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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION
13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

|(MARK ONE)                              
|----------------------------------------
|x                                       
|                                        
|For the
  Fiscal Year Ended May 31, 2004
|                                        
|OR                                      
|                                        
|o                                       

For the
Transition Period From     To
Commission file number 0-26880

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VERITY, INC.(Exact name of registrant as
specified in its charter)

|Delaware                                                           |  | 77-0182779                              
|------------------------------------------------------------------ |  | ----------------------------------------
|(State or
  other jurisdiction of
  incorporation or organization) |  | (I.R.S.
  Employer
  Identification No.)
|                                                                   |  |                                         
|894 Ross
  Drive                                                   |  |                                         
|Sunnyvale,
  California                                            |  | 94089                                   
|(Address of
  principal executive offices)                         |  | (Zip code)                              

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

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

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

Common Stock,
$0.001 Par Value
(Title of class)

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Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  Yes x No o

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. o

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

ii

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TABLE OF CONTENTS

|         |          |                                                                                                                        | Page
|-------- | -------- | ---------------------------------------------------------------------------------------------------------------------- | ----
|         |          |                                                                                                                        |     
|PART I   | 1       
|         | Item 1.  | Business                                                                                                               | 1   
|         | Item 2.  | Properties                                                                                                             | 19  
|         | Item 3.  | Legal
  Proceedings                                                                                                    | 19  
|         | Item 4.  | Submission of
  Matters to a Vote of Securities Holders                                                                | 20  
|Part II  | 21      
|         | Item 5.  | Market for
  the Registrants Common Equity, Related Stockholder Matters and Issuer
  Repurchases of Equity Securities | 21  
|         | Item 6.  | Selected
  Financial Data                                                                                              | 21  
|         | Item 7.  | Managements
  Discussion and Analysis of Financial Condition and Results of Operations                                | 22  
|         | Item 7A. | Quantitative
  and Qualitative Disclosures About Market Risk                                                           | 39  
|         | Item 8.  | Financial
  Statements and Supplementary Data                                                                          | 41  
|         | Item 9.  | Changes in and
  Disagreements with Accountants on Accounting and Financial Disclosure                                 | 41  
|         | Item 9A. | Controls and
  Procedures                                                                                              | 41  
|Part III | 42      
|         | Item 10. | Directors and
  Executive Officers of the Registrant                                                                   | 42  
|         | Item 11. | Executive
  Compensation                                                                                               | 42  
|         | Item 12. | Security
  Ownership of Certain Beneficial Owners and Management and Related Stockholder
  Matters                     | 42  
|         | Item 13. | Certain
  Relationships and Related Transactions                                                                       | 42  
|         | Item 14. | Principal
  Accountant Fees and Services                                                                               | 42  
|Part IV  | 43      
|         | Item 15. | Exhibits,
  Financial Statement Schedules, and Reports on Form 8-K                                                     | 43  

iii

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[Page
Intentionally Left Blank.]

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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 Risks Relating to Our Operations at the end of Part I, Item I
of this Annual Report on Form 10-K, 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.

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. We assume 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.

PARTI

Item 1. Business

We own
or have rights to trademarks or trade names that we use in conjunction with the
operation of our business. Verity, the Verity logo, TOPIC, KeyView, Knowledge
Organizer, TeleForm and Ultraseek are registered trademarks. Verity Portal One,
Verity LiquidOffice, Verity LiquidCapture, Verity Profiler and Powering
Business Portals are trademarks of Verity, Inc. in the United States and
numerous other countries. 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 47 of this Annual Report on Form 10-K. Our business involves significant
risks. You should carefully consider the information under the heading  Risks
Relating to Our Operations below.

Overview

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

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

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

In
March 2004, we completed two acquisitions. The first was the acquisition of
strategic assets of NativeMinds Inc. This added question and answer interface
products to our ICS product family. The acquired software, rebranded as Verity
Response, is currently

1

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in use by a number of large companies. The second
acquisition was of Cardiff Software Inc. This further expanded our offerings
with the content capture and process automation product family. The acquired
software, rebranded Verity TeleForm, Verity MediClaim, Verity LiquidOffice and
Verity LiquidCapture are in use by companies and government organizations of
all sizes. We are continuing development and support of the products acquired from
both NativeMinds and Cardiff Software, and believe that the larger enterprises
in our installed base represent an upgrade opportunity to our broader
intellectual capital management solutions as their needs grow.

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.

Verity Intelligent Content Services

Our
comprehensive and integrated ICS product family enables enterprise-wide
document indexing, content organization, search and retrieval, organization and
navigation, viewing, personalized dissemination, document recommendation,
expert and community location, question and answer interfaces, and hybrid
online and CD/DVD-ROM publishing. Our products organize and provide simple,
single-point access to information across the entire enterprise. By doing so,
our products can be used to create or enhance business portals and other
applications that 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 an intellectual
capital management solution that strengthens their businesses by improving
efficiency, employee productivity and communication.

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 ICS family of products and
markets. Today, our cross-platform ICS product family is scalable and is
designed to solve the content retrieval and organization problems of web,
enterprise and e-commerce sites. Our products:

| |  | use a combination of
  full-text, metadata and rule-based methods to index and retrieve information
  stored in a variety of formats and systems across corporate intranets,
  extranets, and the Internet, as well as information stored in other
  enterprise applications via gateways;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                           
| |  | organize and rank the
  relevance of selected information, enabling users to filter and evaluate
  information personalized to their specific needs and interests;                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                           
| |  | enable user-initiated queries,
  and also 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;                                                
| |   |                                                                                                                                                                                                                                                                                           
| |  | enable the high-speed
  classification of information, the organization of information into
  taxonomies and the visual navigation of information;                                                                                                                                        
| |   |                                                                                                                                                                                                                                                                                           
| |  | deliver the ability to filter
  most common file formats for viewing, and to convert most common file formats
  to HTML (Hypertext Markup Language) and XML (Extensible Markup Language);                                                                                                 
| |   |                                                                                                                                                                                                                                                                                           
| |  | use the information created by
  individuals searching for and retrieving documents to automatically recommend
  additional documents, locate subject matter experts, and recognize
  communities of users with similar interests;                                                        
| |   |                                                                                                                                                                                                                                                                                           
| |  | respond to questions with a
  single, correct answer where possible, and escalate questions it cannot
  answer with a specified confidence level to a full-text search, customer
  support representative or other alternative form of contact, and;                                      
| |   |                                                                                                                                                                                                                                                                                           
| |  | 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.                

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Verity Content Capture and Process Automation

Veritys
integrated content capture and process automation include paper-to-electronic
and Web-based document capture, electronic forms and process automation. Our
content capture products replace manual data entry and processes with automated
solutions that accurately capture the hand- and typewritten content on paper
forms and deliver that content to process automation systems, content
management systems, databases and other business applications. Our electronic
forms product allows companies to replace paper-based forms with electronic
forms that can be filled out by users online. Our process automation product
automates the movement of both captured content and electronic forms through an
enterprise between designated people for approval, action, informational or
storage purposes. We believe the
functionality and flexibility of these products enable us to offer our
customers an intellectual capital management solution that strengthens their
businesses by improving efficiency, making in-process information accessible
and streamlining both manual and electronic processes.

Verity Products

Our
intellectual capital management product families enable organizations to turn
corporate intranets and extranets into a powerful knowledge base or corporate
portal, making business information accessible and reusable across the
enterprise. Because our products are designed to work together, our ICS customers
may begin by deploying basic retrieval technology and can later incorporate
more sophisticated classification and recommendation features as their business
needs expand. Similarly, customers may begin by replacing manual data entry of
the information contained on forms with a content capture solution, followed by
sophisticated process automation. Additionally, because our solutions are
suitable for companies and government organization ranging from small
enterprises to global enterprises, our customers investments are preserved by
the capability of our software to expand to support the greater demands on
document repositories, corporate intranets and extranets as they grow. Product
revenues represented 58%, 56%, and 60% of total revenues in fiscal years 2004,
2003, and 2002, respectively.

Intelligent Content
Services Products:

Verity K2 Enterprise.Verity K2
Enterprise is software that indexes, searches, classifies, recommends and
retrieves information located in various repositories across an enterprise. Applications
include corporate intranets, portals, extranets, research and development,
executive messaging and business intelligence systems. K2 Enterprise utilizes
the Verity K2 architecture to deliver rapid integration, extreme scalability,
fault-tolerant operation and global support including support for multiple
languages.

Verity K2 Catalog.Verity K2
Catalog is e-commerce infrastructure that indexes, searches, classifies,
recommends and retrieves information in Business-to-Customer and
Business-to-Business environments. K2 Catalog utilizes the Verity K2
architecture to deliver rapid integration, adaptive personalization, extreme
scalability, fault-tolerant operation and global support, including support for
multiple languages.

Verity Gateways.These add-on
products and integration services extend the indexing range of Verity K2
products to third-party applications and repositories, including Documentum,
Lotus Notes, Microsoft Exchange, FileNet, Web and file servers, and relational
databases.

Verity Collaborative Classifier.
Verity Collaborative Classifier allows Verity K2 customers to distribute
taxonomy and classification management to assigned subject matter experts and
enable real-time collaboration through workflow. Its automated publishing
options allow administrators to configure the amount of human oversight
required to publish content to categories.

Verity Ultraseek.Verity
Ultraseek software provides high quality basic search functionality, with a
minimum investment in resources for setup, administration, and ongoing
management. The Content Classification Engine add-on provides simple
rules-based classification to allow navigation via browse in addition to
search. Verity Ultraseek is ideal for small and mid-size enterprises, as well
as larger enterprises not yet ready for a wider intellectual capital
management deployment, and therefore
primarily interested in quick implementation of basic search functionality.

Verity Response. Acquired in March
2004 from NativeMinds Inc. and rebranded Verity Response, this software
provides virtual representatives, or vReps, that give internal and external
customers a single interface to ask questions through a natural language
dialog. These vReps combine the search, FAQ and contact us functionality on
websites to provide a single correct answer to questions, convert the question
into a full-text query or escalate the question to a customer service
representative.

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Verity Federator.Verity
Federator enables search across multiple heterogeneous sources (federated
search), whether the indices are Verity created and maintained (Verity K2 or
Ultraseek) or other information sources inside or outside the enterprise. With
a single query, users can search all, or a subset of, the defined repositories
and get an integrated results set, saving significant time. Verity provides
workers (connectors) to Verity K2 and Ultraseek, and using the Federator
Developers Kit  customers can quickly
build workers for almost any information source.

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

Intelligent Content
Services OEM and Custom Application Development Tools:

Verity K2 Developer.Verity K2 Developer is a modular developer
platform that allows independent software vendors to integrate Veritys
indexing, search and retrieval, classification and recommendation technology
into commercial software applications. K2 Developer supports popular
programming interfaces to Suns Java and Microsofts COM, allowing users to
rapidly build applications or integrate K2 Developer into their existing web
environment.

Verity Profiler.Verity
Profiler is used to develop applications that evaluate content against business
rules, or profiles. When content that matches those business rules are
identified, Profiler can trigger events including classification of the content
into taxonomies, alerting users that the content exists, and tagging that
content within the Verity index.

