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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------

                                   FORM 10-K

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

                     FOR THE FISCAL YEAR ENDED MAY 31, 2000
                         COMMISSION FILE NUMBER 0-26880

                            ------------------------

                                  VERITY, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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                     DELAWARE                                           77-0182779
          (STATE OR OTHER JURISDICTION OF                            (I.R.S. EMPLOYER
          INCORPORATION OR ORGANIZATION)                            IDENTIFICATION NO.)

                  894 ROSS DRIVE
               SUNNYVALE, CALIFORNIA                                       94089
     (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                           (ZIP CODE)
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       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 541-1500

        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)

                            ------------------------

     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.  [X]

     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 June 30,
2000, as reported on Nasdaq National Market was approximately $1,216,262,000.
Excludes 2,199,000 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 such person is an affiliate of
the registrant.

     The number of shares of the registrant's Common Stock outstanding on June
30, 2000 was 32,007,000.

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                               TABLE OF CONTENTS

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PART I......................................................    3
     Item 1. Business.......................................    3
     Item 2. Properties.....................................   23
     Item 3. Legal Proceedings..............................   23
     Item 4. Submission of Matters to a Vote of Securities
      Holders...............................................   23
PART II.....................................................   24
     Item 5. Market for the Registrant's Common Stock and
      Related Stockholder Matters...........................   24
     Item 6. Selected Consolidated Financial Data...........   25
     Item 7. Management's Discussion and Analysis of
             Financial Condition and Results of
             Operations.....................................   26
     Item 7A. Quantitative and Qualitative Disclosures About
      Market Risk...........................................   33
     Item 8. Financial Statements and Supplementary Data....   33
     Item 9. Changes in and Disagreements with Accountants
             on Accounting and Financial Disclosure.........   33
PART III....................................................   34
     Item 10. Directors and Executive Officers of the
      Registrant............................................   34
     Item 11. Executive Compensation........................   34
     Item 12. Security Ownership of Certain Beneficial
      Owners and Management.................................   34
     Item 13. Certain Relationships and Related
      Transactions..........................................   34
PART IV.....................................................   35
     Item 14. Exhibits, Financial Statement Schedules, and
      Reports on Form 8-K...................................   35
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                                     PART I

ITEM 1. BUSINESS

     We own or have rights to trademarks or trade names that we use in
conjunction with the operation of our business. We own the Verity, Verity Logo
and Topics trademarks in the United States. This Annual Report on Form 10-K also
includes trademarks owned by other parties.

     You should carefully read the information in this Annual Report on Form
10-K, including our consolidated financial statements and related notes
beginning on page 37 of this Annual Report on Form 10-K. Our business involves
significant risks. You should carefully consider the information under the
heading "-- Risk Factors" below.

OVERVIEW

     We are a leader in powering business portals. These include corporate
portals used for sharing information within an enterprise, e-commerce portals
for on line selling, and market exchange portals for B2B activities. Business
portals provide personalized information to employees, partners, customers and
suppliers.

     The business portal market is in great part the convergence of many core
markets in which we have participated for years.

     We develop, market and support products for corporate intranets, extranets,
corporate portals, online publishers and e-commerce providers, original
equipment manufacturers, or OEMs, and independent software vendors. Our
comprehensive and integrated product family enables enterprise-wide document
indexing, classification, search and retrieval, organization and navigation,
personalized dissemination, and hybrid online and CD publishing all from the
same underlying Verity information index. Our products organize and provide
simple, single-point access to information across the entire enterprise. By
doing so, our products create business portals, which leverage the value of
existing investments in Internets and intranets and network infrastructure.

     Our software has been licensed directly to over 1,200 corporations,
government agencies, software developers, information publishers and e-commerce
vendors. We focus on several core markets, including intranet-based applications
for large corporate and government organizations, information retrieval
solutions for e-commerce merchants, Internet sites and electronic publishers and
OEMs. We pursue sales opportunities within organizations and government agencies
through the efforts of our direct sales force and our products are also sold
indirectly through a network of OEMs, value added resellers and system
integrators.

     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. We maintain a web site on the World Wide Web at
"verity.com." The reference to our web address does not constitute incorporation
by reference of the information contained at the site.

THE VERITY SOLUTION

     Our comprehensive and integrated product family enables enterprise-wide
document indexing, classification, search and retrieval, organization and
navigation, personalized dissemination, and hybrid online and CD publishing all
from the same underlying Verity information index. Our products organize and
provide simple, single-point access to information across the entire enterprise.
By doing so, our products create business portals, which leverage the value of
existing investments in intranet, Internet and network infrastructure. We
believe the functionality and flexibility of our products enable us to offer our
customers a knowledge solution that strengthens their businesses by improving
efficiencies, employee productivity and communication.

     Our cross-platform knowledge retrieval product suite is scalable and is
designed to solve the knowledge retrieval problems of enterprise and commerce
sites. Our products use a combination of full text, metadata and knowledge-based
methods to index and retrieve information stored in a variety of formats and
systems

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across corporate intranets, extranets and portals and the Internet. Our products
organize and rank the relevance of selected information, enabling users to
filter and evaluate information personalized to their specific needs and
interests. Our products enable user-initiated queries, and also enable the
construction of automated software agents that actively and continuously monitor
Internet and intranet information sources such as web sites, news feeds and file
systems for new information or changes in content matching user profiles. Our
products enable the high-speed classification of information, the organization
of information into taxonomies and the visual navigation of information.
Additionally, our products allow organizations to build hybrid online and
offline information distribution systems by publishing information on CD-ROM and
DVD-ROM, maintaining links to active web sites and enabling automatic
synchronization between the Web and a user's local computer.

     We originally developed our core search and retrieval technology for use by
large government agencies in the defense and intelligence communities. In the
past several years, we have enhanced and expanded our family of products and
markets. Today, we offer a broad range of knowledge retrieval products for
corporate intranets, extranets, corporate portals, e-commerce and publishing,
and OEMs and embedded solutions.

     Corporate Intranets and Extranets and Portals. We market an integrated
product suite enabling public and private organizations to index, search,
retrieve, classify, organize, navigate, disseminate and publish textual
information residing in many document formats and in web and file servers
distributed across the enterprise. Verity Information Server, Verity Agent
Server, Verity Knowledge Organizer and Verity Document Navigator are designed to
serve as the foundation of a well-designed corporate portal. Verity Information
Server creates a searchable index to information across the enterprise. Verity
Agent Server notifies users when documents matching their personal information
needs are added to this index and sends them electronic notices via email or
personal web page. With Verity Knowledge Organizer, data from different systems
and sources can be grouped together logically and navigated visually, reducing
content management costs and increasing the usability of corporate information
assets. For especially long or complex documents, Verity Document Navigator
provides a publishing tool, which turns long, awkward documents into rich Web
publications that users can easily search and navigate. Users can search and
traverse an automatically generated table of contents, and efficiently find
valuable information hidden within large documents. You can create these
searchable publications from any format Verity supports, including Microsoft
Word, HTML and PDF.

     Electronic Commerce and Publishing. E-commerce vendors, including online
stores and publishers, demand fast and accurate searches across large bodies of
content. Our Internet products are designed to provide e-commerce vendors and
online information publishers with an integrated solution enabling their users
to efficiently navigate product catalogs, news services and document
repositories, whether on-line or from a remote, disconnected location. Through
the use of our knowledge retrieval products, vendors have the ability to convert
more site visitors into buyers and more buyers into repeat customers. Our
product offerings include the Verity K2 Toolkit and Verity CD-Web Publisher.
Verity K2 Toolkits designed for scalability to support the largest commercial
Internet sites and to enable millions of products and documents to be searched
and indexed by hundreds of users simultaneously. Verity CD-Web Publisher allows
high-volume commercial and corporate publishers to use web-based information
offline or from a low cost, searchable alternative media.

     OEMs and Embedded Solutions. Our toolkits enable software developers to
embed our search-and-retrieval, profiling agent, and viewing and filtering
technologies within their products. Our technology has been embedded in document
repository systems offered by Broadvision, Documentum, Eastman Software and Easy
GmbH as well as enterprise resource planning systems from SAP, and many business
applications including relational and object-oriented database products and
resume tracking, customer care and help desk systems.

PRODUCTS

     Our product suite enables organizations to turn corporate intranets and
extranets into a powerful knowledge base or corporate portal, making business
information accessible and reusable across the enterprise. Our comprehensive and
integrated product family enables enterprise-wide document indexing,
classification, search and retrieval, and personalized information dissemination
all from the same underlying Verity index.

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Because our products are designed to work together, customers may begin by
deploying basic retrieval technology and can later incorporate more
sophisticated classification and dissemination technology as their business
needs expand. Additionally, because we offer enterprise and departmental
solutions, our customer's investment is preserved by our capability to expand to
support the largest document repositories and corporate intranets and extranets.

  Enterprise Business Portal Products:

     Verity Portal One. Verity Portal One is a comprehensive, integrated
business portal offering that delivers all of the essential technology
capabilities needed for a next-generation corporate desktop, as well as partners
and services key to a complete portal. These capabilities include:
personalization, search, navigate and view, unified access, intelligent
classification and enterprise strength.

     Verity Information Server. Verity Information Server indexes, searches and
retrieves information on web and file servers located across an enterprise,
including corporate intranets, portals, extranets, online retail catalogs,
research and development, executive messaging and business intelligence systems.
Information Server includes a powerful search navigation facility, which
includes document clustering, automatic summarization and query by example.
Information Server has the power and flexibility to enable any business to
organize and integrate heterogeneous information repositories into a coherent
index.

     Verity Intranet Spider. Verity Intranet Spider searches and indexes web and
file servers, located internally or externally, extending the reach of
Information Server by enabling users to index multiple domains and to specify
the scope and set of sources to be indexed. Combined with Information Server,
Intranet Spider helps assure efficient search, retrieval and automatic
monitoring of intranet, corporate portal and Internet content.

     Verity Agent Server. Verity Agent Server, an add-on application to
Information Server, automates and personalizes the information retrieval and
delivery processes, allowing users to spend less time looking for information
and more time acting on it. Users configure their own personal agents that
monitor a broad range of intranet, corporate portal and Internet resources
continually, including documents, e-mail, discussion groups, databases and
newswires. Agents notify users proactively when information matching their
interest profiles is discovered. This information is then delivered to the users
by a variety of delivery mechanisms including personalized web pages and email.

     Verity Knowledge Organizer. Verity Knowledge Organizer organizes and
classifies corporate information into categories based on the standard terms
used by companies to describe their business operations. Knowledge Organizer, an
add-on application to Information Server, enables organizations to build master
directories that provide users with an intuitive, visual means to navigate and
retrieve information. Unlike solutions that rely solely on manual categorization
or complicated technology, Knowledge Organizer categorizes information
automatically according to defined business rules.

     Verity Topic Creator. Verity Topic Creator allows content experts to
quickly and easily design precise classification rules using queries, example
documents, directories, or document metadata (information about the documents).
Using a Windows(TM)-based graphical interface, Topic Creator users build
business rules, test them interactively and deploy them for use with Information
Server or Knowledge Organizer applications. Topic Creator offers the highest
relevance and retrieval precision by combining human intelligence with machine
efficiency to build business rules uniquely suited to your company's knowledge
management requirements.

     Verity Document Navigator. Verity Document Navigator, an add-on application
to Information Server, enables organizations to view, navigate and search long
structured documents more effectively and efficiently. Long, complex or
book-length documents are identified in the results of a standard Verity search.
When these documents are selected, users can navigate them visually, organized
by the document's table of contents. The table of contents indicates which
sections of the document are most relevant to the user's query. By simply
pointing and clicking, users can visually and intuitively move to the desired
section of the document.

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Document Navigator organizes and indexes long documents such as operating
manuals, legal and financial filings, and technical documentation.

     Verity Information Connectors and Gateways. These add-on products extend
the indexing range of Information Server. Through the use of information
connectors and gateways, we develop and market access and indexing for popular
information products, including Lotus Notes, Microsoft Exchange and relational
databases.

     Verity CD-Web Publisher. Verity CD-Web Publisher is a hybrid CD-ROM/Web
information publishing system. CD-Web Publisher is designed to publish the
contents of a web site on CD-ROM and DVD-ROM while maintaining links to web
sites. CD-Web Publisher is designed for high-volume information publishers,
customer service organizations and others who need to use web-based information
off-line. CD-Web Publisher includes Verity's standard search capabilities.

  OEM and Custom Application Development Tools:

     Verity Developer's Kit. Verity Developer's Kit enables developers to
incorporate search and retrieval functionality in their software applications.
Developers use the Verity Developer's Kit to build applications with
high-performance indexing, search classification, retrieval and viewing
integrated seamlessly into applications.

     Verity K2 Toolkit. Verity K2 Toolkit combines the precision of the Verity
Developer's Kit with high-performance and scalability. K2 Toolkit is designed to
enable organizations to build scalable, fault-tolerant applications to allow
thousands of users to search hundreds of millions of unstructured documents
online yielding quick and efficient results. The K2 Toolkit supports popular
programming interfaces to Sun's Java and Microsoft's COM, allowing users to
rapidly build applications or integrate K2 Toolkit into their existing web
environment.

     Verity Profiler Kit. Verity Profiler Kit enables users to develop
applications that use content and metadata to classify information automatically
and trigger business events. Profiler Kit enables developers to build
specialized applications, using Verity's patented technology, to disseminate
information accurately to users, to notify users about critical new information,
or to classify documents into specific categories.

     Verity HTML Export. Verity HTML Export lets users view their enterprise
documents without plug-ins or re-purposing content. Normally, to view Microsoft
Office or Lotus SmartSuite documents, users need to open the document in the
native application or use a custom plug-in on their browser. Verity HTML Export
provides on-demand, server-side conversion of these types of documents to HTML.
With server-side conversion, users can see any document, spreadsheet or
presentation instantly, without leaving their browsers and without the help of
any other application. Through the administrative interface, users can control
the look and feel of the resulting HTML using design templates that are applied
at the time of conversion.

     Verity KeyView Pro. Verity KeyView Pro enables users to filter and view
documents residing in hundreds of application formats and is targeted at OEMs,
independent software vendors and corporate customers. KeyView Pro provides
desktop viewing and filtering, and compression functionality.

     Verity KeyView SDK. The Verity KeyView Developer's Kit is designed to allow
independent software vendors to embed KeyView functionality within their own
applications.

SERVICES

     We make extensive technical support and training services available for our
customers, and provide consulting services designed to assist our customers in
utilizing Verity software to develop custom search and retrieval applications.
As of May 31, 2000, we employed 20 people in our technical support organization,
43 people in our consulting group and one person focused on developing and
coordinating training services.

     Technical Support and Maintenance. We provide post-sale customer support
directly through our own technical support engineers, who handle most support
calls by telephone and electronic mail. We offer annual maintenance contracts,
which entitle our customers to full telephone support service, software updates
and
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bug fixes. We also provide our customers access to technical support services by
electronic mail and over the Internet and a bulletin board system.

     Consulting. We offer consulting services to our enterprise customers, OEMs,
value added resellers and system integrators to assist them in designing and
deploying Verity applications tailored to meet their particular information
search and retrieval needs. Consulting services have typically been offered on a
time and materials basis.

     Training. We provide training services at our own training facilities
located in Sunnyvale, California, as well as at the facilities of our customers,
value added resellers and system integrators worldwide. We also provide training
through certain authorized third parties. We have developed an extensive set of
courses and materials for presentation by our professional instructors. We
believe our training helps assure increased customer satisfaction while
enhancing our ability to make additional sales to our existing customer base.
Customers typically pay for training services on a course or fee basis.

CUSTOMERS

     Our software has been licensed directly to over 1,200 corporations,
government agencies, software developers, information publishers and e-commerce
vendors. We focus on several core markets, including intranet-based applications
for large corporate and government organizations, information retrieval
solutions for e-commerce and electronic publishers, and OEMs. See Note 11 of
Notes to Consolidated Financial Statements beginning on page 53 of this Annual
Report on Form 10-K for a discussion of our international revenues, income from
operations and identifiable assets.

SALES AND MARKETING

     We seek to tailor our sales and marketing efforts to most effectively reach
customers in each of our core markets. We pursue opportunities within
organizations and government agencies through the efforts of our direct sales
force. Our products are also sold indirectly through our channel sales force,
which includes a network of OEMs, value added resellers and system integrators.

     Direct Sales. Our direct sales force is trained to assist customers to
acquire and utilize our suite of products to integrate information residing
within the organization over a variety of sources such as word processing
documents, relational database document repositories and web and file servers.
Our direct sales force also targets online service providers and publishers of
information stored on both the Internet and CD-ROM. We maintain direct sales
offices or personnel in a number of metropolitan areas across the United States,
including Falls Church, Chicago, Dallas, New York, Seattle, Sunnyvale and
Washington, D.C. European direct sales operations are located in London,
Utrecht, Munich and Paris. We also have sales partnerships with offices located
in Asia and Australia.

     Channel Sales. Our value added resellers and system integrators distribute
our products as part of integrated turnkey solutions for the enterprise and
Internet. We also market products such as document management and support
automation, which incorporate our information retrieval toolkits. Our products
are resold through partners in North America, Western Europe, Asia and
Australia.

     Our technology is also sold as an integrated feature of more than 200
software applications offered by over 100 OEM and ISV providers. Our OEM
partners are drawn from such application markets as:

     - groupware (Intraspect);

     - document management (Documentum, Eastman Software, Easy GmbH);

     - enterprises resource planning systems (SAP);

     - help desk and customer care solutions (Primus, ServiceWare);

     - product data management solutions;

     - e-commerce (BroadVision); and

     - personal productivity (Adobe, Corel, Qualcomm).

