 10,773  |  |   | 7,034   |  
|In-process research and development charge               |  |                                       | 3,472   |      |   | 1,200   |  |   |        |   |      |   |        |  |   |        |  
|Restructuring charges                                    |  |                                       | 1,226   |      |   | 993     |  |   | 1,563   |   |      |   |        |  |   |        |  
|Charitable contribution                                  |  |                                       |        |      |   |        |  |   | 1,000   |   |      |   |        |  |   |        |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Total operating expenses                                 |  |                                       | 86,972  |      |   | 75,382  |  |   | 87,603  |   |      |   | 88,572  |  |   | 61,176  |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Income (loss) from operations                            |  |                                       | 17,145  |      |   | 11,558  |  |   | (7,596  | ) |      |   | 42,647  |  |   | 25,257  |  
|Other income, net                                        |  |                                       | 4,119   |      |   | 7,217   |  |   | 9,869   |   |      |   | 11,335  |  |   | 5,603   |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Income before provision for income taxes                 |  |                                       | 21,264  |      |   | 18,775  |  |   | 2,273   |   |      |   | 53,982  |  |   | 30,860  |  
|Provision for (benefit from) income taxes                |  |                                       | 9,655   |      |   | 7,134   |  |   | 864     |   |      |   | 20,222  |  |   | (2,150  | )
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Net income                                               |  | $                                     | 11,609  |      | $ | 11,641  |  | $ | 1,409   |   |      | $ | 33,760  |  | $ | 33,010  |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Net income per share  basic                             |  | $                                     | 0.31    |      | $ | 0.33    |  | $ | 0.04    |   |      | $ | 1.00    |  | $ | 1.10    |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Net income per share  diluted                           |  | $                                     | 0.29    |      | $ | 0.31    |  | $ | 0.04    |   |      | $ | 0.92    |  | $ | 0.95    |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Number of shares used in per share calculation  basic   |  |                                       | 37,625  |      |   | 35,410  |  |   | 35,404  |   |      |   | 33,634  |  |   | 30,026  |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Number of shares used in per share calculation  diluted |  |                                       | 39,666  |      |   | 37,595  |  |   | 37,169  |   |      |   | 36,649  |  |   | 34,886  |  
|                                                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Consolidated Balance Sheet Data:                         |  |                                       |         |      |   |         |  |   |         |   |      |   |         |  |   |         |  
|Working capital                                          |  |                                       | 108,797 |      |   | 129,827 |  |   | 149,783 |   |      |   | 163,765 |  |   | 134,885 |  
|Total assets                                             |  |                                       | 344,081 |      |   | 332,535 |  |   | 298,150 |   |      |   | 303,599 |  |   | 213,378 |  
|Long-term obligations                                    |  |                                       | 1,065   |      |   | 3,377   |  |   | 465     |   |      |   | 389     |  |   | 383     |  
|Stockholders equity                                     |  |                                       | 296,826 |      |   | 291,631 |  |   | 264,265 |   |      |   | 264,144 |  |   | 183,634 |  



Verity has
reclassified certain amounts in the prior years financial statements to conform to the current years presentation.



See Note 13 of Notes to Consolidated Financial Statements beginning on page 33 of this Amendment No. 1 to Annual Report on Form 10-K /A for an explanation
of the method used to determine the number of shares used to compute per share amounts.



On March 15, 2004, we acquired Cardiff Software Inc. On March 3, 2004, we acquired the intellectual property, customer agreements and certain other assets of NativeMinds Inc. On December 17, 2002, we acquired from
Inktomi Corporation assets



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relating to Inktomis enterprise search software business, which includes basic search, categorization and content
refinement capabilities, as well as its XML technology assets. In accordance with SFAS No.141, Business Combinations which is effective for all acquisitions after June 30, 2001, all these transactions were accounted for as purchases.
Consequently, from and after the date of purchase we have recorded revenues from the business and products acquired from Cardiff Software, NativeMinds and Inktomi, as well as have incurred added expenses from the acquisitions of these businesses.



Item 7.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 of Verity, Inc., which appear elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements,
which are statements of our expectations as to future events and results, such as our expectations as to our future operating results, 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 Annual Report on Form 10-K, particularly under the heading Item 1. Business Risks Relating to Our Operations.See
Forward-Looking Statements at the beginning of this Annual Report for additional cautionary information regarding the forward-looking statements we make.



Overview



We are a leading provider of intellectual capital management software that enables our customers to maximize their return on their information assets. The
intellectual capital management software market is in great part the convergence of many core markets in which we have participated for years, including search, corporate portals, and e-commerce, as well as markets we have recently entered,
including question and answer interfaces, and content capture and process automation, among others.



We develop, market and support two product families: intelligent content services (which we refer to as ICS), and content capture and process
automation. Intelligent content services are search, classification, recommendation, monitoring/alerting, and question and answer infrastructure products for corporate intranets, extranets, web sites, corporate portals, business applications, online
publishers and e-commerce providers and original equipment manufacturer (OEM) toolkits for independent software vendors. Our comprehensive and integrated ICS product family enables numerous enterprise-wide functionalities, all from the
same underlying Verity information index. Our ICS products organize and provide simple, single-point access to information across the entire enterprise. In doing so, our products can be used to create or enhance business portals and standalone
applications that leverage the value of existing investments in intranets and business applications. Content capture and process automation applications enable the information on paper and electronic forms to be captured in electronic form, and for
manual processes that utilized that information to be automated over corporate networks. Our content capture and process automation products include capabilities for forms design, scanning, optical character recognition, forms recognition,
validation, verification, workflow and routing.



Our software
has been licensed to over 11,500 corporations, government agencies, software developers, information publishers and e-commerce vendors. We pursue sales opportunities within corporations and government agencies through the efforts of our direct sales
force and through a network of value added resellers and system integrators. We also sell OEM toolkits to independent software vendors that embed Verity technology in their products or services.



We were organized as a California corporation in March 1988 and
reincorporated in Delaware in September 1995. Our principal executive offices are located at 894 Ross Drive, Sunnyvale, California 94089, and our telephone number is (408) 541-1500.



Internal Controls



We have historically considered our internal controls over financial reporting a high priority and will continue to do so through a continual review of
and resulting improvement in our internal controls. For example, we have formed a Sarbanes Oxley Steering Committee, comprised primarily of senior financial and operational personnel and governed by our audit committee, which helps ensure our
internal controls over financial reporting, are complete, accurate and appropriately documented. We are in the process of assessing our business processes relating to our financial reporting as required by Section 404 of the Sarbanes-Oxley Act, or
SOX. In accordance with SOX, we will test our internal controls each year and, beginning with our fiscal year ending May 31, 2005.



Recent Acquisitions



Cardiff Software Inc. On March 15, 2004, we acquired Cardiff Software Inc., a privately held software company. Cardiff Software technology enables
the automated capture of dynamic business information. Although the Cardiff Software corporate brand



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has been discontinued, we have retained the product names and rebranded them as Verity TeleForm®, Verity
LiquidOffice, Verity LiquidCapture, and Verity MediClaim. Support and maintenance
services for existing Cardiff Software customers will remain in place. This acquisition further expanded our offerings with the content capture and process automation product family. The acquired software, rebranded Verity TeleForm, Verity
MediClaim, Verity LiquidOffice and Verity LiquidCapture, is in use by companies and government organizations of all sizes. We are continuing development and support of these products, 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.



In accordance with SFAS No. 141, Business Combinations, we accounted for the Cardiff Software transaction as a purchase, and the total
purchase consideration of approximately $65.6 million (including cash, deferred payments, stock options assumed and acquisition costs) was allocated to net tangible and identifiable intangible assets based upon their estimated fair value as of the
date of completion of the acquisition and the residual of $38.4 million was recorded as goodwill. The $65.6 million of total purchase consideration, includes approximately $11.9 million placed into a third party escrow account to be paid to Cardiff
Softwares shareholders in installments over 24 months from the acquisition. These future payments are subject to Cardiff Software meeting certain obligations outlined under the representations and warranties covenants sections of the
definitive merger agreement. We believe that Cardiff Software will meet these obligations and therefore the entire $11.9 million has been recorded as purchase consideration.



NativeMinds Inc. On March 3, 2004, we acquired the intellectual property, customer agreements and other selective
strategic assets from NativeMinds Inc., a privately held software company and provider of integrated self-service solutions. The acquired technology portfolio originally named vRep, re-branded Verity Response, is an integrated set of tools designed
to provide a single interface for internal and external customer inquiries through a natural language dialog. Verity Response includes technology that manages the interaction between a customer and virtual representative and a set of reporting and
analysis tools to help assess performance, identify content opportunities and gather valuable customer insight. We are continuing development and support of the products acquired and believe that the larger enterprises in the installed base
represent an upgrade opportunity to our broader intellectual capital management solution as their needs grow.



In accordance with SFAS No.141, Business Combinations, we accounted for the NativeMinds transaction as a purchase, and the total purchase
consideration of approximately $3.9 million (including cash, deferred payments, acquisition costs) was allocated to net tangible and identifiable intangible assets based upon their estimated fair value as of the date of completion and the residual
of $2.2 million was recorded as goodwill. The $3.9 million of total purchase consideration includes approximately $0.8 million to be paid to Nativeminds shareholders in installments over 18 months from the acquisition. These future payments
are subject to NativeMinds meeting certain obligations outlined under the representations and warranties section of the definitive merger agreement. Of this $0.8 million, $0.2 million was paid in the fourth fiscal quarter of 2004. We believe that
NativeMinds will meet the remaining obligations and therefore have recorded the entire $0.8 million as purchase consideration.



Inktomi Corporation. In December 2002, we acquired 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. We purchased the Enterprise search assets from Inktomi Corporation for approximately $26.8 million in cash, of which $3.0 million, plus $67,500 in interest, was paid in our first fiscal quarter of 2005. We expensed
$1.2 million to in-process research and development (in-process R&D) upon acquisition, and have been amortizing the expense of purchased intangible assets at a rate of approximately $2.6 million per year, which we expect to continue
through fiscal 2007, with the remaining $1.3 million to be amortized in fiscal 2008.



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.



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We believe the following critical accounting policies affect the more significant judgments and estimates
used in the preparation of our consolidated financial statements:



Revenue
Recognition



Our revenues are derived from license fees
for our software products and fees for services complementary to our products, including software maintenance, consulting and training. We also derive nominal revenue from hardware product sales complementary to our software products.



We recognize revenue in accordance with the American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition. The AICPA and its Software
Revenue Recognition Task Force continue to issue interpretations and guidance for applying the relevant standards to a wide range of sales contract terms and business arrangements that are prevalent in the software industry. Also, the Securities and
Exchange Commission (SEC) has issued Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, which provides guidance related to revenue recognition based on
interpretations and practices followed by the SEC. Future interpretations of existing accounting standards or changes in our business practices could result in future changes in our revenue accounting policies that could have a material adverse
effect on our financial position and results of operations.



We
recognize revenue from the sale of software licenses when persuasive evidence of an arrangement exists, the product has been delivered, the fees are fixed or determinable and collection of the resulting receivable is probable. Delivery generally
occurs when the product is delivered to a common carrier or made available to the customer for electronic download. At the time of the transaction, we assess whether the fee associated with our revenue transactions is fixed or determinable and
whether or not collection is probable. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction. We assess collection based on a number of factors, including past transaction history with the
customer and the credit-worthiness of the customer.



For all
sales, we use either a binding purchase order or signed license agreement as evidence of an arrangement. Sales through our distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a
transaction-by-transaction basis. Our arrangements do not generally include acceptance clauses. However, if an arrangement includes an acceptance provision, acceptance occurs upon the earlier of receipt of a written customer acceptance or expiration
of the acceptance period.



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



For agreements with multiple elements, such as license, maintenance, training, hardware and consulting services, we allocate
revenue to each component of the arrangement based upon its fair value as determined by vendor specific objective evidence (VSOE). VSOE of fair value for all elements of an arrangement is based upon the normal pricing and discounting
practices for those products and services when sold separately. We defer revenue for any undelivered elements, and recognize revenue when the product is delivered or over the period in which the service is performed, in accordance with our revenue
recognition policy for such element. If we cannot objectively determine the fair value of any undelivered element included in bundled software, hardware and service arrangements, we defer revenue until all elements are delivered and all services
have been performed, or until fair value can objectively be determined for any remaining undelivered elements. When the fair value of a delivered element has not been established, we use the residual method to record revenue if the fair value of all
undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements and is recognized as revenue.



Sales Commission Expense



Sales commission expense is a variable expense and a significant
portion of our overall sales and marketing expense. In addition to base salaries, our worldwide sales force is eligible to receive variable compensation based on pre-established annual quota



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attainment. On a periodic basis, we accrue estimated sales commission expense and pay out the actual expense in future
periods once actual attainment has been calculated and reviewed. Actual quota attainments and therefore actual commission payments may differ from our estimated accrual based on certain factors such as mix of revenue contribution by sales
representatives and accelerator provisions for overachievement of quotas.



Allowance for Doubtful Accounts



We maintain
an allowance for doubtful accounts for the potential inability of our worldwide direct customers and channel partners to make required payments based upon our assessment of the expected collectibility of all accounts receivable. In estimating the
provision, management considers (i) historical experience, (ii) the length of time the receivables are past due, (iii) any circumstances of which we are aware of a customers inability to meet its financial obligations, and (iv) other known
factors. We review this provision periodically to assess the adequacy of the provision.



Our allowance for doubtful accounts was approximately $2.1 million and $1.7 million at May 31, 2004 and 2003, respectively. These balances each represent approximately 1.7% of both our of fiscal 2004 and fiscal 2003
revenues. These amounts were determined as described above. However, if a single significant direct customer or channel partner is unable or unwilling to make payments, additional allowances may be required. Accordingly, the inability of a single
direct customer or channel partner to make required payments could have a material adverse effect on our results of operations.



Contingencies and Litigation



We are subject to legal proceedings and claims that arise in the ordinary course of business. We periodically make an assessment of the probability of an
adverse judgment resulting from current and threatened litigation. We accrue the cost of an adverse judgment if, in our estimation and based on the advice of legal counsel, the adverse settlement is probable and we can reasonably estimate the
ultimate cost of such a judgment. As of May 31, 2004 we have not accrued for any estimated settlement or judgment as management does not believe amounts are probable and estimable.



Accounting for Income Taxes



As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in
which we operate. Our income tax accounting process involves our recording the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying consolidated balance
sheets, as well as operating loss and tax credit carryforwards. These differences result in the recognition of deferred tax assets and liabilities.



We evaluate this deferred tax asset at each balance sheet date to determine its realizability, considering currently enacted tax laws, expected future
taxable income and origins of the specific components of the deferred tax asset. If we determine that it is not fully realizable, we will record a valuation allowance to reduce the asset balance to its realizable value through a charge to income tax
expense. Determining whether we will be able to utilize the net operating loss carryforward requires that we estimate future taxable income and make judgments regarding the timing of future tax obligations. Actual taxable income could differ from
our estimates.



As of May 31, 2004, we believe it is more
likely than not that we will be able to realize the majority of our tax assets through expected future taxable profits. We have recorded a valuation allowance of $20.3 million for the remainder of our tax assets. The recognition of deferred tax
assets originated from stock compensation has been recorded to additional paid-in-capital.



If we conclude that additional valuation allowance is required in the future, the effect on income tax expense could be material.



Impairment of Goodwill and Other Intangible Assets



We record goodwill and identifiable purchased intangible assets when we acquire other companies. The cost of the acquisition
is allocated to the assets and liabilities acquired, including identifiable intangible assets, with the remaining amount being classified as goodwill. Certain intangible assets such as purchased technology and maintenance agreements are amortized to
operating expense over time, while in-process research and development is recorded as an expense on the acquisition date.



7



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##### Table of Contents

In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. This standard eliminates the amortization of goodwill and requires goodwill to be reviewed at least annually for impairment or whenever events or
changes in circumstances indicate goodwill may be impaired.



This impairment review involves a two-step process as follows:



| |  |  | Step 1  We compare the fair value of our reporting unit to its carrying value, including goodwill. If the reporting units carrying value, including goodwill, exceeds the
units fair value, we move on to Step 2. If the units fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | Step 2  We perform an allocation of the fair value of the reporting unit to its identifiable tangible and non-goodwill intangible assets and liabilities. This derives an
implied fair value for the reporting units goodwill. We then compare the implied fair value of the reporting units goodwill with the carrying amount of the reporting units goodwill. If the carrying amount of the reporting
units goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We perform an annual impairment review in our third fiscal quarter and periodically review the estimated remaining useful lives of our intangible assets.
We have completed the required annual impairment test, which resulted in no impairment for fiscal year 2004. We believe the methodology we use in testing impairment of goodwill provides us with reasonable basis in determining whether an impairment
charge should be taken in the future, however, there can be no assurance that at the time that the review is completed a material impairment charge will not be required and recorded.



Results of Operations



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



|                                            |  |                           |   |  |       |   |  |       |  
|------------------------------------------- |  | ------------------------- | - |  | ----- | - |  | ----- | -
|                                            |  | Fiscal Year Ended May 31, |  
|                                            |  | 2004                      |   |  | 2003  |   |  | 2002  |  
|Revenues:                                   |  |                           |   |  |       |   |  |       |  
|Software products                           |  | 57.9                      | % |  | 56.4  | % |  | 59.6  | %
|Service and other                           |  | 42.1                      |   |  | 43.6  |   |  | 40.4  |  
|                                            |  |                           |   |  |       |   |  |       |  
|Total revenues                              |  | 100.0                     |   |  | 100.0 |   |  | 100.0 |  
|                                            |  |                           |   |  |       |   |  |       |  
|Costs of revenues:                          |  |                           |   |  |       |   |  |       |  
|Software products                           |  | 1.8                       |   |  | 1.2   |   |  | 2.4   |  
|Service and other                           |  | 11.6                      |   |  | 12.2  |   |  | 12.3  |  
|Amortization of purchased intangible assets |  | 2.8                       |   |  | 1.3   |   |  |      |  
|                                            |  |                           |   |  |       |   |  |       |  
|Total costs of revenues                     |  | 16.2                      |   |  | 14.7  |   |  | 14.7  |  
|                                            |  |                           |   |  |       |   |  |       |  
|Gross profit                                |  | 83.8                      |   |  | 85.3  |   |  | 85.3  |  
|Operating expenses:                         |  |                           |   |  |       |   |  |       |  
|Research and development                    |  | 16.3                      |   |  | 19.8  |   |  | 23.2  |  
|Marketing and sales                         |  | 40.2                      |   |  | 41.5  |   |  | 54.7  |  
|General and administrative                  |  | 9.7                       |   |  | 10.5  |   |  | 12.7  |  
|In-process research and development charge  |  | 2.8                       |   |  | 1.2   |   |  |      |  
|Restructuring charge                        |  | 1.0                       |   |  | 1.0   |   |  | 1.7   |  
|Charitable contribution                     |  |                          |   |  |      |   |  | 1.1   |  
|                                            |  |                           |   |  |       |   |  |       |  
|Total operating expenses                    |  | 70.0                      |   |  | 74.0  |   |  | 93.4  |  
|                                            |  |                           |   |  |       |   |  |       |  
|Income from operations                      |  | 13.8                      |   |  | 11.3  |   |  | (8.1  | )
|Other income, net                           |  | 3.3                       |   |  | 7.1   |   |  | 10.5  |  
|                                            |  |                           |   |  |       |   |  |       |  
|Income before provision for income taxes    |  | 17.1                      |   |  | 18.4  |   |  | 2.4   |  
|Provision for income taxes                  |  | 7.8                       |   |  | 7.0   |   |  | 0.9   |  
|                                            |  |                           |   |  |       |   |  |       |  
|Net income                                  |  | 9.3                       | % |  | 11.4  | % |  | 1.5   | %
|                                            |  |                           |   |  |       |   |  |       |  



Years Ended May 31, 2004, 2003
and 2002



In fiscal years 2002 and 2003, our
Management Information Systems (MIS) operations expense was fully allocated to our research and development organization. Beginning in fiscal year 2004, we allocated our total MIS expenses throughout our organization, in order to more
closely match the practices of other software companies. When compared with fiscal years 2002 and 2003, these allocations had the net effect in fiscal year 2004 of reducing our research and development expenses, and increasing expenses of costs of
software products, costs of service and other, marketing and sales and general and administrative. Our worldwide MIS expenses consist primarily of employee compensation and benefits, capital equipment related (expensed or depreciated, including
associated maintenance contracts and rentals) and corporate overhead allocations. In fiscal year 2004, these expenses were approximately $1.0 million per quarter. Fiscal year 2002 and fiscal year 2003 MIS operating expenses have been reclassified to
conform with the 2004 presentation.



9



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##### Table of Contents

Revenues



Total revenues



|               |  |                       |       |               |      |   |      |   |               |  |     |      |  |   |     
|-------------- |  | --------------------- | ----- | ------------- | ---- | - | ---- | - | ------------- |  | --- | ---- |  | - | ----
|               |  | 2004                  |       | PercentChange |      |   | 2003 |   | PercentChange |  |     | 2002
|               |  | (dollars in millions)
|Total revenues |  | $                     | 124.3 |               | 21.9 | % |      | $ | 102.0         |  | 8.7 | %    |  | $ | 93.8



The increase in
total revenues from fiscal year 2003 to fiscal year 2004 was due to a $14.4 million increase in our software product revenues and to a $7.9 million increase in our service and other revenues. In practice, our management tracks most closely and
calculates our average selling prices only for those deals which total $40,000 or more in total deal size (product and services). The increase in total revenue was the result of an increase in the total number of customer transactions for deal sizes
greater than $40,000, combined with a marginal increase in the average revenue per transaction. Fiscal year 2004 results include a full year of revenues for our Ultraseek product, whereas fiscal year 2003 results include revenues from only the
latter six months of fiscal 2003, as the acquisition of the assets from Inktomi Corporation occurred in the middle of fiscal 2003. Also, fiscal year 2004 results include the addition of our suite of content capture products, which were derived from
the purchase of Cardiff Software in March 2004 and to a much lesser extent the Vrep product which was derived came from the purchase of NativeMinds. Additionally, fiscal year 2004 includes a payment in the first quarter from BroadVision of past
royalties in connection with the settlement of outstanding litigation, which was less than 5% of revenues for the full year period.



The increase in total revenues from fiscal year 2002 to fiscal year 2003 was due to a $1.7 million increase in our software product revenues and to a $6.5
million increase in our service and other revenues. The increase was the result of an increase in the total number of customer transactions combined with a relatively smaller reduction in the average revenue per transaction. Fiscal year 2003 results
include the addition of our Ultraseek product, which came from the purchase of assets and obligations of Inktomi Corporations enterprise search software business in December 2002.



International revenues represented 34%, 37% and 36% of our total revenues in fiscal 2004, 2003 and 2002, respectively and no
single customer accounted for 10% or more of our revenues during fiscal years 2004, 2003 or 2002. Revenues derived from sales to the federal government and its agencies were 9.3%, 9.8% and 6.1% of total revenues in fiscal years 2004, 2003 and 2002,
respectively. Sales to government agencies will continue to fluctuate as a percentage of revenues in the future.