Verity KeyView Export
Software Developers Kit (SDK)Verity KeyView Export
provides on-demand, server-side conversion of documents to valid XML using a
predefined Verity document type definition. The resulting XML can be indexed
and searched, and viewed using cascading style sheets or extensible style
language. Verity KeyView Export also provides, on-demand, server-side
conversion of documents to web-ready HTML, so users can see any document,
spreadsheet or presentation instantly through their browsers without the use of
any other application.

Verity KeyView Filter
SDK.VerityKeyView Filter allows the applications of
independent software vendors to index and search multiple file formats by
extracting text and converting it to a data stream or ASCII text file.

Verity KeyView Viewer
SDK.VerityKeyView Viewer allow independent software vendors
to embed functionality within their own applications that displays multiple
file formats without requiring end-users to install the native applications
that created those formats.

Content Capture and
Process Automation Products:

Verity TeleForm.Acquired
in March 2004 from Cardiff Software and rebranded Verity TeleForm, this
application provides high volume, high accuracy information capture that is
capable of processing thousands of paper forms per day. Captured content,
documents and attachments can be sent to multiple archive and retrieval
systems. Round-trip data flow and integration with other back office systems
are made possible via a series of built-in and custom Connect Agents.

Verity MediClaim.Acquired in March 2004 from Cardiff Software and
rebranded Verity MediClaim, this application is an industry-specific version of
Verity TeleForm intended for use by medical claims examiners. In addition to
the functionality of TeleForm described above, MediClaim validates medical
claim form field entries including updated 2003 ICD-9 and CPT codes.

Verity LiquidOffice.Acquired in March 2004 from Cardiff Software and
rebranded Verity LiquidOffice, this application is a web-based process
automation solution for creating, deploying and automatically managing the
routing, tracking and approval processes for electronic forms. LiquidOffice
also provides a design interface for creating electronic forms and supports
industry standards including XML, HTML, Adobe PDF and Microsoft InfoPath
formats,

Verity LiquidCapture.Acquired in March 2004 from Cardiff Software and
rebranded Verity LiquidCapture, this application enables large organizations
with distributed business environments to gather and manage the flow of
critical business documents via web-based scanning and indexing.

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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, content
organization and/or social network applications. As of May 31, 2004, we
employed 42 people in our technical support organization, 67 people in our
consulting group and 2 people focused on developing and coordinating training
services.

Services revenues
represented 42%, 44%, and 40% of total revenues in fiscal years 2004, 2003 and
2002, respectively.

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
bug fixes. We also provide our customers access to technical support
services   over the Internet via a
bulletin board system.

Consulting.We offer consulting services to our enterprise
customers, OEMs, VARs 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, and London, United Kingdom, as
well as at the facilities of our customers, VARs and system integrators
worldwide. We also provide training through certain authorized third parties.
Courses are also delivered online. 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 per course or per day  basis.

Customers

Our
software has been licensed to over 11,500 corporations, government agencies,
and software developers. 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 OEM toolkits
for independent software vendors. See our Consolidated Financial Statements
beginning on page 46 of this Annual Report on Form 10-K for our total revenues,
net income and total assets. See Note 14 of Notes to Consolidated Financial
Statements beginning on page 73 of this Annual Report on Form 10-K for a
discussion of our international revenues, income from operations and long-lived
assets by geographic region. See Our business may suffer due to risks
associated with international sales under the caption Risks Relating to Our
Operations at the end of this Item 1 for a description of risks attendant to
foreign operations.  International
revenues, in total, accounted for 34%, 37% and 36% of our revenues in fiscal
2004, 2003 and 2002, respectively.

Revenues
derived from sales to the federal and state governments and their agencies were
9.3%, 9.8% and 6.1% of total revenues for fiscal years 2004, 2003, and 2002,
respectively. Almost all of our government contracts contain termination
clauses, which permit contract termination upon our default or at the option of
the customer.

Because
we generally ship software products within a short period after receipt of an
order, we typically do not have a material backlog.

Seasonality

General
economic conditions have an impact on our business and financial results. The markets
in which we sell our products and services have, at times, experienced weak
economic conditions that have negatively affected revenues. Our quarterly
results reflect distinct seasonality in the sale of our products and services,
as our revenues are typically highest in our fourth fiscal quarter and
sequentially lowest in our first fiscal quarter.

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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 OEM customers, value added resellers and system
integrators.

Direct Sales.Our direct sales force is trained to assist
customers to acquire and utilize our products. We maintain direct sales offices
or personnel in a number of metropolitan areas across the United States,
including Falls Church, VA, Newton, MA, Chicago, IL, New York, NY, Vista, CA
and Sunnyvale, CA. European direct sales operations are located in London,
Utrecht (The Netherlands), Munich and Paris. We also have direct sales offices
located in Australia, Japan and Mexico.

Channel Sales.We work with a variety of partner types,
including value added resellers, OEM customers, independent software vendors
and system integrators. Partner companies are chosen based upon a strong mutual
value proposition and are located in North America, Western Europe, Asia, South
Africa and Australia.

Our technology is also
sold as an integrated OEM feature of more than 260 software applications
offered by over 100 OEM and independent software vendors. Our OEM partners are
drawn from such application markets as:

| |  | application integration
  (Macromedia, TIBCO);                                                           
| | - | ---------------------------------------------------------------------------------------------------------
| |   |                                                                                                          
| |  | collaboration (Lotus);                                                                                   
| |   |                                                                                                          
| |  | document/content/records
  management (EMC/Documentum, FileNet, Interwoven, Stellent, Xerox);            
| |   |                                                                                                          
| |  | enterprise resource planning systems and customer
  relationship management solutions (PeopleSoft, Kana);
| |   |                                                                                                          
| |  | e-mail and compliance
  (Steelpoint, Tumbleweed); and                                                    
| |   |                                                                                                          
| |  | storage (EMC/Legato).                                                                                    

Our
marketing activities are targeted at building market awareness and identifying
prospective customers for enterprise, Internet and e-commerce, online
publishing, hybrid CD-ROM/DVD-ROM-Web, content capture and process automation,
and OEM applications. Our marketing efforts include participation in
tradeshows, conferences and industry events, Verity seminars and webinars, industry
speaking engagements, and sponsorship, advertising, direct mail, direct email
and Internet banner ad campaigns targeting specific markets. Certain of our OEM
contracts also provide for brand name exposure concerning the independent
software vendor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, 2004, our sales and marketing organizations
consisted of 191 people.

Technology

Our
core search 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 ICS product
offerings to support commercial client/server and web-based computing
environments. We have expanded our ICS markets to include corporate intranets
and e-commerce vendors, independent software vendors and online and
CD-ROM/DVD-ROM information publishers. Our ICS technologies address the major
aspects of information retrieval and classification, including document
indexing, query formulation and search execution, ranking and presentation of
results, parametric selection, federated search of various information sources,
content profiling and evaluation, classification and taxonomies, social
networks/automatic recommendation of documents and subject matter experts,
viewing and filtering of multiple file formats, export of content to HTML and
XML, question and answer interfaces, and hybrid CD-ROM/DVD-ROM-Web publishing.

Our
content capture and process automation technology was originally developed by
Cardiff Software, which we acquired in March 2004. These technologies support
the major standards in the forms industry, including XML, Adobe PDF and
Microsoft InfoPath. The component technologies that enable content capture and
process automation include scanning, recognition and validation of forms;
connectivity with various repositories and applications that store and manage
the captured content; graphical tools for designing electronic forms;
role-based workflow, routing and approval of electronic forms.

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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 enterprise, e-commerce
and OEM markets. Our research and development is focused on enhancing core
indexing and search performance and precision, data access and security
gateways, enterprise scalability, application programming interfaces, product
deployability, information classification and recommendation, content capture
accuracy, and content security. As of May 31, 2004, there were 146 employees on
our research and development staff. Our research and development expenditures
in fiscal 2004, 2003, and fiscal 2002 were $20.2 million, $20.1 million, and
$21.7 million respectively, which represented 16.3%, 19.8% and 23.2% of total
revenues, respectively. We expect that we will continue to commit substantial
resources to product development in the future.

Competition

The
intellectual capital management software market is intensely competitive. We
believe that the principal competitive factors in this market are:

| |  | depth and breadth of
  solutions;         
| | - | ------------------------------------------
| |   |                                           
| |  | performance and price;                    
| |   |                                           
| |  | product functionality and
  features      
| |   |                                           
| |  | vendor and product reputation;            
| |   |                                           
| |  | product quality;                          
| |   |                                           
| |  | strategic alliances;                      
| |   |                                           
| |  | availability of consulting
  services; and
| |   |                                           
| |  | quality of support.                       

Intelligent Content
Services Competitors:

A
number of companies offer competitive products addressing certain of our target
markets. In the ICS market, we compete primarily with Autonomy, Convera,
Endeca, FAST, Google, Hummingbird, Inquira, iPhrase, Mercado, Microsoft, Open
Text and Thunderstone. We also compete indirectly with database vendors, such
as Oracle and IBM, that offer information search and retrieval capabilities
with their core database products, as well as with ERP (Enterprise Resource
Planning) vendors, such as SAP, that offer these capabilities as part of their
overall solution. In the future, we may encounter competition from open source
initiatives, and from companies that enhance products with ICS capabilities
such as:

| |  | application servers;                                              
| | - | ------------------------------------------------------------------
| |   |                                                                   
| |  | content and document
  management systems;                        
| |   |                                                                   
| |  | groupware applications; and                                       
| |   |                                                                   
| |  | operating systems to include
  text search and retrieval features.

Many
of our existing ICS 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 each of the factors outlined
above, we cannot assure you that we will be able to compete successfully
against our 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

7

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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
Verity Publisher product competes primarily with Enigma and Nextpage.

Content Capture and Process Automation
Competitors:

In
the content capture market, we compete with AnyDoc, Captiva, Datacap, Kofax,
and Readsoft, among others. In the process automation market, we compete with Adobe,
FileNet and PureEdge, among others. We also
compete indirectly with content management vendors, such as FileNet, that offer
content capture and workflow with their core content management products, as
well as with platform vendors, such as Microsoft, that offer basic capabilities
as part of their overall solution.

Many
of our existing content capture and process automation 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 each of the factors outlined above, we cannot assure you that we
will be able to compete successfully against our current or future competitors
or that competition will not seriously harm our business.

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;
| | - | ---------------------------------------------------------
| |   |                                                          
| |  | delivery of new products;                                
| |   |                                                          
| |  | frequent enhancements to
  existing products;            
| |   |                                                          
| |  | brand/name recognition; and                              
| |   |                                                          
| |  | reliable product maintenance.                            

We
currently have three issued patents, relating to our search and retrieval
technology, one of which will expire in 2016 and the other two in 2020, and
thirteen patent applications pending. While we believe that our patents
have value, no single patent itself is important to us. 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 in 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 a delay in our ability to ship these products while we seek to
implement technology offered by alternative sources. Any

8

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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, 2004, we had a total of 524 employees, including 146 in research and
development, 158 in sales, 33 in marketing and business development, 111 in
customer support and professional services, 71 in administration and 5 in
manufacturing. Of these employees, 366 were located in the United States, 70 in
Europe, 78 in Canada, 5 in Australia, 3 in Asia Pacific and 2 in Mexico. 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.