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     Our marketing activities are targeted at building market awareness and
identifying prospective customers for enterprise, Internet and e-commerce,
online publishing, hybrid CD-ROM/Web and OEM applications. Our marketing efforts
include participation in tradeshows, conferences and industry events, Verity
seminars, industry speaking engagements, and advertising and direct mail
campaigns targeting specific markets such as corporate portal developers,
intranet web site and content managers, and online catalog developers. Certain
of our OEM contracts also provide for brand name exposure concerning the OEM's
embedding of Verity technology. We also maintain an active public relations
program targeting industry analysts and leaders in the trade and business press,
and maintain a public web site, which has been a source of sales leads. As of
May 31, 2000, our sales and marketing organizations consisted of 140 employees.

TECHNOLOGY

     Our core technology was originally developed by us for use by large
government agencies in the defense and intelligence communities to perform
complex, customized search and retrieval applications on stand-alone, host-based
systems. Since early fiscal 1994, we have expanded our product offerings to
support commercial client/server and web-based computing environments. We have
expanded our markets to include corporate intranets and e-commerce vendors, OEM
and online and CD-ROM information publishers. Our technologies address the major
aspects of knowledge retrieval including document indexing, query formulation
and execution, concept-based information retrieval, ranking and presentation of
results, document classification, automated information dissemination,
information organization and navigation, document viewing and filtering and
hybrid CD-ROM/Web publishing.

     Indexing. The search engine incorporated in our server products and OEM
applications indexes documents automatically based upon administrator-specified
criteria. This index is referred to as a "Verity collection." Verity indices
exploit full text, metadata and our unique knowledge mapping system, Topics(R).
Collections created through the indexing process contain the results of text
analysis performed by our engine, as well as information about the document's
context and structure. End users with Verity-based applications or standard web
browsers can search those collections that administrators make available to
them. The Verity architecture is designed to permit real-time indexing of new
documents into a Verity collection, even while users actively search that
collection. As a result, the system provides enhanced availability, and is
designed to operate during maintenance and back up. The Verity K2 Toolkit
enhances the availability of our applications by providing redundant processing
paths, further enhancing system availability.

     Query Formulation and Execution. Our search engine is designed to enable
users to formulate and refine queries using a series of information retrieval
methods including keyword, thesauri, dictionaries and concept-based retrieval.
Once formulated, queries can be used to retrieve archived information using a
standard, interactive search. Our core query formulation technology is the
Verity Query Language, which contains more than 30 operators that can be used to
formulate precise and filtered information requests. Our search engine is
designed with an open architecture, which employs multiple search techniques and
supports incorporation of additional techniques by us, by third parties or by
organizations building custom applications. This open environment enables
third-party developers to extend the functionality and capabilities of our
products and tools. Our high performance search engine, Verity K2 Toolkit,
employs a network of brokers and servers to offer scalable, parallel searching
across hundreds of millions of documents. The technology is designed to scale
linearly with the growth of users, documents or queries, and to support the
largest corporate intranets and e-commerce sites.

     Concept-based Information Retrieval. Our unique concept-based Topics(R)
technology enables users to construct families of queries, organized
hierarchically into subject themes. Users construct a hierarchical tree of
concepts with weighted branches, which define a Topic. Topic trees graphically
represent rules of evidence describing the probability that a given document is
about a given subject. Topics, because they are stored queries, can be used to
expand a user's query automatically so that all related concepts are used in the
search process, even if the user inputs a simple one or two word query. Topics
can significantly increase the precision of information retrieval over typical
Boolean or natural language methods.

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     Ranking and Results Presentation. The results obtained by matching queries
against document collections are provided with a relevance score calculated by
the Verity engine. This score may be presented, along with other available
document-attribute information desired by the user, in a customizable results
list. We have also developed functionality that enables the organization, or
"clustering", of search results according to common themes within the retrieved
documents. We also provide automatic document summarization and query by
example, a facility allowing any document to be turned into a "find more
documents like this" query. Sets of documents may also be navigated as a
directory using Knowledge Organizer to organize documents into taxonomies that
can be browsed visually.

     Document Classification. Verity Profiler is a high-speed matching engine,
which compares a stream of new documents or a collection of existing documents
to a set of Topics or other stored queries. Verity Profiler determines which
queries best match those documents, based on threshold values established by the
user or administrator. The output of Profiler is a set of metadata identifying
the queries that match individual documents. This metadata can be stored as
persistent classification information or can be used to trigger custom business
processes such as automated routing of information to users. This profiling
process is designed to address high user and data volumes such as those
associated with large corporate intranets and online applications such as news
services.

     Automated Information Dissemination. Any query can be used as an active
agent deployed to watch and "clip" relevant information as it enters a corporate
network or public web site. Verity agents compare new information with a
database of stored queries, which are linked to user profiles. User profiles
specify the frequency and method by which users want to be notified about
subjects that they are tracking. Our agent-based technology can notify and route
information to users via email, a page, a pager or a custom process such as
automated filing of information into subject directories. Our agent technology
is targeted at organizations building executive briefing, message handling,
competitive intelligence and related systems.

     Information Organization and Navigation. We provide technology that enables
organizations to establish a taxonomy-based scheme for organizing information
into subject directories, similar to popular Internet directory services, using
automated methods. Knowledge Organizer uses metadata, pathnames, universal
resource locator and Topic classification rules to classify documents
automatically against the organization's taxonomy. Once the taxonomy has been
populated with intranet or Internet-based information, users can browse the
directory visually. Knowledge Organizer combines visual navigation and searching
enabling a more efficient and intuitive information retrieval process.

     Viewers and Filters. Document filtering automatically detects the kind of
document being indexed and isolates the text to be indexed from embedded
formatting information. Filters are designed to enable the indexing engine to
handle a wide variety of document types and formats. The threadsafe nature of
our filters helps assure fast and reliable access to documents for searching.
Our viewing technology is designed to provide users with the ability to view
documents in a variety of formats without the use of the application, which
generated the document. On the basis of our filtering and viewing technology, we
have developed a series of applications. These include the KeyView Pro desktop
viewing product, Verity HTML Export, a server-side application that converts any
document into a web page enabling any web-enabled desktop to view information
universally, and Document Navigator, a product, which enables the navigation and
searching of long, structured documents.

     Hybrid CD-ROM/Web Publishing. We have developed technology enabling
organizations to publish the contents of web sites onto CD-ROM, DVD-ROM and
other permanent storage media. Used in professional information publishing,
market data distribution and customer care applications, Verity CD-Web Publisher
combines media authoring and the Verity search engine on a CD for DVD for
offline viewing of high volume information. This technology automatically
synchronizes upon connecting to the Web ensuring that local client-based
information is up-to-date.

PRODUCT DEVELOPMENT

     Our development efforts are focused on expanding our suite of products,
designing enhancements to our core technology, and addressing additional
technical challenges inherent in developing new applications for
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enterprise, e-commerce, OEM and sophisticated offline publishing markets. Our
research and development is focused on enhancing core indexing and search
performance and precision, data access and security gateways, enterprise
scalability, business portal functionality, programmable application programming
interfaces, and product deployability. As of May 31, 2000, there were 129
employees on our research and development staff. Our research and development
expenditures in fiscal 1998, fiscal 1999 and fiscal 2000 were $15.5 million,
$13.7 million and $16.0 million, respectively, which represented 40.0%, 21.3%
and 16.7% of total revenues, respectively. We expect that we will continue to
commit substantial resources to product development in the future.

COMPETITION

     The business portal software market is intensely competitive. We believe
that the principal competitive factors in such market are:

     - product quality;

     - performance and price;

     - vendor and product reputation;

     - product architecture;

     - strategic alliances;

     - product functionality and features; and

     - ease of use and quality of support.

     A number of companies offer competitive products addressing certain of our
target markets. In the enterprise market, we compete with Dataware, Infoseek,
Hummingbird/PC Docs and Excalibur, Autonomy, Alta Vista, Microsoft, Mercado,
Viador, Epicentric, Thunderstone and Inktomi, among others. Plumtree is on
occasion a competitor, but is viewed primarily as our partner and customer. In
the Internet/publishing market, we compete with Dataware, Excalibur,
Hummingbird/PC Docs/Fulcrum, Infoseek, Inktomi, Lotus and Microsoft, among
others. We also compete indirectly with database vendors that offer information
search and retrieval capabilities with their core database products. In the
future, we may encounter competition from companies that enhance products such
as:

     - document management systems;

     - groupware applications;

     - Internet products; and

     - operating systems to include text search and retrieval features.

     Many of our existing competitors have significantly greater financial,
technical and marketing resources than we do. Although we believe that our
products and technologies compete favorably with respect to the factors outlined
above, we cannot assure you that we will be able to compete successfully against
its current or future competitors or that competition will not seriously harm
our business.

     One element of our strategy is to embed our technology in products offered
by our OEM customers. Many of the markets for these products are also new and
evolving and, therefore, subject to the same risks that we face in the markets
for our own products. In addition, consolidation in the industries we serve
could, and acquisition or development by any of our significant customers of
technology competitive with ours would, materially and adversely affect our
business and prospects.

     Our CDweb Publisher product competes primarily with Nextpage, Enigma and
Dataware.

                                       10
<PAGE>   11

PROPRIETARY RIGHTS

     Our success and ability to compete is dependent in part upon our
proprietary technology. Any failure to adequately protect our proprietary rights
could result in unexpected costs and delays in shipment. While we rely on trade
secret and copyright law to protect our technology, we believe that the
following factors are more essential to establishing and maintaining a
technology leadership position:

     - the technological and creative skills of our personnel;

     - new product developments;

     - frequent product enhancements;

     - name recognition; and

     - reliable product maintenance.

     We presently have one issued patent, which will expire in January 2016 and
one patent application pending. We cannot assure you that other companies will
not develop technologies that are similar or superior to our technology. The
source code for our proprietary software is protected both as a trade secret and
as a copyrighted work. Despite these precautions, it may be possible for a third
party to copy or otherwise obtain and use our products or technology without
authorization, or to develop similar technology independently. In addition,
effective copyright and trade secret protection may be unavailable or limited in
some foreign countries.

     To license our products, we frequently rely on "shrink wrap" licenses that
are not signed by the end user and, therefore, may be unenforceable under the
laws of several jurisdictions. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy aspects of our products or to
obtain and use information that we regard as proprietary. Policing unauthorized
use of our products is difficult. We cannot assure you that the steps we take
will prevent misappropriation of our technology or that these agreements will be
enforceable. In addition, litigation may be necessary in the future to enforce
our intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Litigation could result in substantial
costs and diversion of resources and could have a material adverse effect on our
business, operating results and financial condition regardless of the outcome of
the litigation.

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

EMPLOYEES

     As of May 31, 2000, we had a total of 364 employees, including 129 in
research and development, 118 in sales, 22 in marketing, 64 in customer support
and professional services, 26 in administration and 5 in manufacturing. Of these
employees, 240 were located in the United States, 52 in Europe, 70 in Canada and
2 in Australia. None of our employees is represented by a collective bargaining
agreement, nor have we experienced any work stoppage. We consider our relations
with our employees to be good.

                                       11
<PAGE>   12

                                  RISK FACTORS

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

                         RISKS RELATED TO OUR BUSINESS

OUR GROWTH RATE MAY SLOW AND WE MAY NOT BE ABLE TO MAINTAIN PROFITABILITY

     Despite our recent financial performance, we have in the past incurred
significant losses and substantial negative cash flow. In the future, our
revenues may grow at a rate slower than was experienced in previous periods and,
on a quarter-to-quarter basis, our growth in net sales may be significantly
lower than our historical quarterly growth rate, particularly over the last
eight quarters. To achieve revenue growth, we must:

     - increase market acceptance of our products;

     - respond effectively to competitive developments;

     - attract, retain and motivate qualified personnel; and

     - upgrade our technologies and commercialize our products and services
       incorporating such technologies.

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

OUR REVENUES AND OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS, WHICH COULD
ADVERSELY AFFECT OUR STOCK PRICE

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

     - the size and timing of orders;

     - changes in the budget or purchasing patterns of corporations and
       government agencies, foreign country exchange rates, or pricing pressures
       from competitors;

     - increased competition in the software and Internet industries;

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

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

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

     - changes in operating expenses and personnel;

     - the overall trend toward industry consolidation; and

     - changes in general economic conditions and specific economic conditions
       in the computer and software industries.

                                       12
<PAGE>   13

     Any of the factors, some of which are discussed in more detail below, could
have a material adverse impact on our operations and financial results, and
consequently our stock price.

THE SIZE AND TIMING OF LARGE ORDERS MAY MATERIALLY AFFECT OUR QUARTERLY
OPERATING RESULTS

     The size and timing of individual orders may cause our operating results to
fluctuate. The dollar amounts of large orders for our products have been
increasing, and therefore the operating results for a quarter could be
materially adversely affected if one or more large orders are either not
received or are delayed or deferred by customers. A significant portion of our
revenues in recent quarters have been derived from these relatively large sales
to a limited number of customers, and we currently anticipate that future
quarters will continue to reflect this trend. Sales cycles for these customers
can be up to six months or longer. In addition, customer order deferrals in
anticipation of new products may cause our operating results to fluctuate. Like
many software companies, we have generally recognized a substantial portion of
our revenues in the last month of each quarter, with these revenues concentrated
in the last weeks of the quarter. Accordingly, the cancellation or deferral of
even a small number of purchases of our products could have a material adverse
effect on our business, results of operations and financial condition in any
particular quarter. In addition, to the extent that significant sales occur
earlier than expected, operating results for subsequent quarters may fail to
keep pace or even decline.

OUR EXPENDITURES ARE TIED TO ANTICIPATED REVENUES, AND THEREFORE IMPRECISE
FORECASTS MAY RESULT IN POOR OPERATING RESULTS

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

WE HAVE BEEN SUED, AND ARE AT RISK OF FUTURE SECURITIES CLASS ACTION LITIGATION,
DUE TO OUR PAST AND EXPECTED STOCK PRICE VOLATILITY

     In the past, securities class action litigation has often been brought
against a company following a decline in the market price of its securities. For
example, in December 1999 our stock price dramatically declined, and a number of
lawsuits were filed against us. See "Item 3. Legal Proceedings" for a
description of these lawsuits. Because we expect our stock price to continue to
fluctuate significantly, we may be the target of similar litigation in the
future. This and other securities litigation could result in substantial costs
and divert management's attention and resources, and could seriously harm our
business.

WE MUST SUCCESSFULLY INTRODUCE NEW PRODUCTS OR OUR CUSTOMERS WILL PURCHASE OUR
COMPETITORS PRODUCTS AND OUR BUSINESS WILL BE ADVERSELY AFFECTED

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

                                       13
<PAGE>   14

     Our development efforts are focused on expanding our suite of products,
designing enhancements to our core technology and addressing additional
technical challenges inherent in integrating our products with those of our
strategic partners and developing new applications for enterprise, e-commerce,
OEM and sophisticated CD-ROM publishing markets. We plan to undertake
development of further enhancements of the search performance, scalability,
functionality and deployability of our products. We cannot assure you that these
products will be developed and released on a timely basis, or that these
products will achieve market acceptance.

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

WE FACE INTENSE COMPETITION FROM COMPANIES WITH SIGNIFICANTLY GREATER FINANCIAL,
TECHNICAL, AND MARKETING RESOURCES, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO
MAINTAIN OR INCREASE SALES OF OUR PRODUCTS

     The business portal software market is intensely competitive and we cannot
assure you that we will maintain our current position of market share. A number
of companies offer competitive products addressing this market. We compete with
Alta Vista, Autonomy, Excalibur, Inktomi, Dataware, Hummingbird/PC Docs/Fulcrum,
Infoseek, Lotus, Mercado, Viador, Epicentric, Thunderstone and Microsoft, among
others. We also compete indirectly with database vendors, such as Oracle, that
offer information search and retrieval capabilities with their core database
products and web platform companies, such as Netscape.

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

WE RELY ON REGENT PACIFIC MANAGEMENT CORPORATION FOR THE MANAGEMENT OF VERITY,
AND THE LOSS OF THESE SERVICES COULD ADVERSELY AFFECT OUR BUSINESS

     Regent Pacific Management Corporation, a management firm of which Gary J.
Sbona is chief executive officer, provides management services for our company.
The management services provided under our agreement with Regent Pacific include
the services of Mr. Sbona as chairman of the board and chief executive officer
of Verity, and other Regent Pacific personnel as part of Verity's management
team. On February 10, 2000, we extended our agreement with Regent Pacific
Management Corporation through August 31, 2001. This is the third 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 the services of Gary J. Sbona as
Chairman and Chief Executive Officer of Verity, and continues to provide
additional Regent Pacific management services to our company. The agreement
provides us with an option to further extend the term of this agreement through
February 2002. If the agreement with Regent Pacific were canceled or not
renewed, the loss of the Regent Pacific personnel could have a material adverse
effect on our operations, especially during the transition phase to new
management. Similarly, if any adverse change in Verity's relationship with
Regent Pacific occurs, it could hinder management's ability to direct our
business and materially and adversely affect our results of operations and
financial condition.

                                       14
<PAGE>   15

OUR BUSINESS MAY SUFFER DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES

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

     - difficulties in complying with regulatory requirements and standards;

     - tariffs and other trade barriers;

     - costs and risks of localizing products for foreign countries;

     - reliance on third parties to distribute our products;

     - longer accounts receivable payment cycles;

     - potentially adverse tax consequences;

     - limits on repatriation of earnings; and

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

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

     Service and other revenues derived from foreign operations accounted for
6.1%, 6.4% and 6.7% of total revenues, respectively, in fiscal 1998, 1999 and
2000. Our export sales consist primarily of products licensed for delivery
outside of the United States. In fiscal years 1998, 1999 and 2000, export sales
accounted for 26.6%, 27.1% and 19.0% of total revenues. We expect that revenues
derived from foreign operations and export sales will continue to account for a
significant percentage of our revenues for the foreseeable future. These
revenues may fluctuate significantly as a percentage of revenues from period to
period. In addition, a portion of these revenues was derived from sales to
foreign government agencies, which may be subject to risks similar to those
described immediately below. See Note 11 of Notes to Consolidated Financial
Statements beginning on page 53 of this Annual Report on Form 10-K for a
discussion of our international revenues, income from operations and
identifiable assets.