Software product revenues



|                             |  |                       |      |   |               |      |   |      |   |      |               |  |     |      |  |   |      |  
|---------------------------- |  | --------------------- | ---- | - | ------------- | ---- | - | ---- | - | ---- | ------------- |  | --- | ---- |  | - | ---- | -
|                             |  | 2004                  |      |   | PercentChange |      |   | 2003 |   |      | PercentChange |  |     | 2002 | 
|                             |  | (dollars in millions) |     
|Software product revenues    |  | $                     | 72.0 |   |               | 25.2 | % |      | $ | 57.5 |               |  | 2.9 | %    |  | $ | 55.9 |  
|Percentage of total revenues |  |                       | 57.9 | % |               |      |   |      |   | 56.4 | %             |  |     |      |  |   | 59.6 | %



Our software product
revenues consist primarily of fees for software licenses and to a lesser extent, the sale of hardware scanners associated with the acquisition of Cardiff Software.



We saw an increase in demand for our software products in fiscal year 2004, compared with fiscal year 2003. The increase in
software product revenues during this period was due primarily to the following:



| |  |  | increased number of sales transactions, in combination with increased average selling price for transactions greater than $40,000;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | increased sales to our OEM customers;
| | - |  | -------------------------------------



| |  |  | increased sales of our Ultraseek product, which we did not have prior to our acquisition of the enterprise search assets of Inktomi Corporation in December 2002; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | incremental sales of our suite of content capture products, which we did not have prior to our acquisition of Cardiff Software in March 2004.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



In addition, software product revenues for fiscal year 2004 included the
recognition of revenue in the first quarter of past royalties in connection with our confidential settlement with BroadVision related to our outstanding litigation. This revenue accounted for less than 5% of total revenues in the period.



The modest increase in software product revenues from fiscal year 2002 to
fiscal year 2003 resulted primarily from sales of our Ultraseek product, which we did not have prior to our acquisition of enterprise search assets of Inktomi Corporation in December 2002. This increase was offset in part by a decrease in sales of
our K2 product application and to decreased OEM royalties.



10



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##### Table of Contents

Service and other revenues



|                             |  |                       |      |   |               |      |   |      |   |      |               |  |      |      |  |   |      |  
|---------------------------- |  | --------------------- | ---- | - | ------------- | ---- | - | ---- | - | ---- | ------------- |  | ---- | ---- |  | - | ---- | -
|                             |  | 2004                  |      |   | PercentChange |      |   | 2003 |   |      | PercentChange |  |      | 2002 | 
|                             |  | (dollars in millions) |     
|Service and other revenues   |  | $                     | 52.3 |   |               | 17.8 | % |      | $ | 44.4 |               |  | 17.2 | %    |  | $ | 37.9 |  
|Percentage of total revenues |  |                       | 42.1 | % |               |      |   |      |   | 43.6 | %             |  |      |      |  |   | 40.4 | %



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



The increase in service and other revenues from fiscal year 2003 to fiscal year 2004 was due to $1.8 million in increased sales of consulting services and to $5.8 million in increased maintenance revenues. This
increase resulted primarily from increased maintenance contracts associated with our increase in software product revenues and from maintenance contracts acquired as part of our acquisitions of Cardiff Software and assets from NativeMinds.



The increase in service and other revenues from fiscal year
2002 to fiscal year 2003 was due to $4.4 million in increased sales of consulting services and to $2.2 million in increased maintenance revenues which resulted primarily from maintenance contracts acquired as part of the purchase of enterprise
search assets of Inktomi Corporation.



Costs of Revenues



Costs of software products



|                                        |  |                       |     |   |               |      |   |      |   |     |               |  |       |      |  |   |     |  
|--------------------------------------- |  | --------------------- | --- | - | ------------- | ---- | - | ---- | - | --- | ------------- |  | ----- | ---- |  | - | --- | -
|                                        |  | 2004                  |     |   | PercentChange |      |   | 2003 |   |     | PercentChange |  |       | 2002 | 
|                                        |  | (dollars in millions) |    
|Costs of software products              |  | $                     | 2.3 |   |               | 91.7 | % |      | $ | 1.2 |               |  | (47.8 | )%   |  | $ | 2.3 |  
|Percentage of software product revenues |  |                       | 3.2 | % |               |      |   |      |   | 2.1 | %             |  |       |      |  |   | 4.1 | %



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. Also included in costs of software products, to a lesser extent, is the cost of the hardware scanners which we began selling as a result of the acquisition of Cardiff Software beginning March 15, 2004.



The increase in costs of software products in absolute dollars for fiscal
year 2004, compared with the prior fiscal year, was primarily attributable to higher average cost associated with our newly acquired content management software, coupled with a $0.4 million increase in costs of third party royalties and a $0.4
million increase in costs for manuals and product media associated with the product release of Verity K2 Enterprise 5.0.



The decrease in costs of software products in absolute dollars and as a percentage of software product revenues from fiscal year 2002 to fiscal year 2003
was attributable to $0.8 million in decreased costs of third-party software components and to $0.3 million in decreased costs for manuals and other shipping expenses from the prior periods which had approximately $0.1 million in total one-time costs
associated with the start-up of European distribution operations.



11



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##### Table of Contents

In fiscal years 2004, 2003 and 2002, we did not capitalize any software development costs since such
costs were not material.



Costs of service and other



|                                         |  |                       |      |   |               |      |   |      |   |      |               |  |     |      |  |   |      |  
|---------------------------------------- |  | --------------------- | ---- | - | ------------- | ---- | - | ---- | - | ---- | ------------- |  | --- | ---- |  | - | ---- | -
|                                         |  | 2004                  |      |   | PercentChange |      |   | 2003 |   |      | PercentChange |  |     | 2002 | 
|                                         |  | (dollars in millions) |     
|Costs of service and other               |  | $                     | 14.5 |   |               | 16.0 | % |      | $ | 12.5 |               |  | 8.7 | %    |  | $ | 11.5 |  
|Percentage of service and other revenues |  |                       | 27.7 | % |               |      |   |      |   | 28.2 | %             |  |     |      |  |   | 30.3 | %



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.



The increase in costs of service and other in absolute dollars from fiscal year 2003 to fiscal year 2004 was due to a $1.4 million increase in
compensation and other employee related expenses, primarily as a result of the Cardiff Software acquisition. Also contributing to the increase was $0.5 million in additional costs associated with using third-party contractors to provide professional
services. The decrease as a percentage of service and other revenues was related to higher margins associated with Cardiff Software services.



The increase in costs of service and other in absolute dollars from fiscal year 2002 to fiscal year 2003 was due to increased compensation and other
employee related expenses resulting from a slightly higher average headcount. The higher average headcount resulted from the addition of personnel necessary to respond to increased demand for services and in connection with the purchase of the
enterprise search assets from Inktomi Corporation purchase in December 2002. This compares with the prior year period in which headcount began at a higher level than at any time during the first two quarters of fiscal year 2003, but was reduced
during our staffing reorganization during the quarter ended November 30, 2001.



Amortization of purchased intangible assets



|                                            |  |                       |     |   |               |       |   |      |   |     |               |  |      |  |   |     |  
|------------------------------------------- |  | --------------------- | --- | - | ------------- | ----- | - | ---- | - | --- | ------------- |  | ---- |  | - | --- | -
|                                            |  | 2004                  |     |   | PercentChange |       |   | 2003 |   |     | PercentChange |  | 2002 | 
|                                            |  | (dollars in millions) |    
|Amortization of purchased intangible assets |  | $                     | 3.5 |   |               | 169.2 | % |      | $ | 1.3 |               |  | nm   |  | $ | 0.0 |  
|Percentage of total revenues                |  |                       | 2.8 | % |               |       |   |      |   | 1.3 | %             |  |      |  |   | 0.0 | %



During fiscal
year 2004, we amortized $3.5 million of the purchased intangible assets in connection with acquired technology, patents and maintenance agreements from our Inktomi, Cardiff Software and NativeMinds acquisitions. We will record quarterly amortization
expenses of $0.6 million associated with the purchased intangible assets of the enterprise search assets of Inktomi Corporation over the estimated useful life of five years, $0.9 million associated with the purchased intangible assets of Cardiff
Software over the estimated useful life of four years, and $0.1 million associated with the purchased intangible assets of NativeMinds over the estimated useful life of four years.



The estimated future amortization expense of purchased intangible assets as of May 31, 2004 is as follows (in thousands):



|            |  |        |       
|----------- |  | ------ | ------
|Fiscal Year |  | Amount
|2005        |  | $      | 6,758 
|2006        |  | $      | 6,757 
|2007        |  | $      | 6,757 
|2008        |  | $      | 4,582 
|            |  |        |       
|Total       |  | $      | 24,854
|            |  |        |       



Operating Expenses



Research and development



|                             |  |                       |      |   |               |     |   |      |   |      |               |  |      |      |  |   |      |  
|---------------------------- |  | --------------------- | ---- | - | ------------- | --- | - | ---- | - | ---- | ------------- |  | ---- | ---- |  | - | ---- | -
|                             |  | 2004                  |      |   | PercentChange |     |   | 2003 |   |      | PercentChange |  |      | 2002 | 
|                             |  | (dollars in millions) |     
|Research and development     |  | $                     | 20.2 |   |               | 0.5 | % |      | $ | 20.1 |               |  | (7.3 | )%   |  | $ | 21.7 |  
|Percentage of total revenues |  |                       | 16.3 | % |               |     |   |      |   | 19.8 | %             |  |      |      |  |   | 23.2 | %



12



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##### Table of Contents

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.



The increase in research and development expenses in absolute dollars from fiscal year 2003 to fiscal year 2004 was primarily due to additional Cardiff
Software related expenses in the fourth quarter of fiscal 2004 which was substantially offset by a decrease in compensation and other employee related expenses associated with the reduction in staffing in our research and development organization in
November 2003.



The decrease in research and development
expenses in absolute dollars from fiscal year 2002 to fiscal year 2003 was primarily due to a decrease in compensation and other employee related expenses associated with the reduction in staffing in our research and development organization during
each of November 2001 and 2002, offset in part by the addition of personnel in connection with the Enterprise purchase during the quarter ended February 28, 2003.



Marketing and sales



|                             |  |                       |      |   |               |      |   |      |   |      |               |  |       |      |  |   |      |  
|---------------------------- |  | --------------------- | ---- | - | ------------- | ---- | - | ---- | - | ---- | ------------- |  | ----- | ---- |  | - | ---- | -
|                             |  | 2004                  |      |   | PercentChange |      |   | 2003 |   |      | PercentChange |  |       | 2002 | 
|                             |  | (dollars in millions) |     
|Marketing and sales          |  | $                     | 50.0 |   |               | 18.2 | % |      | $ | 42.3 |               |  | (17.7 | )%   |  | $ | 51.4 |  
|Percentage of total revenues |  |                       | 40.2 | % |               |      |   |      |   | 41.5 | %             |  |       |      |  |   | 54.8 | %



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.



The increase in marketing and sales expenses in absolute dollars from fiscal
year 2003 to fiscal year 2004 was primarily due to a $3.8 million increase in sales commissions resulting from the combination of higher revenue and an increased commission payout rate. Additionally, $1.4 million of the increase was attributable to
compensation related increases and $0.3 million from allocations, both due to a higher average headcount. Also contributing to the increase was $0.8 million from higher lead generation and sales expenses, $0.4 million from increased travel expenses
and $0.2 million from increased depreciation expenses.



The
decrease in marketing and sales expenses in absolute dollars from fiscal year 2002 to fiscal year 2003 was primarily due to a $9.3 million decrease in compensation and other employee related expenses associated with the reduction in staffing in our
marketing and sales organization during the quarters ended November 30, 2002 and 2001, and the transfer of our current CEO from marketing and sales to the general and administrative organization, offset in part by the addition of personnel in
connection with the purchase of the enterprise assets of Inktomi Corporation during the quarter ended February 28, 2003.



General and administrative



|                             |  |                       |      |   |               |      |   |      |   |      |               |  |       |      |  |   |      |  
|---------------------------- |  | --------------------- | ---- | - | ------------- | ---- | - | ---- | - | ---- | ------------- |  | ----- | ---- |  | - | ---- | -
|                             |  | 2004                  |      |   | PercentChange |      |   | 2003 |   |      | PercentChange |  |       | 2002 | 
|                             |  | (dollars in millions) |     
|General and administrative   |  | $                     | 12.1 |   |               | 13.1 | % |      | $ | 10.7 |               |  | (10.1 | )%   |  | $ | 11.9 |  
|Percentage of total revenues |  |                       | 9.7  | % |               |      |   |      |   | 10.5 | %             |  |       |      |  |   | 12.7 | %



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.



The increase in general and administrative expenses in
absolute dollars from fiscal year 2003 to fiscal year 2004 was primarily due to the additional expenses related to the Cardiff Software acquisition that occurred in the fourth quarter of fiscal year 2004. Additionally, public company expenses (i.e.
audit and tax fees, insurance, and investor relations expenses) increased approximately $0.5 million over the prior fiscal year.



The decrease in general and administrative expenses in absolute dollars from fiscal year 2002 to fiscal year 2003 was due to a $1.6 million decrease in
expenses for outside professional services including legal fees, and audit and tax fees and a $0.7 million decrease in bad debt expense. This was offset in part by a $0.4 million increase in insurance costs, increased compensation costs associated
with the addition of personnel in connection with the purchase of the enterprise assets of Inktomi Corporation during the quarter ended February 28, 2003 and increased costs associated with transferring our CEO to the general and administrative
organization from marketing and sales.



13



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##### Table of Contents

In-process research and development



|                                    |  |                       |     |   |               |     |   |      |   |     |               |  |      |  |   |     |  
|----------------------------------- |  | --------------------- | --- | - | ------------- | --- | - | ---- | - | --- | ------------- |  | ---- |  | - | --- | -
|                                    |  | 2004                  |     |   | PercentChange |     |   | 2003 |   |     | PercentChange |  | 2002 | 
|                                    |  | (dollars in millions) |    
|In-process research and development |  | $                     | 3.5 |   |               | 192 | % |      | $ | 1.2 |               |  | nm   |  | $ | 0.0 |  
|Percentage of total revenues        |  |                       | 2.8 | % |               |     |   |      |   | 1.2 | %             |  |      |  |   | 0.0 | %



Of the total
in-process research and development expense of $3.5 million for fiscal year 2004, approximately $3.3 million was attributable to the Cardiff Software purchase and approximately $0.2 million was attributable to the NativeMinds purchase. Total
in-process research and development expense of $1.2 million for fiscal year 2003 was attributable to the Inktomi purchase. The methodology for allocating the purchase price to in-process research and development is determined through established
valuation techniques as outlined in the In-Process R&D Practice Aid published by the American Institute of Certified Public Accountants, Inc. (AICPA), as more fully discussed in Note 3 to the Consolidated Financial Statements
included in this report. The fair value allocation to in-process research and development was determined, and expensed upon acquisition, by identifying the research projects for which technological feasibility had not been achieved and which had no
alternative future use at the acquisition date, assessing the stage and expected date of completion of the research and development effort at the acquisition date, and calculating the net present value of the cash flows (by discounting expected
future cash flows to present value) expected to result from the successful deployment of the new technology resulting from the in-process research and development effort. The discount rates used in the present value calculations are typically
derived from a weighted-average cost of capital analysis and venture capital surveys, adjusted upward to reflect additional risks inherent in the development life cycle based on each in-process research and development projects stage of
completion.



The development of the acquired in-process
research and development remains a significant risk due to the remaining efforts to achieve technical feasibility, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats from several companies.
The nature of the efforts to develop these technologies into commercially viable products consists principally of completing the software development relating to the planned new functionalities, and testing activities necessary to determine that the
technologies can meet market expectations, including functionality and technical requirements. Failure to bring these products to market in a timely manner could result in a loss of market share or a lost opportunity to capitalize on emerging
markets, and could have a material adverse impact on our business and operating results.



The key assumptions underlying the valuations for our acquisitions primarily consisted of an expected completion date for the in-process research and development projects, estimated costs to complete these projects,
revenue and expense projections assuming the products have entered the market, and discount rates based on the risks associated with the stage of completion of the in-process technology acquired.



Restructuring charge



|                                       |  |                       |      |   |               |      |   |      |   |     |               |  |       |      |  |   |     |  
|-------------------------------------- |  | --------------------- | ---- | - | ------------- | ---- | - | ---- | - | --- | ------------- |  | ----- | ---- |  | - | --- | -
|                                       |  | 2004                  |      |   | PercentChange |      |   | 2003 |   |     | PercentChange |  |       | 2002 | 
|                                       |  | (dollars in millions) |     
|Severance costs                        |  | $                     | 1.2  |   |               | 71.4 | % |      | $ | 0.7 |               |  | (41.6 | )%   |  | $ | 1.2 |  
|Legal and other outside services costs |  |                       | 0.1  |   |               | 0.0  | % |      |   | 0.1 |               |  | (66.6 | )%   |  |   | 0.3 |  
|Adjustments to estimates               |  |                       | (0.1 | ) |               | nm   |   |      |   | 0.0 |               |  | nm    |      |  |   | 0.0 |  
|Facilities and other charges           |  |                       | 0.0  |   |               | nm   |   |      |   | 0.2 |               |  | 100.0 | %    |  |   | 0.1 |  
|                                       |  |                       |      |   |               |      |   |      |   |     |               |  |       |      |  |   |     |  
|Restructuring charge                   |  | $                     | 1.2  |   |               | 20.0 | % |      | $ | 1.0 |               |  | (37.5 | )%   |  | $ | 1.6 |  
|                                       |  |                       |      |   |               |      |   |      |   |     |               |  |       |      |  |   |     |  
|Percentage of total revenues           |  |                       | 1.0  | % |               |      |   |      |   | 1.0 | %             |  |       |      |  |   | 1.7 | %



We had two
restructuring activities in fiscal 2004. As a result of our Cardiff Software acquisition, we recorded a $0.3 million restructuring charge related to positions we identified to be redundant in our the quarter ended May 31, 2004. The anticipated cost
savings resulting from this restructuring consist of reduced compensation expenses from the affected employees, offset by any subsequent headcount additions. In November 2003, we implemented a worldwide restructuring 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 a $1.0 million restructuring in our quarter ended November 30 2003, 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 to legal and other outside services.



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In November 2002, we implemented a worldwide restructuring 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, 2002, 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 approximately 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.



During November 2001, we implemented a worldwide
restructuring and recorded a $1.6 million restructuring charge, of which approximately $1.2 million was related to severance costs associated with the reduction in the worldwide workforce by 65 employees, approximately $0.3 million to legal and
other outside services in connection with the restructuring and approximately $0.1 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, primarily in marketing and sales, and research and development.



As of May 31,2004, $0.3 million, $0.1 million and $0.0 million of the restructuring
charges remain to be paid out from the restructuring charges recorded in fiscal 2004, 2003 and 2002, respectively.



None of these restructuring charges is expected to have a material impact on our future results of operations, liquidity or sources or uses of capital.



Charitable contribution



|                             |  |                       |     |   |               |    |      |   |     |               |  |      |  |   |     |  
|---------------------------- |  | --------------------- | --- | - | ------------- | -- | ---- | - | --- | ------------- |  | ---- |  | - | --- | -
|                             |  | 2004                  |     |   | PercentChange |    | 2003 |   |     | PercentChange |  | 2002 | 
|                             |  | (dollars in millions) |    
|Charitable contribution      |  | $                     | 0.0 |   |               | nm |      | $ | 0.0 |               |  | nm   |  | $ | 1.0 |  
|Percentage of total revenues |  |                       | 0.0 | % |               |    |      |   | 0.0 | %             |  |      |  |   | 1.1 | %



On September 14, 2001,
we made a $1 million donation to help the victims of the September 11th terrorist attacks in New York, Pennsylvania, and Washington D.C. Our donation kicked off the United Way Silicon Valley 9/11 Response Fund. The donation provided immediate
support to established emergency assistance agencies, such as the American Red Cross and Salvation Army, both of which are founding members of the United Way locally and nationally.



Other income, net



|                             |  |                       |     |   |               |       |    |      |   |     |               |  |       |      |  |   |      |  
|---------------------------- |  | --------------------- | --- | - | ------------- | ----- | -- | ---- | - | --- | ------------- |  | ----- | ---- |  | - | ---- | -
|                             |  | 2004                  |     |   | PercentChange |       |    | 2003 |   |     | PercentChange |  |       | 2002 | 
|                             |  | (dollars in millions) |    
|Other income, net            |  | $                     | 4.1 |   |               | (43.1 | )% |      | $ | 7.2 |               |  | (27.3 | )%   |  | $ | 9.9  |  
|Percentage of total revenues |  |                       | 3.3 | % |               |       |    |      |   | 7.1 | %             |  |       |      |  |   | 10.5 | %



Other income consists
primarily of interest income and realized gains from our investments in marketable securities as well as transaction gains and losses associated with foreign currency fluctuations with associated with our Benelux and Canadian subsidiaries offset by
our foreign currency hedging activity. While we engage in simple hedging activities to minimize the impact of foreign currency fluctuation on our consolidated statements of operations, there is no assurance that a significant change in foreign
currency exchange rates may not have a material adverse effect on our consolidated statements of operations in the future.



15



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##### Table of Contents

The decrease in other income in absolute dollars from fiscal year 2002 through fiscal year 2004 was
primarily due to decreasing overall yields on our portfolio of marketable securities caused by the decreasing interest rate environment.



Income tax provision



|                             |  |                       |      |   |               |      |   |      |   |      |               |  |       |      |  |   |      |  
|---------------------------- |  | --------------------- | ---- | - | ------------- | ---- | - | ---- | - | ---- | ------------- |  | ----- | ---- |  | - | ---- | -
|                             |  | 2004                  |      |   | PercentChange |      |   | 2003 |   |      | PercentChange |  |       | 2002 | 
|                             |  | (dollars in millions) |     
|Income tax provision         |  | $                     | 9.7  |   |               | 36.6 | % |      | $ | 7.1  |               |  | 725.7 | %    |  | $ | 0.9  |  
|Percentage of total revenues |  |                       | 7.8  | % |               |      |   |      |   | 7.0  | %             |  |       |      |  |   | 0.9  | %
|Effective tax rate           |  |                       | 45.4 | % |               |      |   |      |   | 38.0 | %             |  |       |      |  |   | 38.0 | %



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.



The increase in our effective tax rate percentage in 2004 as compared to 2003
and 2002 was primarily a result of the in process research and development charge which is excluded as a deduction for tax purpose, and to a lesser extent, reductions in year over year research and development credits.