Business Acquisitions

The
markets in which we compete require a wide variety of technologies, products,
and capabilities. Our strategy of acquiring assets or businesses with
complementary customer bases, products and technologies has resulted in the
completion of a number of acquisitions as described below. We expect these
acquisitions, and potential future acquisitions, will enable us to better serve
our existing and targeted customers by expanding our product offerings and core
technological capabilities. Mergers and acquisitions of high-technology
companies are inherently risky. No assurance can be given that our previous or
future acquisitions will be successful or will not materially adversely affect
our financial condition or operating results. The risks associated with
acquisitions are discussed below under the caption Our recent
acquisitions of Cardiff Software, strategic assets of NativeMinds and the
Inktomi enterprise search software assets, as well as other future potential
acquisitions, may have unexpected material adverse consequences under Risks Relating to Our Operations  Risks Related to
Our Business below.

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

In
March 2004, we acquired the intellectual property, customer agreements and
certain other assets from NativeMinds Inc., a privately held software company
and leading provider of integrated self-service solutions.   The acquired  software, rebranded Verity Response, is part of our ICS product
family and is currently in use by a number of large companies.

In
December2002, we acquired selective assets relating to the enterprise search
software business, from Inktomi Corporation.  
The acquired assets include basic search, categorization and content
refinement capabilities, as well as XML technology assets.

Refer
to the discussions under the caption  Recent
Acquisitionsset forth in Item
7, Part II of this Annual Report on Form 10-K for more information on the
acquisitions, which are incorporated by reference here.

Available
Information

You
may obtain a free copy of our annual reports on Form 10-K, quarterly reports on
Form 10-Q and current reports on Form 8-K and any amendments to those reports
filed with or furnished to the Securities and Exchange Commission (SEC) on
the day they are filed or furnished through our website at www.verity.com. Our
website address is provided solely for informational purposes. We do not
intend, by this reference, that our website or any of the information contained
therein should be deemed to be part of, or incorporated into, this Annual
Report on Form 10-K.

9

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RISKS RELATING TO OUR OPERATIONS

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

Risks Related
to Our Business

Our revenues and operating results are
dependent on many factors, many of which are outside of our control and, as a
result may fluctuate in future periods and be less than we or our investors
anticipate

The
results of operations for any quarter are not necessarily indicative of results
to be expected in future periods. 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, many of which are outside of our control. These factors
include:

| |  | fluctuations in capital
  spending by customers;                                                                                                                                                                                                       
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                        
| |  | the size and timing of orders;                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                        
| |  | changes in the budget or
  purchasing patterns of customers or potential customers, changes in foreign
  country exchange rates, or pricing pressures from competitors;                                                                                
| |   |                                                                                                                                                                                                                                                        
| |  | increased competition in the
  software and Internet industries;                                                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                        
| |  | the introduction and market
  acceptance of new technologies and standards in search and retrieval, Internet,
  document management, database, networking, and communications technology;                                                              
| |   |                                                                                                                                                                                                                                                        
| |  | variations in sales channels,
  product costs, the mix of products sold, or the success of quality control
  measures;                                                                                                                                 
| |   |                                                                                                                                                                                                                                                        
| |  | the integration of people,
  operations, and products from acquired businesses and technologies;                                                                                                                                                       
| |   |                                                                                                                                                                                                                                                        
| |  | changes in operating expenses
  and personnel;                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                        
| |  | changes in accounting
  principles, such as a requirement that stock options be included in
  compensation, which is widely expected to occur, which if adopted, would increase
  our compensation expenses and have a negative effect on our earnings;
| |   |                                                                                                                                                                                                                                                        
| |  | the overall trend toward
  industry consolidation; and                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                        
| |  | changes in general economic
  and geo-political conditions and specific economic conditions in the computer
  and software industries.                                                                                                                 

Any
of the factors, some of which are discussed in more detail below, could
materially and adversely impact our operations and financial results, which
could hurt our business.  Any adverse
impact our operations and financial results as a result of these or any other
factors could cause our stock price to fall.

Our expenditures are tied to anticipated
revenues, and therefore imprecise revenue 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 as a result 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 are dependent upon those
third-party vendors sales and marketing efforts, which may fluctuate
dramatically and are difficult for us to predict. Our expense levels are based,
in part, on our expectations as to future revenues and are to a large extent
fixed in the

10

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short term.
Therefore, we may be unable to adjust spending in a  timely manner to compensate for any
unexpected revenue shortfall. Any  significant shortfall of demand in relation to our
expectations or any material  delay of customer orders would have an almost immediate
adverse affect on our  operating results.

Demand for our products may be adversely
affected if economic and market conditions deteriorate

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

Changes in effective tax rates could affect
our results

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

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

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

Our sales cycle is lengthy and
unpredictable

Any
delay in sales of our products and services could cause our quarterly revenue
and operating results to fluctuate. The typical sales cycle of our products is
lengthy, generally between six to eighteen months, unpredictable, and involves
significant investment decisions by prospective customers, as well as our
education of potential customers regarding the use and benefits of our
products. Our customers spend a substantial amount of time before purchasing
our products in performing internal reviews and obtaining capital expenditure
approvals. We believe our sales cycle lengthened in 2003 and 2004 as a result
of macro-economic factors and we cannot be certain that this cycle will not
continue to lengthen in the future.

Our business may suffer due to risks
associated with international sales

In
fiscal 2004, international sales represented 34% of our revenues. We expect international
revenues will continue to account for a significant percentage of our revenues
for the foreseeable future. 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;                                

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| |  | 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 reduced sales or profitability in
that country. Also, fluctuations in the opposite direction could cause sales
denominated in foreign currencies to decrease U.S. dollar revenues derived from
these sales. Furthermore, future international activity may result in increased
foreign currency denominated sales and, in this event, gains and losses on the
conversion to U.S. dollars of accounts receivable and accounts payable arising
from international operations may contribute significantly to fluctuations in
our results of operations. The financial stability of foreign markets could
also affect our international sales. In addition, income earned in various
countries where we do business may be subject to taxation by more than one
jurisdiction, thereby adversely affecting our consolidated after-tax earnings.
Any of these factors could have an adverse effect on the revenues from our
future international sales and, consequently, our results of operations.

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

Revenues
derived from sales to the U.S. federal and state governments and their agencies
were 9.3% and 9.8% of total revenues for fiscal years 2004 and 2003,
respectively. As a result, any reductions in government spending on information
technologies could harm our operating results. In recent years, budgets of many
governments and/or their agencies have been reduced, causing certain customers
and potential customers of our products to re-evaluate their needs. These
budget reductions are expected to continue over at least the next several
years.

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

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

During
the past few years, our management and other personnel have focused on
modifying and enhancing our core technology to support a broader set of search
and retrieval solutions for use on enterprise-wide systems, over online
services, over the Internet and on CD-ROM. In order for our strategy to succeed
and to remain competitive, we must continue to leverage our core technology to
develop new product offerings by us and by our OEM customers that address the
needs of these new markets or we must acquire new technology, such as we did in
our Cardiff Software and NativeMinds transactions in the latter half of fiscal
2004. The development of new products, whether by leveraging our core technology
or by acquiring new technology, is expensive. If these products do not generate
substantial revenues, our business and results of operations will be adversely
affected. We cannot assure you that any of these products will be successfully
developed and completed on a timely basis or at all, will achieve market
acceptance or will generate significant revenues.

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

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

The
computer software industry is subject to rapid technological change, changing
customer requirements, frequent new product introductions, and evolving
industry standards, each of which may render our existing products and services
obsolete. As a result, our position in our existing markets or other markets
that we may enter could be eroded rapidly by any of these factors.  Our future success will also depend upon our
ability to maintain compatibility between our products and the text publication
formats we believe are or will become popular and widely adopted as well as the
OEM application products in which our products are embedded.  If we are unable to adapt to these rapid
technological developments or customer requirements in a timely manner, our
sales would diminish and our financial condition and results of operations
would be materially and adversely affected.

12

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

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

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

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

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

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

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

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

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

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

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

13

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

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

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

New legislation, higher insurance cost and potential new
accounting pronouncements are likely to impact our future consolidated
financial position and results of operations.

Recently,
there have been significant regulatory changes, including the Sarbanes-Oxley
Act of 2002, and there may be new accounting pronouncements or regulatory
rulings that will have an impact on our future consolidated financial position
and results of operations. The Sarbanes-Oxley Act of 2002 and other rule
changes and proposed legislative initiatives following several highly
publicized corporate accounting and corporate governance failures are likely to
increase general and administrative costs. In addition, insurance companies
significantly increased insurance rates as a result of higher claims over the
past year, and our rates for our various insurance policies increased
substantially. Further, proposed initiatives may result in changes in
accounting rules, including legislative and other proposals to account for
employee stock options as an expense. These and other potential changes could
materially increase the expenses we report under accounting principles
generally accepted in the United States of America and adversely affect our
consolidated operating results.

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

A
number of companies offer competitive products addressing certain of our target
markets. In the ICS market, we compete primarily with Autonomy, Convera,
Endeca, FAST, Google, Hummingbird, Inquira, iPhrase, Mercado, Microsoft, Open
Text and Thunderstone. We also compete indirectly with database vendors, such
as Oracle and IBM, that offer information search and retrieval capabilities
with their core database products, as well as with ERP (Enterprise Resource
Planning) vendors, such as SAP, that offer these capabilities as part of their
overall solution.

In
the content capture market, we compete with AnyDoc, Captiva, Datacap, Kofax,
and Readsoft, among others. In the process automation market, we compete with Adobe,
FileNet and PureEdge, among others. We also
compete indirectly with content management vendors, such as FileNet, that offer
content capture and workflow with their core content management products, as
well as with platform vendors, such as Microsoft, that offer basic capabilities
as part of their overall solution.

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

Our products contain open source software

Products
or technologies acquired or developed by us may include so-called open source
software. Open source software is typically licensed for use at no initial
charge, but imposes on the user of the open source software certain
requirements to license to others both the open source software as well as the
software that relates to, or interacts with, the open source software. Our
ability to

14

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commercialize
products or technologies incorporating open source  software or otherwise fully realize
the anticipated benefits of any such  acquisition may be restricted because, among other
reasons:

| |  | open source license terms may
  be ambiguous and may result in unanticipated obligations regarding our
  products;                                                                     
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                        
| |  | competitors will have improved
  access to information that may help them develop competitive products;                                                                                
| |   |                                                                                                                                                                                        
| |  | open source software cannot be
  protected under trade secret law;                                                                                                                     
| |   |                                                                                                                                                                                        
| |  | it may be difficult for us to
  accurately determine the developers of the open source code and whether the
  acquired software infringes third party intellectual property rights; and
| |   |                                                                                                                                                                                        
| |  | open source software
  potentially increases customer support costs because licensees can modify the
  software and potentially introduce errors.                                      

Further,
to the extent we utilize open source software we face risks. For example, the
scope and requirements of the most common open source software license, the GNU
General Public License (GPL), have not been interpreted in a court of law.
Use of GPL software could subject certain portions of our proprietary software
to the GPL requirements. Other forms of open source software licensing
present license compliance risks, which could result in litigation or loss of
the right to use this software.