A SIGNIFICANT PORTION OF OUR REVENUES IS DERIVED FROM SALES TO THE FEDERAL
GOVERNMENT, WHICH ARE SUBJECT TO BUDGET CUTS AND, CONSEQUENTLY, THE POTENTIAL
LOSS OF REVENUES UPON WHICH WE HAVE HISTORICALLY RELIED

     Revenues derived from sales to the federal government and its agencies were
9.0%, 8.1% and 7.8% of total revenues in fiscal years 1998, 1999 and 2000,
respectively. Future reductions in United States spending on information
technologies could have a material adverse effect on our operating results.
Sales to government agencies declined as a percentage of revenues during these
periods, and may decline in the future. In recent years, budgets of many
government agencies have been reduced, causing certain customers and potential
customers of our products to re-evaluate their needs. These budget reductions
are expected to continue over at least the next several years.

                                       15
<PAGE>   16

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

IF WE ARE UNABLE TO ENHANCE OUR EXISTING PRODUCTS AND DEVELOP NEW PRODUCTS TO
RESPOND TO OUR RAPIDLY CHANGING MARKETS, OUR PRODUCTS MAY BECOME OBSOLETE

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

     The life cycles of our products are difficult to estimate. Our future
success will depend upon our ability to enhance existing products and to develop
new products on a timely basis. In addition, our products must keep pace with
technological developments, conform to evolving industry standards, particularly
client/server and Internet communication and security protocols, as well as
publishing formats such as Hypertext Markup Language, or HTML, and Extensible
Markup Language, or XML, and address increasingly sophisticated customer needs.
We cannot assure you that we will not experience difficulties that could delay
or prevent the successful development, introduction and marketing of new
products, or that new products and product enhancements will meet the
requirements of the marketplace and achieve market acceptance.

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

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

OUR SOFTWARE PRODUCTS ARE COMPLEX AND MAY CONTAIN ERRORS THAT COULD DAMAGE OUR
REPUTATION AND DECREASE SALES

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

                                       16
<PAGE>   17

IF WE LOSE KEY PERSONNEL, OR ARE UNABLE TO ATTRACT ADDITIONAL QUALIFIED
PERSONNEL, OUR ABILITY TO CONDUCT AND GROW OUR BUSINESS WILL BE IMPAIRED

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

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

OUR ABILITY TO COMPETE SUCCESSFULLY WILL DEPEND, IN PART, ON OUR ABILITY TO
PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH WE MAY NOT BE ABLE TO PROTECT

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

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

OUR PRODUCTS EMPLOY TECHNOLOGY THAT MAY INFRINGE ON THE PROPRIETARY RIGHTS OF
THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION

     Third parties may assert that our products infringe their proprietary
rights, or may assert claims for indemnification resulting from infringement
claims against us. Any such claims may cause us to delay or cancel shipment of
our products, which could materially adversely affect our business, financial
condition and results of operations. In addition, irrespective of the validity
or the successful assertion of such claims, we could incur significant costs in
defending against such claims.

WE ARE DEPENDENT ON PROPRIETARY TECHNOLOGY LICENSED FROM THIRD PARTIES, THE LOSS
OF WHICH COULD DELAY SHIPMENTS OF PRODUCTS INCORPORATING THIS TECHNOLOGY AND
COULD BE COSTLY

     Some of the technology used by our products is licensed from third parties,
generally on a nonexclusive basis. We believe that there are alternative sources
for each of the material components of technology we license from third parties.
However, the termination of any of these licenses, or the failure of the
third-party licensors to adequately maintain or update their products, could
result in delay in our ability to ship these products while we seek to implement
technology offered by alternative sources. Any required replacement
                                       17
<PAGE>   18

licenses could prove costly. Also, any delay, to the extent it becomes extended
or occurs at or near the end of a fiscal quarter, could result in a material
adverse effect on our quarterly results of operations. While it may be necessary
or desirable in the future to obtain other licenses relating to one or more of
our products or relating to current or future technologies, we cannot assure you
that we will be able to do so on commercially reasonable terms or at all.

POTENTIAL ACQUISITIONS MAY HAVE UNEXPECTED CONSEQUENCES OR IMPOSE ADDITIONAL
COSTS ON US

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

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

     - the risk of diverting management's attention from normal daily operations
       of the business;

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

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

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

     - the potential loss of key employees of the acquired company; and

     - the assumption of unforeseen liabilities of the acquired company.

We cannot assure you that our previous or future acquisitions will be successful
and will not adversely affect our financial condition or results of operations.
In fiscal 1997, we experienced difficulties in integrating and leveraging our
acquisitions of Cognisoft Corporation and 64K Incorporated. We must also
maintain our ability to manage any such growth effectively. Failure to manage
growth effectively and successfully integrate acquisitions we make could harm
our business and operating results.

                         RISKS RELATED TO OUR INDUSTRY

WE DEPEND ON INCREASING USE OF THE INTERNET, INTRANETS, EXTRANETS AND PORTALS
AND ON THE GROWTH OF ELECTRONIC COMMERCE. IF THE USE OF THE INTERNET, INTRANETS,
EXTRANETS AND PORTALS AND ELECTRONIC COMMERCE DO NOT GROW AS ANTICIPATED, OUR
BUSINESS WILL BE SERIOUSLY HARMED

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

     The business of most of our customers would be seriously harmed if:

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

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<PAGE>   19

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

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

CAPACITY CONSTRAINTS MAY RESTRICT THE USE OF THE INTERNET AS A COMMERCIAL
MARKETPLACE, WHICH WOULD RESTRICT OUR GROWTH

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

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

     - delayed development of enabling technologies and performance
       improvements;

     - delays in the development or adoption of new standards and protocols; and

     - increased governmental regulation.

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

SECURITY RISKS AND CONCERNS MAY DETER THE USE OF THE INTERNET FOR CONDUCTING
ELECTRONIC COMMERCE, WHICH WOULD ADVERSELY AFFECT THE DEMAND FOR OUR PRODUCTS

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

SECURITY RISKS EXPOSE US TO ADDITIONAL COSTS AND TO LITIGATION

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

                 RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK

THE MARKET PRICE OF OUR COMMON STOCK WILL FLUCTUATE AND YOU MAY LOSE ALL OR PART
OF YOUR INVESTMENT

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

     - future announcements concerning Verity or its competitors;

     - quarterly variations in operating results;

     - announcements of technological innovations;
                                       19
<PAGE>   20

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

     - proprietary rights or other litigation; and

     - changes in earnings estimates by analysts or other factors.

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

WE HAVE IMPLEMENTED CERTAIN ANTI-TAKEOVER PROVISIONS THAT MAY PREVENT OR DELAY
AN ACQUISITION OF VERITY THAT MIGHT BE BENEFICIAL TO OUR STOCKHOLDERS

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

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

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

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

     - limitations on who may call special meetings of stockholders;

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

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

     In September 1996, our board of directors adopted a Share Purchase Rights
Plan, commonly referred to as a "poison pill." In addition, the anti-takeover
provisions of Section 203 of the Delaware General Corporations Law and the terms
of our stock option plan may discourage, delay or prevent a change in control of
Verity.

                                       20
<PAGE>   21

                           FORWARD-LOOKING STATEMENTS

     This Annual Report on Form 10-K contains forward-looking statements. These
statements relate to future events or our future financial performance. In some
cases, you can identify forward-looking statements by terminology such as
"anticipates," "believes," "continue," "could," "estimates," "expects,"
"intends," "may," "plans," "potential," "predicts," "should" or "will" or the
negative of such terms or other comparable terminology. These statements are
only predictions and involve known and unknown risks, uncertainties and other
factors, including the risks outlined under "-- Risk Factors" above, that may
cause our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels or
activity, performance or achievements expressed or implied by such
forward-looking statements. In addition, this Annual Report on Form 10-K
contains forward-looking statements attributed to third party industry sources
relating to their estimates regarding the growth of Internet use. You should not
place undue reliance on these forward-looking statements.

     Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of such statements. We
are under no duty to update any of the forward-looking statements after the date
of this Annual Report on Form 10-K to conform such statements to actual results,
unless required by law.

                      EXECUTIVE OFFICERS OF THE REGISTRANT

     As of June 30, 2000, our executive officers and certain other key employees
were as follows:

<TABLE>
<CAPTION>
            NAME               AGE                               POSITION
            ----               ---                               --------
<S>                            <C>   <C>
Gary J. Sbona................  56    Chief Executive Officer and Chairman of the Board
Anthony J. Bettencourt.......  39    President and Director
Stephen W. Young.............  51    Chief Operating Officer
James E. Ticehurst...........  55    Vice President, Administration and Support Operations and
                                     Assistant Secretary
Todd K. Yamami...............  33    Vice President, Corporate Controller and Chief Accounting Officer
Dr. Ashok K. Chandra.........  51    Senior Vice President, Development and New Business Activities
Michael T. Zuckerman.........  44    Vice President, Marketing
Joseph J. Lawless............  46    Vice President, North American and International Sales
Sunil D. Nagdev..............  36    Vice President, Professional Services and Technical Support
Michael D. Mooney............  39    Vice President, Business Development
Hugo L. Sluimer..............  47    Vice President, European Operations
Dr. Prabhakar Raghavan.......  39    Chief Scientist and Vice President, Emerging Technologies
</TABLE>

     GARY J. SBONA has served as our Chief Executive Officer since July 1997, a
director since May 1998 and the Chairman of our Board of Directors since March
1999. Mr. Sbona also served as our President from July 1997 to September 1999.
Mr. Sbona currently serves as Chairman and Chief Executive Officer of Auspex
Systems Inc., a network attached storage company, and as a Director of 3D
Systems Corporation, a solid imaging and mass customization company. Since 1974,
Mr. Sbona also serves as chairman and chief executive officer of Regent Pacific
Management Corporation, a professional services firm that is currently providing
our company with management services.

     ANTHONY J. BETTENCOURT joined our company in July 1995 as Vice President of
North American sales. He was subsequently promoted to Vice President of
Worldwide Sales and Marketing and served in this position until his departure in
December 1996. Mr. Bettencourt rejoined our company in September 1997 as Senior
Vice President, Worldwide Sales and Product Marketing and was appointed to the
position of President in September 1999. Prior to initially joining our company,
Mr. Bettencourt served as vice president of sales for Versant Object Technology
from 1992 to June 1995 and as director of U.S. sales for Versant Object
Technology from July 1990 to 1992. Prior to rejoining us, Mr. Bettencourt served
as an officer of OnLive!

                                       21
<PAGE>   22

Technologies, a private technology company. From December 1988 to July 1990, Mr.
Bettencourt served as Vice President of Sales for Rockwell CMC. Mr. Bettencourt
holds a B.A. from Santa Clara University.

     STEPHEN W. YOUNG joined our company as part of the Regent Pacific
Management team in July 1997 and was subsequently appointed to the position of
Chief Operating Officer. Since 1990, Mr. Young has served as a principal of
Regent Pacific Management Corporation. Mr. Young holds a B.S. in Industrial
Administration and a M.B.A. from the University of Illinois.

     JAMES E. TICEHURST joined our company as Accounting Manager in December
1988 in a consulting capacity. He was subsequently promoted to Controller and in
October 1997 was appointed to the position of Vice President, Administration and
Controller and Assistant Secretary. From February 1999 to June 2000, Mr.
Ticehurst served as Vice President, Finance and Administration and Assistant
Secretary and since June 2000 he has served as Vice President, Administration
and Support Operations and Assistant Secretary. Mr. Ticehurst holds a B.S. in
Accounting from San Jose State University.

     TODD K. YAMAMI joined our company as Accounting Manager in June 1995, and
in November 1997 he was promoted to Director, Finance and Accounting. In
February 1999, Mr. Yamami was appointed to the position of Corporate Controller
and was subsequently promoted to Vice President, Corporate Controller and Chief
Accounting Officer in June 2000. Mr. Yamami holds a B.S. in Finance and a M.B.A.
from Santa Clara University.

     DR. ASHOK K. CHANDRA has served as our Senior Vice President of Development
and New Business Activities since March 2000. Prior to joining Verity, Dr.
Chandra was Director of Database Systems and Computer Science at IBM's Almaden
Research Center, a computer software and hardware research center, and held
several key management positions at IBM Corporation, an information technology
company, since 1973. Dr. Chandra holds his B. Tech in Electrical Engineering
from I.I.T. Karpur, his M.S. from University of California at Berkeley, and his
Ph.D. in Computer Science from Stanford University.

     MICHAEL T. ZUCKERMAN joined Verity in June 2000 as our Vice President of
Marketing. Prior to joining our company, Mr. Zuckerman served as Vice President
of Sales and Marketing at Sensar, Inc., a provider of network security products,
since November 1998. Before Sensar, Mr. Zuckerman worked for S.C. Bernstein &
Co., an investment management firm, from December 1997 to November 1998. From
January 1997 to December 1997 Mr. Zuckerman held the position of Chief Operating
Officer for LocalEyes Corporation, an Internet search and directory service
company. Prior to joining LocalEyes Corporation, Mr. Zuckerman served as Vice
President, Development Operations for File Tek, Inc., a software company, from
January 1995 to December 1996 and held other positions with File Tek to include
Vice President, Sales and Marketing. Mr. Zuckerman holds a B.S. in Electrical
Engineering from the University of Maryland.

     JOSEPH J. LAWLESS joined our company in July 1996 as Sales Manager and in
October 1997 he was promoted to Director of Sales, Northeast region, and was
subsequently appointed to Vice President, North American and International Sales
in September 1999. Prior to joining Verity, Mr. Lawless served as Sales Manager
at Dynasty Technologies, a private technology company, since May 1994. Mr.
Lawless also served as Sales Manager at Intersolv and Computer Associates. He
holds a B.A. in Business Administration from Albany State University.

     SUNIL D. NAGDEV joined our company as our Director of Professional Services
in November 1997, and was subsequently appointed to Vice President, Professional
Services and Technical Support in July 1999. Prior to Verity, he served as
Director of Technical Support at Versant Object Technology, a provider of object
management for e-business applications, since 1991, and before that, he was a
Senior Developer at Consilium. Mr. Nagdev holds a B.S. in Computer Science from
Chico State University.

     MICHAEL D. MOONEY has been our Vice President of Business Development since
February 2000. Prior to joining Verity, Mr. Mooney served as Vice President of
North American Sales for Adaptive Media, a provider of visual collaborative
commerce software and services, since 1997. Before joining Adaptive Media, he
was Vice President, Western Operations for Versant Object Technology, a provider
of object management for e-business applications, from 1991 to 1997. Mr. Mooney
also held a variety of sales and sales management positions at both Alantec and
Rockwell CMC.
                                       22
<PAGE>   23

     HUGO L. SLUIMER has been our Vice President, European Operations since May
1998, Mr. Sluimer joined Verity in June 1990 as Sales Manager and has served as
Director of Sales since March 1995. Prior to Verity, he held management
positions at Oracle BV (The Netherlands) and Digital Equipment BV (The
Netherlands). Mr. Sluimer holds a B.S. in Computer Science.

     DR. PRABHAKAR RAGHAVAN joined our company as Chief Scientist and Vice
President of Emerging Technologies in April 2000. Prior to Verity, he was the
head of the Computer Science Principles department at IBM's Almaden Research
Center, a computer software and hardware research center, since 1995 and was a
Research Staff Member from 1986 to 1994 at IBM T.J. Watson Research Center, also
a computer software and hardware research center. Dr. Raghavan is Consulting
Professor of Computer Science at Stanford University and holds an undergraduate
degree in Electrical Engineering from I.I.T. Madras and a Ph.D. in Electrical
Engineering and Computer Science from University of California at Berkeley.

ITEM 2. PROPERTIES

     Our principal administrative, sales, marketing and research and development
facilities occupy approximately 51,000 square feet in Sunnyvale, California. Our
operating lease agreement for this facility commenced in June 1996 and expires
in March 2005. Our average annual lease payment, based on the total 96,000
square feet of leased property, is scheduled to be approximately $1.2 million.
In addition, we also lease sales offices in Virginia, New York, Texas, Illinois,
England, Netherlands, France, Australia, Germany and a development and technical
support office in Canada.

ITEM 3. LEGAL PROCEEDINGS

     In December 1999, a number of complaints were filed in the United States
District Court for Northern District of California seeking an unspecified amount
of damages on behalf of an alleged class of persons who purchased shares of our
common stock during the period between December 1 and December 14, 1999. The
complaints name as defendants Verity and certain of its directors and officers,
asserting that they violated federal securities laws by misrepresenting Verity's
business and earnings growth ability to continue to achieve profitable growth,
and failing to disclose certain information about our business. While management
intends to defend the actions against us vigorously, there can be no assurance
that an adverse result or settlement with regards to these lawsuits would not
have a material adverse effect on our financial condition or results of
operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

     Not Applicable.

                                       23
<PAGE>   24

                                    PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDERS
MATTERS

     Our common stock is traded on the Nasdaq National Market under the symbol
VRTY.

     The following table sets forth the high and low closing sales prices of our
common stock as reported by the Nasdaq National Market for the periods
indicated.

<TABLE>
<CAPTION>
                                                              HIGH      LOW
                                                             ------    ------
<S>                                                          <C>       <C>
Fiscal Year ended May 31, 1999
  First Quarter............................................  $ 6.57    $ 2.57
  Second Quarter...........................................    9.44      2.94
  Third Quarter............................................   20.32      8.63
  Fourth Quarter...........................................   21.44     15.10
Fiscal Year ended May 31, 2000
  First Quarter............................................  $54.18    $35.38
  Second Quarter...........................................   59.56     22.63
  Third Quarter............................................   56.38     26.13
  Fourth Quarter...........................................   60.00     24.25
</TABLE>

     As of May 31, 2000, there were approximately 187 holders of record of our
common stock and 31,605,641 shares of our common stock outstanding.