16



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##### Table of Contents

Quarterly Results of Operations



The following table sets forth certain unaudited consolidated statements of operations data, both in dollar amount and as a
percentage of total revenues, for each of the eight quarters in the period ended May 31, 2004. In our opinion, this information has been presented on the same basis as the audited consolidated financial statements appearing elsewhere in this Annual
Report on Form 10-K, and all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the unaudited quarterly results when read in conjunction with the audited
consolidated financial statements and related notes thereto. The operating results for any quarter should not be relied upon as necessarily indicative of results for any future period. We expect our quarterly operating results to fluctuate in future
periods due to a variety of reasons, including those specifically discussed in Item 1. Business  Risks Relating to Our Operations.



|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|-------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------ | - | ------ | ------------ |  | - | ------------ | - |  | ----------- | ------ | - | ------------ | - | ------ | ------------ |  | - | ------------ | - |  | - | ------ | - |  | - | ------ | -
|                                                         |  | Quarter Ended                         |       
|                                                         |  | May 31,2004                           |        |   | Feb. 29,2004 |   |        | Nov. 30,2003 |  |   | Aug. 31,2003 |   |  | May 31,2003 |        |   | Feb. 28,2003 |   |        | Nov. 30,2002 |  |   | Aug. 31,2002 |  
|                                                         |  | (in thousands, except per share data) |       
|Consolidated Statements of Operations Data:              |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Revenues:                                                |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Software products                                        |  | $                                     | 23,800 |   |              | $ | 17,795 |              |  | $ | 16,227       |   |  | $           | 14,177 |   |              | $ | 16,552 |              |  | $ | 15,722       |   |  | $ | 12,949 |   |  | $ | 12,306 |  
|Service and other                                        |  |                                       | 14,467 |   |              |   | 12,746 |              |  |   | 12,672       |   |  |             | 12,426 |   |              |   | 12,653 |              |  |   | 12,122       |   |  |   | 9,942  |   |  |   | 9,704  |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Total revenues                                           |  |                                       | 38,267 |   |              |   | 30,541 |              |  |   | 28,899       |   |  |             | 26,603 |   |              |   | 29,205 |              |  |   | 27,844       |   |  |   | 22,891 |   |  |   | 22,010 |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Costs of revenues:                                       |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Software products                                        |  |                                       | 1,134  |   |              |   | 368    |              |  |   | 429          |   |  |             | 339    |   |              |   | 272    |              |  |   | 256          |   |  |   | 291    |   |  |   | 390    |  
|Service and other                                        |  |                                       | 4,531  |   |              |   | 3,260  |              |  |   | 3,288        |   |  |             | 3,388  |   |              |   | 3,421  |              |  |   | 3,268        |   |  |   | 3,078  |   |  |   | 2,743  |  
|Amortization of purchased intangible assets              |  |                                       | 1,521  |   |              |   | 645    |              |  |   | 645          |   |  |             | 645    |   |              |   | 645    |              |  |   | 645          |   |  |   |       |   |  |   |       |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Total costs of revenues                                  |  |                                       | 7,186  |   |              |   | 4,273  |              |  |   | 4,362        |   |  |             | 4,372  |   |              |   | 4,338  |              |  |   | 4,169        |   |  |   | 3,369  |   |  |   | 3,133  |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Gross profit                                             |  |                                       | 31,081 |   |              |   | 26,268 |              |  |   | 24,537       |   |  |             | 22,231 |   |              |   | 24,867 |              |  |   | 23,675       |   |  |   | 19,522 |   |  |   | 18,877 |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Operating expenses:                                      |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Research and development                                 |  |                                       | 5,631  |   |              |   | 4,346  |              |  |   | 4,773        |   |  |             | 5,461  |   |              |   | 5,209  |              |  |   | 5,147        |   |  |   | 4,481  |   |  |   | 5,308  |  
|Marketing and sales                                      |  |                                       | 14,076 |   |              |   | 12,109 |              |  |   | 11,687       |   |  |             | 12,134 |   |              |   | 11,516 |              |  |   | 10,545       |   |  |   | 9,678  |   |  |   | 10,571 |  
|General and administrative                               |  |                                       | 4,007  |   |              |   | 2,451  |              |  |   | 2,712        |   |  |             | 2,887  |   |              |   | 3,126  |              |  |   | 2,474        |   |  |   | 2,462  |   |  |   | 2,674  |  
|In-process research and development charge               |  |                                       | 3,472  |   |              |   |       |              |  |   |             |   |  |             |       |   |              |   |       |              |  |   | 1,200        |   |  |   |       |   |  |   |       |  
|Restructuring charge                                     |  |                                       | 254    |   |              |   |       |              |  |   | 972          |   |  |             |       |   |              |   |       |              |  |   |             |   |  |   | 993    |   |  |   |       |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Total operating expenses                                 |  |                                       | 27,440 |   |              |   | 18,906 |              |  |   | 20,144       |   |  |             | 20,482 |   |              |   | 19,851 |              |  |   | 19,365       |   |  |   | 17,614 |   |  |   | 18,553 |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Income from operations                                   |  |                                       | 3,641  |   |              |   | 7,362  |              |  |   | 4,393        |   |  |             | 1,749  |   |              |   | 5,016  |              |  |   | 4,310        |   |  |   | 1,908  |   |  |   | 324    |  
|Other income, net                                        |  |                                       | 600    |   |              |   | 564    |              |  |   | 1,770        |   |  |             | 1,185  |   |              |   | 1,819  |              |  |   | 1,590        |   |  |   | 1,904  |   |  |   | 1,904  |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Income before provision for income taxes                 |  |                                       | 4,241  |   |              |   | 7,926  |              |  |   | 6,163        |   |  |             | 2,934  |   |              |   | 6,835  |              |  |   | 5,900        |   |  |   | 3,812  |   |  |   | 2,228  |  
|Provision for income taxes                               |  |                                       | 2,846  |   |              |   | 3,170  |              |  |   | 2,524        |   |  |             | 1,115  |   |              |   | 2,596  |              |  |   | 2,242        |   |  |   | 1,449  |   |  |   | 847    |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Net income                                               |  | $                                     | 1,395  |   |              | $ | 4,756  |              |  | $ | 3,639        |   |  | $           | 1,819  |   |              | $ | 4,239  |              |  | $ | 3,658        |   |  | $ | 2,363  |   |  | $ | 1,381  |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Net income per share  basic                             |  | $                                     | 0.04   |   |              | $ | 0.13   |              |  | $ | 0.10         |   |  | $           | 0.05   |   |              | $ | 0.12   |              |  | $ | 0.11         |   |  | $ | 0.07   |   |  | $ | 0.04   |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Net income per share  diluted                           |  | $                                     | 0.04   |   |              | $ | 0.12   |              |  | $ | 0.09         |   |  | $           | 0.05   |   |              | $ | 0.11   |              |  | $ | 0.10         |   |  | $ | 0.07   |   |  | $ | 0.04   |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Number of shares used in per share calculation  basic   |  |                                       | 37,476 |   |              |   | 37,942 |              |  |   | 37,579       |   |  |             | 37,504 |   |              |   | 36,665 |              |  |   | 34,739       |   |  |   | 34,699 |   |  |   | 35,548 |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Number of shares used in per share calculation  diluted |  |                                       | 39,097 |   |              |   | 40,568 |              |  |   | 39,475       |   |  |             | 39,663 |   |              |   | 40,086 |              |  |   | 37,883       |   |  |   | 35,766 |   |  |   | 36,645 |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|                                                         | 
|                                                         |  | As a Percentage of Total Revenues     |       
|Revenues:                                                |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Software products                                        |  |                                       | 62.2   | % |              |   | 58.3   | %            |  |   | 56.2         | % |  |             | 53.3   | % |              |   | 56.7   | %            |  |   | 56.5         | % |  |   | 56.6   | % |  |   | 55.9   | %
|Service and other                                        |  |                                       | 37.8   |   |              |   | 41.7   |              |  |   | 43.8         |   |  |             | 46.7   |   |              |   | 43.3   |              |  |   | 43.5         |   |  |   | 43.4   |   |  |   | 44.1   |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Total revenues                                           |  |                                       | 100.0  |   |              |   | 100.0  |              |  |   | 100.0        |   |  |             | 100.0  |   |              |   | 100.0  |              |  |   | 100.0        |   |  |   | 100.0  |   |  |   | 100.0  |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Costs of revenues:                                       |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Software products                                        |  |                                       | 3.0    |   |              |   | 1.2    |              |  |   | 1.5          |   |  |             | 1.3    |   |              |   | 1.0    |              |  |   | 9            |   |  |   | 1.3    |   |  |   | 1.8    |  
|Service and other                                        |  |                                       | 11.8   |   |              |   | 10.7   |              |  |   | 11.4         |   |  |             | 12.7   |   |              |   | 11.7   |              |  |   | 11.7         |   |  |   | 13.4   |   |  |   | 12.5   |  
|Amortization of purchased intangible assets              |  |                                       | 4.0    |   |              |   | 2.1    |              |  |   | 2.2          |   |  |             | 2.4    |   |              |   | 2.2    |              |  |   | 2.4          |   |  |   |       |   |  |   |       |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Total costs of revenues                                  |  |                                       | 18.8   |   |              |   | 14.0   |              |  |   | 15.1         |   |  |             | 16.4   |   |              |   | 14.9   |              |  |   | 15.0         |   |  |   | 14.7   |   |  |   | 14.3   |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Gross profit                                             |  |                                       | 81.2   |   |              |   | 86.0   |              |  |   | 84.9         |   |  |             | 83.6   |   |              |   | 85.1   |              |  |   | 85.0         |   |  |   | 85.3   |   |  |   | 85.7   |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Operating expenses:                                      |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Research and development                                 |  |                                       | 14.7   |   |              |   | 14.2   |              |  |   | 16.5         |   |  |             | 20.5   |   |              |   | 17.8   |              |  |   | 18.5         |   |  |   | 19.6   |   |  |   | 24.1   |  
|Marketing and sales                                      |  |                                       | 36.8   |   |              |   | 39.6   |              |  |   | 40.4         |   |  |             | 45.6   |   |              |   | 39.4   |              |  |   | 37.9         |   |  |   | 42.3   |   |  |   | 48.0   |  
|General and administrative                               |  |                                       | 10.5   |   |              |   | 8.0    |              |  |   | 9.4          |   |  |             | 10.9   |   |              |   | 10.7   |              |  |   | 8.8          |   |  |   | 10.8   |   |  |   | 12.1   |  
|In-process research and development charge               |  |                                       | 9.1    |   |              |   |       |              |  |   |             |   |  |             |       |   |              |   |       |              |  |   | 4.3          |   |  |   |       |   |  |   |       |  
|Restructuring charge                                     |  |                                       | 0.7    |   |              |   |       |              |  |   | 3.4          |   |  |             |       |   |              |   |       |              |  |   |             |   |  |   | 4.3    |   |  |   |       |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Total operating expenses                                 |  |                                       | 71.7   |   |              |   | 61.9   |              |  |   | 69.7         |   |  |             | 77.0   |   |              |   | 67.9   |              |  |   | 69.5         |   |  |   | 77.0   |   |  |   | 84.2   |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Income from operations                                   |  |                                       | 9.5    |   |              |   | 24.1   |              |  |   | 15.2         |   |  |             | 6.6    |   |              |   | 17.2   |              |  |   | 15.5         |   |  |   | 8.3    |   |  |   | 1.5    |  
|Other income, net                                        |  |                                       | 1.6    |   |              |   | 1.8    |              |  |   | 6.1          |   |  |             | 4.5    |   |              |   | 6.2    |              |  |   | 5.7          |   |  |   | 8.4    |   |  |   | 8.7    |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Income before provision for income taxes                 |  |                                       | 11.1   |   |              |   | 26.0   |              |  |   | 21.3         |   |  |             | 11.0   |   |              |   | 23.4   |              |  |   | 21.2         |   |  |   | 16.7   |   |  |   | 10.2   |  
|Provision for income taxes                               |  |                                       | 7.4    |   |              |   | 10.4   |              |  |   | 8.7          |   |  |             | 4.2    |   |              |   | 8.9    |              |  |   | 8.1          |   |  |   | 6.3    |   |  |   | 3.9    |  
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  
|Net income                                               |  |                                       | 3.6    | % |              |   | 15.6   | %            |  |   | 12.6         | % |  |             | 6.8    | % |              |   | 14.5   | %            |  |   | 13.1         | % |  |   | 10.4   | % |  |   | 6.3    | %
|                                                         |  |                                       |        |   |              |   |        |              |  |   |              |   |  |             |        |   |              |   |        |              |  |   |              |   |  |   |        |   |  |   |        |  



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In fiscal years 2002 and 2003, our Management Information Systems (MIS) operations expense
was fully allocated to our research and development organization. Beginning in fiscal year 2004, we allocated our total MIS expenses throughout our organization, in order to more closely match the practices of other software companies. When compared
with fiscal years 2002 and 2003, these allocations had the net effect in fiscal year 2004 of reducing our research and development expenses, and increasing expenses of costs of software products, costs of service and other, marketing and sales and
general and administrative. Our worldwide MIS expenses consist primarily of employee compensation and benefits, capital equipment related (expensed or depreciated, including associated maintenance contracts and rentals) and corporate overhead
allocations. In fiscal year 2004, these expenses were approximately $1.0 million per quarter. Fiscal year 2002 and fiscal year 2003 MIS operating expenses have been reclassified to conform with the 2004 presentation.



Liquidity and Capital Resources



As of May 31, 2004, we had $201.7 million in cash and cash equivalents
and available-for-sale securities compared to $250.7 million at May 31, 2003. At May 31, 2004, our principal sources of liquidity were our cash and cash equivalents and short-term investments of $117.5 million. As of May 31, 2004, we had a $0.6
million liability under a deferred purchase payment to NativeMinds Inc in connection with the acquisition of the intellectual property.



As of May 31, 2004, available-for-sale securities consist of the following (in thousands):



|                  |  |                |         |                        |   |      |            |  |   |        
|----------------- |  | -------------- | ------- | ---------------------- | - | ---- | ---------- |  | - | -------
|                  |  | Amortized Cost |         | Gross Unrealized Gains |   |      | Fair Value
|Short-term        |  | $              | 78,479  |                        | $ | 27   |            |  | $ | 78,506 
|Long-term         |  |                | 85,003  |                        |   | (755 | )          |  |   | 84,248 
|                  |  |                |         |                        |   |      |            |  |   |        
|Total investments |  | $              | 163,482 |                        | $ | (728 | )          |  | $ | 162,754
|                  |  |                |         |                        |   |      |            |  |   |        



As of May 31,
2003, available-for-sale securities consisted of the following (in thousands):



|                  |  |                |         |                        |   |            |  |   |        
|----------------- |  | -------------- | ------- | ---------------------- | - | ---------- |  | - | -------
|                  |  | Amortized Cost |         | Gross Unrealized Gains |   | Fair Value
|Short-term        |  | $              | 110,377 |                        | $ | 801        |  | $ | 111,178
|Long-term         |  |                | 111,371 |                        |   | 708        |  |   | 112,079
|                  |  |                |         |                        |   |            |  |   |        
|Total investments |  | $              | 221,748 |                        | $ | 1,509      |  | $ | 223,257
|                  |  |                |         |                        |   |            |  |   |        



Our cash flows
for the last three years were as follows:



Fiscal period ended
May 31,



|                                                    |  |                       |       |   |      |   |       |      |  |   |       |  
|--------------------------------------------------- |  | --------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                    |  | 2004                  |       |   | 2003 |   |       | 2002 | 
|                                                    |  | (dollars in millions) |      
|Net cash provided by operating activities           |  | $                     | 22.9  |   |      | $ | 24.1  |      |  | $ | 18.9  |  
|Net cash provided by (used in) investing activities |  |                       | 5.4   |   |      |   | (40.0 | )    |  |   | (18.0 | )
|Net cash provided by (used in) financing activities |  | $                     | (17.3 | ) |      | $ | 7.5   |      |  | $ | (2.6  | )



Our cash
provided by operating activities in fiscal 2004 was driven primarily from our net income of $11.6 million and the add back of non-cash expenses reported in our consolidated statements of operations, primarily non-cash depreciation and amortization
of $6.9 million and a non-cash write-off of in-process research and development of $3.5 million. Changes in working capital including other accrued liabilities, prepaid and other assets and deferred revenue collectively generated cash flow of $10.2
million. These cash flow generating activities were offset by cash outflows in our working capital including a $6.9 increase in accounts receivable, primarily resulting from our year over year increase in revenues, $2.5 million relating to accrued
compensation and $1.8 million due to accounts payable. Cash provided by operating activities increased to $24.1 million for fiscal year 2003 compared to $18.9 million in fiscal year 2002. This $5.2 million increase was primarily due to the increase
in net income of $10.2 million, the effect on cash flow of which was further increased by approximately $5.2 million due to greater non-cash expenses, offset by changes in operating assets and liabilities, comprised mostly of a $15.8 million
decrease in accounts receivable in fiscal year 2002 compared to only a $2.5 million decrease in fiscal year 2003.



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Cash provided by investing activities for fiscal year 2004 of $5.4 million was primarily due to the
sales and maturity of marketable securities, partially offset by the purchases of marketable securities and $50.9 million for the purchase of Cardiff Software and NativeMinds. Cash (used in) investing activities for fiscal years 2003 and 2002 of
$(40.0) million and $(18.0) million respectively, was primarily due to purchases of marketable securities, offset by sales and maturities of marketable securities. We also used $23.8 million in fiscal 2003 to purchase the Inktomi enterprise search
software assets. Capital expenditures were $2.0 million, $1.7 million and $3.1 million in fiscal years 2004, 2003 and 2002, respectively. For fiscal years 2004, 2003 and 2002, the capital expenditures consisted primarily of purchases for computer
hardware and software.



Cash used of $17.3 million in
financing activities in fiscal year 2004 was primarily due to the $50.0 million in repurchases of our common stock through our stock repurchase program, offset by $32.7 million in proceeds from the sale of common stock as a result of stock option
exercises and from the issuance of common stock in connection with our Employee Stock Purchase Plan. Cash provided by financing activities in fiscal year 2003 was primarily due to $36.1 million in proceeds from the sales of common stock as a result
of stock option exercises and from the issuance of common stock in connection with our Employee Stock Purchase Plan, offset by $28.6 million in repurchases of our common stock through our stock repurchase program. Cash used by financing activities
in fiscal year 2002 was primarily due to $20.0 million in repurchases of our common stock through our stock repurchase program, partially offset by $17.4 million in proceeds from the sale of common stock as a result of stock option exercises and
from the issuance of common stock in connection with our Employee Stock Purchase Plan. Our Board of Directors has authorized a $50 million stock repurchase program in fiscal 2005. Although we are not obligated to make any repurchases under this
program, if we do make the majority of the repurchases authorized then we expect to use cash in financing activities in 2005.



Our principal commitments as of May 31, 2004 consist of obligations under operating leases, totaling $16.3 million over the life of these leases. We have
no long-term debt obligations or capital lease obligations.



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



|                           |  |                 |        |                 |   |      |  
|-------------------------- |  | --------------- | ------ | --------------- | - | ---- | -
|Fiscal Year Ending May 31, |  | Rental Payments |        | Sublease Income |  
|2005                       |  |                 | 3,625  |                 |   | (319 | )
|2006                       |  |                 | 3,487  |                 |   | (134 | )
|2007                       |  |                 | 2,657  |                 |   | (75  | )
|2008                       |  |                 | 2,535  |                 |   |     |  
|2009 and thereafter        |  |                 | 4,010  |                 |   |     |  
|                           |  |                 |        |                 |   |      |  
|                           |  | $               | 16,314 |                 | $ | (528 | )
|                           |  |                 |        |                 |   |      |  



Contractual
obligations at May 31, 2004 were as follows:



|                                               |       |                        |                  |  |           |     |           |   |               |  |   |     |  |   |    
|---------------------------------------------- | ----- | ---------------------- | ---------------- |  | --------- | --- | --------- | - | ------------- |  | - | --- |  | - | ---
|(dollars in millions)  Contractual Obligations |       | Payments Due by Period
|                                               | Total |                        | Less than 1 year |  | 1-3 years |     | 4-5 years |   | After 5 years
|Operating Leases                               |       | $                      | 16.3             |  | $         | 3.6 |           | $ | 6.1           |  | $ | 4.2 |  | $ | 2.4
|Deferred Purchase Payment                      |       |                        | 3.7              |  |           | 3.1 |           |   | 0.6           |  |   | 0.0 |  |   | 0.0
|                                               |       |                        |                  |  |           |     |           |   |               |  |   |     |  |   |    
|Total Contractual Cash Obligations             |       | $                      | 20.0             |  | $         | 6.7 |           | $ | 6.7           |  | $ | 4.2 |  | $ | 2.4
|                                               |       |                        |                  |  |           |     |           |   |               |  |   |     |  |   |    



On December 17, 2002,
we completed the purchase of certain assets and obligations of Inktomi Corporations enterprise search software business. Of the total $25.0 million purchase price, we deferred $3.0 million in order to secure Inktomis indemnification
obligations under the Purchase Agreement. On June 17, 2004, we paid Inktomi /Yahoo! an amount equal to the sum of (i) $3.0 million plus (ii) $67,500 in simple interest thereon calculated from the December 17, 2002 through the date of payment at an
annual rate of 1.5%.



On March 3, 2004, we concluded the
NativeMinds strategic asset purchase for $3.9 million. Of the total purchase, we deferred $0.8 million to secure NativeMinds indemnification obligations under the Purchase Agreement. In April 2004, we paid $0.2 million and we are obligated to
pay the remaining $0.6 million in September of 2005.



In fiscal
2004, we repurchased and retired 3,694,978 shares of our common stock through open market transactions for a total of $50.0 million. Our previous program, initiated on September 12, 2001, terminated at May 31, 2003. Under that program, we
repurchased and retired 3,952,005 shares of our common stock through open market transactions, valued at approximately $48.5 million.



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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 2005. 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 reduce costs or seek to obtain additional sources of financing to support our capital needs, but we cannot assure you that such financing will be
available on commercially reasonable terms, or at all.



Recent Accounting
Pronouncements



In December 2003, the Securities and
Exchange Commission issued Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104) which revises or rescinds certain sections of Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB
101), in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and Securities and Exchange Commission rules and regulations. The changes noted in SAB 104 did not have a material effect
on our 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 in EITF No. 03-05 clarifies
the guidance in EITF 00-21. The adoption of Issue No. 03-05 did not have a material effect on our consolidated financial position, results of operations or cash flows.



In May, 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. Verity 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 our consolidated financial position, results of operations or cash flows.



In April, 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.



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
requires that its provisions are effective immediately for all arrangements entered into after January 31, 2003. We do not have any variable interest entities.



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.



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.



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We have adopted the disclosure provisions of FIN 45 and evaluated the impact of the measurement
provisions on our financial position and results of operations. As of May 31, 2003, our guarantees that were issued or modified after December 31, 2002 were not material. Our guarantees issued before December 31, 2002, which would have been
disclosed in accordance with the disclosure requirements of FIN 45, were not material.



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, which has undergone a series of amendments. 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 have been reduced. In addition, pursuant to the amendment, Gary
J. Sbona continues to serve as our Executive Chairman of the Board, but Stephen W. Young ceased to serve as Veritys Chief Operating Officer effective as of March 1, 2004. In accordance with the agreement, Verity pays Regent Pacific $12,500 per
week for the management services that Regent Pacific provides to Verity.