Our recent acquisitions of Cardiff
Software, strategic assets of Native Minds and the Inktomi enterprise search
software assets, as well as other future potential acquisitions, may have
unexpected material adverse consequences

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

| |  | difficulties in integration of
  the operations, technologies, products and personnel of the acquired
  companies;                                         
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                            
| |  | the risk of diverting
  managements attention from normal daily operations of the business;                                                               
| |   |                                                                                                                                                            
| |  | accounting consequences,
  including changes in purchased research and development expenses, resulting
  in variability in our quarterly earnings;         
| |   |                                                                                                                                                            
| |  | potential difficulties in
  completing projects associated with purchased in-process research and
  development;                                           
| |   |                                                                                                                                                            
| |  | risks of entering markets in
  which we have no or limited direct prior experience and where competitors in
  these markets have stronger market positions;
| |   |                                                                                                                                                            
| |  | the potential loss of key
  employees of the acquired company;                                                                                             
| |   |                                                                                                                                                            
| |  | the assumption of known and
  potentially unknown liabilities of the acquired company;                                                                     
| |   |                                                                                                                                                            
| |  | we may find that the acquired
  company or assets do not further our business strategy or that we paid more
  than what the company or assets are worth;   
| |   |                                                                                                                                                            
| |  | we may have product liability
  associated with the sale of the acquired companys products;                                                               
| |   |                                                                                                                                                            
| |  | we may have difficulty
  maintaining uniform standards, controls, procedures and policies;                                                                 
| |   |                                                                                                                                                            
| |  | our relationship with current
  and new employees and clients could be impaired;                                                                           

15

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| |  | the acquisition may result in
  litigation from terminated employees or third parties who believe a claim
  against us would be valuable to pursue;           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                               
| |  | our due diligence process may
  fail to identify significant issues with product quality, product
  architecture and legal contingencies, among other matters;
| |   |                                                                                                                                                               
| |  | insufficient revenues to
  offset increased expenses associated with acquisitions;                                                                            
| |   |                                                                                                                                                               
| |  | inability to renew third-party
  software license agreements; and                                                                                             
| |   |                                                                                                                                                               
| |  | market acceptance of new releases.                                                                                                                            

Acquisitions
may also cause us to:

| |  | issue common stock that would
  dilute our current stockholders percentage ownership;                                                         
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                
| |  | record goodwill and
  non-amortizable intangible assets that will be subject to impairment testing
  and potential periodic impairment charges;
| |   |                                                                                                                                                
| |  | incur amortization expenses
  related to certain intangible assets; or                                                                         
| |   |                                                                                                                                                
| |  | incur large and immediate
  write-offs.                                                                                                        

We
cannot assure you that future acquisitions will be successful and will not
adversely affect our business. We must also maintain our ability to manage any
growth effectively. Failure to manage growth effectively and successfully
integrate acquisitions we make could harm our business.

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

There
has been ongoing public debate whether employee stock option and employee stock
purchase plans shares should be treated as a compensation expense and, if so,
how to properly value such charges. If we elected or were required to record an
expense for our stock-based compensation plans using the fair value method, we
could have significant accounting charges. For example, in fiscal year 2004,
had we accounted for stock-based compensation plans using the fair-value method
prescribed in FASB Statement No. 123 as amended by Statement 148, net income
would have been reduced by $32.9 million. We are not currently required to
record any compensation expense using the fair value method in connection with
option grants to employees that have an exercise price at or above fair market
value at the grant date and for shares issued under our employee stock purchase
plan. On March 31, 2004, the Financial Accounting Standard Board
(FASB) issued an Exposure Draft, Share-Based
Payment: an amendment of FASB Statements No. 123 and 95, which would
require a company to recognize the fair value of stock options and other
stock-based compensation to employees for 2005 reporting periods.  If
adopted, the proposed requirements in the Exposure Draft would be
effective as of the beginning of the first fiscal year beginning after December
15, 2004 for public companies.

See
Note 9 to Consolidated Financial Statements for a more detailed presentation of
accounting for stock-based compensation plans.

16

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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

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

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

| |  | use of the Internet, the Web
  and other online services does not continue to increase or increases more
  slowly than expected;                                                                           
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                            
| |  | the infrastructure for the
  Internet, the Web and other online services does not effectively support
  expansion that may occur; or                                                                       
| |   |                                                                                                                                                                                                            
| |  | the Internet, the Web and
  other online services do not create a viable commercial marketplace,
  inhibiting the development of electronic commerce and reducing the need for
  our products and services.

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

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

| |  | potentially inadequate
  development of the necessary communication and network infrastructure,
  particularly if rapid growth of the Internet continues;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                          
| |  | delayed development of
  enabling technologies and performance improvements;                                                                             
| |   |                                                                                                                                                          
| |  | delayed development or
  adoption of new standards and protocols; and                                                                                    
| |   |                                                                                                                                                          
| |  | increased governmental
  regulation.                                                                                                                     

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

17

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EXECUTIVE
OFFICERS OF THE REGISTRANT

As of May 31st,
2004, our executive officers and certain other key employees were as follows:

| | Name                   |  | Age |  | Position                                                                         
| | ---------------------- |  | --- |  | ---------------------------------------------------------------------------------
| |                        |  |     |  |                                                                                  
| | Gary J. Sbona          |  | 61  |  | Executive Chairman of the Board                                                  
| | Anthony J. Bettencourt |  | 43  |  | President and Chief Executive Officer                                            
| | Steven R. Springsteel  |  | 46  |  | Senior Vice President of Finance  &  Administration  &  Chief
  Financial Officer
| | Andrew D. Feit         |  | 43  |  | Senior Vice President, Marketing                                                 
| | Sunil D. Nagdev        |  | 40  |  | Senior Vice President, Professional Services and TechnicalSupport                
| | Michael D. Mooney      |  | 43  |  | Senior Vice President, North American Sales and Business Development             
| | Dr. Prabhakar Raghavan |  | 43  |  | Senior Vice President, Chief Technology Officer                                  
| | Hugo Sluimer           |  | 51  |  | Senior Vice President, International Sales and European Operations               
| | Mark Seamans           |  | 37  |  | Senior Vice President, Research and Development                                  

GARY J. SBONA has served as a
member of our board of directors since May 1998, as our Chairman of the Board
since  March 1999 and as our Executive Chairman
of the Board since March 2003. Mr. Sbona also served as our President from July
1997 to September 1999 and as our Chief Executive Officer from July 1997 to
February 2003.  Mr. Sbona currently
serves as Vice Chairman of the Board of Trustees of KTEH Public Television
Foundation in San Jose, California. Mr. Sbona also serves as
Chairman and Chief Executive Officer of Regent Pacific Management Corporation,
a management services firm that is currently providing us with management services;
Mr. Sbona has held this position since 1974.

ANTHONY J. BETTENCOURT has served as a member of our
board of directors since September 1999. Mr. Bettencourt joined us in July 1995
as Vice President of North American sales. Mr. Bettencourt was subsequently
promoted to Vice President of Worldwide Sales and Marketing and served in this
position until his departure in December 1996. From December 1996 to September
1997, Mr. Bettencourt served as an officer of OnLive! Technologies, a private
technology company. Mr. Bettencourt rejoined us in September 1997 as Senior
Vice President, Worldwide Sales and Product Marketing. We appointed him to the
position of President in September 1999and to the position of President and
Chief Executive Officer in March 2003. Prior to initially joining us, 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. From December 1988 to July 1990, Mr.
Bettencourt served as Vice President of Sales for Rockwell CMC.

STEVEN
R. SPRINGSTEEL has
served as our Senior Vice President of Finance and Administration and Chief
Financial Officer since January 2003. Prior to joining Verity, Mr. Springsteel
served as the Chief Operating Officer and Chief Financial Officer of Sagent
Technology, a publicly traded enterprise business intelligence software company
from November 2001 to January 2003. Before joining Sagent, Mr. Springsteel
served as the Chief Operating Officer and Chief Financial Officer of privately
held NOCpulse a privately held IT service level monitoring company
(subsequently sold to Red Hat), from October 2000 to November 2001. Mr.
Springsteel served as the Executive Vice President and Chief Financial Officer
of Chordiant Software, a publicly traded customer relationship management
software company from November 1996 to October 2000. Mr. Springsteel also
serves on the Board of Directors for both Chordiant Software and Critical Path.
Mr. Springsteel holds a B.A. in Business Administration from Cleveland State
University.

ANDREW
D. FEIT joined our
company as our Vice President of Product Marketing in December 2002, as a
result of the acquisition of Inktomi Corporations enterprise search business,
and was promoted to Senior Vice President of Marketing in June 2003. Prior to
joining our company, Mr. Feit served as Vice President of Marketing at Inktomi
Corporation, an Internet infrastructure software company, which he joined when
Inktomi Corporation acquired Quiver Inc. in August 2002. Before Inktomi, Mr.
Feit held the position of Chief Operating Officer for Quiver, Inc., a provider
of taxonomy and classification applications, from February 2001 to August 2002.
From July 2000 to January 2001. Mr. Feit held the position of Vice President,
Enterprise Search for Inktomi Corporation. Mr. Feit joined Inktomi Corporation
as a result of the acquisition of Ultraseek Corporation, a subsidiary of
Infoseek Corporation, an Internet search and directory service company, where
Mr. Feit served as Vice President and General Manager of the Enterprise
Software division from September 1996 to July 2000. Prior to Infoseek, Mr. Feit
served as Director and Principal Analyst at Gartner Group/Dataquest from 1995
to 1996, and held a variety of sales and marketing positions at Digital
Equipment Corporation from 1983 through 1995. Mr. Feit holds a B.S. in Chemical
Engineering from Tufts University.

18

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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. In June 2003, Mr. Nagdev was promoted to Senior Vice
President, Professional Services and Technical Support. 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 worked at Consilium and Ask Computer Systems. Mr. Nagdev holds
a B.S. in Computer Science from Chico State University.

MICHAEL
D. MOONEY joined
our company as Vice President of Business Development in February 2000, and was
subsequently appointed to the position of Vice President, North American Sales
& Business Development in November 2001. In February 2003, Mr. Mooney was
promoted to Senior of Vice President, North American Sales & Business
Development. 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.

DR.
PRABHAKAR RAGHAVAN joined Verity as chief scientist and Vice
President of emerging technologies in April 2000. In June 2001, he was elected
to serve as the companys Vice President and Chief Technology Officer. Dr Raghavan
was promoted to Senior Vice President and Chief Technology Officer in May 2004.
In addition to his role at Verity, Dr. Raghavan is a consulting professor of
computer science at Stanford University. Dr. Raghavan has served on the
editorial boards of several journals and currently is editor-in-chief of the
Journal of the Association for Computer Machinery (ACM). In addition, he is a
Fellow of the ACM and of the Institute of Electrical and Electronics Engineers
(IEEE). Prior to joining Verity in March 2000, Dr. Raghavan worked in a number
of technical and managerial capacities at IBM, a leading manufacturer and
supplier of computers. He holds a doctorate in computer science from the
University of California at Berkeley and an undergraduate degree in electrical
engineering from the Indian Institute of Technology, Madras.