     We have never declared or paid any cash dividends on our common stock. We
currently intend to retain all future earnings to finance the expansion of our
business and, therefore, do not anticipate declaring or paying any cash
dividends on our common stock in the foreseeable future. The payment of
dividends, if any, in the future is within the discretion of our board of
directors and will depend on our earnings, capital requirements, financial
condition, and other relevant factors.

                                       24
<PAGE>   25

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                      FISCAL YEAR ENDED MAY 31,
                                        ------------------------------------------------------
                                         1996        1997        1998       1999        2000
                                        -------    --------    --------    -------    --------
                                                (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                     <C>        <C>         <C>         <C>        <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues:
  Software products...................  $24,472    $ 34,934    $ 28,658    $48,327    $ 69,655
  Service and other...................    6,246       7,737      10,200     16,098      26,445
                                        -------    --------    --------    -------    --------
          Total revenues..............   30,718      42,671      38,858     64,425      96,100
                                        -------    --------    --------    -------    --------
Costs of revenues:
  Software products...................    2,074       2,688       2,426      1,218         880
  Service and other...................    2,785       3,892       5,178      4,660       8,357
                                        -------    --------    --------    -------    --------
          Total costs of revenues.....    4,859       6,580       7,604      5,878       9,237
                                        -------    --------    --------    -------    --------
Gross profit..........................   25,859      36,091      31,254     58,547      86,863
                                        -------    --------    --------    -------    --------
Operating expenses:
  Research and development............    8,488      14,310      15,544     13,711      16,017
  Acquisition of in-process research
     and development and other........      381      14,894          --         --          --
  Marketing and sales.................   14,912      21,505      22,757     26,860      38,742
  General and administrative..........    3,469       4,864       7,610      6,323       6,847
  Restructuring charges...............       --          --       3,006         --          --
                                        -------    --------    --------    -------    --------
          Total operating expenses....   27,250      55,573      48,917     46,894      61,606
                                        -------    --------    --------    -------    --------
Income/(loss) from operations.........   (1,391)    (19,482)    (17,663)    11,653      25,257
Other income, net.....................    1,342       1,943       1,553      1,085       5,623
Interest expense......................     (264)       (212)       (100)        (8)        (20)
                                        -------    --------    --------    -------    --------
Income/(loss) before provision for
  income taxes........................     (313)    (17,751)    (16,210)    12,730      30,860
Income tax provision/(benefit)........       --         180         300        600      (2,150)
                                        -------    --------    --------    -------    --------
Net income/(loss).....................  $  (313)   $(17,931)   $(16,510)   $12,130    $ 33,010
                                        =======    ========    ========    =======    ========
Net income/(loss) per share --basic...  $ (0.06)   $  (0.83)   $  (0.74)   $  0.50    $   1.10
                                        =======    ========    ========    =======    ========
Net income/(loss) per
  share -- diluted....................  $ (0.06)   $  (0.83)   $  (0.74)   $  0.44    $   0.95
                                        =======    ========    ========    =======    ========
Number of shares used in per share
  calculation -- basic................   15,658      21,680      22,450     24,198      30,026
                                        =======    ========    ========    =======    ========
Number of shares used in per share
  calculation -- diluted..............   15,658      21,680      22,450     27,700      34,886
                                        =======    ========    ========    =======    ========
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.............  $ 2,482    $  2,934    $  5,505    $ 7,907    $  7,183
Working capital.......................   44,087      18,676      15,912     33,282     134,527
Total assets..........................   62,724      49,443      41,449     65,026     213,378
Long-term obligations, net of current
  portion.............................      639         167           2         --          --
Stockholders' equity..................   52,808      37,273      24,055     43,419     183,634
</TABLE>

     The net loss used in computing net loss per share has been increased by the
accretion of the mandatorily redeemable convertible preferred stock to its
redemption value in the year ended May 31, 1996 of $611,000. See Note 2 of Notes
to Consolidated Financial Statements beginning on page 41 of this Annual Report
on Form 10-K for an explanation of the method used to determine the number of
shares used to compute per share amounts.

                                       25
<PAGE>   26

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, which appear elsewhere in
this Annual Report on Form 10-K. The following discussion contains
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including those discussed below and
elsewhere in this Annual Report on Form 10-K, particularly under the heading
"Item 1. Business -- Risk Factors."

OVERVIEW

     From 1988 to 1994, we derived substantially all of our revenues from the
license of custom search and retrieval applications and consulting and other
services related to such applications. Recently, we have refined and enhanced
our core technology to add functionality and facilitate incorporation of our
technology in a variety of applications addressing the enterprise, Internet,
online, and original equipment manufacturer, or OEM, markets. We expect that for
the foreseeable future we will continue to derive the largest portion of our
revenues from licensing our technology for enterprise applications.

     During fiscal 1997 and early fiscal 1998, we incurred substantial net
losses and our quarterly revenues fluctuated significantly. In particular, we
incurred reduced revenues on a quarter-to-quarter basis in the first quarter of
fiscal 1997, the third quarter of fiscal 1997 and the first quarter of fiscal
1998. In this period, we experienced significant turnover in our workforce,
including turnover of several members of senior management. Also, we experienced
difficulties in integrating or leveraging our acquisitions of Cognisoft
Corporation and 64K Incorporated in fiscal 1997. Under these circumstances, on
July 31, 1997 we retained Mr. Gary J. Sbona as our president and chief executive
officer, and we entered into an agreement with Regent Pacific Management
Corporation, a management firm of which Mr. Sbona is the chairman and chief
executive officer. Pursuant to this agreement, Regent Pacific has provided
management services for Verity, including the services of Mr. Sbona as chief
executive officer and other Regent Pacific personnel as part of our management
team.

     Starting in fiscal 1998, the new management team implemented changes
designed to refocus our business on our core products and markets and to
streamline operations. In connection with the changes, we incurred a $3.0
million restructuring charge in the quarter ended November 30, 1997. Our
restructuring and renewed focus contributed to significantly improved results
during the second half of fiscal 1998 and during fiscal years 1999 and 2000.
During the quarterly periods ended August 31, 1997 to August 31, 1999 and
February 29, 2000 to May 31, 2000, we experienced increased revenues on a
quarterly basis. In addition, during the quarterly periods ended May 31, 1998 to
August 31, 1999 and February 29, 2000 to May 31, 2000, we experienced eight
quarters of record revenues and profitability. Due to a delay in closing three
large transactions, revenues for the quarter ended November 31, 1999 were lower
than expected. We incurred a net loss of $16.5 million in fiscal 1998, which
included the $3.0 million restructuring charge. In fiscal years 1999 and 2000,
we achieved net income of $12.1 million and $33.0 million, respectively. While
our goal is to increase revenue and generate net income in future periods, we
cannot assure you that our strategy will be successful, that we will experience
the rate of revenue growth we experienced from August 31, 1997 to May 31, 2000
in future periods, or that we will continue to maintain positive cash flow or
profitability.

     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. Fees for services generally are charged separately from
the license fees for our software products. Effective for contracts entered into
starting June 1, 1998, we recognize revenues in accordance with the provisions
of American Institute of Certified Public Accountants Statement of Position No.
97-2, "Software Revenue Recognition." In December 1998, AcSEC released
provisions of SOP 98-9 that extend the deferral of certain paragraphs of SOP
97-2. These paragraphs of SOP 97-2 and SOP 98-9 became effective for
transactions that are entered into fiscal years beginning after March 15, 1999.
We recognize maintenance revenues from ongoing customer support and product
upgrades ratably over the term of the applicable maintenance agreement, which is
typically 12 months. Generally, we receive payments for maintenance fees in
advance and they are nonrefundable. We

                                       26
<PAGE>   27

recognize revenues for consulting and training generally when the services are
performed. Statement of Position No. 97-2 supersedes Statement of Position No.
91-1, "Software Revenue Recognition," and was effective for transactions we
entered into in fiscal years beginning after December 15, 1997.

     For contracts with multiple elements (e.g., deliverable and undeliverable
products, maintenance and other services), the Company allocates revenue to each
component of the contract based on objective evidence of its fair value, which
is specific to the Company, or for products not being sold separately, the price
established by management. The Company recognizes revenue allocated to
undelivered products when the criteria for product revenue set forth above are
met. The Company recognizes revenue allocated to maintenance fees for ongoing
customer support and product updates ratably over the period of the maintenance
contract. Payments for maintenance fees are generally made in advance and are
non-refundable. For revenue allocated to training and consulting services, the
Company recognizes revenue as the related services are performed.

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:

<TABLE>
<CAPTION>
                                                      FISCAL YEAR ENDED MAY 31,
                                                      --------------------------
                                                       1998      1999      2000
                                                      ------    ------    ------
<S>                                                   <C>       <C>       <C>
Revenues:
  Software products.................................   73.8%     75.0%     72.5%
  Service and other.................................   26.2      25.0      27.5
                                                      -----     -----     -----
          Total revenues............................  100.0     100.0     100.0
                                                      -----     -----     -----
Costs of revenues:
  Software products.................................    6.3       1.9       0.9
  Service and other.................................   13.3       7.2       8.7
                                                      -----     -----     -----
          Total costs of revenues...................   19.6       9.1       9.6
                                                      -----     -----     -----
Gross margin........................................   80.4      90.9      90.4
                                                      -----     -----     -----
Operating expenses:
  Research and development..........................   40.0      21.3      16.7
  Marketing and sales...............................   58.6      41.7      40.3
  General and administrative........................   19.6       9.8       7.1
  Restructuring charges.............................    7.7       0.0       0.0
                                                      -----     -----     -----
          Total operating expenses..................  125.9      72.8      64.1
                                                      -----     -----     -----
Income/(loss) from operations.......................  (45.5)     18.1      26.3
Other income, net...................................    3.8       1.7       5.8
                                                      -----     -----     -----
Income/(loss) before provision for income taxes.....  (41.7)     19.8      32.1
Income tax provision/(benefit)......................    0.8       1.0      (2.2)
                                                      -----     -----     -----
Net income/(loss)...................................  (42.5)%    18.8%     34.3%
                                                      =====     =====     =====
</TABLE>

YEARS ENDED MAY 31, 1998, 1999 AND 2000

  Revenues

     Our total revenues increased 65.8% from $38.9 million in fiscal 1998 to
$64.4 million in fiscal 1999 and increased 49.2% to $96.1 million in fiscal
2000. The increase from fiscal years 1998 to 1999 was due principally to higher
revenues from licensing development kits and enterprise products. The increase
from fiscal year 1999 to 2000 was due primarily to higher revenues from
licensing Topic tools and enterprise products. Software product revenues
increased as a percentage of total revenues from 73.8% in fiscal 1998 to 75.0%
in fiscal 1999 and decreased to 72.5% in fiscal 2000. Service and other revenues
decreased as a percentage of total revenues from 26.2% in fiscal 1998 to 25.0%
in fiscal 1999 and increased to 27.5% in fiscal 2000.

                                       27
<PAGE>   28

     Software products revenues. Our software products revenues increased 68.6%
from $28.7 million in fiscal 1998 to $48.3 million in fiscal 1999 and increased
44.1% to $69.7 million in fiscal 2000. The increase from fiscal 1998 to fiscal
1999 was principally due to higher revenues from licensing development kits and
enterprise products. The increase from fiscal 1999 to 2000 was due primarily to
higher revenues from licensing Topic tools and enterprise products.

     Service and other revenues. Our service and other revenues consist
primarily of fees for software, maintenance, consulting and training. Service
and other revenues increased 57.8% from $10.2 million in fiscal 1998 to $16.1
million in fiscal 1999 and increased 64.3% to $26.4 million in fiscal 2000. The
increase in service revenues in fiscal 1999 and fiscal 2000 was due primarily to
increase in maintenance and consulting revenues.

     Revenues derived from foreign operations accounted for 6.1%, 6.4% and 6.8%
of total revenues, respectively, in fiscal 1998, 1999 and 2000. Our export sales
consist primarily of products licensed for delivery outside of the United
States. In fiscal years 1998, 1999 and 2000, export sales accounted for 26.6%,
27.1% and 19.0% of total revenues, respectively.

     No single customer accounted for 10% or more of our revenues during fiscal
years 1998, 1999 or 2000. Revenues derived from sales to the federal government
and its agencies were 9.0%, 8.1% and 7.8% of total revenues in fiscal years
1998, 1999 and 2000, respectively. Sales to government agencies declined as a
percentage of revenues from fiscal 1998 to fiscal 2000, and may decline in the
future.

  Costs of Revenues

     Costs of software products. The cost of our software products consist
primarily of product media, duplication, manuals, packaging materials, shipping
expenses and royalties, and in certain instances, licensing of third-party
software incorporated in our products. Costs of our software products decreased
49.8% from $2.4 million in fiscal 1998 to $1.2 million in fiscal 1999 and
decreased 27.8% to $880,000 in fiscal 2000, representing 8.5%, 2.5% and 1.3%,
respectively, of software product revenues. The decrease in costs of revenues
from fiscal 1998 to fiscal 1999 was related to the elimination of the
amortization expense related to capitalized software and decreasing costs of
third party software components in fiscal 1999. The decrease in absolute dollars
from fiscal 1999 to fiscal 2000 was principally related to decreasing costs of
third party software components in fiscal 2000. The decrease as a percentage of
software product revenue was also due to increased software product revenue.
During fiscal 1998, we capitalized software development costs in the amount of
$198,000, which have been fully amortized as of May 31, 1998. In fiscal 1999 and
fiscal 2000, we did not capitalize any software development costs since such
costs were not significant. Amortization is included in the costs of software
products.

     Costs of service and other. Our costs of service and other consists of
costs incurred in providing consulting services, customer training, telephone
support and product upgrades to customers. Costs of service and other decreased
10.0% from $5.2 million in fiscal 1998 to $4.7 million in fiscal 1999 and
increased 79.3% to $8.4 million in fiscal 2000. As a percentage of service and
other revenue, these costs represented 50.8%, 29.0% and 31.6% in fiscal years
1998, 1999 and 2000, respectively. The decrease in costs of service and other
from fiscal 1998 to fiscal 1999 was primarily related to reduced expenses
associated with the transfer of technical support operations from California to
Calgary, Canada. The increase in costs of service and other and as a percentage
of service and other revenue from fiscal 1999 to fiscal 2000 was primarily
related to increasing consulting staff and third party consulting services in
order to support a greater customer demand for consulting services.

  Operating Expenses

     Research and development. Research and development expenses decreased 11.8%
from $15.5 million in fiscal 1998 to $13.7 million in fiscal 1999 and increased
16.8% to $16.0 million in fiscal 2000, representing 40.0%, 21.3% and 16.7% of
total revenues, respectively. The decrease in absolute dollars from fiscal 1998
to fiscal 1999 was a result of a discontinuation of certain operations related
to our Insite, Cognisoft and 64K subsidiaries in fiscal 1998. The increase in
absolute dollars from fiscal 1999 to fiscal 2000 was primarily due to a
significant increase in research and development personnel to focus on
enhancement of existing
                                       28
<PAGE>   29

products and development of new products addressing the business portal market.
We believe that research and development expenses will continue to increase in
the future primarily due to the introduction of new products and other
anticipated product development efforts. Our future research and development
expenses may vary as a percentage of total revenues.

     During fiscal 1998, we capitalized software development costs in the amount
of $198,000. We did not capitalize software development costs in fiscal 1999 and
fiscal 2000 since such costs were not significant.

     Marketing and sales. Our marketing and sales expenses consist primarily of
salaries and commissions of sales and marketing personnel, advertising and
promotion expenses, pre-sales customer service and support costs. Marketing and
sales expenses increased 18.0% from $22.8 million in fiscal 1998 to $26.9
million in fiscal 1999 and increased 44.2% to $38.7 million in fiscal 2000,
representing 58.6%, 41.7% and 40.3% of total revenues, respectively. These
increases in absolute dollars were primarily related to our expansion of our
marketing and sales organizations, and continued development of our sales
distribution channels in the United States and Europe. We anticipate that we
will continue to make significant investments in marketing and sales.

     General and administrative. General and administrative expenses decreased
16.9% from $7.6 million in fiscal 1998 to $6.3 million in fiscal 1999 and
increased 8.3% to $6.8 million in fiscal 2000, representing 19.6%, 9.8% and 7.1%
of total revenues, respectively. The decrease from fiscal 1998 to fiscal 1999 in
absolute dollars was primarily due to a decrease in legal expenses as well as
the discontinuation of our Cognisoft subsidiary. The increase in absolute
dollars from fiscal 1999 to fiscal 2000 was primarily due to increases in
professional service fees required to support our operations.

     Restructuring charges. During the quarter ended November 30, 1997, we
implemented a worldwide restructuring of our corporate operations, which
resulted in workforce reductions and business consolidations. In connection with
the restructuring, we recorded a $3.0 million restructuring charge in the
quarter ended November 30, 1997, of which $1.6 million was related to severance
costs associated with the reduction in the worldwide workforce, $0.5 million to
the termination of certain lease agreements, $0.6 million to the write-off of
certain assets and $0.3 million to the costs associated with the restructuring.

INCOME TAXES

     As of May 31, 2000, we had approximately $49.8 million and $15.3 million of
net operating loss carryforwards for federal and California State income tax
purposes, respectively, to offset future taxable income. At May 31, 2000, we
have federal and state research and development tax credit carryforwards of
approximately $3.2 million and $1.0 million, respectively. These carryforwards
expire in the years 2000 to 2020 if not utilized. A portion of our net operating
loss and tax credit carryforwards are subject to an annual limitation of
approximately $4.9 million as a result of an ownership change, as defined by tax
laws.