Item 7A.Quantitative and Qualitative Disclosures About Market Risk



Interest Rate Risk.The primary objective of our investment activities is to preserve the principal while at the same time maximizing yields
without significantly increasing the risk. To achieve this objective, we maintain our portfolio of cash equivalents and investments in a variety of securities, including both government and corporate obligations and money market funds, none of which
we hold for trading purposes. As of May 31, 2004, we expected approximately 49% of our portfolio to mature 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. For purposes of this calculation we categorize auction rate securities as expected to mature within one year
(even though they generally mature much later), since these are liquid investments, representing an investment of cash that is available for current operations. Additionally, we do not expect to hold any of these liquid securities to maturity. On
May 31, 2004 and 2003, we held $58.3 million, and $60.8 million, respectively, of auction rate securities, all of which we classified as variable rate securities in the following tables.



The following table presents the amounts of our cash equivalents and
investments that are subject to interest rate risk by year of expected maturity and average interest rates as of May 31, 2004:



|                         |  |                        |        |   |        |   |        |        |  |   |        |   |  |            |         |   |  |   |         |  
|------------------------ |  | ---------------------- | ------ | - | ------ | - | ------ | ------ |  | - | ------ | - |  | ---------- | ------- | - |  | - | ------- | -
|                         |  | FY2005                 |        |   | FY2006 |   |        | FY2007 |  |   | Total  |   |  | Fair Value |        
|                         |  | (Dollars in thousands) |       
|Cash equivalents         |  | $                      | 2,556  |   |        |   |       |        |  |   |       |   |  | $          | 2,556   |   |  | $ | 2,556   |  
|Average interest rate    |  |                        | 0.94   | % |        |   |       |        |  |   |       |   |  |            | 0.94    | % |  |   | 0.94    | %
|Fixed-rate securities    |  | $                      | 20,256 |   |        | $ | 37,177 |        |  | $ | 47,071 |   |  | $          | 104,504 |   |  | $ | 104,504 |  
|Average interest rate    |  |                        | 2.67   | % |        |   | 2.33   | %      |  |   | 2.67   | % |  |            | 2.55    | % |  |   | 2.55    | %
|Variable-rate securities |  | $                      | 58,250 |   |        |   |       |        |  |   |       |   |  | $          | 58,250  |   |  | $ | 58,250  |  
|Average interest rate    |  |                        | 1.21   | % |        |   |       |        |  |   |       |   |  |            | 1.21    | % |  |   | 1.21    | %



During fiscal
year 2004, our cash equivalents and investments decreased by $63.2 million in total value from fiscal year 2003. This decrease in value of our portfolio resulted from the purchase of Cardiff Software and NativeMinds. Commensurate with the decrease
in value, the composition of our portfolio changed in that our fixed rate securities decreased by $58.0 million and our cash and cash equivalents and variable rate investments decreased by $5.2 million



As a result of the decrease in the amount of fixed-rate securities, the
amount of interest we earn on our portfolio as of May 31, 2004 will be more responsive to interest rate fluctuations as compared to May 31, 2003, but the value of the portfolio will be less responsive to interest rate fluctuation. By policy, we
strive to maintain a diverse portfolio with limits on maximum individual security duration and weighted average portfolio maturity.



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The following table presents the amounts of our cash equivalents and investments that are subject to
interest rate risk by year of expected maturity and average interest rates as of May 31, 2003:



|                         |  |                        |        |   |        |   |        |        |  |   |        |   |  |            |         |   |  |   |         |  
|------------------------ |  | ---------------------- | ------ | - | ------ | - | ------ | ------ |  | - | ------ | - |  | ---------- | ------- | - |  | - | ------- | -
|                         |  | FY2004                 |        |   | FY2005 |   |        | FY2006 |  |   | Total  |   |  | Fair Value |        
|                         |  | (Dollars in thousands) |       
|Cash equivalents         |  | $                      | 5,223  |   |        |   |       |        |  |   |       |   |  | $          | 5,223   |   |  | $ | 5,223   |  
|Average interest rate    |  |                        | 1.27   | % |        |   |       |        |  |   |       |   |  |            | 1.27    | % |  |   | 1.27    | %
|Fixed-rate securities    |  | $                      | 50,393 |   |        | $ | 45,940 |        |  | $ | 66,139 |   |  | $          | 162,472 |   |  | $ | 162,472 |  
|Average interest rate    |  |                        | 4.31   | % |        |   | 2.59   | %      |  |   | 2.73   | % |  |            | 3.18    | % |  |   | 3.18    | %
|Variable-rate securities |  | $                      | 60,785 |   |        |   |       |        |  |   |       |   |  | $          | 60,785  |   |  | $ | 60,785  |  
|Average interest rate    |  |                        | 1.36   | % |        |   |       |        |  |   |       |   |  |            | 1.36    | % |  |   | 1.36    | %



Foreign
Currency Transaction Risk. We transact business in various foreign currencies and have established a program that primarily utilizes foreign currency forward contracts to offset the risk associated with the effects of certain foreign currency
exposures. Under this program, increases or decreases in our foreign currency exposures are offset by gains or losses on the forward contracts, to mitigate the possibility of foreign currency transaction gains or losses. These foreign currency
exposures typically arise from intercompany sublicense fees and other intercompany transactions. Our forward contracts generally have terms of 180 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 expense, 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 loss included in Other expense, net in the accompanying consolidated statements of operations were ($0.9 million) ($0.3
million) and ($0.1 million) in fiscal 2004, 2003 and 2002, respectively. The fair value of the foreign currency forward contracts was $2.8 million and $ 7.4 million as of May 31, 2004 and 2003, respectively.



The table below presents the notional amounts (at contract exchange rates)
and the weighted average contractual foreign currency exchange rates for the outstanding forward contracts as of May 31, 2004. Notional weighted average exchange rates are quoted using market conventions where the currency is expressed in currency
units per United States dollar. All of our forward contracts mature in 180 days or less as of May 31, 2004.



Table of Forward Contracts:



|                      |  |                                                              |     |                                                              |   |                                         |  |     
|--------------------- |  | ------------------------------------------------------------ | --- | ------------------------------------------------------------ | - | --------------------------------------- |  | ----
|(Dollars in millions) |  | Exchange Foreign Currency for U.S. Dollars (Notional Amount) |     | Exchange U.S. Dollars for Foreign Currency (Notional Amount) |   | Notional Weighted Average Exchange Rate
|Functional Currency:  |  |                                                              |     |                                                              |   |                                         |  |     
|Canadian Dollar       |  | $                                                            | 2.9 |                                                              | $ |                                        |  | 1.29



The table below
presents the notional amounts (at contract exchange rates) and the weighted average contractual foreign currency exchange rates for the outstanding forward contracts as of May 31, 2003. Notional weighted average exchange rates are quoted using
market conventions where the currency is expressed in currency units per United States dollar. All of our forward contracts mature in 90 days or less as of May 31, 2003.



Table of Forward Contracts:



|                      |  |                                                              |     |                                                              |   |                                         |  |     
|--------------------- |  | ------------------------------------------------------------ | --- | ------------------------------------------------------------ | - | --------------------------------------- |  | ----
|(Dollars in millions) |  | Exchange Foreign Currency for U.S. Dollars (Notional Amount) |     | Exchange U.S. Dollars for Foreign Currency (Notional Amount) |   | Notional Weighted Average Exchange Rate
|Functional Currency:  |  |                                                              |     |                                                              |   |                                         |  |     
|Canadian Dollar       |  | $                                                            | 2.1 |                                                              | $ |                                        |  | 1.42
|Euro                  |  |                                                              | 4.6 |                                                              |   |                                        |  | 0.96
|                      |  |                                                              |     |                                                              |   |                                         |  |     
|Total                 |  | $                                                            | 6.7 |                                                              | $ |                                        |  |     
|                      |  |                                                              |     |                                                              |   |                                         |  |     



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Item 8.Financial Statements and Supplementary Data



Our Consolidated Financial Statements and Notes thereto, and related
Financial Schedule, begin on page 28 of this Annual Report on Form 10-K/A and are incorporated by reference here. Supplementary financial information for the eight quarters ended May 31, 2004 is set forth under Item 7  Managements
Discussion and Analysis of Financial Condition and Results of Operations  Quarterly Results of Operations and is incorporated by reference here.



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PART IV



Item 15.Exhibits, Financial
Statement Schedules, and Reports on Form 8-K



|(a) | The following documents are filed as a part of this Form:
|--- | ---------------------------------------------------------



|   |  |                                                                                                                                                                |  |            
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------
|   |  |                                                                                                                                                                |  | Page Number
|1. |  | Financial Statements:                                                                                                                                          |  |            
|   |  | Reports of Independent Registered Public Accounting Firms                                                                                                      |  | 26         
|   |  | Consolidated Balance Sheets  As of May 31, 2004 and 2003                                                                                                      |  | 27         
|   |  | Consolidated Statements of Operations  For the Years Ended May 31, 2004, 2003 and 2002                                                                        |  | 28         
|   |  | Consolidated Statements of Changes in Stockholders Equity  For the Years Ended May 31, 2004, 2003 and 2002                                                   |  | 29         
|   |  | Consolidated Statements of Cash Flows  For the Years Ended May 31, 2004, 2003 and 2002                                                                        |  | 30         
|   |  | Consolidated Statements of Comprehensive Income  For the Years Ended May 31, 2004, 2003 and 2002                                                              |  | 31         
|   |  | Notes to Consolidated Financial Statements                                                                                                                     |  | 32         
|2. |  | Financial Statement Schedule  For the Years Ended May 31, 2004, 2003 and 2002:                                                                                |  |            
|   |  | Schedule II  Valuation and Qualifying Accounts                                                                                                                |  | 56         
|   |  | All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto |  |            
|3. |  | Exhibits: See Index to Exhibits on page listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this report             |  | 58         



|(b) | Reports on Form 8-K:
|--- | --------------------



March 11, 2004, we furnished to the Securities and Exchange Commission a Current Report on Form 8-K to furnish under Item 12 the announcement of our
financial results for the third quarter of fiscal year 2004, which announcement included our consolidated statements of operations and consolidated balance sheets for the periods reported in that press release.



March 30, 2004, we filed with the Securities and Exchange Commission a
Current Report on Form 8-K reporting under Item 2 our acquisition of Cardiff Software, Inc., and filing the announcement of the acquisition under Item 7. We subsequently determined that the filing was not required by Item 2, and consequently no
financial statements were required to be filed.



|(c) | Exhibits
|--- | --------



See Index to Exhibits immediately following the signature page of the Original Form 10-K, as well as this Form 10-K/A, which are incorporated by reference here, for the exhibits filed with this report.



|(d) | Financial Statement Schedules
|--- | -----------------------------



See Item 15(a)(2) above.



24



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##### Table of Contents

Report of Independent Registered Public Accounting Firm



The Board of Directors and Stockholders

Verity, Inc:



We have audited the accompanying consolidated balance sheet of Verity, Inc. and subsidiaries, as of May 31, 2004, and the related consolidated statements of operations, changes in stockholders equity, cash
flows, and comprehensive income for the year then ended. Our audit also included the related financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of Verity, Inc. and subsidiaries as of May 31, 2004, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.



/s/ KPMG LLP



Mountain View, California

June 22, 2004



25



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##### Table of Contents

Report of Independent Registered Public Accounting Firm



To the Board of Directors and Stockholders

Verity, Inc.



In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 43 present fairly, in all material
respects, the financial position of Verity, Inc. and its subsidiaries at May 31, 2003, and the results of their operations and their cash flows for the years ended May 31, 2003 and 2002, in conformity with accounting principles generally accepted in
the United States of America. In addition, in our opinion, the financial statement schedule for the years 2002 and 2003 listed in the index appearing under Item 15(a)(2) on page 43 presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Companys management; our responsibility is to express an opinion on
these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



/s/ PricewaterhouseCoopers LLP



PricewaterhouseCoopers LLP



San Jose, California

June 13, 2003



26



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##### Table of Contents

VERITY, INC.



CONSOLIDATED
BALANCE SHEETS

(in thousands, except per share data)



ASSETS



|                                                                                                        |  |         |         |   |      |   |        
|------------------------------------------------------------------------------------------------------- |  | ------- | ------- | - | ---- | - | -------
|                                                                                                        |  | May 31,
|                                                                                                        |  | 2004    |         |   | 2003
|Current assets:                                                                                         |  |         |         |   |      |   |        
|Cash and cash equivalents                                                                               |  | $       | 38,995  |   |      | $ | 27,487 
|Short-term investments                                                                                  |  |         | 78,506  |   |      |   | 111,178
|Trade accounts receivable, net of allowance for doubtful accounts of $2,131 and $1,720                  |  |         | 31,807  |   |      |   | 22,597 
|Deferred tax assets                                                                                     |  |         | 2,482   |   |      |   | 1,704  
|Prepaid and other assets                                                                                |  |         | 3,197   |   |      |   | 4,388  
|                                                                                                        |  |         |         |   |      |   |        
|Total current assets                                                                                    |  |         | 154,987 |   |      |   | 167,354
|Property and equipment, net                                                                             |  |         | 4,272   |   |      |   | 5,168  
|Long-term investments                                                                                   |  |         | 84,248  |   |      |   | 112,079
|Deferred tax assets                                                                                     |  |         | 17,884  |   |      |   | 20,388 
|Intangible assets, net                                                                                  |  |         | 24,854  |   |      |   | 11,610 
|Goodwill                                                                                                |  |         | 55,824  |   |      |   | 15,145 
|Other assets                                                                                            |  |         | 2,012   |   |      |   | 791    
|                                                                                                        |  |         |         |   |      |   |        
|Total assets                                                                                            |  | $       | 344,081 |   |      | $ | 332,535
|                                                                                                        |  |         |         |   |      |   |        
|                                                                                                       
|LIABILITIES                                                                                            
|                                                                                                        |  |        
|Current liabilities:                                                                                    |  |         |         |   |      |   |        
|Accounts payable                                                                                        |  | $       | 2,855   |   |      | $ | 2,181  
|Accrued compensation                                                                                    |  |         | 10,086  |   |      |   | 8,518  
|Income tax payable                                                                                      |  |         | 4,214   |   |      |   | 3,493  
|Deferred purchase payment                                                                               |  |         | 3,066   |   |      |   |       
|Other accrued liabilities                                                                               |  |         | 4,548   |   |      |   | 4,461  
|Deferred revenue                                                                                        |  |         | 21,421  |   |      |   | 18,874 
|                                                                                                        |  |         |         |   |      |   |        
|Total current liabilities                                                                               |  |         | 46,190  |   |      |   | 37,527 
|                                                                                                        |  |         |         |   |      |   |        
|Other non-current liabilities:                                                                          |  |         |         |   |      |   |        
|Deferred rent                                                                                           |  |         | 495     |   |      |   | 356    
|Deferred purchase payment                                                                               |  |         | 570     |   |      |   | 3,021  
|                                                                                                        |  |         |         |   |      |   |        
|Total liabilities                                                                                       |  |         | 47,255  |   |      |   | 40,904 
|                                                                                                        |  |         |         |   |      |   |        
|                                                                                                       
|STOCKHOLDERS EQUITY                                                                                   
|                                                                                                        |  |        
|Preferred stock, $0.001 par value:                                                                      |  |         |         |   |      |   |        
|Authorized: 2,000 shares                                                                                |  |         |         |   |      |   |        
|Issued and outstanding: none                                                                            |  |         |         |   |      |   |        
|Common stock, $0.001 par value:                                                                         |  |         |         |   |      |   |        
|Authorized: 200,000 shares in ; issued and outstanding: 37,280 shares in 2004 and 37,560 shares in 2003 |  |         | 37      |   |      |   | 38     
|Additional paid-in capital                                                                              |  |         | 259,245 |   |      |   | 264,645
|Accumulated other comprehensive income                                                                  |  |         | 2,249   |   |      |   | 3,174  
|Deferred stock compensation                                                                             |  |         | (88     | ) |      |   |       
|Retained earnings                                                                                       |  |         | 35,383  |   |      |   | 23,774 
|                                                                                                        |  |         |         |   |      |   |        
|Total stockholders equity                                                                              |  |         | 296,826 |   |      |   | 291,631
|                                                                                                        |  |         |         |   |      |   |        
|Total liabilities and stockholders equity                                                              |  | $       | 344,081 |   |      | $ | 332,535
|                                                                                                        |  |         |         |   |      |   |        



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



27



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##### Table of Contents

VERITY, INC.



CONSOLIDATED
STATEMENTS OF OPERATIONS

(in thousands, except per share data)



|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|------------------------------------------- |  | ------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                            |  | Year Ended May 31, |        
|                                            |  | 2004               |         |   | 2003 |   |         | 2002 | 
|Revenues:                                   |  |                    |         |   |      |   |         |      |  |   |        |  
|Software products                           |  | $                  | 71,999  |   |      | $ | 57,529  |      |  | $ | 55,859 |  
|Service and other                           |  |                    | 52,311  |   |      |   | 44,421  |      |  |   | 37,906 |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Total revenues                              |  |                    | 124,310 |   |      |   | 101,950 |      |  |   | 93,765 |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Costs of revenues:                          |  |                    |         |   |      |   |         |      |  |   |        |  
|Software products                           |  |                    | 2,270   |   |      |   | 1,210   |      |  |   | 2,289  |  
|Service and other                           |  |                    | 14,467  |   |      |   | 12,510  |      |  |   | 11,469 |  
|Amortization of purchased intangible assets |  |                    | 3,456   |   |      |   | 1,290   |      |  |   |       |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Total costs of revenues                     |  |                    | 20,193  |   |      |   | 15,010  |      |  |   | 13,758 |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Gross profit                                |  |                    | 104,117 |   |      |   | 86,940  |      |  |   | 80,007 |  
|                                            |  |                    |        
|Operating expenses:                         |  |                    |         |   |      |   |         |      |  |   |        |  
|Research and development                    |  |                    | 20,211  |   |      |   | 20,144  |      |  |   | 21,725 |  
|Marketing and sales                         |  |                    | 50,006  |   |      |   | 42,310  |      |  |   | 51,399 |  
|General and administrative                  |  |                    | 12,057  |   |      |   | 10,736  |      |  |   | 11,917 |  
|In-process research and development charge  |  |                    | 3,472   |   |      |   | 1,200   |      |  |   |       |  
|Restructuring charges                       |  |                    | 1,226   |   |      |   | 993     |      |  |   | 1,563  |  
|Charitable contribution                     |  |                    |        |   |      |   |        |      |  |   | 1,000  |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Total operating expenses                    |  |                    | 86,972  |   |      |   | 75,382  |      |  |   | 87,603 |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Income (loss) from operations               |  |                    | 17,145  |   |      |   | 11,558  |      |  |   | (7,596 | )
|                                            |  |                    |        
|Interest income                             |  |                    | 4,851   |   |      |   | 7,474   |      |  |   | 10,053 |  
|Interest expense                            |  |                    | (51     | ) |      |   | (35     | )    |  |   | (36    | )
|Other expense, net                          |  |                    | (681    | ) |      |   | (222    | )    |  |   | (148   | )
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Income before provision for income taxes    |  |                    | 21,264  |   |      |   | 18,775  |      |  |   | 2,273  |  
|Provision for income taxes                  |  |                    | 9,655   |   |      |   | 7,134   |      |  |   | 864    |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Net income                                  |  | $                  | 11,609  |   |      | $ | 11,641  |      |  | $ | 1,409  |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Net income per share  basic                |  | $                  | 0.31    |   |      | $ | 0.33    |      |  | $ | 0.04   |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Net income per share  diluted              |  | $                  | 0.29    |   |      | $ | 0.31    |      |  | $ | 0.04   |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Number of shares  basic                    |  |                    | 37,625  |   |      |   | 35,410  |      |  |   | 35,404 |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  
|Number of shares  diluted                  |  |                    | 39,666  |   |      |   | 37,595  |      |  |   | 37,169 |  
|                                            |  |                    |         |   |      |   |         |      |  |   |        |  



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



28



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##### Table of Contents

VERITY, INC.



CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

For the years ended May 31, 2004, 2003 and 2002 (in thousands)



|                                                    |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  
|--------------------------------------------------- | ------ | ------------ | - | ------ | ------------------------ | -- | - | ------------------------- | - | ------- | ----------------------------------- |  | - | ---------------- | - | ------------------------ | - | ------ | - |  | - | ------ |  | - | ------- | -
|                                                    |        | Common Stock |   |        | AdditionalPaid-InCapital |    |   | DeferredStockCompensation |   |         | AccumulatedOtherComprehensiveIncome |  |   | RetainedEarnings |   | TotalStockholdersEquity |  
|                                                    | Shares |              |   | Amount |                          |    |   |                           |   |        
|Balances, May 31, 2001                              |        | 35,158       |   |        |                          | 35 |   |                           |   | 252,733 |                                     |  |   |                 |   |                          |   | 652    |   |  |   | 10,724 |  |   | 264,144 |  
|Issuance of common stock:                           |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  
|Upon exercise of stock options                      |        | 1,769        |   |        |                          | 2  |   |                           |   | 14,533  |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 14,535  |  
|Under employee stock purchase plan                  |        | 350          |   |        |                          |   |   |                           |   | 2,852   |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 2,852   |  
|Repurchase of common stock                          |        | (1,502       | ) |        |                          | (1 | ) |                           |   | (19,985 | )                                   |  |   |                 |   |                          |   |       |   |  |   |       |  |   | (19,986 | )
|Unrealized gain on investments                      |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   | 647    |   |  |   |       |  |   | 647     |  
|Effect of foreign currency translation adjustments  |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   | 664    |   |  |   |       |  |   | 664     |  
|Net income                                          |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   |       |   |  |   | 1,409  |  |   | 1,409   |  
|                                                    |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  
|Balances, May 31, 2002                              |        | 35,775       |   |        | $                        | 36 |   |                           | $ | 250,133 |                                     |  | $ |                 |   |                          | $ | 1,963  |   |  | $ | 12,133 |  | $ | 264,265 |  
|                                                    |        |              |   |        |                          |    |  
|Issuance of common stock:                           |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  
|Common shares issued outside of plans               |        | 2            |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   |        |  
|Upon exercise of stock options                      |        | 3,826        |   |        |                          | 4  |   |                           |   | 32,795  |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 32,799  |  
|Under employee stock purchase plan                  |        | 407          |   |        |                          |   |   |                           |   | 3,273   |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 3,273   |  
|Deferred tax benefit from disqualified dispositions |        |             |   |        |                          |   |   |                           |   | 7,006   |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 7,006   |  
|Repurchase of common stock                          |        | (2,450       | ) |        |                          | (2 | ) |                           |   | (28,562 | )                                   |  |   |                 |   |                          |   |       |   |  |   |       |  |   | (28,564 | )
|Unrealized gain on investments                      |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   | 115    |   |  |   |       |  |   | 115     |  
|Effect of foreign currency translation adjustments  |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   | 1,096  |   |  |   |       |  |   | 1,096   |  
|Net income                                          |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   |       |   |  |   | 11,641 |  |   | 11,641  |  
|                                                    |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  
|Balances, May 31, 2003                              |        | 37,560       |   |        | $                        | 38 |   |                           | $ | 264,645 |                                     |  | $ |                 |   |                          | $ | 3,174  |   |  | $ | 23,774 |  | $ | 291,631 |  
|                                                    |        |              |   |        |                          |    |  
|Issuance of common stock:                           |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  
|Upon exercise of stock options                      |        | 3,040        |   |        |                          | 3  |   |                           |   | 28,997  |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 29,000  |  
|Under employee stock purchase plan                  |        | 375          |   |        |                          |   |   |                           |   | 3,664   |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 3,664   |  
|Deferred tax benefit from disqualified dispositions |        |             |   |        |                          |   |   |                           |   | 8,167   |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 8,167   |  
|Repurchase of common stock                          |        | (3,695       | ) |        |                          | (4 | ) |                           |   | (49,996 | )                                   |  |   |                 |   |                          |   |       |   |  |   |       |  |   | (50,000 | )
|Stock options assumed in business combinations      |        |             |   |        |                          |   |   |                           |   | 3,768   |                                     |  |   |                 |   |                          |   |       |   |  |   |       |  |   | 3,768   |  
|Unrealized loss on investments                      |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   | (1,343 | ) |  |   |       |  |   | (1,343  | )
|Deferred stock compensation                         |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   | (89              | ) |                          |   |       |   |  |   |       |  |   | (89     | )
|Amortization of deferred stock compensation         |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   | 1                |   |                          |   |       |   |  |   |       |  |   | 1       |  
|Effect of foreign currency translation adjustments  |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   | 418    |   |  |   |       |  |   | 418     |  
|Net income                                          |        |             |   |        |                          |   |   |                           |   |        |                                     |  |   |                 |   |                          |   |       |   |  |   | 11,609 |  |   | 11,609  |  
|                                                    |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  
|Balances, May 31, 2004                              |        | 37,280       |   |        | $                        | 37 |   |                           | $ | 259,245 |                                     |  | $ | (88              | ) |                          | $ | 2,249  |   |  | $ | 35,383 |  | $ | 296,826 |  
|                                                    |        |              |   |        |                          |    |   |                           |   |         |                                     |  |   |                  |   |                          |   |        |   |  |   |        |  |   |         |  



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



29



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##### Table of Contents

VERITY, INC.