HUGO
SLUIMER joined
our company as Sales Manager in June 1990, and in March 1995 he was promoted to
Director of Sales. In May 1998, Mr. Sluimer was promoted to the position of
Vice President, European Operations. In November 2001, Mr. Sluimer was
appointed to the position of Vice President, International Sales & European
Operations. In June 2003, Mr. Sluimer was promoted to the Senior Vice
President, International Sales & European Operations. 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.

MARK SEAMANS joined our company with its acquisition of
Cardiff Software and is Veritys Senior Vice President of Research and Development.  Mr. Seamans was Cardiff Softwares Chief
Technology Officer and Vice President of Business Development. Mr. Seamans
joined Cardiff in 1994 from NCR as Vice President of Consulting Services. He
holds a Bachelors Degree in Cognitive Science from the University of
California at San Diego and a Master of Science in Engineering Management from
Colorados National Technological University. Mr. Seamans was awarded the
master of information technology designation from the Association for
Information and Imaging Management International, which also designated him a
certified document-imaging architect.

Item
2. Properties

We currently
occupy two buildings in Sunnyvale California totaling approximately 96,000
square feet, which are used as our principal administrative, sales, marketing
and research and development facilities. The operating lease agreement for
these facilities commenced in June 1996 and was renewed in April 2004 for a
term of seven years with an expiration date of March 2011. In addition, we
lease a development and technical support office in Canada, where we occupy
approximately 20,500 square feet. As a result of our acquisition of Cardiff
Software, we acquired the lease of a sales and development facility, where we
occupy approximately 37,000 square feet of the 60,000 square foot building in
Vista, California, with a lease that expires in June 2006.  Of the 60,000 square feet that we lease in
the Vista facility, approximately 5,000 square feet is currently sublet and we
expect to partition and sublet another 18,000 square feet of this facility in
the first half of fiscal 2005. We also lease sales offices in Georgia,
Illinois, Massachusetts, New York, Texas, Virginia, England, France, Germany, Netherlands
and Japan.

Item 3.Legal
Proceedings

We
are subject to legal proceedings and claims that arise in the ordinary course
of business.  While the outcome of these
proceedings and claims cannot be predicted with certainty, management does not
believe that the outcome of any of these legal matters will have a material
adverse effect on our financial results.

19

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Item 4.Vote of
Securities Holders

Not Applicable.

20

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PART II

Item 5.Market for
the Registrants Common Equity, Related Stockholders Matters and Issuer
Repurchases of Equity Securities

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

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

|                               |  | High |       | Low |  
|------------------------------ |  | ---- | ----- | --- | -
|                               |  |      |       |     |  
|Fiscal Year ended May 31, 2004 |  |      |       |     |  
|First Quarter                  |  | $    | 20.00 |     | $
|Second Quarter                 |  |      | 16.16 |     |  
|Third Quarter                  |  |      | 17.56 |     |  
|Fourth Quarter                 |  |      | 16.92 |     |  
|Fiscal Year ended May 31, 2003 |  |      |       |     |  
|First Quarter                  |  | $    | 12.97 |     | $
|Second Quarter                 |  |      | 14.46 |     |  
|Third Quarter                  |  |      | 17.03 |     |  
|Fourth Quarter                 |  |      | 21.05 |     |  

As of May 31,
2004, there were approximately 145 holders of record of our common stock and
37,279,770 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
repurchase our common stock 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.

The table below
sets forth information regarding repurchases of Verity common stock by Verity
during the three months ended May 31, 2004.

|Period                               |  | Total
  Number of
  Shares 
  Purchased |           | Average Price Paid
  Per Share |  | Total Number of
  Shares Purchased as 
  Part of Publicly 
  Announced Programs (1) |       | Maximum Dollar
  Value of Shares that 
  May Yet Be Purchased 
  Under the Programs | 
|------------------------------------ |  | --------------------------------------- | --------- | ------------------------------ |  | ----------------------------------------------------------------------------------- | ----- | ----------------------------------------------------------------------------------- | 
|                                     |  |                                         |           |                                |  |                                                                                     |       |                                                                                     | 
|                                     |  |                                         |           |                                |  |                                                                                     |       |                                                                                     | 
|March 1, 2004 through March 31, 2004 |  |                                         | 1,619,601 |                                |  | $                                                                                   | 12.90 |                                                                                     | 
|April 1, 2004 through April 30, 2004 |  |                                         | 884,390   |                                |  | $                                                                                   | 13.68 |                                                                                     | 
|May 1, 2004 through May 31, 2004     |  |                                         |          |                                |  |                                                                                     |      |                                                                                     | 
|Total                                |  |                                         | 2,503,991 |                                |  | $                                                                                   | 13.18 |                                                                                     | 

(1) On June 24,
2003, we announced that our Board of Directors approved a stock repurchase
program of up to $50.0 million to repurchase shares of our common stock during
our fiscal year ending May 31, 2004. 
This program has now ended, as the last of the entire authorized amount
were repurchased in April 2004.

Item 6.Selected
Consolidated Financial Data

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

21

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|                                                         |  | Fiscal Year Ended May 31,             |        
|-------------------------------------------------------- |  | ------------------------------------- | -------
|                                                         |  |                                       |        
|                                                         |  | 2004                                  |        
|                                                         |  |                                       |        
|                                                         |  | (in thousands, except per share data) |        
|Consolidated Statements of Operations Data:              |  |                                       |        
|Revenues:                                                |  |                                       |        
|Software products                                        |  | $                                     | 71,999 
|Service and other                                        |  |                                       | 52,311 
|                                                         |  |                                       |        
|Total
  revenues                                         |  |                                       | 124,310
|                                                         |  |                                       |        
|Costs of revenues:                                       |  |                                       |        
|Software products                                        |  |                                       | 2,270  
|Service and other                                        |  |                                       | 14,467 
|Amortization of purchased intangible
  assets            |  |                                       | 3,456  
|                                                         |  |                                       |        
|Total
  costs of revenues                                |  |                                       | 20,193 
|                                                         |  |                                       |        
|Gross profit                                             |  |                                       | 104,117
|Operating expenses:                                      |  |                                       |        
|Research and development                                 |  |                                       | 20,211 
|Marketing and sales                                      |  |                                       | 50,006 
|General and administrative                               |  |                                       | 12,057 
|In-process research and development
  charge             |  |                                       | 3,472  
|Restructuring charges                                    |  |                                       | 1,226  
|Charitable contribution                                  |  |                                       |       
|                                                         |  |                                       |        
|Total
  operating expenses                               |  |                                       | 86,972 
|                                                         |  |                                       |        
|Income (loss) from operations                            |  |                                       | 17,145 
|Other income, net                                        |  |                                       | 4,119  
|                                                         |  |                                       |        
|Income before provision for income taxes                 |  |                                       | 21,264 
|Provision for (benefit from) income taxes                |  |                                       | 9,655  
|                                                         |  |                                       |        
|Net income                                               |  | $                                     | 11,609 
|                                                         |  |                                       |        
|                                                         |  |                                       |        
|Net income per share  basic                             |  | $                                     | 0.31   
|                                                         |  |                                       |        
|Net income per share  diluted                           |  | $                                     | 0.29   
|                                                         |  |                                       |        
|Number of shares used in per share calculation  basic   |  |                                       | 37,625 
|                                                         |  |                                       |        
|Number of shares used in per share calculation  diluted |  |                                       | 39,666 
|                                                         |  |                                       |        
|                                                         |  |                                       |        
|Consolidated Balance Sheet Data:                         |  |                                       |        
|Working capital                                          |  |                                       | 109,741
|Total assets                                             |  |                                       | 344,081
|Long-term obligations                                    |  |                                       | 570    
|Stockholders equity                                     |  |                                       | 296,826

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

See Note 13 of Notes to Consolidated Financial Statements beginning on page 51 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.

On March 15,
2004, we acquired Cardiff Software Inc. 
On March 3, 2004, we acquired the intellectual property, customer
agreements and certain other assets of NativeMinds Inc.  On December 17, 2002, we acquired from
Inktomi Corporation assets relating to Inktomis enterprise search software
business, which includes basic search, categorization and content refinement
capabilities, as well as its XML technology assets. In accordance
with SFAS No.141, Business Combinations which is effective for all
acquisitions after June 30, 2001, all these transactions
were accounted for as purchases. Consequently, from and after the date of
purchase we have recorded revenues from the business and products acquired from
Cardiff Software, NativeMinds and Inktomi, as well as have incurred added
expenses from the acquisitions of these businesses.

Item 7.Managements
Discussion and Analysis of Financial Condition and Results of Operations

The
following discussion should be read in conjunction with the consolidated
financial statements and related notes of Verity, Inc., which appear elsewhere
in this Annual Report on Form 10-K. The following discussion contains forward-looking
statements, which are statements of our expectations as to future events and
results, such as our expectations as to our future operating results, that
involve risks and uncertainties. Our actual results could differ materially
from those anticipated in these forward-looking statements

22

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as a result of
certain factors, including those discussed below and elsewhere in this Annual Report on
Form 10-K, particularly under the heading Item 1. Business Risks Relating to Our
Operations. See Forward-Looking Statements at the beginning of
this Annual Report for additional cautionary information regarding the forward-looking
statements we make.

Overview

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

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

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

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

Internal Controls

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

Recent Acquisitions

Cardiff
Software Inc. On
March 15, 2004, we acquired Cardiff Software Inc., a privately held software
company. Cardiff Software technology enables the automated capture of dynamic
business information. Although the Cardiff Software corporate brand has been
discontinued, we have retained the product names and rebranded them as Verity
TeleForm®, Verity LiquidOffice, Verity LiquidCapture, and Verity MediClaim.
Support and maintenance services for existing Cardiff Software customers will
remain in place. This acquisition further expanded our
offerings with the content capture and process automation product family. The
acquired software, rebranded Verity TeleForm, Verity MediClaim, Verity
LiquidOffice and Verity LiquidCapture, is in use by companies and government organizations
of all sizes. We are continuing development and support of these products, and believe that the
larger enterprises in the installed base represent an upgrade opportunity to
our broader intellectual capital management solutions as their needs grow.

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

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consideration, includes approximately $11.9 million placed into a
third party escrow account to be paid to Cardiff Softwares shareholders in
installments over 24 months from the acquisition.  These future payments are subject to Cardiff Software meeting
certain obligations outlined under the representations and warranties covenants
sections of the definitive merger agreement. 
We believe that Cardiff  Software
will meet these obligations and therefore the entire $11.9 million has been
recorded as purchase consideration.

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

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

Inktomi
Corporation. In
December 2002, we acquired the enterprise search assets of Inktomi Corporation,
further expanding our product portfolio to include solutions for smaller
organizations and departments within larger enterprises. In addition to
addressing these markets, the acquired enterprise search software, re-branded
Verity Ultraseek, is in use at a number of larger enterprises for search-only
applications as well. We are continuing development and support of the
Ultraseek product line, and believe that the larger enterprises in the
installed base represent an upgrade opportunity to our broader intellectual
capital management solutions as their needs grow. We purchased the Enterprise
search assets from Inktomi Corporation for approximately $26.8 million in cash,
of which $3.0 million, plus $67,500 in interest, was paid in our first fiscal
quarter of 2005. We expensed $1.2 million to in-process research and
development (in-process R&D) upon acquisition, and have been amortizing
the expense of purchased intangible assets at a rate of approximately $2.6
million per year, which we expect to continue through fiscal 2007, with the
remaining $1.3 million to be amortized in fiscal 2008.