     Prior to the quarter ended May 31, 2000, we established a valuation
allowance against our deferred tax assets due to the uncertainty surrounding the
realization of such assets. On a quarterly basis, we review the recoverability
of the deferred tax assets. At May 31, 1999, we had a valuation allowance
totaling $18.9 million against our deferred tax assets. At May 31, 2000, we
assessed the realizability of the deferred tax assets and the entire valuation
allowance was reversed, due to our increased earnings. Based on management's
assessment, it is more likely than not that all the net deferred tax assets will
be realized through future taxable earnings. See Note 7 of Notes to Consolidated
Financial Statements beginning on page 50 of this Annual Report on Form 10-K.

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, 2000. 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

                                       29
<PAGE>   30

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 -- Risk Factors."

<TABLE>
<CAPTION>
                                                                                 QUARTER ENDED
                                              -----------------------------------------------------------------------------------
                                              AUG. 31,   NOV. 30,   FEB. 28,   MAY 31,   AUG. 31,   NOV. 30,   FEB. 29,   MAY 31,
                                                1998       1998       1999      1999       1999       1999       2000      2000
                                              --------   --------   --------   -------   --------   --------   --------   -------
                                                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                           <C>        <C>        <C>        <C>       <C>        <C>        <C>        <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues:
  Software products.........................  $ 9,889    $11,497    $12,468    $14,473   $14,474    $10,093    $22,514    $22,574
  Service and other.........................    3,331      3,713      4,267      4,787     5,291      6,624      6,706      7,824
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total revenues......................   13,220     15,210     16,735     19,260    19,765     16,717     29,220     30,398
                                              -------    -------    -------    -------   -------    -------    -------    -------
Costs of revenues:
  Software products.........................      437        401        211        169       144        173        254        309
  Service and other.........................    1,082      1,074      1,159      1,345     1,620      2,290      2,050      2,397
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total costs of revenues.............    1,519      1,475      1,370      1,514     1,764      2,463      2,304      2,706
                                              -------    -------    -------    -------   -------    -------    -------    -------
Gross profit................................   11,701     13,735     15,365     17,746    18,001     14,254     26,916     27,692
                                              -------    -------    -------    -------   -------    -------    -------    -------
Operating expenses:
  Research and development..................    3,275      3,299      3,521      3,616     3,726      3,736      4,018      4,537
  Marketing and sales.......................    5,952      6,608      6,783      7,517     8,064      8,718     10,589     11,371
  General and administrative................    1,381      1,610      1,630      1,702     1,580      1,600      1,779      1,888
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total operating expenses............   10,608     11,517     11,934     12,835    13,370     14,054     16,386     17,796
                                              -------    -------    -------    -------   -------    -------    -------    -------
Income from operations......................    1,093      2,218      3,431      4,911     4,631        200     10,530      9,896
Other income, net...........................      287        297        229        264       629      1,490      1,800      1,684
                                              -------    -------    -------    -------   -------    -------    -------    -------
Income before provision for income taxes....    1,380      2,515      3,660      5,175     5,260      1,690     12,330     11,580
Income tax provision/(benefit)..............      150        150        150        150       150        150        150     (2,600)
                                              -------    -------    -------    -------   -------    -------    -------    -------
Net income..................................  $ 1,230    $ 2,365    $ 3,510    $ 5,025   $ 5,110    $ 1,540    $12,180    $14,180
                                              =======    =======    =======    =======   =======    =======    =======    =======
Net income per share -- basic...............  $  0.05    $  0.10    $  0.14    $  0.20   $  0.19    $  0.05    $  0.39    $  0.45
                                              =======    =======    =======    =======   =======    =======    =======    =======
Net income per share -- diluted.............  $  0.05    $  0.09    $  0.12    $  0.17   $  0.16    $  0.04    $  0.34    $  0.39
                                              =======    =======    =======    =======   =======    =======    =======    =======
Number of shares used in per share
  calculation -- basic......................   23,254     23,647     24,543     25,350    26,972     30,514     31,159     31,460
                                              =======    =======    =======    =======   =======    =======    =======    =======
Number of shares used in per share
  calculation -- diluted....................   25,764     26,290     29,082     29,660    31,612     35,357     36,306     36,269
                                              =======    =======    =======    =======   =======    =======    =======    =======
</TABLE>

<TABLE>
<CAPTION>
                                                                       AS A PERCENTAGE OF TOTAL REVENUES
                                              -----------------------------------------------------------------------------------
<S>                                           <C>        <C>        <C>        <C>       <C>        <C>        <C>        <C>
Revenues:
  Software products.........................     74.8%      75.6%      74.5%      75.1%     73.2%      60.4%      77.0%      74.3%
  Service and other.........................     25.2       24.4       25.5       24.9      26.8       39.6       23.0       25.7
                                               ------    -------    -------    -------   -------    -------    -------    -------
        Total revenues......................    100.0      100.0      100.0      100.0     100.0      100.0      100.0      100.0
                                               ------    -------    -------    -------   -------    -------    -------    -------
Costs of revenues:
  Software products.........................      3.3        2.6        1.3        0.9       0.7        1.0        0.9        1.0
  Service and other.........................      8.2        7.1        6.9        7.0       8.2       13.7        7.0        7.9
                                               ------    -------    -------    -------   -------    -------    -------    -------
        Total costs of revenues.............     11.5        9.7        8.2        7.9       8.9       14.7        7.9        8.9
                                               ------    -------    -------    -------   -------    -------    -------    -------
Gross profit................................     88.5       90.3       91.8       92.1      91.1       85.3       92.1       91.1
                                               ------    -------    -------    -------   -------    -------    -------    -------
Operating expenses:
  Research and development..................     24.8       21.7       21.0       18.8      18.9       22.3       13.8       14.9
  Marketing and sales.......................     45.0       43.4       40.6       39.0      40.8       52.2       36.2       37.4
  General and administrative................     10.4       10.6        9.7        8.8       8.0        9.6        6.1        6.2
                                               ------    -------    -------    -------   -------    -------    -------    -------
        Total operating expenses............     80.2       75.7       71.3       66.6      67.7       84.1       56.1       58.5
                                               ------    -------    -------    -------   -------    -------    -------    -------
Income from operations......................      8.3       14.6       20.5       25.5      23.4        1.2       36.0       32.6
Other income, net...........................      2.1        2.0        1.4        1.4       3.2        8.9        6.2        5.5
                                               ------    -------    -------    -------   -------    -------    -------    -------
Income before provision for income taxes....     10.4       16.6       21.9       26.9      26.6       10.1       42.2       38.1
Income tax provision/(benefit)..............      1.1        1.0        0.9        0.8       0.7        0.9        0.5       (8.5)
                                               ------    -------    -------    -------   -------    -------    -------    -------
Net income..................................      9.3%      15.6%      21.0%      26.1%     25.9%       9.2%      41.7%      46.6%
                                               ======    =======    =======    =======   =======    =======    =======    =======
</TABLE>

                                       30
<PAGE>   31

LIQUIDITY AND CAPITAL RESOURCES

     Since our inception, we have financed our operations primarily through
proceeds of approximately $23.6 million from private sales of preferred stock,
proceeds from our initial public offering and secondary offerings of common
stock and, to a lesser extent, bank credit lines and capital leases. We
completed our initial public offering of common stock in October 1995 and
realized net proceeds of $32.5 million. In January 1996, we completed our
secondary offering of common stock, which generated net proceeds of $16.5
million. In August 1999, we completed another public offering of common stock,
which generated net proceeds of $71.0 million. We intend to use the net proceeds
from the sale of the common stock for general corporate purposes, including
working capital, content development and licensing, advertising and brand
promotion, and potentially for the acquisition of or investment in companies,
technologies or assets that complement our business. As of May 31, 2000, we had
$154.3 million in cash and cash equivalents and available-for-sale securities
compared to $40.3 million at May 31, 1999.

     Our operating activities used cash of $9.0 million in fiscal 1998, and
provided cash of $14.9 million and $8.2 million in fiscal 1999 and 2000,
respectively. Cash used in our operations in fiscal 1998 was primarily due to
our net loss and increase in accounts receivable partially offset by
depreciation and amortization expense and an increase in deferred revenue. Cash
provided by operations in fiscal 1999 was primarily due to our net income, an
increase in accrued compensation and other accrued liabilities and depreciation
and amortization expense partially offset by an increase in accounts receivable.
Cash provided in connection with operating activities in fiscal 2000 was
principally due to our net income, depreciation and amortization expense, an
increase in deferred revenue and accrued compensation and other accrued
liabilities, offset mainly by an increase in accounts receivable and the release
of the deferred tax assets.

     Cash provided by investing activities in fiscal 1998 was $9.0 million and
cash used in investing activities in fiscal 1999 and 2000 was $19.6 million and
$116.5 million, respectively. In fiscal 1998, the sale and maturity of
marketable securities were substantially offset by the purchase of marketable
securities and property and equipment. In fiscal 1999 and 2000, our purchase of
marketable securities was partially offset by the sale and maturity of
marketable securities.

     Cash provided by financing activities was $2.7 million, $7.1 million and
$107.6 million in fiscal 1998, 1999 and 2000, respectively. In fiscal 1998 and
1999, such financing activities consisted primarily of the sale of common stock
to employees through our employee stock purchase plan and proceeds from the
exercise of stock options. In fiscal 1998, financing activities also consisted
of the proceeds from stockholders on notes receivable. Financing activities in
fiscal 2000 consisted principally of proceeds from the secondary offering of our
common stock, the exercise of stock options, sales of common stock to employees
through our employee stock purchase plan and the release of our deferred tax
assets.

     At May 31, 2000, our principal sources of liquidity were our cash and cash
equivalents and short-term investments of $116.7 million. As of May 31, 2000, we
had no outstanding debt obligations.

     Capital expenditures, including capital leases, were approximately
$707,000, $577,000 and $1.9 million in fiscal 1998, 1999 and 2000, respectively.
In fiscal 1998 and 1999, these expenditures consisted principally of purchases
of property and equipment, primarily for computer hardware and software. In
fiscal 2000, the increase was due principally to the purchases of property and
equipment, primarily for computer hardware and software as a result of our
increase in headcount during the fiscal year. Under our operating leases, we
have minimum rental payments of approximately $1.7 million for each of our
fiscal years through fiscal 2005. See Note 5 of Notes to our Consolidated
Financial Statements.

     We believe that our current cash and cash equivalents, proceeds from our
public offering, and our funds generated from operations, if any, will provide
adequate liquidity to meet our capital and operating requirements through at
least fiscal 2002. Thereafter, or if our spending plans change, we may find it
necessary to seek to obtain additional sources of financing to support our
capital needs, but we cannot assure you that such financing will be available on
commercially reasonable terms, or at all.

                                       31
<PAGE>   32

RECENT PRONOUNCEMENTS

     In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS
133"), which establishes new standards of accounting and reporting for
derivative instruments and hedging activities. SFAS 133 requires that all
derivatives be recognized at fair value in the statement of financial position,
and that the corresponding gains or losses be reported either in the statement
of operations or as a component of comprehensive income, depending on the type
of hedging relationship that exists. SFAS 133 is effective for fiscal years
beginning after June 15, 2000. We are currently assessing the potential impact
of this pronouncement on our financial statements.

     In December 1998, AcSEC released Statement of Position 98-9, Modification
of SOP 97-2, Software Revenue Recognition ("SOP 98-9"), with Respect to Certain
Transactions. SOP 98-9 amends SOP 97-2 to require that an entity recognize
revenue for multiple element arrangements by means of the "residual method" when
(1) there is vendor-specific objective evidence ("VSOE") of the fair values of
all the undelivered elements that are not accounted for by means of long-term
contract accounting, (2) VSOE of fair value does not exist for one or more of
the delivered elements, and (3) all revenue recognition criteria of SOP 97-2
(other than the requirement for VSOE of the fair value of each delivered
element) are satisfied. The provisions of SOP 98-9 that extend the deferral of
certain paragraphs of SOP 97-2 became effective December 15, 1998. These
paragraphs of SOP 97-2 and SOP 98-9 were effective for transactions that are
entered into in fiscal years beginning after March 15, 1999. Retroactive
application is prohibited. The adoption of SOP 98-9 did not have a material
impact on our financial statements.

     In December 1999, the Securities Exchange Commission ("SEC") issued to
Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements, which outlines the basic criteria that must be met to recognize
revenue and provides guidance for presentation of revenue and for disclosure
related to revenue recognition policies in financial statements filed with the
SEC. In June 2000, the SEC issued SAB 101(B), which defers the implementation
date of SAB 101 to no later than the fourth fiscal quarter of fiscal years
commencing after December 15, 1999. We have evaluated the provision of SAB 101
and we are in compliance with SAB 101.

     In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation -- an
Interpretation of APB 25." This Interpretation clarifies (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a non-compensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. This Interpretation is effective July 1, 2000,
but certain conclusions in this Interpretation cover specific events that occur
after either December 15, 1998, or January 12, 2000. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000 the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. We do not expect that the adoption of FIN 44 will have a
material effect on the financial statements.

IMPACT OF EUROPEAN MONETARY CONVERSION

     We are aware of the issues associated with the changes in Europe resulting
from the formation of a European economic and monetary union. One change
resulting from this union required EMU member states to irrevocably fix their
respective currencies to a new currency, the Euro, as of January 1, 1999, at
which date the euro became a functional legal currency of these countries.
During the next three years, business in the EMU member states will be conducted
in both the existing national currencies, such as the French franc or the
Deutsche mark, and the euro. As a result, companies operating or conducting
business in EMU member states will need to ensure that their financial and other
software systems are capable of processing transactions and properly handling
these currencies, including the euro. The adoption of Euro by EMU member states
has had no material impact on our operations or financial results.

                                       32
<PAGE>   33

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 risk. To achieve this objective, we maintain our
portfolio of cash equivalents and investments in a variety of securities,
including both government and corporate obligations and money market funds. As
of May 31, 2000, approximately 71% of our total portfolio matures in one year or
less, with the remainder maturing in less than three years. We do not use
derivative financial instruments in our investment portfolio. We place our
investments with high credit quality issuers and, by policy, limit the amount of
credit exposure to any one issuer.

     The following table presents the amounts of our cash equivalents and
investments that are subject to interest rate risk by year of expected maturity
and average interest rates as of May 31, 2000:

<TABLE>
<CAPTION>
                                 FY2001     FY2002     FY2003    FY2004     TOTAL      FAIR VALUE
                                --------    -------    ------    ------    --------    ----------
                                                         (IN THOUSANDS)
<S>                             <C>         <C>        <C>       <C>       <C>         <C>
Cash equivalents............    $  7,183         --        --     --       $  7,183     $  7,183
Average interest rate.......         2.7%
Short-term investments......    $109,472         --        --     --       $109,472     $109,472
Average interest rate.......         6.4%
Long-term investments.......          --    $35,616    $2,000     --       $ 37,616     $ 37,616
Average interest rates......                    6.3%      7.4%
</TABLE>

     Foreign Currency Risk. We transact business in various foreign currencies,
including the British pound, the German mark, the Dutch guilder, the French
Franc, the Canadian dollar and the Australian dollar. We have established a
foreign currency hedging program utilizing foreign currency forward exchange
contracts to hedge certain sales contracts denominated in foreign currency.
Under this program, fluctuations in foreign currencies during the period from
the signing of the contract until payment are partially offset by realized gains
and losses on the hedging instruments. The goal of this hedging program is to
lock in exchange rates on our sales contracts denominated in foreign currencies.
The notional amount of hedged contracts and the estimated fair value are not
material.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Our Consolidated Financial Statements and Notes thereto, and related
Financial Schedule, appear on pages 37 to 55 of this Annual Report on Form 10-K.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS OR ACCOUNTING AND
FINANCIAL MATTERS

     Not applicable.

                                       33
<PAGE>   34

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information relating to our executive officers required by this item is set
forth in Part I -- Item 1 of this report under the caption "Executive Officers
of the Registrant" and is incorporated herein by reference. The other
information required by this Item is incorporated by reference from the
definitive proxy statement for our 2000 annual meeting of stockholders to be
filed with the Commission pursuant to Regulation 14A not later than 120 days
after the end of the fiscal year covered by this Form (the "Proxy Statement")
under the captions "PROPOSAL 1, ELECTION OF DIRECTORS" and "SECTION 16(A)
BENEFICIAL OWNERSHIP REPORTING COMPLIANCE."

ITEM 11. EXECUTIVE COMPENSATION

     The information required by this Item is incorporated by reference from the
Proxy Statement under the caption "EXECUTIVE COMPENSATION," "Employment
Agreements and Termination and Change in Control Agreements" and "Compensation
Committee Interlocks and Insider Participation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this Item is incorporated by reference from the
Proxy Statement under the captions "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this Item is incorporated by reference from the
Proxy Statement under the captions "CERTAIN TRANSACTIONS."

                                       34
<PAGE>   35

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

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

<TABLE>
<CAPTION>
                                                               PAGE
                                                              NUMBER
                                                              ------
<S>                                                           <C>
1. Financial Statements:
  Report of Independent Accountants.........................    36
  Consolidated Balance Sheets -- As of May 31, 2000 and
     1999...................................................    37
  Consolidated Statements of Operations -- For the Years
     Ended May 31, 2000, 1999 and 1998......................    38
  Consolidated Statements of Changes in Stockholders'
     Equity -- For the Years Ended May 31, 2000, 1999 and
     1998...................................................    39
  Consolidated Statements of Cash Flows -- For the Years
     Ended May 31, 2000, 1999 and 1998......................    40
  Notes to Consolidated Financial Statements................    41
2. Financial Statement Schedules -- For Years Ended May 31,
  1998, 1999 and 2000:
  Schedule II -- Valuation and Qualifying Accounts..........    55
  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 57. The Exhibits
  listed in the accompanying Index to Exhibits are filed or
  incorporated by reference as part of this report
</TABLE>

(b) Reports on Form 8-K:

     None.