CONSOLIDATED
STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------------------------------------- |  | -------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                            |  | For the Year Ended May 31, |         
|                                                                                            |  | 2004                       |          |   | 2003 |   |          | 2002 | 
|Cash flow from operating activities:                                                        |  |                            |          |   |      |   |          |      |  |   |          |  
|Net income                                                                                  |  | $                          | 11,609   |   |      | $ | 11,641   |      |  | $ | 1,409    |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                            |          |   |      |   |          |      |  |   |          |  
|Depreciation and amortization                                                               |  |                            | 6,857    |   |      |   | 4,700    |      |  |   | 4,251    |  
|Noncash restructuring charges                                                               |  |                            | 144      |   |      |   | 202      |      |  |   | (6       | )
|Provision for bad debt expense                                                              |  |                            | 319      |   |      |   | 563      |      |  |   | 1,065    |  
|Deferred income taxes                                                                       |  |                            | 751      |   |      |   | 3,141    |      |  |   | 409      |  
|Write-off of in-process research and development                                            |  |                            | 3,472    |   |      |   | 1,200    |      |  |   |         |  
|Amortization of premium on securities, net                                                  |  |                            | 837      |   |      |   | 1,458    |      |  |   | 352      |  
|Changes in operating assets and liabilities:                                                |  |                            |          |   |      |   |          |      |  |   |          |  
|Trade accounts receivable                                                                   |  |                            | (6,902   | ) |      |   | 2,474    |      |  |   | 15,715   |  
|Prepaid and other assets                                                                    |  |                            | 2,642    |   |      |   | 1,116    |      |  |   | 1,292    |  
|Accounts payable                                                                            |  |                            | (1,828   | ) |      |   | 546      |      |  |   | (822     | )
|Accrued compensation                                                                        |  |                            | (2,510   | ) |      |   | (2,027   | )    |  |   | (1,423   | )
|Other accrued liabilities                                                                   |  |                            | 6,494    |   |      |   | 1,562    |      |  |   | (1,233   | )
|Deferred revenue                                                                            |  |                            | 1,063    |   |      |   | (2,461   | )    |  |   | (2,091   | )
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Net cash provided by operating activities                                                   |  |                            | 22,948   |   |      |   | 24,115   |      |  |   | 18,918   |  
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Cash flows from investing activities:                                                       |  |                            |          |   |      |   |          |      |  |   |          |  
|Acquisition of property and equipment                                                       |  |                            | (1,976   | ) |      |   | (1,745   | )    |  |   | (3,073   | )
|Purchases of investments                                                                    |  |                            | (359,534 | ) |      |   | (239,462 | )    |  |   | (225,611 | )
|Maturity of investments                                                                     |  |                            | 171,742  |   |      |   | 159,294  |      |  |   | 139,355  |  
|Proceeds from sale of investments                                                           |  |                            | 246,115  |   |      |   | 65,701   |      |  |   | 71,370   |  
|Purchase of business, net of cash acquired                                                  |  |                            | (50,949  | ) |      |   | (23,826  | )    |  |   |         |  
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) investing activities                                         |  |                            | 5,398    |   |      |   | (40,038  | )    |  |   | (17,959  | )
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Cash flows from financing activities:                                                       |  |                            |          |   |      |   |          |      |  |   |          |  
|Proceeds from the sale of common stock, net of issuance costs                               |  |                            | 32,664   |   |      |   | 36,070   |      |  |   | 17,387   |  
|Repurchase of common stock                                                                  |  |                            | (50,000  | ) |      |   | (28,564  | )    |  |   | (19,986  | )
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) financing activities                                         |  |                            | (17,336  | ) |      |   | 7,506    |      |  |   | (2,599   | )
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Effect of exchange rate changes on cash and cash equivalents                                |  |                            | 498      |   |      |   | 671      |      |  |   | 668      |  
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Net increase (decrease) in cash and cash equivalents                                        |  |                            | 11,508   |   |      |   | (7,746   | )    |  |   | (972     | )
|                                                                                            |  |                            |         
|Cash and cash equivalents, beginning of period                                              |  |                            | 27,487   |   |      |   | 35,233   |      |  |   | 36,205   |  
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Cash and cash equivalents, end of period                                                    |  | $                          | 38,995   |   |      | $ | 27,487   |      |  | $ | 35,233   |  
|                                                                                            |  |                            |          |   |      |   |          |      |  |   |          |  
|Supplemental disclosure of cash flow information:                                           |  |                            |          |   |      |   |          |      |  |   |          |  
|Cash paid for interest                                                                      |  | $                          | 51       |   |      | $ | 35       |      |  | $ | 17       |  
|Cash paid for income taxes                                                                  |  | $                          | 1,418    |   |      | $ | 1,062    |      |  | $ | 375      |  



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



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VERITY, INC.



CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)



|                                                                |  |                    |        |   |      |   |        |  |   |      
|--------------------------------------------------------------- |  | ------------------ | ------ | - | ---- | - | ------ |  | - | -----
|                                                                |  | Year Ended May 31,
|                                                                |  | 2004               |        |   | 2003 |   | 2002  
|Net income                                                      |  | $                  | 11,609 |   |      | $ | 11,641 |  | $ | 1,409
|                                                                |  |                    |        |   |      |   |        |  |   |      
|Unrealized gain (losses) on available for sale investments, net |  |                    | (1,343 | ) |      |   | 115    |  |   | 647  
|Cumulative effect of foreign currency translation adjustments   |  |                    | 418    |   |      |   | 1,096  |  |   | 664  
|                                                                |  |                    |        |   |      |   |        |  |   |      
|Net change in comprehensive income                              |  |                    | (925   | ) |      |   | 1,211  |  |   | 1,311
|                                                                |  |                    |        |   |      |   |        |  |   |      
|Comprehensive income                                            |  | $                  | 10,684 |   |      | $ | 12,852 |  | $ | 2,720
|                                                                |  |                    |        |   |      |   |        |  |   |      



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



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VERITY, INC.



NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS



1. Nature of Operations



Verity is a leading provider of intellectual capital
management software that enables our customers to maximize their return on their information assets. The intellectual capital management software market is in great part the convergence of many core markets in which we have participated for years,
including search, corporate portals, and e-commerce, as well as markets we have recently entered, including question and answer interfaces, and content capture and process automation, among others.



The Company develops, markets and supports two product families: intelligent
content services (ICS), and content capture and process automation . Intelligent content services are search, classification, recommendation, monitoring/alerting, and question and answer infrastructure products for corporate intranets,
extranets, web sites, corporate portals, business applications, online publishers, and e-commerce providers and original equipment manufacturer (OEM) toolkits for independent software vendors. Our comprehensive and integrated ICS product
family enables numerous enterprise-wide functionalities, from the same underlying Verity information index. Our ICS products organize and provide simple, single-point access to information across the entire enterprise. In doing so, our products can
be used to create or enhance business portals and standalone applications that leverage the value of existing investments in intranets and business applications. Content capture and process automation applications enable the information on paper and
electronic forms to be captured in electronic form, and for manual processes that utilized that information to be automated over corporate networks. Our content capture and process automation products include capabilities for forms design, scanning,
optical character recognition, forms recognition, validation, verification, workflow and routing.



Our software has been licensed to numerous corporations, government agencies, software developers, information publishers and e-commerce vendors. We
pursue sales opportunities within corporations and government agencies through the efforts of our direct sales force and through a network of value added resellers and system integrators. We also sell OEM toolkits to independent software vendors
that embed Verity technology in their products or services.



2. Summary of
Significant Accounting Policies



Basis of consolidation



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



Cash and cash equivalents



Cash and cash equivalents consist of highly liquid investments with an original or remaining maturity of 90 days or less as of the date of purchase. Cash
equivalents are stated at amortized cost plus accrued interest, which approximates fair value. Cash equivalents consist primarily of money market instruments and certificates of deposit, which amounted to $39.0 million and $27.5 million at May 31,
2004 and 2003, respectively.



Use of estimates



The preparation of financial statements in accordance 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 the
financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.



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Investments



The Company considers all highly liquid interest-earning investments with a maturity of 90 days or less at the date of purchase to be cash equivalents.
Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. All cash and
investments are classified as available for sale and are recorded at market value using the specific identification method; unrealized gains and losses (excluding other-than-temporary impairments) are reflected in Other Comprehensive Income.



Property and equipment



Property and equipment are stated at cost less accumulated depreciation.
Equipment is depreciated on a straight-line basis over the estimated useful lives of the related assets; computers are depreciated over three years, software is depreciated up to two years, and furniture and fixtures are depreciated over five years.
Leasehold improvements are amortized on a straight-line basis over the lesser of their estimated useful life or the lease term. Gains and losses upon asset disposal are taken into income in the year of disposition.



The Company evaluates the carrying value of property and equipment to be held
and used when events and circumstances warrant such a review. The carrying value of property and equipment and leasehold improvements is considered impaired when the anticipated undiscounted cash flows from the asset is separately identifiable and
is less than the assets carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the asset. Fair value is determined primarily using the anticipated cash flows discounted at
a rate commensurate with the risk involved. Losses on assets to be disposed of are determined in a similar manner, except that fair values are reduced for the cost to dispose.



Research and development costs



Costs related to research, design and development of products are charged to research and development expense as incurred. Software development costs are
capitalized beginning when a products technological feasibility has been established and ending when a product is available for general release to customers. Such costs are amortized on a straight-line basis based over the estimated useful
life ranging between two to five years. The Company regularly evaluates estimated net realizable value of costs and records write-downs for any product for which the net book value is in excess of discounted cashflows. In fiscal 2004, 2003 and 2002,
the Company did not capitalize any software development costs since such costs were not significant.



Revenue recognition



The Companys revenues are derived from license fees for software products and fees for services complementary to its products, including software maintenance, consulting, hardware and training.



The Company recognizes revenue from the sale of software licenses when
persuasive evidence of an arrangement exists, the product has been delivered, the fees are fixed or determinable and collection of the resulting receivable is probable. Delivery generally occurs when the product is delivered to a common carrier or
made available to the customer for electronic download. At the time of the transaction, the Company assesses whether the fee associated with its revenue transactions is fixed or determinable and whether or not collection is probable. The Company
assesses whether the fee is fixed or determinable based on the payment terms associated with the transaction. The Company assesses collection based on a number of factors, including any past transaction history with the customer and the
credit-worthiness of the customer.



For all sales, the Company
uses either a binding purchase order or signed license agreement as evidence of an arrangement. Sales through the Companys distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a
transaction-by-transaction basis. The Companys arrangements do not generally include acceptance clauses. However, if an arrangement includes an acceptance provision, acceptance occurs upon the earlier of receipt of written customer acceptance
or expiration of the acceptance period.



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The Company recognizes maintenance revenues from ongoing customer support and product upgrades ratably
over the term of the applicable maintenance agreement, which is typically twelve months. Generally, the Company receives payments for maintenance fees in advance and they are nonrefundable. The Company recognizes revenues for consulting and training
when the services are performed. The Company recognizes hardware revenue when the product is delivered.



For agreements with multiple elements, such as license, maintenance, training, hardware and consulting services, the Company allocates revenue to each
component of the arrangement based upon its fair value as determined by vendor specific objective evidence. Vendor specific objective evidence of fair value for all elements of an arrangement is based upon the normal pricing and
discounting practices for those products and services when sold separately. The Company defers revenue for any undelivered elements, and recognizes revenue when the product is delivered or over the period in which the service is performed, in
accordance with its revenue recognition policy for such element. If the Company cannot objectively determine the fair value of any undelivered element included in bundled software, hardware and service arrangements, the Company defers revenue until
all elements are delivered and all services have been performed, or until fair value can objectively be determined for any remaining undelivered elements. When the fair value of a delivered element has not been established, the Company uses the
residual method to record revenue if the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is allocated to the
delivered elements and is recognized as revenue.



Allowance for doubtful
accounts



The Companys management makes estimates of
the collectibility of accounts receivable. Management specifically analyzes accounts receivable and analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms
when evaluating the adequacy of the allowance for doubtful accounts.



Stock-based compensation



The Company accounts
for stock-based employee compensation arrangements based on the difference, if any, on the date of grant, between the fair value of the Companys stock and the exercise price. The Company accounts for stock-based arrangements issued to
non-employees based on the fair value of the stock granted using the Black-Scholes option pricing model at the date of grant.



Deferred stock-based compensation is being amortized using the graded vesting method over the vesting period of each respective option, which is generally
four years. Under the graded vesting method, each option grant is separated into portions based on its vesting terms, which results in acceleration of amortization expense for the overall award.



The Company has adopted the disclosure requirements of Statement of Financial
Accounting Standards No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure.



Pro forma stock-based compensation



The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123,) Accounting for Stock-Based Compensation. Accordingly, no compensation
cost has been recognized for the Companys stock option plans or Employee Stock Purchase Plan. Had compensation cost for the Companys stock option plans and Employee Stock Purchase Plan been determined based on the fair value at the grant
date for awards in fiscal years 2004, 2003 and 2002 consistent with the provisions of SFAS No. 123, the Companys net income and net income per share for fiscal years 2004, 2003 and 2002 would have been reduced to the pro forma amounts
indicated below (in thousands, except per share amounts):



|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                                                |  | Fiscal Years |        
|                                                                                                                                                |  | 2004         |         |   | 2003 |   |         | 2002 | 
|Net income  as reported                                                                                                                        |  | $            | 11,609  |   |      | $ | 11,641  |      |  | $ | 1,409   |  
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|Add: Stock compensation expense included in reported net income, net of related tax effects                                                     |  |              | 6       |   |      |   | 17      |      |  |   |        |  
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax
effects |  |              | (32,881 | ) |      |   | (39,993 | )    |  |   | (49,517 | )
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|Net loss  pro forma                                                                                                                            |  | $            | (21,266 | ) |      | $ | (28,335 | )    |  | $ | (48,108 | )
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|Net income per share  basic  as reported                                                                                                      |  | $            | 0.31    |   |      | $ | 0.33    |      |  | $ | 0.04    |  
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|Net income per share  diluted  as reported                                                                                                    |  | $            | 0.29    |   |      | $ | 0.31    |      |  | $ | 0.04    |  
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|Net loss per share  basic  pro forma                                                                                                          |  | $            | (0.57   | ) |      | $ | (0.80   | )    |  | $ | (1.36   | )
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  
|Net loss per share  diluted  pro forma                                                                                                        |  | $            | (0.57   | ) |      | $ | (0.80   | )    |  | $ | (1.36   | )
|                                                                                                                                                |  |              |         |   |      |   |         |      |  |   |         |  



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The above pro forma disclosures are not necessarily representative of the effects on reported net income
(loss) for future years.



See Note 9 
Stockholders Equity for the assumptions and methodology used to determine the fair value of stock-based compensation.



Accounting for income taxes



As part of the process of preparing its consolidated financial statements the Company estimates its income taxes in each of the jurisdictions in which it
operates. The Companys income tax accounting process involves recording the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying consolidated balance
sheets, as well as operating loss and tax credit carryforwards. These differences result in the recognition of deferred tax assets and liabilities.



The Company evaluates deferred tax assets at each balance sheet date to determine their realizability, considering currently enacted tax laws, expected
future taxable income and origins of the specific components of the deferred tax asset. If the Company determines that deferred tax assets are not fully realizable, it records a valuation allowance to reduce the asset balance to its realizable value
through a charge to income tax expense. Determining whether it will be able to utilize the net operating loss carryforward requires that the Company estimate future taxable income and make judgments regarding the timing of future tax obligations.
Actual taxable income could differ from the Companys estimates.



As of May 31, 2004, the Company believes it is more likely than not that it will be able to realize the majority of our tax assets through expected future taxable profits. The Company has recorded a valuation allowance of $20.3 million for
the remainder of our tax assets. The recognition of deferred tax assets originated from stock compensation has been recorded to additional paid-in-capital.



If the Company concludes that additional valuation allowance is required in the future, the effect on income tax expense could be material.



Goodwill and other long lived intangible assets



The Company records goodwill and identifiable purchased intangible assets
when it acquires other companies. The cost of the acquisition is allocated to the assets and liabilities acquired, including identifiable intangible assets, with the remaining amount being classified as goodwill. Certain intangible assets such as
purchased technology and maintenance agreements are amortized to operating expense over time, while in-process research and development is recorded as an expense on the acquisition date.



In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other Intangible Assets. This standard eliminates the amortization of goodwill and requires goodwill to be reviewed at least annually for impairment, or whenever events or changes in circumstances
indicate goodwill may be impaired, the useful lives of previously recognized intangible assets to be reassessed and the remaining amortization periods to be adjusted accordingly. There can be no assurance that at the time that the review is
completed a material impairment charge will not be required and recorded. The Company performs an annual impairment review in its third fiscal quarter. The Company periodically reviews the estimated remaining useful lives of its intangible assets. A
reduction in the Companys estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.



SFAS No. 142 requires that intangibles with finite useful lives be reviewed for impairment in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 establishes a single accounting model for long-lived assets to be disposed of by sale, whether they were previously held and used or newly acquired, and it also broadens the presentation
of discontinued operations to include more disposal transactions. The Company continually monitors events and changes in circumstances that could indicate carrying amounts of the long-lived assets, including intangible assets, may not be
recoverable. When such events or changes in circumstances occur, the Company assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash
flow. If the future undiscounted cash flow is less than the carrying amount of these assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets.



This impairment review involves a two-step process as follows:



| |  |  | Step 1  We compare the fair value of our reporting unit to its carrying value, including goodwill. If the reporting units carrying value, including goodwill, exceeds the
units fair value, we move on to Step 2. If the units fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------







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| |  |  | Step 2  We perform an allocation of the fair value of the reporting unit to its identifiable tangible and non-goodwill intangible assets and liabilities. This derives an
implied fair value for the reporting units goodwill. We then compare the implied fair value of the reporting units goodwill with the carrying amount of the reporting units goodwill. If the carrying amount of the reporting
units goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Certain risks and concentrations



The Companys products are concentrated in the electronic information search and retrieval software industry, which is highly competitive and rapidly
changing. A number of companies offer competitive products addressing certain of the Companys target markets and act as direct competitors of the Company. The Company is dependent on the success of its strategic partners to obtain its
competitive edge.



A small portion of the Companys
revenue is derived from relatively large sales to individual customers, representing exposure to the loss of a major customer or any reduction in orders by such customers, significant technological changes in the industry, and the infringement or
expropriation of proprietary intellectual property rights or patents. In addition, a significant portion of the Companys revenue is derived from international sales, and therefore exposes the Company to fluctuation of the U.S. dollar against
foreign currencies or local economic conditions.



Financial
instruments, which potentially subject the Company to a concentration of credit risk principally consist of cash and cash equivalents, investments and accounts receivable. The Company maintains the majority of its cash and cash equivalents in demand
accounts with two major financial institutions.



The Company
maintains cash balances in excess of its operating requirements in commercial paper securities issued by various corporate institutions, and debt securities backed by the United States government. The Company has not experienced any material losses
in any of the instruments it has used for excess cash balances.



The Company sells products to companies in North America, Europe, Asia, South Africa, South America and Australia. The Company performs ongoing credit evaluations of its customers financial condition and, generally, requires no
collateral from its customers. The Company also performs an analysis of the expected collectibility of accounts receivable and records an allowance for doubtful accounts receivable when necessary. The Company maintains allowances for potential
losses and such losses have been within managements expectations. For the fiscal years ended May 31, 2004 and 2003, no customer accounted for more than 10% of the total accounts receivable balance. No customer accounted for more than 10% of
the total revenue in any period reported.



Foreign currency



Assets and liabilities of foreign subsidiaries, whose functional currency
is the local currency, are translated at period-end exchange rates. Income and expense items are translated at the average rates of exchange prevailing during the period. The adjustment resulting from translating the financial statements of such
foreign subsidiaries is reflected in accumulated other comprehensive income within stockholders equity. Foreign currency transaction gains or losses are reported in results of operations.



Fair value of financial instruments



Carrying amounts of certain of the Companys financial instruments,
including cash and cash equivalents, investments, accounts receivable and accounts payable approximate fair value due to their short maturities. The fair value of the Companys investments is set forth in Note 5.



Computation of net income 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 shares of common stock and potential common shares outstanding during the period. Dilutive potential common shares consist of
stock options.



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Comprehensive income



The Company has adopted Statement of Financial Accounting Standards No. 130 (SFAS 130) Comprehensive income, as defined, includes all changes
in equity (net assets) during a period from non-owner sources. Other comprehensive income for all periods presented consists of unrealized gains and losses on available-for-sale securities and the effect of foreign currency translation.