Critical Accounting
Policies and Estimates

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

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

Revenue Recognition

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

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

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

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

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

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

Sales
Commission Expense

Sales
commission expense is a variable expense and a significant portion of our
overall sales and marketing expense.  In
addition to base salaries, our worldwide sales force is eligible to receive
variable compensation based on pre-established annual quota attainment.  On a periodic basis, we accrue estimated sales
commission expense and pay out the actual expense in future periods once actual
attainment has been calculated and reviewed. 
Actual quota attainments and therefore actual commission
payments may differ from our estimated accrual based on certain factors such as
mix of revenue contribution by sales representatives and accelerator provisions
for overachievement of quotas.

Allowance for
Doubtful Accounts

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

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

Contingencies
and Litigation

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

Accounting for
Income Taxes

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

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

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

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

Impairment of Goodwill and Other Intangible
Assets

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

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

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

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

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

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

Results of Operations

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

|                                              |  | Fiscal Year Ended May 31, |      
|--------------------------------------------- |  | ------------------------- | -----
|                                              |  |                           |      
|                                              |  | 2004                      |      
|                                              |  |                           |      
|Revenues:                                     |  |                           |      
|Software products                             |  |                           | 57.9 
|Service and other                             |  |                           | 42.1 
|                                              |  |                           |      
|Total
  revenues                              |  |                           | 100.0
|                                              |  |                           |      
|Costs of revenues:                            |  |                           |      
|Software products                             |  |                           | 1.8  
|Service and other                             |  |                           | 11.6 
|Amortization of purchased intangible
  assets |  |                           | 2.8  
|                                              |  |                           |      
|Total
  costs of revenues                     |  |                           | 16.2 
|                                              |  |                           |      
|Gross profit                                  |  |                           | 83.8 
|Operating expenses:                           |  |                           |      
|Research and development                      |  |                           | 16.3 
|Marketing and sales                           |  |                           | 40.2 
|General and administrative                    |  |                           | 9.7  
|In-process research and development
  charge  |  |                           | 2.8  
|Restructuring charge                          |  |                           | 1.0  
|Charitable contribution                       |  |                           |     
|                                              |  |                           |      
|Total
  operating expenses                    |  |                           | 70.0 
|                                              |  |                           |      
|Income from operations                        |  |                           | 13.8 
|Other income, net                             |  |                           | 3.3  
|                                              |  |                           |      
|Income before provision for income taxes      |  |                           | 17.1 
|Provision for income taxes                    |  |                           | 7.8  
|                                              |  |                           |      
|Net income                                    |  |                           | 9.3  
|                                              |  |                           |      

Years Ended May 31, 2004, 2003 and 2002

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

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Revenues

| | Total revenues |  | 2004                  |       | Percent
  Change |  | 2003 |      | Percent
  Change |  | 2002 |      
| | -------------- |  | --------------------- | ----- | ---------------- |  | ---- | ---- | ---------------- |  | ---- | -----
| |                |  |                       |       |                  |  |      |      |                  |  |      |      
| |                |  | (dollars in millions) |      
| | Total revenues |  | $                     | 124.3 |                  |  |      | 21.9 | %                |  | $    | 102.0
| |                |  |                       |       |                  |  |      |      |                  |  |      |      

The increase in total revenues from
fiscal year 2003 to fiscal year 2004 was due to a $14.4 million increase in our
software product revenues and to a $7.9 million increase in our service and
other revenues. In practice, our management tracks most closely and calculates
our average selling prices only for those deals which total $40,000 or more in
total deal size (product and services). The increase in total revenue was the result
of an increase in the total number of customer transactions for deal sizes
greater than $40,000,combined with a marginal increase in the average revenue
per transaction. Fiscal year 2004 results include a full year of revenues for
our Ultraseek product, whereas fiscal year 2003 results include revenues from
only the latter six months of fiscal 2003, as the acquisition of the assets
from Inktomi Corporation occurred in the middle of fiscal 2003. Also, fiscal
year 2004 results include the addition of our suite of content capture
products, which were derived from the purchase of Cardiff Software in March
2004 and to a much lesser extent the Vrep product which was derived came from
the purchase of NativeMinds. Additionally, fiscal year 2004 includes a payment
in the first quarter from BroadVision of past royalties in connection with the
settlement of outstanding litigation, which was less than 5% of revenues for
the full year period. For fiscal year 2005, we expect our total revenues to
increase as a result of an increase in volumes of transactions of deal sizes
greater than $40,000, and to a lesser extent, increased volumes and revenues
associated with transaction less than $40,000. We expect volumes of
transactions and total revenues to increase as we expect to maintain a growth
rate consistent with the overall growth rates with the markets we serve as well
we expect to see increased revenue from a full year worth of Cardiff Software
products and the NativeMind product that we acquired in March of 2004. These
expectations are based on assumptions we believe are reasonable, but actual
results may differ from our expectations as a result of the risks set forth in
Risks Relating to Our Operations at the end of Item 1 of this form 10-K.

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

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

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

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

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

| |  | increased number of sales transactions, in combination with increased
  average selling price for transactions greater than $40,000;                                     
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increased sales to our OEM customers;                                                                                                                                    
| |  | increased sales of our Ultraseek product, which we did not have prior
  to our acquisition of the enterprise search assets of Inktomi Corporation in
  December 2002; and
| |  | incremental sales of our suite of content capture products, which we
  did not have prior to our acquisition of Cardiff Software in March 2004.                          

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

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

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

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

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

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

Costs
of Revenues

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

Costs of
software products consist primarily of product media, duplication, manuals,
packaging materials, shipping expenses,employee compensation expenses, royalties paid to
third-party vendors, and in certain instances, licensing of third-party
software incorporated in our products. Also included in costs of software
products, to a lesser extent, is the cost of the hardware scanners which we
began selling as a result of the acquisition of Cardiff Software beginning
March 15, 2004. We believe that costs of software products will increase in
absolute dollars in fiscal 2005, primarily as a result of increased royalties
paid to third-party software vendors and to increased costs associated with the
additional forecasted revenues. Additionally, we expect an increase in the
costs of software products as a percentage of software product revenues
resulting from the increased royalties cost of third-party software vendors
relating to Cardiff Softwares product line.

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

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

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

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

Costs of
service and other consists of costs incurred in providing consulting services,
customer training, telephone support and product upgrades to customers.
Significant cost components include personnel-related and third-party
contractor costs, facilities costs, travel expenses associated with training
and consulting implementation services, depreciation expense and corporate
overhead allocations.

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

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

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

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

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

| | Fiscal

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

Operating
Expenses

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

30

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Research and
development expenses consist primarily of employee compensation and benefits,
payments to outside contractors, depreciation on equipment used for development
and corporate overhead allocations. We believe that research and
development is essential to maintaining our competitive position and we will
continue to make significant investments in research and development with the
goal of continuing to align research and development expenses with anticipated
revenues.Beyond our first quarter
of fiscal 2005, we anticipate that research and development expenses will
increase modestly resulting from annual compensation increases.

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

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

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

Marketing and sales expenses consist
primarily of employee compensation, including sales commissions and benefits,
tradeshows, outbound marketing and other lead generation activities, public
relations, travel expenses associated with our sales staff and corporate
overhead allocations. We anticipate that we will continue to make significant
investments in marketing and sales with the goal of continuing to align
marketing and sales expenses with anticipated revenues. Beyond our first
quarter of fiscal 2005, we anticipate that marketing and sales expenses will
increase modestly as a result of planned annual compensation increases and from
planned increased headcount and lead generation activities necessary to support
our increased revenue projections in the second half of fiscal 2005.

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

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

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

General and
administrative expenses consist primarily of personnel costs for finance,
legal, human resources and general management, provisions for doubtful
accounts, insurance, fees for external professional advisors and corporate
overhead allocations.

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

31

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---

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

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

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

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

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



| | Restructuring
      charge                     |  | 2004                          |      | Percent
        Change |      | 2003 |  | Percent
        Change |     | 2002 |      
| | ---------------------------------------------- |  | ----------------------------- | ---- | ---------------------- | ---- | ---- |  | ---------------------- | --- | ---- | -----
| |                                                |  |                               |      |                        |      |      |  |                        |     |      |      
| |                                                |  | (dollars
        in millions) |     
| | Severance
        costs                        |  | $                             | 1.2  |                        | 71.4 | %    |  | $                      | 0.7 |      | (41.6
| | Legal
        and other outside services costs |  |                               | 0.1  |                        | 0.0  | %    |  |                        | 0.1 |      | (66.6
| | Adjustments
        to estimates               |  |                               | (0.1 | )                      | nm   |      |  |                        | 0.0 |      | nm   
| | Facilities
        and other charges           |  |                               | 0.0  |                        | nm   |      |  |                        | 0.2 |      | 100  
| |                                                |  |                               |      |                        |      |      |  |                        |     |      |      
| | Restructuring
        charge                   |  | $                             | 1.2  |                        | 20.0 | %    |  | $                      | 1.0 |      | (37.5
| |                                                |  |                               |      |                        |      |      |  |                        |     |      |      
| | Percentage
        of total revenues           |  |                               | 1.0  | %                      |      |      |  |                        | 1.0 | %    |      

We
had two restructuring activities in fiscal 2004.  As a result of our Cardiff Software acquisition, we recorded a
$0.3 million restructuring charge related to positions we identified to be
redundant in our the quarter ended May 31, 2004. The anticipated cost

32

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---

savings
resulting from this restructuring consist of reduced compensation expenses from  the
affected employees, offset by any subsequent headcount additions.In November 2003, we
implemented a worldwide restructuring to focus on reducing expenses and  improving
efficiency due to continued macro-economic and capital spending  issues affecting the
software industry. In connection with the restructuring,  we recorded a $1.0 million
restructuring in our quarter ended November 30 2003,  of which approximately $0.9 million
was related to severance costs associated  with the reduction in the worldwide workforce
by approximately 40 employees and  approximately $0.1 million to legal and other outside
services.

In
November 2002, we implemented a worldwide restructuring to focus on reducing
expenses and improving efficiency due to continued macro-economic and capital
spending issues affecting the software industry. In connection with the
restructuring, we recorded in the quarter ended November 30, 2002, a $1.0
million restructuring charge, of which approximately $0.7 million was related
to severance costs associated with the reduction in the worldwide workforce by
approximately 50 employees, approximately $0.1 million to legal and other
outside services in connection with the restructuring, and approximately $0.2
million to other costs associated with the restructuring. The restructuring
impacted operations in the U.S., Canada and the Netherlands and was
concentrated in research and development and, to a lesser extent, sales and
marketing.

During
November 2001, we implemented a worldwide restructuring and recorded a $1.6
million restructuring charge, of which approximately $1.2 million was related
to severance costs associated with the reduction in the worldwide workforce by
65 employees, approximately $0.3 million to legal and other outside services in
connection with the restructuring and approximately $0.1 million to other costs
associated with the restructuring. The restructuring impacted operations in the
U.S., Canada, the U.K., Germany, France, the Netherlands, Sweden and South
Africa, primarily in marketing and sales, and research and development.