                                       35
<PAGE>   36

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
Verity, Inc.

     In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 35 present fairly, in all material
respects, the financial position of Verity, Inc. and Subsidiaries at May 31,
2000 and 1999, and the results of their operations and their cash flows for each
of the three years in the period ended May 31, 2000, in conformity with
generally accepted accounting principles in the United States. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 14(a)(2) on page 35 present fairly, in all material respects, the
information set forth herein 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 generally accepted auditing standards in the
United States, 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 the opinion expressed above.

PricewaterhouseCoopers LLP

San Jose, California
June 16, 2000

                                       36
<PAGE>   37

                         VERITY, INC. AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                       (IN THOUSANDS, EXCEPT SHARE DATA)

                                     ASSETS

<TABLE>
<CAPTION>
                                                                    MAY 31,
                                                              --------------------
                                                                2000        1999
                                                              --------    --------
<S>                                                           <C>         <C>
Current assets:
  Cash and cash equivalents.................................  $  7,183    $  7,907
  Short-term investments....................................   109,472      28,327
  Trade accounts receivable, net............................    23,418      17,174
  Deferred tax assets.......................................    20,210          --
  Prepaid and other current assets..........................     3,988       1,481
                                                              --------    --------
          Total current assets..............................   164,271      54,889
Equipment and leasehold improvements, net...................     4,773       5,693
Long-term investments.......................................    37,616       4,132
Deferred tax assets.........................................     6,562          --
Other assets................................................       156         312
                                                              --------    --------
          Total assets......................................  $213,378    $ 65,026
                                                              ========    ========
                       LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................  $  6,488    $  3,786
  Accrued compensation......................................     9,327       6,665
  Other accrued liabilities.................................     1,198       1,989
  Deferred revenue..........................................    12,731       9,167
                                                              --------    --------
     Total current liabilities..............................    29,744      21,607
                                                              --------    --------
     Total liabilities......................................    29,744      21,607
                                                              --------    --------
Commitments and contingencies (Note 5)
Stockholders' equity:
Preferred stock, $.001 par value:
  Authorized: 2,000,000 shares in 2000 and 1999
  Issued and outstanding: none
Common stock, $.001 par value:
  Authorized: 100,000,000 shares in 2000 and 30,000,000
     shares in 1999
  Issued and outstanding: 31,606,000 shares in 2000 and
     25,612,000 shares in 1999..............................        31          26
Additional paid-in capital..................................   207,040      99,412
Other comprehensive income (loss)...........................      (401)         27
Accumulated deficit.........................................   (23,036)    (56,046)
                                                              --------    --------
     Total stockholders' equity.............................   183,634      43,419
                                                              --------    --------
          Total liabilities and stockholders' equity........  $213,378    $ 65,026
                                                              ========    ========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       37
<PAGE>   38

                         VERITY, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                       (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                   YEAR ENDED MAY 31,
                                                              ----------------------------
                                                               2000      1999       1998
                                                              -------   -------   --------
<S>                                                           <C>       <C>       <C>
REVENUES:
  Software products.........................................  $69,655   $48,327   $ 28,658
  Service and other.........................................   26,445    16,098     10,200
                                                              -------   -------   --------
     Total revenues.........................................   96,100    64,425     38,858
COSTS OF REVENUES:
  Software products.........................................      880     1,218      2,426
  Service and other.........................................    8,357     4,660      5,178
                                                              -------   -------   --------
     Total costs of revenues................................    9,237     5,878      7,604
                                                              -------   -------   --------
Gross profit................................................   86,863    58,547     31,254
                                                              -------   -------   --------
OPERATING EXPENSES:
  Research and development..................................   16,017    13,711     15,544
  Marketing and sales.......................................   38,742    26,860     22,757
  General and administrative................................    6,847     6,323      7,610
  Restructuring charges.....................................       --        --      3,006
                                                              -------   -------   --------
     Total operating expenses...............................   61,606    46,894     48,917
                                                              -------   -------   --------
Income/(loss) from operations...............................   25,257    11,653    (17,663)
Other income, net...........................................    5,623     1,085      1,553
Interest expense............................................      (20)       (8)      (100)
                                                              -------   -------   --------
Income/(loss) before provision for income taxes.............   30,860    12,730    (16,210)
Income tax provision/(benefit)..............................   (2,150)      600        300
                                                              -------   -------   --------
Net income/(loss)...........................................  $33,010   $12,130   $(16,510)
                                                              =======   =======   ========
Net income/(loss) per share -- basic........................  $  1.10   $  0.50   $  (0.74)
                                                              =======   =======   ========
Net income/(loss) per share -- diluted......................  $  0.95   $  0.44   $  (0.74)
                                                              =======   =======   ========
Number of shares used in per share calculation -- basic.....   30,026    24,198     22,450
                                                              =======   =======   ========
Number of shares used in per share calculation -- diluted...   34,886    27,700     22,450
                                                              =======   =======   ========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       38
<PAGE>   39

                         VERITY, INC. AND SUBSIDIARIES

           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                FOR THE YEARS ENDED MAY 31, 2000, 1999 AND 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                            NOTES      UNREALIZED
                                           COMMON STOCK     ADDITIONAL   RECEIVABLE    GAIN (LOSS)                     TOTAL
                                          ---------------    PAID-IN        FROM           ON        ACCUMULATED   STOCKHOLDERS'
                                          SHARES   AMOUNT    CAPITAL     STOCKHOLDER   INVESTMENTS     DEFICIT         EQUITY
                                          ------   ------   ----------   -----------   -----------   -----------   --------------
<S>                                       <C>      <C>      <C>          <C>           <C>           <C>           <C>
Balances, May 31, 1997..................  22,036    $22      $ 90,001      $(1,090)       $   6       $(51,666)       $ 37,273
Issuance of common stock:
  Upon exercise of stock options........     468     --           883           --           --             --             883
  Under employee stock purchase plan....     630      2         1,319           --           --             --           1,321
  Net exercise of warrants..............
Payments on notes receivable from
  stockholders..........................      --     --            --        1,090           --             --           1,090
Repurchase of common stock from
  stockholders..........................      (4)    --            (3)          --           --             --              (3)
Unrealized gain on investments..........      --     --            --           --            1             --               1
Net loss................................      --     --            --           --           --        (16,510)        (16,510)
                                          ------    ---      --------      -------        -----       --------        --------
Balances, May 31, 1998..................  23,130     24        92,200           --            7        (68,176)         24,055
Issuance of common stock:
  Upon exercise of stock options........   1,806      2         5,338           --           --             --           5,340
  Under employee stock purchase plan....     676     --         1,820           --           --             --           1,820
Stock compensation......................                           54                                                       54
Unrealized gain on investments..........      --     --            --           --           20             --              20
Net income..............................      --     --            --           --           --         12,130          12,130
                                          ------    ---      --------      -------        -----       --------        --------
Balances, May 31, 1999..................  25,612     26        99,412           --           27        (56,046)         43,419
Issuance of common stock:
  Upon exercise of stock options........   2,293      2        10,577           --           --             --          10,579
  Under employee stock purchase plan....     402     --         3,074           --           --             --           3,074
  Secondary offering....................   3,279      3        69,309           --           --             --          69,312
Disqualified/dispositions tax
  deferred..............................      20     --        24,668           --           --             --          24,668
Unrealized gain on investments..........      --     --            --           --         (428)            --            (428)
Net income..............................      --     --            --           --           --         33,010          33,010
                                          ------    ---      --------      -------        -----       --------        --------
Balances, May 31, 2000..................  31,606    $31      $207,040      $    --        $(401)      $(23,036)       $183,634
                                          ======    ===      ========      =======        =====       ========        ========
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       39
<PAGE>   40

                         VERITY, INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                    YEAR ENDED MAY 31,
                                                              -------------------------------
                                                                2000        1999       1998
                                                              ---------   --------   --------
<S>                                                           <C>         <C>        <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss).........................................  $  33,010   $ 12,130   $(16,510)
  Adjustments to reconcile net income (loss) to net cash
     provided by (used in) operating activities:
     Depreciation and amortization..........................      2,797      2,646      4,539
     Noncash restructuring charges..........................       (229)      (514)       767
     Provision for doubtful accounts........................         42        207        699
     Deferred income taxes..................................    (26,772)        --         --
     Amortization of discount on securities.................       (286)      (963)       (55)
     Changes in operating assets and liabilities:
       Trade accounts receivable............................     (6,483)    (2,594)    (4,320)
       Prepaid and other current assets.....................     (2,565)       345        748
       Accounts payable.....................................      2,757         40       (665)
       Accrued compensation and other accrued liabilities...      2,383      3,243      1,607
       Deferred revenue.....................................      3,556        327      4,146
                                                              ---------   --------   --------
          Net cash provided by (used in) operating
            activities......................................      8,210     14,867     (9,044)
                                                              ---------   --------   --------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Acquisition of equipment and leasehold improvements.......     (1,873)      (577)      (707)
  Capitalization of software development costs..............         --         --       (198)
  Purchases of investments..................................   (465,554)   (99,664)   (17,215)
  Maturity of investments...................................    219,531     52,775     10,856
  Proceeds from sale of investments.........................    131,408     27,852     16,217
                                                              ---------   --------   --------
          Net cash provided by (used in) investing
            activities......................................   (116,488)   (19,614)     8,953
                                                              ---------   --------   --------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Borrowings under line of credit...........................         --         --      1,500
  Payments on line of credit................................         --         --     (1,500)
  Proceeds from the sale of common stock net of issuance
     costs..................................................    107,633      7,214      2,201
  Payments from stockholders on notes receivable............         --         --      1,090
  Principal payments on notes payable and capital lease
     obligations............................................         --       (151)      (633)
                                                              ---------   --------   --------
          Net cash provided by financing activities.........    107,633      7,063      2,658
                                                              ---------   --------   --------
Effect of exchange rate changes on cash.....................        (79)        86          4
                                                              ---------   --------   --------
Net increase (decrease) in cash and cash equivalents........       (724)     2,402      2,571
Cash and cash equivalents, beginning of period..............      7,907      5,505      2,934
                                                              ---------   --------   --------
Cash and cash equivalents, end of period....................  $   7,183   $  7,907   $  5,505
                                                              =========   ========   ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid during the period for interest..................  $      20   $      8   $    100
  Cash paid during the period for income taxes..............  $     237   $     82   $     35
</TABLE>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                       40
<PAGE>   41

                         VERITY, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 1. NATURE OF OPERATIONS

     The Company develops, markets and supports knowledge retrieval software
products for corporate intranets and extranets and portals, online publishers
and e-commerce providers, original equipment manufacturers, or OEMs, and
independent software vendors. The comprehensive and integrated product family
enables enterprise-wide document indexing, classification, search and retrieval,
organization and navigation, personalized dissemination, and hybrid online and
CD publishing all from the same underlying Verity information index. The Company
markets and sells its software and services to commercial end users across many
industries and government entities through multiple distribution channels,
including direct sales and telesales organizations, primarily in the United
States and Europe and a worldwide network of value added resellers and system
integrators.

 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.

  Stock split

     On October 21, 1999, the Company's board of directors authorized a
two-for-one split of its common stock effective December 3, 1999 in the form of
a stock dividend for stockholders of record at the close of business on November
17, 1999. All share data information in these consolidated financial statements
and in these notes is restated to reflect the stock split.

  Accounting estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

  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.

  Investments

     The Company has classified its investments as available-for-sale. Such
investments are recorded at fair value and unrealized gains and losses, if
material, are recorded as a separate component of stockholders' equity, net of
tax, until realized. Interest income is recorded using an effective interest
rate with the associated premium or discount amortized to interest income. The
cost of securities sold is based upon the specific identification method. As of
the balance sheet date, investments with maturity dates of one year or less are
classified as current, and those with maturity dates of greater than one year
are classified as long-term.

  Equipment and leasehold improvements

     Equipment and leasehold improvements are stated at cost less accumulated
depreciation and amortization. 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 over one year, and furniture and
fixtures
                                       41
<PAGE>   42
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

are depreciated over five years. Leasehold improvements and leased assets are
amortized on a straight-line basis over the lesser of their estimated useful
life or the lease term, whichever is shorter. Gains and losses upon asset
disposal are taken into income in the year of disposition.

     The Company periodically evaluates the carrying value of equipment and
leasehold improvements to be held and used when events and circumstances warrant
such a review. The carrying value of equipment and leasehold improvements is
considered impaired when the anticipated undiscounted cash flows from the asset
is separately identifiable and is less than its 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.

  Intangible assets

     Intangible assets consist primarily of goodwill, purchased software and
capitalized software development costs. Goodwill and purchased software are
amortized on a straight-line basis over their estimated useful lives, generally
four years and three years, respectively. Intangible assets are included in
other assets.

     On a regular basis, the Company assesses the value of recorded goodwill and
other intangible assets for possible impairment based primarily on the ability
to recover the balances from expected future cash flows on an undiscounted
basis. If the sum of the expected future cash flows on an undiscounted basis is
less than the carrying amount of the intangible asset, an impairment loss would
be recognized for the amount by which the carrying value of the intangible asset
exceeds its estimated fair value. The Company has not recorded any provisions
for possible impairment of goodwill or intangible assets.

  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 using the greater of the amount computed
using the ratio that current gross revenues for a product bear to the total of
current and anticipated future gross revenues for that product, or on a straight
line basis over 12 to 18 months. 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 1999 and 2000,
the Company did not capitalize any software development costs since such costs
were not significant. During fiscal 1998, the Company capitalized software
development costs in the amounts of $198,000, which has been fully amortized as
of May 31, 2000. Amortization is included in costs of software products revenue.

  Revenue recognition

     The Company's revenue is derived from primarily two sources, across many
industries: (i) product license revenue, derived primarily from product sales to
resellers and end users, including large scale enterprises and royalty revenue,
derived primarily from initial license fees and ongoing royalties from product
sales by source code OEMs; and (ii) service and support revenue, derived
primarily from providing software updates, support and education and consulting
services to end users.

     In December 1998, AcSEC released Statement of Position 98-9, Modification
of SOP 97-2, Software Revenue Recognition ("SOP 98-9"), with Respect to Certain
Transactions. SOP 98-9 amends SOP 97-2 to require that an entity recognize
revenue for multiple element arrangements by means of the "residual method" when
(1) there is vendor-specific objective evidence ("VSOE") of the fair values of
all the undelivered elements that are not accounted for by means of long-term
contract accounting, (2) VSOE of fair value does

                                       42
<PAGE>   43
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

not exist for one or more of the delivered elements, and (3) all revenue
recognition criteria of SOP 97-2 (other than the requirement for VSOE of the
fair value of each delivered element) are satisfied. The provisions of SOP 98-9
that extend the deferral of certain paragraphs of SOP 97-2 became effective
December 15, 1998. These paragraphs of SOP 97-2 and SOP 98-9 were effective for
transactions that are entered into in fiscal years beginning after March 15,
1999. Retroactive application is prohibited. The adoption of SOP 98-9 did not
have a material impact on the Company's financial statements.

     For contracts with multiple elements (e.g., deliverable and undeliverable
products, maintenance and other services), the Company allocates revenue to each
component of the contract based on objective evidence of its fair value, which
is specific to the Company, or for products not being sold separately, the price
established by management. The Company recognizes revenue allocated to
undelivered products when the criteria for product revenue set forth above are
met. The Company recognizes revenue allocated to maintenance fees for ongoing
customer support and product updates ratably over the period of the maintenance
contract. Payments for maintenance fees are generally made in advance and are
non-refundable. For revenue allocated to training and consulting services, the
Company recognizes revenue as the related services are performed.

     The Company recognizes product revenue from royalty payments upon receipt
of quarterly royalty reports from OEMs related to their product sales for the
previous quarter.

  Income taxes

     Deferred tax assets and liabilities are determined based on the differences
between financial reporting and tax bases of assets and liabilities, measured at
tax rates that will be in effect when the differences are expected to reverse.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized.

  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, and the failure of the products of the Company's strategic
partners to achieve or maintain market acceptance could have a material adverse
effect on the Company's competitive position. Revenue is mainly derived from
relatively large sales to a limited number of customers. 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 could affect operating results
adversely. In addition, a significant portion of the Company's revenue is
derived from international sales; therefore, fluctuation of the U.S. dollar
against foreign currencies or local economic conditions could adversely affect
operating results.

     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 and
Australia. The Company performs ongoing credit evaluations of its customers'
financial condition and generally does not require collateral. The Company
maintains allowances for potential losses and such losses have been within
                                       43
<PAGE>   44
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

management's expectations. One customer accounted for more than 10% of the
accounts receivable balance at May 31, 2000, and no single customer accounted
for more than 10% of the accounts receivable balance at May 31, 1999.

  Foreign currency translation

     The Company translates the accounts of its foreign branches and
subsidiaries using historical rates for nonmonetary assets and current rates for
monetary assets. Remeasurement gains and losses from the translation of these
branches and those that arise from exchange rate changes on transactions
denominated in a currency other than the local currency are included in the
statements of operations. The Company's foreign branches and subsidiaries use
the U.S. dollar as their functional currency as the U.S. parent exclusively
funds the branches and subsidiaries' operations with U.S. dollars. The net gain
(loss) on foreign currency remeasurement and exchange rate changes for fiscal
years 2000, 1999 and 1998, which is included in other income (expense) net on
the accompanying statements of operations, was ($440,000), $175,000 and $95,000,
respectively.

  Fair value of financial instruments

     Carrying amounts of certain of the Company's financial instruments,
including cash and cash equivalents, accounts receivable, accounts payable,
accrued expenses and other liabilities approximate fair value due to their short
maturities. Based upon borrowing rates currently available to the Company for
loans with similar terms, the carrying value of long-term debt and capital lease
obligations approximate fair value. The fair value of the Company's investments
is set forth in Note 3.