Reclassification



Certain prior period balances have been reclassified to conform to the current period presentation. Historically, the
Company believed that auction rate securities were properly classified as cash and cash equivalents since these instruments were highly liquid investments and the reset date (date which instrument could be sold at par) was less than 90 days. After
reviewing interpretative guidance, the Company concluded that the stated or contractual maturity, not the reset date, was the proper date for calculating the original maturity and that these auction rate securities should be categorized as
short-term investments in accordance with SFAS 95.



The
following tables summarize the impact of these reclassifications for the last three years (in thousands);



Auction rate securities balance sheet reclassification:



|             |  |                        |        |                       |   |         |  |                         |         |                        |   |        |  |   |         |  |   |        
|------------ |  | ---------------------- | ------ | --------------------- | - | ------- |  | ----------------------- | ------- | ---------------------- | - | ------ |  | - | ------- |  | - | -------
|             |  | Pre-reclassification   |        | Post-reclassification
|             |  | Cash & CashEquivalents |        | Short-termInvestments |   | Total   |  | Cash & Cash Equivalents |         | Short-term Investments |   | Total 
|May 31, 2004 |  | $                      | 92,245 |                       | $ | 25,256  |  | $                       | 117,501 |                        | $ | 38,995 |  | $ | 78,506  |  | $ | 117,501
|May 31, 2003 |  |                        | 85,672 |                       |   | 52,993  |  |                         | 138,665 |                        |   | 27,487 |  |   | 111,178 |  |   | 138,665
|May 31, 2002 |  |                        | 52,803 |                       |   | 101,120 |  |                         | 153,923 |                        |   | 35,233 |  |   | 118,690 |  |   | 153,923



Auction rate
securities cash flows reclassification:



|                                                    |  |                            |   |  |          |   |  |          |  
|--------------------------------------------------- |  | -------------------------- | - |  | -------- | - |  | -------- | -
|Pre-reclassification                                |  | For the Year ended May 31, |  
|                                                    |  | 2004                       |   |  | 2003     |   |  | 2002     |  
|Cash flows from investing activities :              |  |                            |   |  |          |   |  |          |  
|Acquisition of property and equipment               |  | (1,976                     | ) |  | (1,745   | ) |  | (3,073   | )
|Purchases of investments                            |  | (686,198                   | ) |  | (529,858 | ) |  | (512,409 | )
|Maturity of investments                             |  | 185,140                    |   |  | 242,611  |   |  | 293,552  |  
|Proceeds from sale of investments                   |  | 554,447                    |   |  | 313,395  |   |  | 203,628  |  
|Purchase of business, net of cash acquired          |  | (50,949                    | ) |  | (23,826  | ) |  |         |  
|                                                    |  |                            |   |  |          |   |  |          |  
|Net cash provided by (used in) investing activities |  | 464                        |   |  | 577      |   |  | (18,302  | )
|                                                    |  |                            |   |  |          |   |  |          |  
|                                                    | 
|Post-reclassification                               |  | For the Year ended May 31, |  
|                                                    |  | 2004                       |   |  | 2003     |   |  | 2002     |  
|Cash flows from investing activities :              |  |                            |   |  |          |   |  |          |  
|Acquisition of property and equipment               |  | (1,976                     | ) |  | (1,745   | ) |  | (3,073   | )
|Purchases of investments                            |  | (359,534                   | ) |  | (239,462 | ) |  | (225,611 | )
|Maturity of investments                             |  | 171,742                    |   |  | 159,294  |   |  | 139,355  |  
|Proceeds from sale of investments                   |  | 246,115                    |   |  | 65,701   |   |  | 71,370   |  
|Purchase of business, net of cash acquired          |  | (50,949                    | ) |  | (23,826  | ) |  |         |  
|                                                    |  |                            |   |  |          |   |  |          |  
|Net cash provided by (used in) investing activities |  | 5,398                      |   |  | (40,038  | ) |  | (17,959  | )
|                                                    |  |                            |   |  |          |   |  |          |  



The changes to the net cash provided by (used in) investing activities above were solely a result of the reclassification of auction rate securities from cash and cash equivalents to
short-term investments. The changes to the purchases, maturity, and proceeds from sale of investments above were a result of eliminating the cash flows from the purchases, maturity and proceeds from sale of cash equivalents which had previously been
included in these line items.



Prepaid and other assets
reclassification:



|             |  |                         |       |                       |   |       |  |                         |       |             |   |       |  |   |       |  |   |      
|------------ |  | ----------------------- | ----- | --------------------- | - | ----- |  | ----------------------- | ----- | ----------- | - | ----- |  | - | ----- |  | - | -----
|             |  | Pre-reclassification    |       | Post-reclassification
|             |  | Prepaid andOther assets |       | OtherAssets           |   | Total |  | Prepaid andOther assets |       | OtherAssets |   | Total
|May 31, 2004 |  | $                       | 4,636 |                       | $ | 573   |  | $                       | 5,209 |             | $ | 3,197 |  | $ | 2,012 |  | $ | 5,209
|May 31, 2003 |  |                         | 4,719 |                       |   | 460   |  |                         | 5,179 |             |   | 4,388 |  |   | 791   |  |   | 5,179
|May 31, 2002 |  |                         | 5,497 |                       |   | 0     |  |                         | 5,497 |             |   | 5,205 |  |   | 292   |  |   | 5,497



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Deferred Rent reclassification:



|             |  |                          |       |                       |   |       |  |                          |       |              |   |       |  |   |     |  |   |      
|------------ |  | ------------------------ | ----- | --------------------- | - | ----- |  | ------------------------ | ----- | ------------ | - | ----- |  | - | --- |  | - | -----
|             |  | Pre-reclassification     |       | Post-reclassification
|             |  | Other AccruedLiabilities |       | DeferredRent          |   | Total |  | Other AccruedLiabilities |       | DeferredRent |   | Total
|May 31, 2004 |  | $                        | 5,043 |                       | $ | 0     |  | $                        | 5,043 |              | $ | 4,548 |  | $ | 495 |  | $ | 5,043
|May 31, 2003 |  |                          | 4,817 |                       |   | 0     |  |                          | 4,817 |              |   | 4,461 |  |   | 356 |  |   | 4,817
|May 31, 2002 |  |                          | 2,779 |                       |   | 0     |  |                          | 2,779 |              |   | 2,314 |  |   | 465 |  |   | 2,779



3. Recent Accounting Pronouncements



In December 2003, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104) which revises or rescinds certain sections of Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), in order to make
this interpretive guidance consistent with current authoritative accounting and auditing guidance and Securities and Exchange Commission rules and regulations. The changes noted in SAB 104 did not have a material effect on Veritys 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.



In May, 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 April, 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.



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 requires that its provisions are effective immediately for all arrangements entered into after January 31, 2003. We do not have any variable
interest entities.



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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.



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 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 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 our financial position and results of operations. As of May 31, 2003, our guarantees that were issued or modified after December 31, 2002 were not material. Our guarantees issued before December 31, 2002, which would
have been disclosed in accordance with the disclosure requirements of FIN 45, were not material.



4. Business Combination



Cardiff Software Inc. On March 15, 2004, we acquired Cardiff Software Inc., a privately held software company. Cardiff Softwares technology enables the automated capture of dynamic business information and the acquired
software, rebranded Verity TeleForm, Verity MediClaim, Verity LiquidOffice and Verity LiquidCapture, is what composes our content capture process automation product family.



The total purchase price for Cardiff Software is as follows (in thousands):



|                      |  |   |       
|--------------------- |  | - | ------
|Cash                  |  | $ | 59,680
|Stock options assumed |  |   | 3,768 
|Acquisition costs     |  |   | 2,121 
|                      |  |   |       
|Total purchase price  |  | $ | 65,569
|                      |  |   |       



In accordance with
SFAS No.141, Business Combinations, we accounted for the Cardiff Software transaction as a purchase, and the total purchase consideration of approximately $65.6 million (including cash, deferred payments, outstanding vested and unvested
stock options assumed, and acquisition costs) was allocated to net tangible and identifiable intangible assets based upon their estimated fair value as of the date of the acquisition and the residual of $38.4 million was recorded as goodwill.



The fair value of the Companys stock options
assumed was estimated using the Black-Scholes option pricing model. The fair value of the stock-based awards to employees was estimated assuming no expected dividends and the following weighted-average assumptions:



|                         |  |      |  
|------------------------ |  | ---- | -
|Expected Life (in years) |  | 0.74 |  
|Expected volatility      |  | 55   | %
|Risk free interest rate  |  | 1.12 | %



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##### Table of Contents

The Company recorded approximately $89,000 as unearned compensation related to the assumption of unvested
options. Approximately 412,000 of the approximately 457,000 options issued were fully vested.



Based upon the purchase price and the independent valuation, the purchase price allocation is as follows (in thousands):



Identifiable intangible assets acquired (Useful life (years))



|                                                   |  |   |       
|-------------------------------------------------- |  | - | ------
|Developed technology (4)                           |  | $ | 12,385
|Customer relationships (4)                         |  |   | 2,039 
|Tradenames (4)                                     |  |   | 644   
|                                                   |  |   |       
|Total amortizable intangible assets                |  |   | 15,068
|In-process research and development                |  |   | 3,310 
|Fair value of net tangible assets assumed          |  |   | 8,667 
|Deferred Compensation                              |  |   | 89    
|Goodwill                                           |  |   | 38,435
|                                                   |  |   |       
|Total purchase price (including transaction costs) |  | $ | 65,569
|                                                   |  |   |       



The detail for the
components of the fair value of assets assumed from Cardiff Software is as follows (in thousands):



|                                  |  |   |       
|--------------------------------- |  | - | ------
|Cash and cash equivalents         |  | $ | 14,181
|Trade accounts receivable, net    |  |   | 2,215 
|Prepaid and other assets          |  |   | 874   
|Property and equipment, net       |  |   | 531   
|                                  |  |   |       
|Fair value of assets assumed      |  | $ | 17,801
|                                  | 
|Accounts payable                  |  | $ | 2,411 
|                                  | 
|Accrued compensation              |  |   | 1,884 
|Other accrued liabilities         |  |   | 3,744 
|Deferred revenue                  |  |   | 1,095 
|                                  |  |   |       
|Fair value of liabilities assumed |  | $ | 9,134 
|                                  | 
|Fair value of net assets assumed  |  | $ | 8,667 
|                                  |  |   |       



The following table
presents details of these amortizable intangible assets as of May 31, 2004 (in thousands):



|                                 |  |       |        |                          |   |     |  |   |       
|-------------------------------- |  | ----- | ------ | ------------------------ | - | --- |  | - | ------
|                                 |  | Gross |        | Accumulated Amortization |   | Net
|Developed technology             |  | $     | 12,385 |                          | $ | 645 |  | $ | 11,740
|Customer relationships           |  |       | 2,039  |                          |   | 106 |  |   | 1,933 
|Tradenames                       |  |       | 644    |                          |   | 33  |  |   | 611   
|                                 |  |       |        |                          |   |     |  |   |       
|Purchased intangible assets, net |  | $     | 15,068 |                          | $ | 784 |  | $ | 14,284
|                                 |  |       |        |                          |   |     |  |   |       



The amount of the
purchase price allocated to in process-research and development was based on established valuation techniques used in the high-technology and the computer software industry. The fair value assigned to the acquired in-process research and development
was determined using the income approach, which discounts expected future cash flows to present value. The key assumptions used in the valuation include, among others, the expected completion date of the in-process projects identified as of the
acquisition date, the estimated costs to complete the projects, revenue contributions and expense projections assuming the resulting products have entered the market, and the discount rate based on the risks associated with the development life
cycle of the in-process technology acquired. The discount rate used in the present value calculations are normally obtained from a weighted-average cost of capital analysis, adjusted upward to account for the inherent uncertainties surrounding the
successful development of the in-process research and development, the expected profitability levels of such technology, and the uncertainty of technological advances that could potentially impact the estimates. The Company believes the pricing
model for the resulting product of the acquired in process research and technology to be standard within its industry. The Company, however, did not take into consideration any consequential amount of expense reductions from integrating the acquired
in-process technology with other existing in-process or completed technology. Therefore, the valuation assumptions do not include significant anticipated cost savings.



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##### Table of Contents

The key assumptions underlying the valuation of acquired in-process research and development from Cardiff
Software are as follows (in thousands):



|                   |  |                 |  |                         |  |                 
|------------------ |  | --------------- |  | ----------------------- |  | ----------------
|IPR&D Product      |  | Leverage Factor |  | Risk Free Discount Rate |  | Expected Revenue
|Teleform 9.0       |  | 50%             |  | 25%                     |  | Q1 2005         
|Liquid Office 4.0  |  | 90%             |  | 25%                     |  | Q2 2005         
|Liquid Capture 2.0 |  | 25%             |  | 25%                     |  | Q2 2005         





Of the total purchase price, the Company placed $11.9 million into a third party escrow account in order to secure Cardiff Softwares indemnification
obligations. Under the terms of the merger agreement $3 million will be released from the escrow account September 15, 2004, another $3 million will be released from the escrow account on September 15 2005, and the remaining $5.9 million will be
released on March 15, 2006 assuming Cardiff Software meets their indemnification obligations. The Company shall have the right to withhold or deduct from the escrow account any sum that may be owed to it by Cardiff Software pursuant to Cardiff
Softwares indemnification obligations under the Purchase Agreement if the cumulative aggregate amount of such claims exceeds $300,000. The Company believes the likelihood of such indemnifications is remote and therefore has recorded the entire
$11.9 million held in the third party escrow account in the purchase price.



The Consolidated Financial Statements include the operating results of Cardiff Software from March 15, 2004. The following unaudited pro forma financial information presents the combined results of the Company and
Cardiff Software as if the purchase had occurred at the beginning of the period presented. Net income for 2003 includes acquired in-process research and development of $3.3 million. Amortization of intangible assets related to the acquisition of
$3.8 million in both 2004 and 2003.



|                                       |      |                    |         |  |   |        
|-------------------------------------- | ---- | ------------------ | ------- |  | - | -------
|( in thousands, except per share data) |      | Year Ended May 31,
|                                       | 2004 |                    | 2003   
|                                       |      | (unaudited)       
|Total revenues                         |      | $                  | 144,778 |  | $ | 125,131
|                                       |      |                    |         |  |   |        
|Net income                             |      | $                  | 9,618   |  | $ | 3,581  
|                                       |      |                    |         |  |   |        
|Net income per share  basic           |      | $                  | .26     |  | $ | .10    
|                                       |      |                    |         |  |   |        
|Net income per share  diluted         |      | $                  | .24     |  | $ | .09    
|                                       |      |                    |         |  |   |        
|Number of shares  basic               |      |                    | 37,625  |  |   | 35,410 
|                                       |      |                    |         |  |   |        
|Number of shares  diluted             |      |                    | 39,755  |  |   | 37,726 
|                                       |      |                    |         |  |   |        



NativeMinds
Inc. On March 3, 2004, we acquired the intellectual property, customer agreements and certain other assets from NativeMinds Inc., a privately held software company and provider of integrated self-service solutions which the Company accounted for
as a purchase of a business. The acquired software, rebranded Verity Response, is part of our ICS product family.



The total purchase price for NativeMinds is as follows (in thousands):



|                     |  |   |      
|-------------------- |  | - | -----
|Cash                 |  | $ | 2,956
|Deferred payment     |  |   | 770  
|Acquisition costs    |  |   | 153  
|                     |  |   |      
|Total purchase price |  | $ | 3,879
|                     |  |   |      



In accordance with
SFAS No.141, Business Combinations, we accounted for the NativeMinds transaction as a purchase, and the total purchase consideration of approximately $3.9 million (including cash, deferred payments, acquisition costs) was allocated to
net tangible and identifiable intangible assets based upon their estimated fair value as of the date of completion of the acquisition and the residual of $2.2 million was recorded as goodwill. The $3.9 million of total purchase consideration
includes approximately $0.8 million to be paid to Nativeminds shareholders in installments over 24 months from the acquisition.



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##### Table of Contents

The purchase price was allocated as follows (in thousands):



Identifiable intangible assets acquired (Useful life (years))



|                                                   |  |   |       |  
|-------------------------------------------------- |  | - | ----- | -
|Developed technology (4)                           |  | $ | 1,183 |  
|Customer base (4)                                  |  |   | 449   |  
|                                                   |  |   |       |  
|Total amortizable intangible assets                |  |   | 1,632 |  
|In-process technology                              |  |   | 162   |  
|Fair value of net tangible liabilities assumed     |  |   | (159  | )
|Goodwill                                           |  |   | 2,244 |  
|                                                   |  |   |       |  
|Total purchase price (including transaction costs) |  | $ | 3,879 |  
|                                                   |  |   |       |  



The following table
presents details of these amortizable intangible assets as of May 31, 2004 (in thousands):



|                                 |  |       |       |                          |   |     |  |   |      
|-------------------------------- |  | ----- | ----- | ------------------------ | - | --- |  | - | -----
|                                 |  | Gross |       | Accumulated Amortization |   | Net
|Developed technology             |  | $     | 1,183 |                          | $ | 64  |  | $ | 1,119
|Customer base                    |  |       | 449   |                          |   | 28  |  |   | 421  
|                                 |  |       |       |                          |   |     |  |   |      
|Purchased intangible assets, net |  | $     | 1,632 |                          | $ | 92  |  | $ | 1,540
|                                 |  |       |       |                          |   |     |  |   |      



The amount of the
purchase price allocated to in process-research and development was based on established valuation techniques used in the high-technology and the computer software industry. The fair value assigned to the acquired in-process research and development
was determined using the income approach, which discounts expected future cash flows to present value. The key assumptions used in the valuation include, among others, the expected completion date of the in-process projects identified as of the
acquisition date, the estimated costs to complete the projects, revenue contributions and expense projections assuming the resulting product have entered the market, and the discount rate based on the risks associated with the development life cycle
of the in-process technology acquired. The discount rate used in the present value calculations are normally obtained from a weighted-average cost of capital analysis, adjusted upward to account for the inherent uncertainties surrounding the
successful development of the in-process research and development, the expected profitability levels of such technology, and the uncertainty of technological advances that could potentially impact the estimates. The Company assumes the pricing model
for the resulting product of the acquired in process research and technology to be standard within its industry. The Company, however, did not take into consideration any consequential amount of expense reductions from integrating the acquired
in-process technology with other existing in-process or completed technology. Therefore, the valuation assumptions do not include significant anticipated cost savings.



The key assumptions underlying the valuation of acquired in-process research and development from NativeMinds are as follows
(in thousands):



|              |  |                 |  |                         |  |                 
|------------- |  | --------------- |  | ----------------------- |  | ----------------
|IPR&D Product |  | Leverage Factor |  | Risk Free Discount Rate |  | Expected Revenue
|Vrep 3.0      |  | 65%             |  | 25%                     |  | Q1 2005         



Of the total purchase
price, the Company retained $770,000 in order to secure Nativeminds indemnification obligations under the asset purchase agreement. As of May 31, 2004 we paid and recorded $200,000 of this obligation. We are obligated to pay the remaining
$570,000 on September 3, 2005. The Company shall have the right to withhold or deduct from the remaining deferred payment amount any sum that may be owed to it by NativeMinds pursuant to NativeMinds indemnification obligations under the Asset
Purchase Agreement. The Company believes the likelihood of such indemnifications is remote.



Pro-forma information has not been provided as the acquisition is not material to the results of operations.



Enterprise search assets of Inktomi Corporation. During our third fiscal quarter of 2003, the Company completed the purchase of certain assets and
obligations of Inktomi Corporations enterprise search software business (Enterprise), which the Company accounted for as the purchase of a business.





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##### Table of Contents

The total purchase price of the acquisition of Enterprise is as follows (in thousands):



|                     |  |   |       
|-------------------- |  | - | ------
|Cash                 |  | $ | 22,000
|Deferred payment     |  |   | 3,000 
|Acquisition costs    |  |   | 1,826 
|                     |  |   |       
|Total purchase price |  | $ | 26,826
|                     |  |   |       



Under the purchase
method of accounting, the total purchase price is allocated to Enterprises net tangible and identifiable intangible assets based upon their estimated fair value as of the date of completion of the acquisition. The purchase price was allocated
as follows (in thousands):



Identifiable intangible assets acquired (Useful
life (years))



|                                                   |  |   |        |  
|-------------------------------------------------- |  | - | ------ | -
|Developed technology (5)                           |  | $ | 8,300  |  
|Patents/core technology (5)                        |  |   | 2,800  |  
|Maintenance agreements (5)                         |  |   | 1,800  |  
|                                                   |  |   |        |  
|Total amortizable intangible assets                |  |   | 12,900 |  
|In-process technology                              |  |   | 1,200  |  
|Fair value of net liabilities assumed              |  |   | (2,419 | )
|Goodwill                                           |  |   | 15,145 |  
|                                                   |  |   |        |  
|Total purchase price (including transaction costs) |  | $ | 26,826 |  
|                                                   |  |   |        |  



The following table
presents details of these total purchased intangible assets (in thousands):



|                                 |  |       |        |                   |   |                     |  |                   |        |                     |   |       |  |   |      
|-------------------------------- |  | ----- | ------ | ----------------- | - | ------------------- |  | ----------------- | ------ | ------------------- | - | ----- |  | - | -----
|                                 |  | Gross |        | 2003 Amortization |   | Net at May 31, 2003 |  | 2004 Amortization |        | Net at May 31, 2004
|Developed technology             |  | $     | 8,300  |                   | $ | 830                 |  | $                 | 7,470  |                     | $ | 1,660 |  | $ | 5,810
|Patents/core technology          |  |       | 2,800  |                   |   | 280                 |  |                   | 2,520  |                     |   | 560   |  |   | 1,960
|Maintenance agreements           |  |       | 1,800  |                   |   | 180                 |  |                   | 1,620  |                     |   | 360   |  |   | 1,260
|                                 |  |       |        |                   |   |                     |  |                   |        |                     |   |       |  |   |      
|Purchased intangible assets, net |  | $     | 12,900 |                   | $ | 1,290               |  | $                 | 11,610 |                     | $ | 2,580 |  | $ | 9,030
|                                 |  |       |        |                   |   |                     |  |                   |        |                     |   |       |  |   |      



The Companys
methodology for allocating the purchase price to in-process research and development is determined through established valuation techniques in the high-technology and the software industry and expensed upon acquisition because technological
feasibility has not been established and no future alternative uses exist. The fair value allocation to in-process research and development was determined by identifying the research projects for which technological feasibility had not been achieved
and which had no alternative future use at the acquisition date, assessing the stage and expected date of completion of the research and development effort at the acquisition date, and calculating the net present value of the cash flows expected to
result from the successful deployment of the new technology resulting from the in-process research and development effort.