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

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



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

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



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

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

33

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



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

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

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

34

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Quarterly Results of
Operations

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

|                                                         |  | Quarter Ended                         |       
|-------------------------------------------------------- |  | ------------------------------------- | ------
|                                                         |  |                                       |       
|                                                         |  | May 31,
  2004                        |       
|                                                         |  |                                       |       
|                                                         |  | (in thousands, except per share data) |       
|Consolidated Statements of Operations Data:              |  |                                       |       
|Revenues:                                                |  |                                       |       
|Software products                                        |  | $                                     | 23,800
|Service and other                                        |  |                                       | 14,467
|                                                         |  |                                       |       
|Total revenues                                           |  |                                       | 38,267
|                                                         |  |                                       |       
|Costs of revenues:                                       |  |                                       |       
|Software products                                        |  |                                       | 1,134 
|Service and other                                        |  |                                       | 4,531 
|Amortization of purchased intangible assets              |  |                                       | 1,521 
|                                                         |  |                                       |       
|Total costs of revenues                                  |  |                                       | 7,186 
|                                                         |  |                                       |       
|Gross profit                                             |  |                                       | 31,081
|                                                         |  |                                       |       
|Operating expenses:                                      |  |                                       |       
|Research and development                                 |  |                                       | 5,631 
|Marketing and sales                                      |  |                                       | 14,076
|General and administrative                               |  |                                       | 4,007 
|In-process research and development charge               |  |                                       | 3,472 
|Restructuring charge                                     |  |                                       | 254   
|                                                         |  |                                       |       
|Total operating expenses                                 |  |                                       | 27,440
|                                                         |  |                                       |       
|Income from operations                                   |  |                                       | 3,641 
|Other income, net                                        |  |                                       | 600   
|                                                         |  |                                       |       
|Income before provision for income taxes                 |  |                                       | 4,241 
|Provision for income taxes                               |  |                                       | 2,846 
|                                                         |  |                                       |       
|Net income                                               |  | $                                     | 1,395 
|                                                         |  |                                       |       
|                                                         |  |                                       |       
|Net income per share  basic                             |  | $                                     | 0.04  
|                                                         |  |                                       |       
|Net income per share  diluted                           |  | $                                     | 0.04  
|                                                         |  |                                       |       
|                                                         |  |                                       |       
|Number of shares used in per share calculation  basic   |  |                                       | 37,476
|                                                         |  |                                       |       
|Number of shares used in per share calculation  diluted |  |                                       | 39,097
|                                                         |  |                                       |       

|                                            |  | As a Percentage of Total Revenues |      
|------------------------------------------- |  | --------------------------------- | -----
|                                            |  |                                   |      
|Revenues:                                   |  |                                   |      
|Software products                           |  |                                   | 62.2 
|Service and other                           |  |                                   | 37.8 
|                                            |  |                                   |      
|Total revenues                              |  |                                   | 100.0
|                                            |  |                                   |      
|Costs of revenues:                          |  |                                   |      
|Software products                           |  |                                   | 3.0  
|Service and other                           |  |                                   | 11.8 
|Amortization of purchased intangible assets |  |                                   | 4.0  
|                                            |  |                                   |      
|Total costs of revenues                     |  |                                   | 18.8 
|                                            |  |                                   |      
|Gross profit                                |  |                                   | 81.2 
|                                            |  |                                   |      
|Operating expenses:                         |  |                                   |      
|Research and development                    |  |                                   | 14.7 
|Marketing and sales                         |  |                                   | 36.8 
|General and administrative                  |  |                                   | 10.5 
|In-process research and development charge  |  |                                   | 9.1  
|Restructuring charge                        |  |                                   | 0.7  
|                                            |  |                                   |      
|Total operating expenses                    |  |                                   | 71.7 
|                                            |  |                                   |      
|Income from operations                      |  |                                   | 9.5  
|Other income, net                           |  |                                   | 1.6  
|                                            |  |                                   |      
|Income before provision for income taxes    |  |                                   | 11.1 
|Provision for income taxes                  |  |                                   | 7.4  
|                                            |  |                                   |      
|Net income                                  |  |                                   | 3.6  
|                                            |  |                                   |      

35

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

Liquidity
and Capital Resources

As
of May 31, 2004, we had $201.8 million in cash and cash equivalents and
available-for-sale securities compared to $250.7 million at May 31, 2003. At
May 31, 2004, our principal sources of liquidity were our cash and cash
equivalents and short-term investments of $117.5 million. As of May 31, 2004,
we had a $0.6 million liability under a deferred purchase payment to
NativeMinds Inc in connection with the acquisition of the intellectual
property.

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

|                    |  | Amortized
  Cost |   | Gross
  Unrealized
  Gains |  | Fair
  Value | 
|------------------- |  | ---------------- | - | -------------------------- |  | ------------ | 
|                    |  |                  |   |                            |  |              | 
|Short-term          |  |                  | $ | 25,229                     |  |              | 
|Long-term           |  |                  |   | 85,003                     |  |              | 
|                    |  |                  |   |                            |  |              | 
|Total
  investments |  |                  | $ | 110,232                    |  |              | 
|                    |  |                  |   |                            |  |              | 

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

|                    |  | Amortized
  Cost |   | Gross
  Unrealized
  Gains |  | Fair
  Value | 
|------------------- |  | ---------------- | - | -------------------------- |  | ------------ | 
|                    |  |                  |   |                            |  |              | 
|Short-term          |  |                  | $ | 52,192                     |  |              | 
|Long-term           |  |                  |   | 111,371                    |  |              | 
|                    |  |                  |   |                            |  |              | 
|Total
  investments |  |                  | $ | 163,563                    |  |              | 
|                    |  |                  |   |                            |  |              | 

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



| | Fiscal period
ended May 31, |                                                       | 2004 |                         | 2003  |   | 2002 |     
| | --------------------------- | ----------------------------------------------------- | ---- | ----------------------- | ----- | - | ---- | ----
| |                             |                                                       |      |                         |       |   |      |     
| |                             |                                                       |      | (dollars in
  millions) |      
| |                             | Net cash provided by operating
  activities           |      | $                       | 22.9  |   | $    | 24.1
| |                             | Net cash provided by (used in)
  investing activities |      |                         | 0.5   |   |      | 0.6 
| |                             | Net cash provided by (used in)
  financing activities |      | $                       | (17.3 | ) | $    | 7.5 

Our
cash provided by operating activities in fiscal 2004 was driven primarily from
our net income of $11.6 million and the add back of non-cash expenses reported
in our consolidated statements of operations, primarily non-cash depreciation
and amortization of $6.9 million and a non-cash write-off of in-process
research and development of $3.5 million.  Changes in working captial including other accrued liabilities, prepaid and other assets and deferred
revenue collectively generated cash flow of $10.2 million. These cash flow
generating activities were offset by cash outflows in our working capital
including a $6.9 increase in accounts receivable, primarily resulting from our
year over year increase in revenues, $2.5 million relating to accrued compensation and $1.8 million due to accounts payable. 
Cash provided by operating activities increased to $24.1 million for
fiscal year 2003 compared to $18.9 million in fiscal year 2002.  This $5.2 million increase was primarily due
to the increase in net income of $10.2 million, the effect on cash flow of
which was further increased by approximately $5.2 million due to greater
non-cash expenses, offset by changes in operating assets and liabilities, comprised mostly
of a $15.8 million decrease in accounts receivable in fiscal year 2002 compared
to only a $2.5 million decrease in fiscal year 2003.  We expect we will have positive cash flows from operating
activities in 2005, as we believe we will be profitable for this time
period  and do not expect significant changes in working capital that would more than
offset the forecasted cash flow generating capacity of our operations in fiscal  2005.

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Cash provided by investing activities for
fiscal year 2004 of $0.5 million was primarily due to the sales and maturity of
marketable securities, partially offset by the purchases of marketable
securities and $50.9 million for the purchase of Cardiff Software and
NativeMinds. Cash provided by investing activities for fiscal years 2003 and
2002 of $0.6 million and $(18.3) million, was primarily due to the purchases of
marketable securities offset by the sale and maturity of marketable securities.
We also used $23.8 million in fiscal 2003 to purchase the Inktomi enterprise
search software assets. Capital expenditures were $2.0 million, $1.7 million
and $3.1 million in fiscal years 2004, 2003 and 2002, respectively. For fiscal
years 2004, 2003 and 2002, the capital expenditures consisted primarily of
purchases for computer hardware and software.

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

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

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

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

Contractual
obligations at May 31, 2004 were as follows:

| | (dollars in millions)                |  | Payments Due by Period |     
| | ------------------------------------ |  | ---------------------- | ----
| |                                      |  |                        |     
| | Contractual Obligations              |  | Total                  |     
| |                                      |  |                        |     
| | Operating Leases                     |  | $                      | 16.3
| | Deferred Purchase Payment            |  |                        | 3.7 
| |                                      |  |                        |     
| | Total Contractual Cash
  Obligations |  | $                      | 20.0
| |                                      |  |                        |     

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

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

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

37

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repurchased and retired 3,952,005 shares of our common stock
through open market transactions, valued at approximately $48.5 million.

We
believe that our current cash and cash equivalents, interest income and cash
generated from operations, if any, will provide adequate liquidity to meet our
working capital and operating resource expenditure requirements through at
least fiscal 2005. If the global economy weakens further, our cash, cash
equivalents and investments balances may decline. As a result, or if our
spending plans materially change, we may find it necessary to reduce costs or
seek to obtain additional sources of financing to support our capital needs,
but we cannot assure you that such financing will be available on commercially
reasonable terms, or at all.

Recent
Accounting Pronouncements

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

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

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

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

In
January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). FIN 46 requires that if an entity has a
controlling financial interest in a variable interest entity, the assets,
liabilities and results of activities of the variable interest entity should be
included in the consolidated financial statements of the entity. FIN 46
requires that its provisions are effective immediately for all arrangements
entered into after January 31, 2003. We do not have any variable interest
entities.

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

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

38

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

Related Party Transactions

Regent
Pacific Management Corporation (Regent Pacific) has been providing management
services to Verity pursuant to a Retainer Agreement between Verity and Regent
Pacific dated July 31, 1997, which has undergone a series of amendments. In
January 2004, Verity and Regent Pacific entered into an amendment to the
Retainer Agreement providing for a 75% reduction in weekly fees payable by
Verity under the Retainer Agreement, beginning in March 2004, as well as an
extension of the non-cancelable period of the Retainer Agreement from February
28, 2004 to February 28, 2005. As a result of the amendment, the services to be
rendered by Regent Pacific to Verity under the Retainer Agreement have been
reduced. In addition, pursuant to the amendment, Gary J. Sbona continues to serve
as our Executive Chairman of the Board, but Stephen W. Young ceased to serve as
Veritys Chief Operating Officer effective as of March 1, 2004. In accordance
with the agreement, Verity pays Regent Pacific $12,500 per week for the
management services that Regent Pacific provides to Verity.