  Computation of net income (loss) per share

     Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted average number of common and common equivalent
shares outstanding during the period. Dilutive common equivalent shares consist
of stock options. For fiscal year 1998, the effects of outstanding stock options
were excluded from the calculation of diluted earnings per share because their
effect was antidilutive. Accordingly, no adjustments were required to previously
reported earnings per share amounts.

  Comprehensive income

     The Company has adopted SFAS 130. Other comprehensive income (loss) for all
periods presented consists of unrealized gains and losses on available-for-sale
securities.

  Recent accounting pronouncements

     In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS
133"), which establishes new standards of accounting and reporting for
derivative instruments and hedging activities. SFAS 133 requires that all
derivatives be recognized at fair value in the statement of financial position,
and that the corresponding gains or losses be reported either in the statement
of operations or as a component of comprehensive income, depending on the type
of hedging relationship that exists. SFAS 133 is effective for fiscal years
beginning after June 15, 2000. The Company is currently assessing the potential
impact of this pronouncement on its financial statements.

     In December 1998, AcSEC released Statement of Position 98-9, Modification
of SOP 97-2, Software Revenue Recognition ("SOP 98-9"), with Respect to Certain
Transactions. SOP 98-9 amends SOP 97-2 to require that an entity recognize
revenue for multiple element arrangements by means of the "residual method" when
(1) there is vendor-specific objective evidence ("VSOE") of the fair values of
all the undelivered

                                       44
<PAGE>   45
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

elements that are not accounted for by means of long-term contract accounting,
(2) VSOE of fair value does not exist for one or more of the delivered elements,
and (3) all revenue recognition criteria of SOP 97-2 (other than the requirement
for VSOE of the fair value of each delivered element) are satisfied. The
provisions of SOP 98-9 that extend the deferral of certain paragraphs of SOP
97-2 became effective December 15, 1998. These paragraphs of SOP 97-2 and SOP
98-9 were effective for transactions that are entered into in fiscal years
beginning after March 15, 1999. Retroactive application is prohibited. The
adoption of SOP 98-9 did not have a material impact on the Company's financial
statements.

     In December 1999, the Securities Exchange Commission ("SEC") issued to
Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements, which outlines the basic criteria that must be met to recognize
revenue and provides guidance for presentation of revenue and for disclosure
related to revenue recognition policies in financial statements filed with the
SEC. In June 2000, the SEC issued SAB 101(B), which defers the implementation
date of SAB 101 to no later than the fourth fiscal quarter of fiscal years
commencing after December 15, 1999. The Company has evaluated the provision of
SAB 101 and it is in compliance with SAB 101.

     In March 2000, the FASB issued Interpretation No. 44, ("FIN 44"),
"Accounting for Certain Transactions Involving Stock Compensation -- an
Interpretation of APB 25." This Interpretation clarifies (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a non-compensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. This Interpretation is effective July 1, 2000,
but certain conclusions in this Interpretation cover specific events that occur
after either December 15, 1998, or January 12, 2000. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. Management does not expect that the adoption of FIN 44 will
have a material effect on the financial statements.

 3. INVESTMENTS

     As of May 31, 1999, available-for-sale securities consist of the following
(in thousands):

<TABLE>
<CAPTION>
                                                       GROSS        GROSS
                                         AMORTIZED   UNREALIZED   UNREALIZED    FAIR
                                           COST        GAINS        LOSSES      VALUE
                                         ---------   ----------   ----------   -------
<S>                                      <C>         <C>          <C>          <C>
Corporate commercial paper --
  short-term...........................   $28,327       $--          $--       $28,327
Corporate commercial paper --
  long-term............................     4,105        27           --         4,132
                                          -------       ---          ---       -------
          Total investments............   $32,432       $27          $--       $32,459
                                          =======       ===          ===       =======
</TABLE>

     As of May 31, 2000, available-for-sale securities consist of the following
(in thousands):

<TABLE>
<CAPTION>
                                                      GROSS        GROSS
                                        AMORTIZED   UNREALIZED   UNREALIZED     FAIR
                                          COST        GAINS        LOSSES      VALUE
                                        ---------   ----------   ----------   --------
<S>                                     <C>         <C>          <C>          <C>
Corporate commercial
  paper -- short-term.................  $109,723       $--          $251      $109,472
Corporate commercial
  paper -- long-term..................    37,766       $--           150        37,616
                                        --------       ---          ----      --------
          Total investments...........  $147,489       $--          $401      $147,088
                                        ========       ===          ====      ========
</TABLE>

                                       45
<PAGE>   46
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     At May 31, 2000, scheduled maturities of investments classified as
available-for-sale are as follows (in thousands):

<TABLE>
<S>                                                           <C>
Within one year.............................................  $109,739
After one year through five years...........................    37,750
                                                              --------
                                                              $147,489
                                                              ========
</TABLE>

 4. BALANCE SHEET DETAIL

  Trade receivables

     As of May 31, 2000 and 1999, the balance of trade receivables is as follows
(in thousands):

<TABLE>
<CAPTION>
                                                               MAY 31,
                                                         --------------------
                                                           2000        1999
                                                         --------    --------
<S>                                                      <C>         <C>
Trade receivables......................................  $ 24,318    $ 18,074
Allowance for doubtful accounts........................      (900)       (900)
                                                         --------    --------
                                                         $ 23,418    $ 17,174
                                                         ========    ========
</TABLE>

  Equipment and leasehold improvements

     As of May 31, 2000 and 1999, equipment and leasehold improvements consist
of the following (in thousands):

<TABLE>
<CAPTION>
                                                               MAY 31,
                                                         --------------------
                                                           2000        1999
                                                         --------    --------
<S>                                                      <C>         <C>
Computer equipment.....................................  $ 12,201    $ 10,718
Furniture and fixtures.................................     4,243       3,997
Leasehold improvements.................................     3,644       3,496
                                                         --------    --------
                                                           20,088      18,211
Less accumulated depreciation and amortization.........   (15,315)    (12,518)
                                                         --------    --------
                                                         $  4,773    $  5,693
                                                         ========    ========
</TABLE>

Depreciation expense for fiscal years 2000, 1999 and 1998 was $2,797,000,
$2,444,000 and $3,187,000, respectively.

At May 31, 1999 and May 31, 2000, there were no assets under capital leases.

 5. COMMITMENTS AND CONTINGENCIES

     The Company leases various facilities and vehicles under noncancelable
operating leases expiring through March 2005. Under the terms of the leases, the
Company is responsible for taxes, insurance and normal maintenance costs. Under
its primary operating lease 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 2000.

                                       46
<PAGE>   47
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     At May 31, 2000, future minimum rental payments and receipts under the
operating leases are as follows (in thousands):

<TABLE>
<CAPTION>
                                                            RENTAL     SUBLEASE
               FISCAL YEAR ENDING MAY 31,                  PAYMENTS     INCOME
               --------------------------                  --------    --------
<S>                                                        <C>         <C>
2001.....................................................   $1,686      $1,443
2002.....................................................    1,704          --
2003.....................................................    1,706          --
2004.....................................................    1,724          --
2005.....................................................    1,724          --
                                                            ------      ------
                                                            $8,544      $1,443
                                                            ======      ======
</TABLE>

     Rent expense, excluding sublease income, for fiscal years 2000, 1999 and
1998 was $1,522,000, $1,346,000, and $1,285,000, respectively.

     In December 1999, a number of complaints were filed in the United States
District Court for Northern District of California seeking an unspecified amount
of damages on behalf of an alleged class of persons who purchased shares of the
Company's common stock during the period between December 1 and December 14,
1999. The complaints name as defendants the Company and certain of its directors
and officers, asserting that they violated federal securities laws by
misrepresenting Verity's business and earnings growth ability to continue to
achieve profitable growth, and failing to disclose certain information about the
Company's business. While management intends to defend the actions against the
Company vigorously, there can be no assurance that an adverse result or
settlement with regards to these lawsuits would not have a material adverse
effect on the Company's financial condition or results of operations.

     The Company is also involved in other routine legal and administrative
proceedings that arise from the normal conduct of business. Management believes
that the ultimate disposition of these matters will not have a material adverse
effect on the financial results or condition of the Company.

 6. 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. During
fiscal year 1996, the Company increased the number of shares reserved under the
1995 Stock Option Plan from the 2,600,000 shares initially reserved under the
1988 Stock Option Plan to 5,822,000 shares of the Company's common stock. In
September 1996, the Company's stockholders approved a further increase to the
number of shares reserved under the 1995 Stock Option Plan from 5,822,000 to
6,622,000 shares of the Company's common stock. In September 1998 and September
1999, the Company's stockholders approved a further increase to the number of
shares reserved under the 1995 Stock Option Plan to a total of 8,122,000 and
10,122,000 shares, respectively.

     Under the terms of the Plan, incentive options may be granted at prices not
lower than fair market value at the date of grant, while 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. Options granted under the Plan
are exercisable immediately and expire over periods of eight to ten years from
the date of grant.

     Common shares purchased under the Plan are subject to the Company's right
of repurchase, which generally lapses as to 12.5% of the shares six months from
the individual's date of employment and thereafter ratably over the remainder of
a 3 1/2 year period at the holder's original purchase price. Thereafter, the
Company has the right of first refusal to purchase such shares. At May 31, 2000
and 1999, the Company had 9,793 and 1,156 shares, respectively, subject to the
Company's right to repurchase. At May 31, 2000, 976,000 shares of common stock
were available for grant under the 1995 Stock Option Plan.
                                       47
<PAGE>   48
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

  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. In April
1997, the Company increased the number of shares reserved under the Plan from
600,000 to 1,200,000 shares of common stock for issuance to certain employees
and consultants of the Company. In March 1998 and May 1999, the Company raised
the number of shares to 3,720,000 and 5,720,000 shares of common stock,
respectively, for issuance to certain employees and consultants of the Company.
In October 1999, the Company increased the number of shares of common stock to a
total of 8,420,000 shares. At May 31, 2000, 523,000 shares of common stock were
available for grant under the 1996 Nonstatutory Stock Option Plan.

  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 Plan, each current outside director was
automatically granted an option to purchase 40,000 shares of common stock at the
following annual meeting of stockholders. Each new outside director is
automatically 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 Director's 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, 2000, 370,000 shares of common stock were available for
grant under this plan.

  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. Under this plan, the Company has
reserved 300,000 shares of common stock for issuance to certain employees and
consultants of 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. In
March 1998, the Company increased the number of shares reserved under the Plan
from 300,000 to 780,000 shares of common stock for issuance to certain employers
and consultants of the Company. In May and October 1999, the Company increased
the number of shares reserved under the 1997 Plan to a total of 1,180,000 and
1,480,000 shares, respectively. At May 31, 2000, 201,000 shares of common stock
were available for grant under the 1997 Stock Option Plan for Verity Canada.

                                       48
<PAGE>   49
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

  Activity under stock option plans

     Activity under the above stock option plans is set forth below:

<TABLE>
<CAPTION>
                                                            OPTIONS OUTSTANDING
                                                  ---------------------------------------
                                                                WEIGHTED
                                                                 AVERAGE
                                      SHARES                    PRICE PER
                                    AVAILABLE       SHARES        SHARE         TOTAL
                                    ----------    ----------    ---------    ------------
<S>                                 <C>           <C>           <C>          <C>
Balances, May 31, 1997............   1,952,000     4,894,000     $ 4.05      $ 19,797,000
  Shares reserved under plans.....   3,000,000
  Options reinstated..............       4,000        (4,000)
  Options granted.................  (5,330,000)    5,330,000     $ 2.65        14,141,000
  Options canceled................   3,842,000    (3,842,000)    $ 4.12       (15,826,000)
  Options exercised...............          --      (464,000)    $ 1.90          (883,000)
                                    ----------    ----------                 ------------
Balances, May 31, 1998............   3,468,000     5,914,000     $ 2.91        17,229,000
  Shares reserved under plans.....   3,900,000
  Options granted.................  (5,604,000)    5,604,000     $ 9.78        54,802,000
  Options canceled................     618,000      (618,000)    $ 3.60        (2,223,000)
  Options exercised...............          --    (1,806,000)    $ 2.96        (5,339,000)
                                    ----------    ----------                 ------------
Balance, May 31, 1999.............   2,382,000     9,094,000     $ 7.09        64,469,000
  Shares reserved under plans.....   5,600,000
  Options granted.................  (6,567,000)    6,567,000     $31.99       210,075,000
  Options canceled................     648,000      (648,000)    $12.34        (7,999,000)
  Options exercised...............          --    (2,293,000)    $ 4.61       (10,577,000)
                                    ----------    ----------                 ------------
Balances, May 31, 2000............   2,063,000    12,720,000     $20.12      $255,968,000
                                    ==========    ==========                 ============
</TABLE>

  Common stock option plans

     The following table summarizes information with respect to stock options
outstanding at May 31, 2000:

<TABLE>
<CAPTION>
                          OPTIONS OUTSTANDING             OPTIONS NOT SUBJECT TO
                 -------------------------------------   REPURCHASE UPON EXERCISE
                                 WEIGHTED                ------------------------
                   NUMBER        AVERAGE      WEIGHTED                  WEIGHTED
                 OUTSTANDING    REMAINING     AVERAGE     NUMBER AT     AVERAGE
   RANGE OF      AT MAY 31,    CONTRACTUAL    EXERCISE     MAY 31,      EXERCISE
EXERCISE PRICE      2000       LIFE (YEARS)    PRICE        2000         PRICE
--------------   -----------   ------------   --------   -----------   ----------
<S>              <C>           <C>            <C>        <C>           <C>
$ 1.00 - $ 4.99..  3,791,163       5.81        $ 3.24     2,493,931      $ 3.19
$ 5.00 - $16.49..  2,436,120       6.76        $15.07     1,710,067      $15.60
$16.50 - $29.99..  1,135,430       7.33        $26.29       244,801      $26.20
$30.00 - $53.00..  5,356,994       7.48        $33.06     1,127,911      $31.20
                 ----------        ----        ------     ---------      ------
                 12,719,707        6.83        $19.42     5,576,710      $19.05
                 ==========                               =========
</TABLE>

  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 1996, the Company's stockholders approved an
increase to the number of shares reserved under the employee stock purchase plan
from 500,000 to 1,000,000 shares of common stock. In September 1997 and
September 1999, the Company's stockholders approved a further increase to
2,600,000 and 4,000,000 shares of common stock, respectively. The Employee Stock
Purchase Plan permits eligible employees to purchase shares of the
                                       49
<PAGE>   50
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Company's common stock at 85% of the lesser of fair market value of the common
stock on the first day of the offering period or the last day of the purchase
period. At May 31, 1999 and 2000, 1,950,000 and 2,352,000 shares, respectively,
of the Company's common stock have been issued under the plan and 650,000 shares
and 1,648,000 shares, respectively, remained available for purchase.

  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 2000, 1999 and 1998 consistent with the provisions of
SFAS No. 123, the Company's net income (loss) and net income (loss) per share
for fiscal years 2000, 1999 and 1998 would have been increased to the pro forma
amounts indicated below (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                               FISCAL YEARS
                                                      -------------------------------
                                                        2000       1999        1998
                                                      --------    -------    --------
<S>                                                   <C>         <C>        <C>
Net income/(loss) applicable to common
  stockholders -- as reported.......................  $ 33,010    $12,130    $(16,510)
                                                      ========    =======    ========
Net income/(loss) applicable to common
  stockholders -- pro forma.........................  $(25,148)   $ 1,929    $(20,185)
                                                      ========    =======    ========
Net income/(loss) per share -- basic -- as
  reported..........................................  $   1.10    $  0.50    $  (0.74)
                                                      ========    =======    ========
Net income/(loss) per share -- diluted -- as
  reported..........................................  $   0.95    $  0.44    $  (0.74)
                                                      ========    =======    ========
Net income/(loss) per share -- basic -- pro forma...  $  (0.84)   $  0.08    $  (0.90)
                                                      ========    =======    ========
Net income/(loss) per share -- diluted -- pro
  forma.............................................  $  (0.84)   $  0.07    $  (0.90)
                                                      ========    =======    ========
</TABLE>

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

     The aggregate fair value and weighted average fair value of each option
granted in fiscal years 2000, 1999 and 1998 were $145.9 million, $36.8 million
and $7.1 million, and $21.13, $13.14 and $2.74, respectively. The fair value of
each option grant is estimated on the date of grant using the Black-Scholes
Option Pricing Model with the following weighted average assumptions for fiscal
years 2000, 1999, and 1998:

<TABLE>
<CAPTION>
                                                           2000       1999       1998
                                                          -------    -------    -------
<S>                                                       <C>        <C>        <C>
Expected volatility.....................................      100%        90%        60%
Risk-free interest rate.................................      6.8%       5.7%       5.6%
Expected life...........................................  3 years    4 years    4 years
Expected dividend yield.................................      0.0%       0.0%       0.0%
</TABLE>

     The Company has also estimated the fair value for the purchase rights under
the Employee Stock Purchase Plan using the Black-Scholes Model with the
following assumptions for fiscal years 2000, 1999 and 1998:

<TABLE>
<CAPTION>
                                             2000                1999                1998
                                       -----------------   -----------------   ----------------
<S>                                    <C>                 <C>                 <C>
Expected volatility..................        100%                 90%                60%
Risk-free interest rate..............        6.8%                5.7%                5.6%
Expected life........................  .50 - 1.00 years    .50 - 1.00 years.   .50 - 1.00 years
Expected dividend yield..............        0.0%                0.0%                0.0%
</TABLE>

                                       50
<PAGE>   51
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

  Preferred stock purchase rights plan

     In September 1996, the Company's Board of Directors adopted a Preferred
Stock Purchase Rights Plan designed to enable all Verity stockholders to realize
the full value of their investment and to provide for fair and equal treatment
for all Verity stockholders in the event that an unsolicited attempt is made to
acquire Verity. Under the Plan, stockholders will receive one Right to purchase
one one-hundredth of a share of a new series of Preferred Stock for each
outstanding share of Verity common stock held at the close of business on
October 2, 1996. The Rights expire on September 17, 2006.