The stages of completion were determined by estimating the costs and time incurred to date relative to the costs and time incurred to develop the
in-process technology into a commercially viable technology or product, while considering the relative difficulty of completing the various tasks and obstacles necessary to attain technological feasibility. As of the acquisition date, Enterprise had
released Ultraseek 5.0, XML Toolkit 1.0, and the latest version of Quiver to the market. Current development efforts, considered in-process research and development, were focused on Ultraseek 5.1 and XML Toolkit 2.0. There were no development
efforts (that meet the criteria of in-process research and development) related to the Quiver product line as of the acquisition date. The estimated stage of completion of both Ultraseek 5.1 and XML Toolkit 2.0 was 55% complete. Total in-process
research and development expense for the year ended May 31, 2003 was $1.2 million.



Of the total purchase price, the Company retained $3.0 million in order to secure Inktomis indemnification obligations under the asset purchase agreement. In its first fiscal quarter of 2005 the Company paid
$3.0 million plus simple interest calculated from the December 17, 2002 through June 16, 2004.



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##### Table of Contents

5. Investments



As of May 31, 2004, available-for-sale securities consist of the following (in thousands):



|                          |  |                |         |                                |   |      |            |  |   |        
|------------------------- |  | -------------- | ------- | ------------------------------ | - | ---- | ---------- |  | - | -------
|                          |  | Amortized Cost |         | Gross Unrealized Gains(Losses) |   |      | Fair Value
|Short-term investments:   |  |                |         |                                |   |      |            |  |   |        
|Market Auction Securities |  |                | 58,250  |                                |   |     |            |  |   | 58,250 
|Corporate Notes           |  |                | 13,729  |                                |   | 40   |            |  |   | 13,769 
|Government Securities     |  |                | 6,500   |                                |   | (13  | )          |  |   | 6,487  
|                          |  |                |         |                                |   |      |            |  |   |        
|Short-term investments    |  |                | 78,479  |                                |   | 27   |            |  |   | 78,506 
|                          |  |                |         |                                |   |      |            |  |   |        
|Long-term investments:    |  |                |         |                                |   |      |            |  |   |        
|Municipal Securities      |  |                | 2,375   |                                |   | (36  | )          |  |   | 2,339  
|Corporate Notes           |  |                | 6,122   |                                |   | (64  | )          |  |   | 6,058  
|Government Securities     |  |                | 76,506  |                                |   | (655 | )          |  |   | 75,851 
|                          |  |                |         |                                |   |      |            |  |   |        
|Long-term investments     |  |                | 85,003  |                                |   | (755 | )          |  |   | 84,248 
|                          |  |                |         |                                |   |      |            |  |   |        
|Total investments         |  | $              | 163,482 |                                | $ | (728 | )          |  | $ | 162,754
|                          |  |                |         |                                |   |      |            |  |   |        



At May 31, 2004,
scheduled maturities of investments classified as available-for-sale are as follows (in thousands):



|                                    |  |   |        
|----------------------------------- |  | - | -------
|Within one year                     |  | $ | 20,256 
|After one year through two years    |  |   | 37,177 
|After two years through three years |  |   | 49,071 
|After three years                   |  |   | 56,250 
|                                    |  |   |        
|                                    |  | $ | 162,754
|                                    |  |   |        



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



|                          |  |                |         |                                |   |            |  |   |        
|------------------------- |  | -------------- | ------- | ------------------------------ | - | ---------- |  | - | -------
|                          |  | Amortized Cost |         | Gross Unrealized Gains(Losses) |   | Fair Value
|Short-term investments:   |  |                |         |                                |   |            |  |   |        
|Market Auction Securities |  |                | 60,785  |                                |   |           |  |   | 60,785 
|Corporate Notes           |  |                | 48,592  |                                |   | 788        |  |   | 49,380 
|Government Securities     |  |                | 1,000   |                                |   | 13         |  |   | 1,013  
|                          |  |                |         |                                |   |            |  |   |        
|Short-term investments    |  |                | 110,377 |                                |   | 801        |  |   | 111,178
|                          |  |                |         |                                |   |            |  |   |        
|Long-term investments:    |  |                |         |                                |   |            |  |   |        
|Municipal Securities      |  |                | 1,375   |                                |   | 5          |  |   | 1,380  
|Corporate Notes           |  |                | 14,031  |                                |   | 290        |  |   | 14,321 
|Government Securities     |  |                | 95,965  |                                |   | 413        |  |   | 96,378 
|                          |  |                |         |                                |   |            |  |   |        
|Long-term investments     |  |                | 111,371 |                                |   | 708        |  |   | 112,079
|                          |  |                |         |                                |   |            |  |   |        
|Total investments         |  | $              | 221,748 |                                | $ | 1,509      |  | $ | 223,257
|                          |  |                |         |                                |   |            |  |   |        



At May 31, 2003,
scheduled maturities of investments classified as available-for-sale are as follows (in thousands):



|                                    |  |   |        
|----------------------------------- |  | - | -------
|Within one year                     |  | $ | 64,493 
|After one year through two years    |  |   | 45,940 
|After two years through three years |  |   | 69,639 
|After three years                   |  |   | 43,185 
|                                    |  |   |        
|                                    |  | $ | 223,257
|                                    |  |   |        



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6. Restructuring Charge



The Company had two restructuring activities in fiscal 2004. As a result of the Cardiff Software acquisition, a $0.3 million restructuring charge was
recorded related to positions identified to be redundant in the quarter ended May 31, 2004. In November 2003, the Company implemented a worldwide restructuring 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, a $1.0 million restructuring charge was recorded in the quarter ended November 30 2003, 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 to legal and other outside services.



In November 2002, the Company implemented a worldwide restructuring 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, 2002, 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 approximately 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.



During November 2001, the Company implemented a worldwide restructuring and
recorded a $1.6 million restructuring charge, of which approximately $1.2 million was related to severance costs associated with the reduction in the worldwide workforce by 65 employees, approximately $0.3 million to legal and other outside services
in connection with the restructuring and approximately $0.1 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,
primarily in marketing and sales, and research and development.



The following table presents details of the restructuring charges (in thousands):



|                |  |           |   |  |                     |   |  |                           |   |  |        |  
|--------------- |  | --------- | - |  | ------------------- | - |  | ------------------------- | - |  | ------ | -
|                |  | Severance |   |  | Facilitiesand other |   |  | Legal and outsideservices |   |  | Total  |  
|At May 31, 2002 |  |          |   |  |                    |   |  |                          |   |  |       |  
|Charges         |  | 664       |   |  | 210                 |   |  | 119                       |   |  | 993    |  
|Paid            |  | (664      | ) |  | (40                 | ) |  | (76                       | ) |  | (780   | )
|At May 31, 2003 |  |          |   |  | 170                 |   |  | 43                        |   |  | 213    |  
|Charges         |  | 1,200     |   |  |                    |   |  | 66                        |   |  | 1,266  |  
|Adjustments     |  |          |   |  |                    |   |  | (40                       | ) |  | (40    | )
|Paid            |  | (941      | ) |  | (67                 | ) |  | (69                       | ) |  | (1,077 | )
|At May 31, 2004 |  | 259       |   |  | 103                 |   |  |                          |   |  | 362    |  



The remaining $259,000
balance relating to severance will be paid in January, 2005. The remaining $103,000 facilities and other balance will be paid out ratably through October, 2005.



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##### Table of Contents

7. Balance Sheet Detail



Property and equipment



As of May 31, 2004 and 2003, property and equipment consist of the following (in thousands):



|                              |  |         |         |   |      |   |         |  
|----------------------------- |  | ------- | ------- | - | ---- | - | ------- | -
|                              |  | May 31, |        
|                              |  | 2004    |         |   | 2003 |  
|Computer equipment & software |  | $       | 14,067  |   |      | $ | 13,153  |  
|Furniture and fixtures        |  |         | 2,422   |   |      |   | 2,412   |  
|Leasehold improvements        |  |         | 6,305   |   |      |   | 5,907   |  
|                              |  |         |         |   |      |   |         |  
|                              |  |         | 22,794  |   |      |   | 21,472  |  
|Less accumulated depreciation |  |         | (18,522 | ) |      |   | (16,304 | )
|                              |  |         |         |   |      |   |         |  
|                              |  | $       | 4,272   |   |      | $ | 5,168   |  
|                              |  |         |         |   |      |   |         |  



Depreciation expense
for fiscal years 2004, 2003 and 2002 was $3.40 million, $3.41 million and $4.25 million, respectively.



At May 31, 2004 and 2003, there were no assets under capital leases.



Intangible assets



As of May 31, 2004 and 2003, intangible assets, net consist of the following (in thousands):



|                            |  |         |        |      |   |       
|--------------------------- |  | ------- | ------ | ---- | - | ------
|                            |  | May 31,
|                            |  | 2004    |        | 2003
|Developed technology        |  | $       | 18,669 |      | $ | 7,470 
|Patents/core technology     |  |         | 1,960  |      |   | 2,520 
|Maintenance agreements      |  |         | 1,260  |      |   | 1,620 
|Customer base/relationships |  |         | 2,354  |      |   |      
|Tradenames                  |  |         | 611    |      |   |      
|                            |  |         |        |      |   |       
|                            |  | $       | 24,854 |      | $ | 11,610
|                            |  |         |        |      |   |       



The estimated future
amortization expense of purchased intangible assets as of May 31, 2004 is as follows (in thousands):



|            |  |        |       
|----------- |  | ------ | ------
|Fiscal Year |  | Amount
|2005        |  | $      | 6,758 
|2006        |  | $      | 6,757 
|2007        |  | $      | 6,757 
|2008        |  | $      | 4,582 
|            |  |        |       
|Total       |  | $      | 24,854
|            |  |        |       



8. Commitments and Contingencies



Commitments



The Company leases various facilities and vehicles under noncancelable
operating leases expiring through March 2011. Under the terms of the leases, the Company is responsible for taxes, insurance and normal maintenance costs. Under its primary operating facility lease, the Company may extend the lease term for an
additional five years by providing written notice of its exercise of this option no later than six months before the expiration of the lease term. The Company has subleased certain of its space to other companies for various periods through October
2004.



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At May 31, 2004, future minimum rental payments and receipts under the operating leases are as follows
(in millions):



|                           |  |                 |      |                 |   |   
|-------------------------- |  | --------------- | ---- | --------------- | - | --
|Fiscal Year Ending May 31, |  | Rental Payments |      | Sublease Income
|2005                       |  |                 | 3.6  |                 |   | .3
|2006                       |  |                 | 3.5  |                 |   | .1
|2007                       |  |                 | 2.7  |                 |   | .1
|2008                       |  |                 | 2.5  |                 |   |  
|2009 and thereafter        |  |                 | 4.0  |                 |   |  
|                           |  |                 |      |                 |   |   
|                           |  | $               | 16.3 |                 | $ | .5
|                           |  |                 |      |                 |   |   



Rent expense,
excluding sublease income, for fiscal years 2004, 2003 and 2002 was $4.1 million, $3.7 million and $3.9 million, respectively.



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 paid Inktomi an amount equal to the sum of (i) $3.0
million plus (ii) simple interest thereon calculated from the December 17, 2002 through the date of payment at an annual rate of 1.5%. The Company shall have 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.



Under the terms of the Companys software license agreements with its customers, the Company agrees that in the event
the software licensed infringes upon any patent, copyright, trademark, or any other proprietary rights of a third party, it will defend, hold harmless, and indemnify its customer licensees, against any loss, expense, or liability from any damages
that may be awarded against its customer. The Company includes this infringement indemnification in a substantial number of its software license agreements and services agreements. In the event the customer licensee can not use the software or
services due to infringement and the Company is unable to obtain the right to use, replace or modify the license or service in a commercially feasible manner so that it is no longer infringes, then the Company may terminate the license and provide
the customer licensee a refund of the fees paid by the customer for the infringing license or service. The term of these indemnification obligations are generally perpetual. The maximum potential amount of future payments the Company could be
required to make under these agreements is generally unlimited. The Company has recorded no liability associated with this infringement indemnification, and it is not aware of any pending or threatened actions.



The Company enters into standard third party vendor agreements, which include
indemnification clauses, in the ordinary course of business. Pursuant to these agreements, the Company agrees that in the event the Company modifications to the licensed product, or Companys information infringes upon any patent, copyright,
trademark, or any other proprietary rights of a third party Company will defend, hold harmless, and indemnify the indemnified party against any loss, expense, or liability from any damages that may be awarded against such indemnified party. The
Company includes this infringement indemnification in a selected number of its third party vendor agreements. The term of these indemnification obligations are generally perpetual. The maximum potential amount of future payments the Company could be
required to make under these indemnification agreements is generally unlimited. The Company has recorded no liability associated with this infringement indemnification, and it is not aware of any pending or threatened actions.



The Company warrants that its software products will perform in all material
respects in accordance with the Companys standard published specifications and documentation in effect at the time of delivery of the licensed software to the customer. The warranty period is limited in duration. If, within the warranty
period, the customer reports an error which represents a failure of the warranty, Company will correct the error, replace the software with software which complies with the warranty, or if necessary refund the fees paid for the software and
terminate the agreement. Additionally, the Company warrants that its consulting services will be performed consistent with generally accepted industry standards. If the Company fails to perform services as warranted and customer reports such failure
within the warranty period, the Company will at its expense re-perform the services, or if necessary refund the fees paid for the services. Company has not incurred significant expense under its software or services warranties.



The Company has agreed to indemnify members of the board of directors, as
well as officers of the Company, if they are made a party or are threatened to be made a party to any proceeding (other than an action by or in the right of the Company) by reason of the fact that they are an agent of the Company, or by reason of
anything done or not done by them in any such capacity. The indemnity is for any and all expenses and liabilities of any type whatsoever (including but not limited to, judgments, fines and amounts paid in



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##### Table of Contents

settlement) actually and reasonably incurred by the directors or officers in connection with the investigation, defense,
settlement or appeal of such proceeding, provided they acted in good faith. The Company maintains insurance coverage for directors and officers liability (D&O insurance). No maximum liability is stipulated in these agreements that
include indemnifications of members of the board of directors and officers of the Company. The Company has recorded no liability associated with these indemnifications as it is not aware of any pending or threatened actions or claims against it
members of board of directors or officers that are probable losses in excess of amounts covered by its D&O insurance. As a result of the insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements
is minimal.



9. Stockholders Equity



1995 Stock Option Plan



In July 1995, the Company adopted the Amended and Restated 1995 Stock Option Plan, which amended and restated the 1988 Stock
Option Plan. In September 2000, the Companys stockholders approved increases to the number of shares reserved under the 1995 Stock Option Plan to 12,122,000 shares.



Under the terms of the 1995 Stock Option Plan, options may be granted at prices not lower than the fair market value at the
date of grant as determined by the Board of Directors. Incentive and non-statutory options, which are granted to stockholders who own more than 10% of the total combined voting power of all classes of Companys stock are granted at not less
than 110% of the fair market value of the shares at the date of grant. The term of options granted to the stockholders who own more than 10% of the total combined voting power of all classes of stock of the Company is five years from the date of
grant or shorter term as provided in the written option agreement. All other option grants from the 1995 Stock Option Plan may have a term of eight years or shorter as provided in the written option agreement.



Common shares purchased under the 1995 Stock Option Plan are subject to the
Companys right of repurchase, which generally lapses as to 12.5% of the shares six months from the grant date and thereafter ratably over the remainder of a 31/2year period at the holders original purchase price. Thereafter, the Company has the right of first refusal to purchase such shares. At May 31, 2004, 2003 and 2002, no
shares were subject to the Companys right to repurchase. As of May 31, 2004, 522,314 shares of common stock were available for grant under the 1995 Stock Option Plan and options for 4,593,000 shares of common stock were outstanding.



Outside Directors Plan



In July 1995, the Companys Board of Directors approved the 1995
Outside Directors Plan and reserved 400,000 shares of common stock for issuance to directors of the Company who are not employees of the Company. The Outside Directors Plan provides for the automatic granting of nonqualified stock options to
directors of the Company who are not employees of the Company.



At the initiation of the 1995 Outside Directors Plan, each current outside director was granted an option to purchase 40,000 shares of common stock at the following annual meeting of stockholders. Each new outside director is granted an
option to purchase shares of the Companys common stock at the time of annual meeting following their appointment. Thereafter, at each annual meeting of the stockholders, outside directors who have previously received options will receive a new
option to purchase 40,000 shares of the Companys common stock. The exercise price of the options in all cases will be equal to the fair market value of the Companys common stock at the date of grant. Options granted under the 1995
Outside Directors Plan are immediately exercisable, but vest over four years and generally must be exercised within ten years. In September 1999, the Companys stockholders approved an increase to the number of shares reserved under the Outside
Directors Plan to a total of 1,000,000 shares. As of May 31, 2004, two shares of common stock were available for grant under this plan and options for 820,000 shares of common stock were outstanding.



1996 Nonstatutory Stock Option Plan



In February 1996, the Companys Board of Directors approved the 1996
Nonstatutory Stock Option Plan. The terms of the 1996 Nonstatutory Stock Option Plan are substantially the same as those of the 1995 Stock Option Plan with the exception of the type of options available, the option exercise price and the maximum
option term. Nonqualified options may be granted at prices not lower than 85% of fair market value at the date of grant as determined by the Board of Directors. The option may have a term of ten years or shorter as provided in the written option
agreement.



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##### Table of Contents

In fiscal year 2003, the Company increased the number of shares reserved under the 1996 Nonstatutory
Stock Option Plan to 29,700,000 for issuance to certain employees and consultants of the Company. As of May 31, 2004, 4,467,000 shares of common stock were available for grant under the 1996 Nonstatutory Stock Option Plan and options for 15,414,000
shares of common stock were outstanding.



1997 Stock Option Plan for Verity
Canada



In May 1997, the Companys Board of Directors
authorized the adoption of the 1997 Stock Option Plan for Verity Canada. The terms of the 1997 Stock Option Plan for Verity Canada are substantially the same as those of the 1995 Stock Option Plan with the exception of option type and term.



In fiscal year 2003, the Company increased the number of
shares reserved under the 1997 Stock Option Plan for Verity Canada to 2,590,000 for issuance to certain employees and consultants of the Company. As of May 31, 2004, 189,870 shares of common stock were available for grant under the 1997 Stock Option
Plan for Verity Canada and options for 1,304,000 shares of common stock were outstanding.



1997 and 2000 Stock Option Plans for Cardiff Software, Inc.



In March 2004, the Company assumed the outstanding options and shares reserved for future issuance under the 1997 Equity Incentive Plan and 2000 Stock
Option Plan for Cardiff Software, Inc. The Plans allow for the issuance of incentive stock options, nonstatutory stock options, stock bonuses, stock appreciation rights, and restricted stock. As of May 31, 2004, 83,497 shares of common stock were
available for grant under these Plans and options for 274,000 shares of common stock were outstanding.



Activity under stock option plans



Activity under the above stock option plans is set forth below (shares in thousands):



|                                     |  |                    |   |      |                              |       |        |        |   |                                 |   |        |  |        |                              |  |   |      
|------------------------------------ |  | ------------------ | - | ---- | ---------------------------- | ----- | ------ | ------ | - | ------------------------------- | - | ------ |  | ------ | ---------------------------- |  | - | -----
|                                     |  | Year Ended May 31,
|                                     |  | 2004               |   | 2003 |                              | 2002 
|                                     |  | Shares             |   |      | WeightedAverageExercisePrice |       | Shares |        |   | Weighted Average Exercise Price |   | Shares |  |        | WeightedAverageExercisePrice
|Outstanding at beginning of period   |  | 23,591             |   |      | $                            | 18.30 |        | 19,285 |   |                                 | $ | 20.00  |  | 16,277 |                              |  | $ | 23.91
|Options assumed via acquisition      |  | 457                |   |      |                              | 7.27  |        |       |   |                                 |   |       |  |       |                              |  |   |     
|Granted                              |  | 4,067              |   |      |                              | 13.68 |        | 9,562  |   |                                 |   | 10.99  |  | 7,164  |                              |  |   | 9.47 
|Exercised                            |  | (3,040             | ) |      |                              | 9.54  |        | (3,826 | ) |                                 |   | 8.56   |  | (1,769 | )                            |  |   | 8.22 
|Cancelled                            |  | (2,670             | ) |      |                              | 21.89 |        | (1,430 | ) |                                 |   | 18.53  |  | (2,387 | )                            |  |   | 23.71
|                                     |  |                    |   |      |                              |       |        |        |   |                                 |   |        |  |        |                              |  |   |      
|Outstanding at end of period         |  | 22,405             |   |      |                              | 17.99 |        | 23,591 |   |                                 |   | 18.30  |  | 19,285 |                              |  |   | 20.00
|                                     |  |                    |   |      |                              |       |        |        |   |                                 |   |        |  |        |                              |  |   |      
|Options exercisable at end of period |  | 16,720             |   |      | $                            | 19.44 |        | 14,806 |   |                                 | $ | 20.65  |  | 12,217 |                              |  | $ | 21.11
|                                     |  |                    |   |      |                              |       |        |        |   |                                 |   |        |  |        |                              |  |   |      



Common stock option plans



The following table summarizes information with respect
to stock options outstanding at May 31, 2004 (shares in thousands):



|                        |  |                      |  |                                                 |  |                              |       |                      |        |                              |   |      
|----------------------- |  | -------------------- |  | ----------------------------------------------- |  | ---------------------------- | ----- | -------------------- | ------ | ---------------------------- | - | -----
|                        |  | Options Outstanding  |  | Options Exercisable                            
|Range of Exercise Price |  | Number atMay 31,2004 |  | WeightedAverageRemainingContractualLife (Years) |  | WeightedAverageExercisePrice |       | Number atMay 31,2004 |        | WeightedAverageExercisePrice
|$   0.75  $4.99        |  | 2                    |  | 1.03                                            |  | $                            | 0.75  |                      | 2      |                              | $ | 0.75 
|$   5.00  $16.49       |  | 15,640               |  | 5.99                                            |  |                              | 12.06 |                      | 10,322 |                              |   | 11.53
|$ 16.50  $ 29.99       |  | 1,454                |  | 4.60                                            |  |                              | 22.61 |                      | 1,190  |                              |   | 23.48
|$ 30.00  $53.00        |  | 5,309                |  | 3.80                                            |  |                              | 34.22 |                      | 5,206  |                              |   | 34.20
|                        |  |                      |  |                                                 |  |                              |       |                      |        |                              |   |      
|                        |  | 22,405               |  | 5.38                                            |  | $                            | 17.99 |                      | 16,720 |                              | $ | 19.44
|                        |  |                      |  |                                                 |  |                              |       |                      |        |                              |   |      



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Generally, shares granted to existing employees vest over a four-year period from the date of grant.
12.5% of the shares vest six months after the date of commencement of employment and 2.083% of the shares vest upon completion of each succeeding full month of continuous employment for the remaining 42 month term. The Companys board retains
discretion to modify certain terms including the vest schedule.



Employee
stock purchase plan



In July 1995, the Companys
Board of Directors approved the 1995 Employee Stock Purchase Plan and reserved 500,000 shares of common stock for issuance to eligible employees. In September 1999, the Companys stockholders approved an increase to 4,000,000 shares of common
stock. The Employee Stock Purchase Plan permits eligible employees to purchase shares of the Companys common stock at 85% of the lesser of fair market value of the common stock on the first day of the 12-month offering period or the last day
of the six-month purchase period within the offering period. During the fiscal years ended May 31, 2004, 2003 and 2002, employees purchased 374,974, 406,628 and 350,321 shares at average prices of $9.77, $8.05 and $8.20 per share, respectively. As
of May 31, 2004, 3,643,215 shares of the Companys common stock have been issued under the plan and 356,785 shares remained available for purchase.



Preferred stock purchase rights plan



In September 1996, the Companys Board of Directors adopted a Preferred Stock Purchase Rights Plan. Under the Plan, in the event that an unsolicited
attempt is made to acquire the Company stockholders will receive one right to purchase one one-hundredth of a share of a new series of Preferred Stock for each outstanding share of Company common stock issued and outstanding at the close of business
on October 2, 1996. The rights expire on September 17, 2006.



Preferred
stock and common stock



The Company is authorized to issue
two classes of shares to be designated respectively Preferred Stock, having a par value of $0.001 per share, and Common Stock, having a par value of $0.001 per share. The total number of shares of Preferred Stock the Company has the authority to
issue is 1,999,995, and the total number of shares of Common Stock the Company has authority to issue is 200,000,000. None of the shares outstanding are subject to repurchase as of May 31, 2004.



Stock Based Compensation



As permitted under SFAS 123, the Company has elected to continue to follow
APB Opinion No. 25 in accounting for stock-based awards to employees. Under APB Opinion No. 25, the Company generally recognizes no compensation expense with respect to such awards, since the exercise price of the stock options granted are generally
equal to the fair market value of the underlying security on the grant date.



Pro forma information regarding net income and earnings per share is presented in Note 2 as if the Company had accounted for its stock-based awards to employees under the fair value method of SFAS 123. The fair value
of the Companys stock-based awards to employees was estimated as of the date of the grant using a Black-Scholes option pricing model. Limitations on the effectiveness of the Black-Scholes option valuation model are that it was developed for
use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable and that the model requires the use of highly subjective assumptions including expected stock price volatility. The fair value of the
Companys stock-based awards to employees was estimated assuming no expected dividends and the following weighted-average assumptions:



|                               |  |              |  |             |  |             
|------------------------------ |  | ------------ |  | ----------- |  | ------------
|                               |  | 2004         |  | 2003        |  | 2002        
|Expected volatility            |  | 87%          |  | 80%         |  | 100%        
|Risk-free interest rate ranges |  | 1.61  3.25% |  | 1.81 -3.72% |  | 3.14 - 4.35%
|Expected life                  |  | 4.07 years   |  | 2.9 years   |  | 3.5 years   



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The Company has also estimated the fair value for the purchase rights under the Employee Stock Purchase
Plan using the Black-Scholes Option Pricing Model with the following assumptions for fiscal years 2004, 2003 and 2002:



|                               |  |              |  |              |  |                 
|------------------------------ |  | ------------ |  | ------------ |  | ----------------
|                               |  | 2004         |  | 2003         |  | 2002            
|Expected volatility            |  | 72%          |  | 80%          |  | 100%            
|Risk-free interest rate ranges |  | 1.02 - 1.23% |  | 1.16 - 1.56% |  | 1.98 - 2.33%    
|Expected life                  |  | 1.00 year    |  | 1.00 year    |  | .50  1.00 years
|Expected dividend yield        |  | 0.0%         |  | 0.0%         |  | 0.0%            



The aggregate fair
value and weighted average fair value of each option granted in fiscal years 2004, 2003 and 2002 were $39.2 million, $54.9 million and $45.9 million, and $8.66, $5.74 and $6.41, respectively.



Stock Repurchase Program



On June 22, 2004, the Companys Board of Directors approved a $50
million stock repurchase program whereby it was authorized to repurchase up to $50 million of common stock in fiscal 2005.



In June 2003, the Company announced that the Board of Directors approved a stock repurchase program of up to $50.0 million to repurchase shares of common
stock during the fiscal year ending May 31, 2004. This program has now ended, as the last of the entire authorized amount was repurchased in April 2004.



10. Income Taxes



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



Income before taxes consist of the following (in thousands):



|         |  |              |        |      |   |        |  |   |      
|-------- |  | ------------ | ------ | ---- | - | ------ |  | - | -----
|         |  | Fiscal Years
|         |  | 2004         |        | 2003 |   | 2002  
|Domestic |  | $            | 18,364 |      | $ | 16,905 |  | $ | 1,056
|Foreign  |  |              | 2,900  |      |   | 1,870  |  |   | 1,217
|         |  |              |        |      |   |        |  |   |      
|         |  | $            | 21,264 |      | $ | 18,775 |  | $ | 2,273
|         |  |              |        |      |   |        |  |   |      



Details of the income
tax provision for fiscal years 2004, 2003 and 2002 consist of the following (in thousands):



|          |  |         |        |   |      |   |       |      |  |   |        |  
|--------- |  | ------- | ------ | - | ---- | - | ----- | ---- |  | - | ------ | -
|          |  | May 31, |       
|          |  | 2004    |        |   | 2003 |   |       | 2002 | 
|Current:  |  |         |        |   |      |   |       |      |  |   |        |  
|Federal   |  | $       | 8,634  |   |      | $ | 6,366 |      |  | $ | 1,262  |  
|State     |  |         | 1,247  |   |      |   | 448   |      |  |   | 126    |  
|Foreign   |  |         | 1,062  |   |      |   | 743   |      |  |   | 502    |  
|          |  |         |        |   |      |   |       |      |  |   |        |  
|          |  |         | 10,943 |   |      |   | 7,557 |      |  |   | 1,890  |  
|          |  |         |        |   |      |   |       |      |  |   |        |  
|          |  |         |       
|Deferred: |  |         |        |   |      |   |       |      |  |   |        |  
|Federal   |  |         | (1,308 | ) |      |   | (378  | )    |  |   | (1,066 | )
|State     |  |         | 20     |   |      |   | (45   | )    |  |   | 40     |  
|Foreign   |  |         |       |   |      |   |      |      |  |   |       |  
|          |  |         |        |   |      |   |       |      |  |   |        |  
|          |  |         | (1,288 | ) |      |   | (423  | )    |  |   | (1,026 | )
|          |  |         |        |   |      |   |       |      |  |   |        |  
|          |  | $       | 9,655  |   |      | $ | 7,134 |      |  | $ | 864    |  
|          |  |         |        |   |      |   |       |      |  |   |        |  



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The Companys effective tax rate differs from the statutory federal income tax rate as shown in the
following schedule:



|                                          |  |              |   |  |      |   |  |       |  
|----------------------------------------- |  | ------------ | - |  | ---- | - |  | ----- | -
|                                          |  | Fiscal Years |  
|                                          |  | 2004         |   |  | 2003 |   |  | 2002  |  
|Income tax benefit at statutory rates     |  | 35.0         | % |  | 35.0 | % |  | 35.0  | %
|State income taxes net of federal benefit |  | 3.9          |   |  | 3.3  |   |  | (18.3 | )
|Non-deductible expenses                   |  | 1.8          |   |  | 1.6  |   |  | 33.0  |  
|Foreign taxes                             |  | 0.2          |   |  | 0.7  |   |  | 28.2  |  
|Research and development credit           |  | (0.9         | ) |  | (2.6 | ) |  | (39.9 | )
|In process research and development       |  | 5.4          |   |  |     |   |  |      |  
|                                          |  |              |   |  |      |   |  |       |  
|Effective tax rate                        |  | 45.4         | % |  | 38.0 | % |  | 38.0  | %
|                                          |  |              |   |  |      |   |  |       |  



The components of the
net deferred tax asset are (in thousands):



|                                                   |  |         |         |   |      |   |         |  
|-------------------------------------------------- |  | ------- | ------- | - | ---- | - | ------- | -
|                                                   |  | May 31, |        
|                                                   |  | 2004    |         |   | 2003 |  
|Deferred tax assets                                |  |         |         |   |      |   |         |  
|Current deferred tax assets:                       |  |         |         |   |      |   |         |  
|Accrued compensation                               |  | $       | 1,475   |   |      | $ | 975     |  
|Other accruals and allowance for doubtful accounts |  |         | 3,106   |   |      |   | 2,706   |  
|                                                   |  |         |         |   |      |   |         |  
|Total current deferred tax assets                  |  |         | 4,581   |   |      |   | 3,681   |  
|                                                   |  |        
|Valuation allowance                                |  |         | (2,099  | ) |      |   | (1,977  | )
|                                                   |  |         |         |   |      |   |         |  
|Net current deferred tax assets                    |  |         | 2,482   |   |      |   | 1,704   |  
|                                                   |  |         |         |   |      |   |         |  
|Non-current deferred tax assets and liabilities:   |  |         |         |   |      |   |         |  
|Accumulated depreciation                           |  |         | 3,849   |   |      |   | 3,378   |  
|Research and development credits                   |  |         | 14,251  |   |      |   | 10,737  |  
|Net operating loss carryforwards                   |  |         | 25,448  |   |      |   | 25,863  |  
|Unrealized gain on investments                     |  |         | 799     |   |      |   |        |  
|                                                   |  |         |         |   |      |   |         |  
|Gross non current deferred tax assets              |  |         | 44,347  |   |      |   | 39,978  |  
|                                                   |  |        
|Deferred tax liabilities:                          |  |         |         |   |      |   |         |  
|                                                   |  |        
|Intangible assets                                  |  | $       | (6,148  | ) |      | $ |        |  
|Other accruals and allowance for doubtful accounts |  |         |        |   |      |   | (94     | )
|                                                   |  |         |         |   |      |   |         |  
|Gross non-current deferred tax liabilities         |  |         | (6,148  | ) |      |   | (94     | )
|Total non-current deferred tax assets              |  |         | 38,199  |   |      |   | 39,884  |  
|Valuation allowance                                |  |         | (20,315 | ) |      |   | (19,496 | )
|                                                   |  |         |         |   |      |   |         |  
|Net non-current deferred tax assets                |  | $       | 17,884  |   |      | $ | 20,388  |  
|                                                   |  |         |         |   |      |   |         |  



The Company has
established a valuation allowance to reduce the deferred tax assets to a level the Company believes is more likely than not to be realized. Approximately $21.65 million of the valuation allowance for the deferred tax assets is attributable to
employee stock option deductions, the tax benefits from which if realized will be recorded to additional paid-in-capital.



As of May 31, 2004, the Company had approximately $70.45 million and $17.01 million of net operating loss carryforwards for federal and California
purposes, respectively, to offset future taxable income. If not utilized, net operating loss carryforwards will expire in the years 2005 through 2024. The Company also has federal and state research and development tax credit carryforwards of
approximately $9.78 million and $8.34 million respectively, at May 31, 2004. If not utilized, the credit carryforwards for federal purpose will expire in the years 2005 through 2024 while in California research and development tax credits may be
carried forward indefinitely.



The utilization of net operating
loss carryforwards, as well as research and development credit carryforwards, is limited by current tax laws and regulations. The amount of benefits from these carryforwards may be impaired or limited if the Company has incurred a cumulative
ownership change as defined in the Internal Revenue Code section 382.



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11. Related Party Transactions



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 services firm of which Mr. Sbona is the Chairman and 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 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. Mr. Sbona became an employee of the Company effective February 16, 1998. On April 13, 1998, the Company and Regent Pacific agreed to amend the agreement to provide that Regent Pacific personnel continued
to 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, CEO and an employee
of the Company, the Compensation Committee of the Companys Board of Directors also granted to him an option to purchase 700,000 shares of the Companys common stock, at an exercise price of $2.563 per share. In October 1998, the
Companys Board granted Mr. Sbona another option to purchase 520,000 additional shares of the Companys common stock, at an exercise price of $3.813 per share. In May 1999, the Companys Board granted Mr. Sbona another option to
purchase 420,000 additional shares of the Companys common stock, at an exercise price of $16.250 per share. In October 1999 and January 2000, the Companys Board granted Mr. Sbona options to purchase 606,000 and 394,000 of the
Companys common stock, at an exercise price of $30.75 and $31.75 per share, respectively. In July and December 2000, the Companys Board granted Mr. Sbona options to purchase 407,000 and 400,000 of the Companys common stock, at an
exercise price of $36.38 and $13.94 per share, respectively. In September 2001, the Companys Board granted Mr. Sbona an option to purchase 1,000,000 shares of the Companys common stock, at an exercise price of $8.74 per share. In July
2002, the Companys Board granted Mr. Sbona an option to purchase 1,000,000 shares of the Companys common stock, at an exercise price of $9.75 per share. In October 2003, the Companys Board granted Mr. Sbona an option to purchase
77,000 shares of the Companys common stock, at an exercise price of $14.69 per share. The shares subject to such options will vest entirely upon certain change of control transactions or upon a termination of Mr. Sbona without cause. The
options will also remain exercisable for one year following the termination of Mr. Sbonas services.



On March 12, 1999, the Company extended its agreement with Regent Pacific Management Corporation until August 31, 2000. This is the second amendment to
the retainer agreement between Regent Pacific Management Corporation and the Company since the original agreement dated July 31, 1997. Under this amended agreement, Regent Pacific continued to provide certain services to the Company at a fee of
$50,000 per week. The new agreement provided the Company with an option to further extend the term of this agreement through February 2001. Furthermore, on March 12, 1999, Mr. Sbona was appointed as the Chairman of the Board of Directors of the
Company. Mr. Sbona was the Companys President from July 1997 to September 1999, was the Companys Chief Executive Officer from July 1997 through February 2003, and has been a Board member since May 1998.



On each of February 10, 2000, March 12, 2001 and June 17, 2002, the Company
extended its agreement with Regent Pacific Management Corporation. These were the third, fourth and fifth amendments to the retainer agreement between Regent Pacific Management Corporation and Verity, Inc. since the original agreement dated July 31,
1997. Under this amended agreement, Regent Pacific continued to provide management services to the Company.



On March 4, 2003, the Company extended its agreement with Regent Pacific Management Corporation through August 31, 2004. This is the sixth amendment to
the retainer agreement between Regent Pacific Management Corporation and Verity, Inc. since the original agreement dated July 31, 1997. Under this amended agreement, Regent Pacific continues to provide management services to the Company. The
agreement provides Verity with an option to further extend the term of this agreement through February 2005. The agreement terminates on February 28, 2005, but provides the Company with an option to further extend the term of this agreement through
August 2005. If the Company exercises this option, the agreement will terminate after August 2005 unless Regent Pacific and the Companys Board agree to further extend it. The Company may discharge Regent Pacific at any time after February 28,
2004 provided that it has delivered a 60-day written notice of intent to cancel this agreement. On March 6, 2003, Mr. Sbona was moved to the position of Executive Chairman of the Board.



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In January 2004, the Company and Regent Pacific entered into the seventh 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 were reduced. In addition, pursuant to the amendment, Gary J. Sbona continues to serve as the Companys Executive
Chairman of the Board, but Stephen W. Young ceased to serve as the Companys Chief Operating Officer effective as of March 1, 2004.



The Company paid fees to Regent Pacific Management Corporation totaling $2.1 million, $2.6 million and $2.6 million for the fiscal years ended May 31,
2004, 2003 and 2002. As of May 31, 2004, there is no balance payable to Regent Pacific Management.



12. Employee Benefit Plan



As allowed under Section 401(k) of the Internal Revenue Code, Veritys 401(k) Plan allows for salary deductions for eligible employees to participate in a tax deferred savings and investment plan for retirement purposes. Employees are
eligible to enroll in the plan during the first enrollment period after hire. Enrollment periods are offered four times a year, at the beginning of each calendar year quarter (January 1st, April 1st, July 1st and October 1st). Changes in
contribution elections may only be done during these four enrollment periods. The plan also includes rollover and loan features.



Participants may make voluntary contributions to the plan from 1% to 50% of their compensation through payroll deductions on a pre-tax basis. The plan
does not provide for Company contributions. For 2004, the annual maximum contribution limit is $13,000. A Catch Up Provision (for employees aged 50 and over) allows for an additional $3,000 contribution - to an annual maximum of $16,000.



13. Computation of Net Income Per Share



Basic and diluted net income per share are calculated as follows for fiscal
years 2004, 2003 and 2002 (in thousands, except per share amounts):



|                                                     |  |              |        |      |   |        |  |   |       
|---------------------------------------------------- |  | ------------ | ------ | ---- | - | ------ |  | - | ------
|                                                     |  | Fiscal Years
|                                                     |  | 2004         |        | 2003 |   | 2002  
|Basic:                                               |  |              |        |      |   |        |  |   |       
|Weighted average common shares outstanding (basic)   |  |              | 37,625 |      |   | 35,410 |  |   | 35,404
|Net income                                           |  | $            | 11,609 |      | $ | 11,641 |  | $ | 1,409 
|Net income per share                                 |  | $            | 0.31   |      | $ | 0.33   |  | $ | 0.04  
|Diluted:                                             |  |              |        |      |   |        |  |   |       
|Weighted average common shares outstanding (basic)   |  |              | 37,625 |      |   | 35,410 |  |   | 35,404
|Dilutive effect of common stock options              |  |              | 2,041  |      |   | 2,185  |  |   | 1,765 
|                                                     |  |              |        |      |   |        |  |   |       
|Weighted average common shares outstanding (diluted) |  |              | 39,666 |      |   | 37,595 |  |   | 37,169
|                                                     |  |              |        |      |   |        |  |   |       
|Net income                                           |  | $            | 11,609 |      | $ | 11,641 |  | $ | 1,409 
|Net income per share                                 |  | $            | 0.29   |      | $ | 0.31   |  | $ | 0.04  



For fiscal years 2004,
2003, and 2002, 10,637,775, 12,844,038, and 10,169,232 anti-dilutive weighted potential shares have been excluded from the diluted net income per share calculation.



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14. Foreign Sales and Segment Reporting



The Company has adopted the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and
services, geographic areas and major customers. The method for determining the information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial
performance.



The Companys chief operating decision-maker
is considered to be the Chief Executive Officer. The Chief Executive Officer 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. On this basis, the Company is organized and operates in a single segment: develops, markets and supports infrastructure products for corporate intranets, extranets, web sites, corporate
portals, business applications, online publishers and e-commerce providers and original equipment manufacturer toolkits for independent software vendors:



The Company has sales and marketing operations located outside the United States in the Netherlands, the United Kingdom, France, Germany, South Africa,
Mexico and Australia, 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 country comprising greater than ten percent of total revenues.



|                                                   |  |     |                    |                |     |                   |  |     |                    |    |  |                     |                 |              |  |     |                    |  |     |                     |     |  |     |                      |  
|-------------------------------------------------- |  | --- | ------------------ | -------------- | --- | ----------------- |  | --- | ------------------ | -- |  | ------------------- | --------------- | ------------ |  | --- | ------------------ |  | --- | ------------------- | --- |  | --- | -------------------- | -
|Financial Data by Geographical Area (in thousands) |  | US  |                    | United Kingdom |     | Other Europe      |  |     | Other Foreign      |    |  | Total International |                 | Eliminations |  |     | Total              | 
|Revenues: 2004 2003 2002                           |  | $$$ | 81,44263,87760,354 |                | $$$ | 15,34413,0029,523 |  | $$$ | 18,55918,60617,434 |    |  | $$$                 | 8,9656,4656,454 |              |  | $$$ | 42,86838,07333,411 |  |     |                  |     |  | $$$ | 124,310101,95093,765 |  
|Income (loss) from operations: 2004 2003 2002      |  | $$$ | 9,95612,7546,900   |                | $$$ | 7,2656,7373,566   |  | $$$ | 8,515(5,140(1,082  | )) |  | $$$                 | (523472514      | )            |  | $$$ | 15,2572,0692,998   |  | $$$ | (8,068(3,265(17,494 | ))) |  | $$$ | 17,14511,558(7,596   | )
|Long-lived assets(1) 2004 2003 2002                |  | $$$ | 85,81831,2814,801  |                | $$$ | 189190308         |  | $$$ | 253424530          |    |  | $$$                 | 7028191,278     |              |  | $$$ | 1,1441,4332,116    |  |     |                  |     |  | $$$ | 86,96232,7146,917    |  

---

|(1) | Excluding financial instruments and deferred tax assets.
|--- | --------------------------------------------------------



Transfers between geographic areas are recorded at amounts generally above cost and in accordance with the rules and regulations of the respective
governing tax authorities. Operating income consists of total net sales less operating expenses, and does not include interest and other income, net, or income taxes. Long-lived assets of geographic areas are those assets used in the Companys
operations in each area.



No single customer accounted for 10%
or more of the Companys revenue during fiscal years 2004, 2003 and 2002. Revenues from the federal government and its agencies were 9.3%, 9.8% and 6.1% of total revenues for fiscal years 2004, 2003 and 2002, respectively.



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##### Table of Contents

SCHEDULE II  VERITY, INC.



VALUATION AND
QUALIFYING ACCOUNTS

(in thousands)



|                                                       |  |                              |       |                                    |   |                                  |  |            |     |  |                        |      |   |  |   |      
|------------------------------------------------------ |  | ---------------------------- | ----- | ---------------------------------- | - | -------------------------------- |  | ---------- | --- |  | ---------------------- | ---- | - |  | - | -----
|Description                                            |  | Balance at Beginning of Year |       | Amounts Charged to Profit and Loss |   | Additiondue toCardiffAcquisition |  | Deductions |     |  | Balance at End of Year
|Allowance for doubtful accounts:                       |  |                              |       |                                    |   |                                  |  |            |     |  |                        |      |   |  |   |      
|                                                       |  |                              |       |                                    |  
|Year ended May 31, 2004Allowance for doubtful accounts |  | $                            | 1,720 |                                    | $ | 319                              |  | $          | 366 |  | $                      | (274 | ) |  | $ | 2,131
|Year ended May 31, 2003Allowance for doubtful accounts |  | $                            | 1,640 |                                    | $ | 563                              |  |            |    |  | $                      | (483 | ) |  | $ | 1,720
|Year ended May 31, 2002Allowance for doubtful accounts |  | $                            | 1,418 |                                    | $ | 1,137                            |  |            |    |  | $                      | (915 | ) |  | $ | 1,640



56



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##### Table of Contents

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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.
|                    |  |             
|Date: July 13, 2005 |  | By:          |  | /s/ ANTHONY J. BETTENCOURT             
|                    |  |              |  | (President and Chief Executive Officer)



57



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##### Table of Contents

INDEX TO EXHIBITS



|               |  |                                                                                                                                                                                                      
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                              
|23.1           |  | Consent of Independent Registered Public Accounting Firm, KPMG LLP.(25)                                                                                                                              
|               | 
|23.2           |  | Consent of Independent Accountants, PricewaterhouseCoopers LLP.(25)                                                                                                                                  
|               | 
|31.1           |  | Certification of Principal Executive Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.(25)                                                             
|               | 
|31.2           |  | Certification of Principal Financial Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.(25)                                                             
|               | 
|32             |  | Certification of Principal Executive Officer and Principal Financial Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, and 18 U.S.C. Section
1350. (25)

---

|(25) | Filed herewith.
|---- | ---------------



58