 7. INCOME TAXES

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

<TABLE>
<CAPTION>
                                                        FISCAL YEARS
                                               ------------------------------
                                                2000       1999        1998
                                               -------    -------    --------
<S>                                            <C>        <C>        <C>
Domestic.....................................  $28,669    $ 9,899    $(16,890)
Foreign......................................    2,191      2,831         680
                                               -------    -------    --------
                                               $30,860    $12,730    $(16,210)
                                               =======    =======    ========
</TABLE>

     Details of the income tax provision (benefit) for fiscal years 2000, 1999
and 1998 consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                             MAY 31,
                                                     -----------------------
                                                      2000      1999    1998
                                                     -------    ----    ----
<S>                                                  <C>        <C>     <C>
Current:
  Federal..........................................  $    --    $243    $ --
  State............................................       20      55     108
  Foreign..........................................      600     302     192
                                                     -------    ----    ----
                                                         620     600     300
                                                     -------    ----    ----
Deferred:
  Federal..........................................   (2,392)     --      --
  State............................................     (346)     --      --
  Foreign..........................................      (32)     --      --
                                                     -------    ----    ----
                                                      (2,770)     --      --
                                                     -------    ----    ----
                                                     $(2,150)   $600    $300
                                                     =======    ====    ====
</TABLE>

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

<TABLE>
<CAPTION>
                                                           FISCAL YEARS
                                                      -----------------------
                                                      2000     1999     1998
                                                      -----    -----    -----
<S>                                                   <C>      <C>      <C>
Income tax benefit at statutory rates...............   35.0%    34.0%   (34.0)%
State income taxes net of federal benefit...........    3.2      0.4      0.7
Non-deductible expenses.............................    0.6      0.1      1.0
Foreign taxes.......................................    2.5      0.1      1.3
Release of valuation allowance......................  (44.5)      --       --
Research and development credit.....................   (3.7)      --       --
Net operating loss (benefited) not benefited........     --    (29.7)    33.0
                                                      -----    -----    -----
Effective tax rate..................................   (6.9)%    4.9%     2.0%
                                                      =====    =====    =====
</TABLE>

                                       51
<PAGE>   52
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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

<TABLE>
<CAPTION>
                                                                MAY 31,
                                                          -------------------
                                                           2000        1999
                                                          -------    --------
<S>                                                       <C>        <C>
Deferred tax assets:
  Accumulated depreciation..............................  $ 2,237    $  1,939
  Accrued compensation..................................    1,115         202
  Other accruals and allowance for doubtful accounts....    1,065         940
  Research and development credits......................    4,262       2,868
  Net operating loss carryforwards......................   18,093      12,938
                                                          -------    --------
                                                           26,772      18,887
Valuation allowance.....................................       --     (18,887)
                                                          -------    --------
     Net deferred.......................................  $26,772    $     --
                                                          =======    ========
</TABLE>

     As of May 31, 2000, the Company had approximately $49,838,000 and
$15,309,000 of net operating loss carryforwards for federal and California
purposes, respectively, to offset future taxable income. The Company also has
federal and state research and development tax credit carryforwards of
approximately $3,216,000 and $1,047,000, respectively, at May 31, 2000. These
carryforwards expire in the years 2000 to 2020 if not utilized. A portion of the
Company's net operating loss and tax credit carryforwards are subject to an
annual limitation of approximately $4,900,000 as a result of an ownership
change, as defined by tax laws.

     At May 31, 1999, the Company had a valuation allowance, totaling
$18,887,000 against its deferred tax assets. During fiscal year 2000, the entire
valuation allowance was reversed, due to the increased earnings of the Company.
Based on management's assessment, it is more likely than not that all the net
deferred tax assets will be realized through future taxable earnings.

 8. 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 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 required that the Company indemnify Regent Pacific and Mr.
Sbona for certain liabilities arising out of the performance of services under
the agreement. On April 13, 1998, the Company and Regent Pacific agreed to amend
the agreement to provide that Mr. Sbona and other Regent Pacific personnel would
serve as part of the Company's management team. The amendment also served to
extend the term of the agreement until August 31, 1999, and to extend the
noncancelable period of the agreement until February 28, 1999.

     In connection with Mr. Sbona's service as President and CEO, an employee of
the Company, the Compensation Committee of the Company's Board 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 additional 520,000 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 additional 420,000
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

                                       52
<PAGE>   53
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

606,000 and 394,000 of the Company's common stock, at an exercise price of
$30.75 and $31.75 per share, respectively. 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. Under this amended agreement,
Regent Pacific continues to provide certain services to the Company at a fee of
$50,000 per week. The new agreement provides Verity with an option to further
extend the term of this agreement through February 2001. Additionally, the
parties agree that Mr. Sbona became an employee of the Company effective
February 16, 1998. Furthermore, on March 12, 1999, Mr. Sbona was appointed as
the Chairman of the Board of Directors of the Company. Mr. Sbona has been
Verity's President and Chief Executive Officer since July 1997 and has been a
Board member since May 1998.

     On February 10, 2000, we extended our agreement with Regent Pacific
Management Corporation through August 31, 2001. This is the third 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 the services of Gary J. Sbona as
Chairman and Chief Executive Officer of Verity, and continues to provide
additional Regent Pacific management services to our company. The agreement
provides us with an option to further extend the term of this agreement through
February 2002.

 9. EMPLOYEE BENEFIT PLAN

     The Verity, Inc. 401(k) Plan, as allowed under Section 401(k) of the
Internal Revenue Code, provides tax deferred salary deductions for eligible
employees. Employees are eligible to participate immediately upon date of hire.

     Participants may make voluntary contributions to the plan up to 20% of
their compensation. The plan does not provide for Company contributions.

10. COMPUTATION OF NET INCOME (LOSS) PER SHARE

     Basic and diluted net income (loss) per share are calculated as follows for
fiscal years 2000, 1999 and 1998 (in thousands, except per share amounts):

<TABLE>
<CAPTION>
                                                        FISCAL YEARS
                                               ------------------------------
                                                2000       1999        1998
                                               -------    -------    --------
<S>                                            <C>        <C>        <C>
Basic:
  Weighted average common shares outstanding
     (basic).................................   30,026     24,198      22,450
  Net income/(loss) applicable to common
     stockholders............................  $33,010    $12,130    $(16,510)
  Net income/(loss) per share................  $  1.10    $  0.50    $  (0.74)
Diluted:
  Weighted average common shares outstanding
     (diluted)...............................   34,886     27,700      22,450
  Net income/(loss) applicable to common
     stockholders............................  $33,010    $12,130    $(16,510)
  Net income/(loss) per share................  $  0.95    $  0.44    $  (0.74)
</TABLE>

     The calculation of diluted shares outstanding for fiscal year 1998 excludes
774,000 stock options, as their effect was antidilutive in this period.

                                       53
<PAGE>   54
                         VERITY, INC. AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

11. BUSINESS SEGMENT, FOREIGN SALES AND OPERATIONS, AND MAJOR CUSTOMERS

     The Company develops, markets and supports knowledge retrieval software
products for corporate intranets and extranets and portals, online publishers
and e-commerce providers, original equipment manufacturers, or OEMs, and
independent software vendors. The comprehensive and integrated product family
enables enterprise-wide document indexing, classification, search and retrieval,
organization and navigation, personalized dissemination, and hybrid online and
CD publishing all from the same underlying Verity information index.

     The Company has sales and marketing operations located outside the United
States in the Netherlands, United Kingdom, France, Germany and Australia, and a
development and technical support operation in Canada. Foreign branch and
subsidiary revenues consist primarily of maintenance and consulting services and
is being allocated based on foreign branch and subsidiary location.

<TABLE>
<CAPTION>
    FINANCIAL DATA BY        UNITED                   OTHER
    GEOGRAPHICAL AREA        STATES     EUROPE       FOREIGN        ELIMINATIONS     TOTAL
    -----------------       --------    ------       -------        ------------    --------
                                                  (IN THOUSANDS)
<S>                         <C>         <C>       <C>               <C>             <C>
Revenues:
  1998....................  $ 36,440    $2,418        $  --                --       $ 38,858
  1999....................    60,334     4,091           --                --         64,425
  2000....................    89,666     6,434           --                --         96,100
Income (loss) from
  operations:
  1998....................   (13,752)      613           54            (4,578)       (17,663)
  1999....................    21,018     2,800           73           (12,238)        11,653
  2000....................    36,638     2,673         (156)          (13,898)        25,257
Identifiable assets:
  1998....................    37,275     3,902          272                --         41,449
  1999....................    60,342     4,241          443                --         65,026
  2000....................   206,664     6,214          500                --        213,378
</TABLE>

     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. Identifiable assets of geographic areas are those assets used in
the Company's operations in each area.

     Included in software product revenues are export sales of approximately
$18,307,000, $17,464,000 and $10,317,000 in fiscal years 2000, 1999 and 1998,
respectively.

     No single customer accounted for 10% or more of the Company's revenue
during fiscal years 2000, 1999 and 1998. Revenues from the federal government
and its agencies were $7,467,000, $5,216,000 and $3,489,000 for fiscal years
2000, 1999 and 1998, respectively.

                                       54
<PAGE>   55

                          SCHEDULE II -- VERITY, INC.

                       VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                  AMOUNTS
                                                   BALANCE AT    CHARGED TO                  BALANCE
                                                   BEGINNING     PROFIT AND                  AT END
                   DESCRIPTION                      OF YEAR         LOSS       DEDUCTIONS    OF YEAR
                   -----------                     ----------    ----------    ----------    -------
<S>                                                <C>           <C>           <C>           <C>
Allowance for Bad Debts:
  Year ended May 31, 1998
     Allowance for doubtful accounts.............   $   540       $    699       $(533)      $   706
  Year ended May 31, 1999
     Allowance for doubtful accounts.............   $   706       $    639       $(445)      $   900
  Year ended May 31, 2000
     Allowance for doubtful accounts.............   $   900       $    621       $(621)      $   900

Allowance for Deferred Tax Assets:
  Year ended May 31, 1998
     Valuation Allowance.........................   $11,225       $  5,779       $  --       $17,004
  Year ended May 31, 1999
     Valuation Allowance.........................   $17,004       $  1,883       $  --       $18,887
  Year ended May 31, 2000
     Valuation Allowance.........................   $18,887       $(18,887)      $  --       $    --
</TABLE>

                                       55
<PAGE>   56

                                   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 28, 2000                         By:           /s/ GARY J. SBONA
                                                         -----------------------
                                                            (Chief Executive
                                                            Officer)

     Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the date indicated.

<TABLE>
<CAPTION>
                      SIGNATURE                                      TITLE                    DATE
                      ---------                                      -----                    ----
<S>                                                    <C>                                <C>

                  /s/ GARY J. SBONA                       Chief Executive Officer and     July 28, 2000
-----------------------------------------------------        Chairman of the Board
                    Gary J. Sbona                        (Principal Executive Officer
                                                       and Principal Financial Officer)

             /s/ ANTHONY J. BETTENCOURT                     President and Director        July 28, 2000
-----------------------------------------------------
               Anthony J. Bettencourt

                 /s/ TODD K. YAMAMI                      Vice President and Corporate     July 28, 2000
-----------------------------------------------------             Controller
                   Todd K. Yamami                       (Principal Accounting Officer)

                /s/ STEVEN M. KRAUSZ                               Director               July 28, 2000
-----------------------------------------------------
                  Steven M. Krausz

              /s/ STEPHEN A. MACDONALD                             Director               July 28, 2000
-----------------------------------------------------
                Stephen A. MacDonald

              /s/ CHARLES P. WAITE, JR.                            Director               July 28, 2000
-----------------------------------------------------
                Charles P. Waite, Jr.
</TABLE>

                                       56
<PAGE>   57

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
    EXHIBIT
    NUMBER                       DESCRIPTION OF DOCUMENT
    -------                      -----------------------
    <C>        <S>
     2.1       Form of Agreement and Plan of Merger between Verity, Inc., a
               California corporation, and Verity Delaware Corporation, a
               Delaware corporation, filed September 22, 1995.(1)
     2.2       Agreement and Plan of Reorganization dated January 10, 1997
               among Verity, Inc., Cognisoft Acquisition Corporation and
               Cognisoft Corporation, and certain shareholders of
               Cognisoft.(2)
     2.3       Form of Stock Purchase Agreement dated as of May 31, 1997
               among Verity, 64K and certain shareholders of 64K.(3)
     2.4       Agreement for Purchase and Sale of Assets dated as of May
               30, 1997 among FTP US, FTP Canada, Verity US and Verity
               Canada.(4)
     3.1       Certificate of Incorporation of the Company. Reference is
               made to Section 2 of Exhibit 2.1.
     3.2       By-Laws.(1)
     3.3       Certificate of Retirement of Series of Preferred Stock.(5)
     3.4       Certificate of Designation, Preferences and Rights of Series
               A Preferred Stock.(5)
     3.5       Certificate of Amendment of Certificate of Incorporation of
               Verity, Inc., dated September 21, 1999 and filed with the
               Secretary of State of the State of Delaware.(16)
     4.1       Amended and Restated Rights Agreement dated August 1, 1995,
               as amended.(1)
     4.2       Form of Rights Agreement between Verity, Inc. and First
               National Bank of Boston dated September 18, 1996.(6)
     4.3       First Amendment to Rights Agreement dated as of July 23,
               1999 among Verity, Inc. and BankBoston, N.A.(18)
    10.1       Form of Indemnification Agreement for directors and
               officers.(1),(7)
    10.2       Amended and Restated 1995 Stock Option Plan and forms of
               agreements thereunder.(7),(8)
    10.3       1995 Employee Stock Purchase Plan, as amended.(7),(19)
    10.4       1995 Outside Directors Stock Option Plan, as amended, and
               forms of agreement thereunder.(7),(20)
    10.18      Lease Agreement between Ross Drive Investors and the Company
               dated January 22, 1996.(9)
    10.19      Retainer Agreement between Regent Pacific Management
               Corporation and Verity, Inc. dated July 31, 1997.(7),(10)
    10.21      Employment Agreement between Anthony J. Bettencourt and the
               Company dated August 28, 1997.(7),(11)
    10.22      Security and Loan Agreement between Imperial Bank and the
               Company dated November 30, 1997.(12)
    10.23      Amendment to Retainer Agreement between Regent Pacific
               Management Corporation and Verity, Inc. dated April 13,
               1998.(7),(13)
    10.24      Amendment to Security and Loan Agreement between Imperial
               Bank and the Company dated November 15, 1998.(14)
    10.25      Amendment to Employment Agreement between Anthony J.
               Bettencourt and the Company dated October 6, 1998.(7),(14)
    10.26      Amendment to Retainer Agreement between Regent Pacific
               Management Corporation and Verity, Inc. dated March 12,
               1999.(7),(15)
    10.27      Amendment to Retainer Agreement between Regent Pacific
               Management Corporation and Verity, Inc. dated February 9,
               2000.(7),(17)
    10.28      Amendment to Employment Agreement between Anthony J.
               Bettencourt and the Company dated September 23, 1999.(7)
    11.1       Subsidiaries of the Company.
    23.1       Consent of PricewaterhouseCoopers LLP.
    27.1       Financial Data Schedule.
</TABLE>

                                       57
<PAGE>   58

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

 (2) Incorporated by reference from Exhibit No. 2.1 from the Company's Form 8-K
     as filed with the Securities and Exchange Commission on January 28, 1997.

 (3) Relating to the 64K acquisition incorporated by reference from Exhibit No.
     2.1 to the Company's report on Form 8-K as filed with the Securities and
     Exchange Commission on June 13, 1997.

 (4) Relating to the Key View acquisition, incorporated by reference from
     Exhibit No. 2.1 to the Company's report on Form 8-K as filed with the
     Securities and Exchange Commission on June 13, 1997.

 (5) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended August 31, 1996.

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

 (7) Management contract or compensatory plan or arrangement required to be
     filed as an exhibit.

 (8) With respect to the Amended and Restated 1995 Stock Option Plan,
     incorporated by reference to Exhibit 99.2 to the Company's Registration
     Statement on Form S-8 filed October 22, 1999. With respect to the form of
     agreements under the Amended and Restated 1995 Stock Option Plan,
     incorporated by reference to such agreements filed as exhibits with
     corresponding exhibit number from the Company's Form 10-Q for the quarter
     ended August 31, 1996.

 (9) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended February 29, 1996.

(10) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-K for the year ended May 31, 1997.

(11) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended August 31, 1997.

(12) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended February 28, 1998.

(13) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-K for the year ended May 31, 1998.

(14) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended November 30, 1998.

(15) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended February 28, 1999.

(16) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended November 30, 1999.

(17) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended February 29, 2000.

(18) Incorporated by reference from Exhibit No. 99.2 to the Company's Form 8-K
     as filed with the Securities and Exchange Commission on July 29, 1999.

(19) Incorporated by reference to Exhibit 99.1 to the Company's Registration
     Statement on Form S-8 filed October 22, 1999.

(20) With respect to the 1995 Outside Directors Stock Option Plan, as amended,
     incorporated by reference to Exhibit 99.3 to the Company's Registration
     Statement on Form S-8 filed October 22, 1999. With respect to the form of
     agreements under the 1995 Outside Directors Stock Option Plan, as amended,
     incorporated by reference to such agreements filed as exhibits with
     corresponding exhibit number from the Company's Registration Statement (No.
     33-96228), declared effective on October 5, 1995.

                                       58