Item 7A.
Quantitative and Qualitative Disclosures
About Market Risk

Interest
Rate Risk.The primary
objective of our investment activities is to preserve the principal while at
the same time maximizing yields without significantly increasing the risk. To
achieve this objective, we maintain our portfolio of cash equivalents and
investments in a variety of securities, including both government and corporate
obligations and money market funds, none of which we hold for trading
purposes.  As of May 31, 2004,
approximately 58% of our portfolio matures in one year or less, with the
remainder maturing in less than three years. We do not use derivative financial
instruments in our investment portfolio. We place our investments with high
credit quality issuers and, by policy, limit the amount of credit exposure to
any one issuer.

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

| |                           |                        | FY2005         |        | FY2006 |   | FY2007 |     | Total |        | Fair Value |  
| | ------------------------- | ---------------------- | -------------- | ------ | ------ | - | ------ | --- | ----- | ------ | ---------- | -
| |                           |                        |                |        |        |   |        |     |       |        |            |  
| |                           |                        | (in
thousands) |       
| | Cash and cash equivalents |                        | $              | 92,245 |        |   |       |     |       |       |            | $
| |                           | Average interest rate  |                |        | 1.1    | % |        |    |       |        |           |  
| | Fixed-rate securities     |                        | $              | 20,256 |        | $ | 37,177 |     | $     | 47,071 |            | $
| |                           | Average interest rate  |                |        | 2.7    | % |        | 2.3 | %     |        | 2.7        | %
| | Variable-rate securities  |                        | $              | 5,000  |        |   |       |     |       |       |            | $
| |                           | Average interest rates |                |        | 1.2    | % |        |    |       |        |           |  

During
fiscal year 2004, our cash equivalents and investments decreased by $49.0
million in total value from fiscal year 2003. 
This decrease in value of our portfolio resulted from the purchase of
Cardiff Software  and NativeMinds.  Commensurate with the decrease in value, the
composition of our portfolio changed in that our fixed rate securities
decreased by $57.9 million while our combined cash and cash equivalents and
variable rate investments increased by $8.9 million

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

39

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

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

Foreign Currency Transaction Risk.
We transact business in various foreign currencies and have established a
program that primarily utilizes foreign currency forward contracts to offset
the risk associated with the effects of certain foreign currency exposures.
Under this program, increases or decreases in our foreign currency exposures
are offset by gains or losses on the forward contracts, to mitigate the
possibility of foreign currency transaction gains or losses. These foreign
currency exposures typically arise from intercompany sublicense fees and other
intercompany transactions.
Our forward contracts generally have terms of 180 days or less. We do not use
forward contracts for trading purposes. All foreign currency transactions and
all outstanding forward contracts (non equity hedges) are marked to market at
the end of the period with any changes in market value included in Other
expense, net. Our ultimate realized gain or loss with respect to currency
fluctuations will depend on the currency exchange rates and other factors in
effect as the contracts mature. Net foreign exchange transaction loss included
in Other expense, net in the accompanying consolidated statements of operations
were ($0.9 million) ($0.3 million) and ($0.1 million) in fiscal 2004, 2003 and
2002, respectively. The fair value of the
foreign currency forward contracts was $2.8 million and $ 7.4 million as of May
31, 2004 and 2003, respectively.

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

Table of
Forward Contracts:

|(Dollars
in millions) |  | ExchangeForeign
  Currencyfor
  U.S. Dollars(Notional Amount) |   | ExchangeU.S.
  Dollars forForeign
  Currency(Notional Amount) |  | NotionalWeighted
  AverageExchange Rate | 
|--------------------- |  | ------------------------------------------------------------- | - | ------------------------------------------------------------- |  | --------------------------------------- | 
|                      |  |                                                               |   |                                                               |  |                                         | 
|Functional Currency:  |  |                                                               |   |                                                               |  |                                         | 
|Canadian Dollar       |  |                                                               | $ | 2.9                                                           |  |                                         | 

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

Table of
Forward Contracts:

|(Dollars
in millions) |  | ExchangeForeign
  Currencyfor
  U.S. Dollars(Notional Amount) |   | ExchangeU.S.
  Dollars forForeign
  Currency(Notional Amount) |  | NotionalWeighted
  AverageExchange Rate | 
|--------------------- |  | ------------------------------------------------------------- | - | ------------------------------------------------------------- |  | --------------------------------------- | 
|                      |  |                                                               |   |                                                               |  |                                         | 
|Functional Currency:  |  |                                                               |   |                                                               |  |                                         | 
|Canadian Dollar       |  |                                                               | $ | 2.1                                                           |  |                                         | 
|Euro                  |  |                                                               |   | 4.6                                                           |  |                                         | 
|                      |  |                                                               |   |                                                               |  |                                        
|                      |  |                                                               | $ | 6.7                                                           |  |                                         | 
|                      |  |                                                               |   |                                                               |  |                                        

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Item 8. Financial Statements and Supplementary Data

Our
Consolidated Financial Statements and Notes thereto, and related Financial
Schedule, begin on page 47 of this Annual Report on Form 10-K and are
incorporated by reference here. Supplementary financial information for the
eight quarters ended May 31, 2004 is set forth under Item 7  Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Quarterly Results of Operations and is incorporated by reference here.

Item 9. Changes In and Disagreements with Accountants on
Accounting and Financial Disclosure

Our
change in independent accountants to audit our financial statements in fiscal
2004 was previously reported in our Current Report on Form 8-K filed with the
Securities and exchange Commission on October 29, 2003, as amended by a Form
8-K/A filed October 31, 2003.

Item 9A.Controls and
Procedures

Limitations on the
Effectiveness of Controls.
Our management, including the Chief Executive Officer and Chief Financial
Officer, believes that our disclosure controls and procedures and our internal control over
financial reporting will provide reasonable assurance that
all errors will be detected, but does not expect that our disclosure controls and
procedures or our internal control over financial reporting will provide
absolute assurance that all errors will be detected. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within Verity have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.

Evaluation of Disclosure
Controls and Procedures.
An evaluation was performed under the supervision and with the participation of
management, including the Chief Executive Officer and the Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as of May 31, 2004. Based on that evaluation, our
management, including the Chief Executive Officer and Chief Financial Officer,
concluded that our disclosure controls and procedures were effective as of May
31, 2004, to provide reasonable assurance that the information required to be
disclosed by us in this Annual Report on Form 10-K was recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commissions rules and Form 10-K.

Changes in Internal Control
over Financial Reporting.
During the three months ended May 31, 2004, there were no changes in our
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.

Consistent
with Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by
Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for listing
the non-audit services approved by our Audit Committee to be performed by KPMG
LLP, our independent auditor. Non-audit services are defined as services other
than those provided in connection with an audit or a review of our financial
statements. The only non-audit services approved by our Audit Committee to be
performed by KPMG LLP are: (1) tax compliance services; (2) tax consulting
services; and (3) financial due diligence in connection with potential mergers
or acquisitions.

41

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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 2004 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, including under the captions Executive Compensation, Employment
Agreements, Severance and Change of Control Arrangements and Compensation
Committee Interlocks and Insider Participation.

Item 12.
Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters

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, and Equity Compensation Plan Information.

Item 13.Certain Relationships and Related Transactions

The
information required by this Item is incorporated by reference from the Proxy
Statement under the caption Certain Relationships And Transactions.

Item
14.Principal Accountant Fees and Services

The
information required by this Item is incorporated by reference from the Proxy
Statement under the caption Proposal 3, Ratification Of Selection Of Independent
Auditors under the subcaptions Independent Auditors Fees and Pre-Approval
Policies and Procedures.

42

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PART
IV

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

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

| |    |                                                                                                                                                                        | Page
  Number
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------
| |    |                                                                                                                                                                        |              
| | 1. | Financial Statements:                                                                                                                                                  |              
| |    | Report of
  Independent Registered Public Accounting Firms                                                                                                             | 44           
| |    | Consolidated Balance
  Sheets  As of May 31, 2004 and 2003                                                                                                            | 46           
| |    | Consolidated Statements
  of Operations  For the Years Ended May 31, 2004, 2003 and 2002                                                                              | 47           
| |    | Consolidated
  Statements of Changes in Stockholders Equity  For the Years Ended May 31,
  2004, 2003
    and 2002                                                   | 48           
| |    | Consolidated
  Statements of Cash Flows  For the Years Ended May 31, 2004, 2003 and 2002                                                                              | 49           
| |    | Consolidated
  Statements of Comprehensive Income  For the Years Ended May 31, 2004, 2003
  and 2002                                                                  | 50           
| |    | Notes to
  Consolidated Financial Statements                                                                                                                           | 51           
| | 2. | Financial Statement Schedule 
  For the Years Ended May 31, 2004, 2003 and 2002:                                                                                      |              
| |    | Schedule II 
  Valuation and Qualifying Accounts                                                                                                                      | 74           
| |    | All other schedules are
  omitted because they are not applicable or the required information is shown
  in the
    consolidated financial statements or notes thereto |              
| | 3. | Exhibits: See
  Index to Exhibits on page listed in the accompanying Index to Exhibits
    are filed or incorporated by reference as part of this report               | 76           

|(b) | Reports on Form 8-K:                                                                                                                                                                                                                                                                                                                                                                
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                     
|    | March 11, 2004, we furnished to the
  Securities and Exchange Commission a Current Report on Form 8-K to furnish
  under Item 12 the announcement of our financial results for the third quarter
  of fiscal year 2004, which announcement included our consolidated statements
  of operations and consolidated balance sheets for the periods reported in
  that press release.   
|    |                                                                                                                                                                                                                                                                                                                                                                                     
|    | March 30, 2004, we filed with the
  Securities and Exchange Commission a Current Report on Form 8-K reporting
  under Item 2 our acquisition of Cardiff Software, Inc., and filing the
  announcement of the acquisition under Item 7.  We subsequently determined that the filing was not required by
  Item 2, and consequently no financial statements were required to be filed.
|    |                                                                                                                                                                                                                                                                                                                                                                                     
|(c) | Exhibits                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                     
|    | See Index to Exhibits immediately
  following the signature page of this Form 10-K, which is incorporated by
  reference here, for the exhibits filed with this report.                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                     
|(d) | Financial Statement Schedules                                                                                                                                                                                                                                                                                                                                                       
|    |                                                                                                                                                                                                                                                                                                                                                                                     
|    | See Item 15(a)(2) above.                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                     

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Report of Independent
Registered Public Accounting Firm

The Board of Directors
and Stockholders
Verity, Inc:

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

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

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

|                          |  | /s/ KPMG LLP
|------------------------- |  | ------------
|                          |  |             
|Mountain View, California |  |             
|June 22, 2004             |  |             

44

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REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To
the Board of Directors and StockholdersVerity, Inc.

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

|                           |  | /s/ PricewaterhouseCoopers LLP
|-------------------------- |  | ------------------------------
|                           |  |                               
|PricewaterhouseCoopers LLP |  |                               
|                           |  |                               
|San Jose, California       |  |                               
|June 13, 2003              |  |                               

45

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---

VERITY, INC.

CONSOLIDATED BALANCE SHEETS(in thousands, except per share data)

|                                                                                                                     |  | May 31, |        
|-------------------------------------------------------------------------------------------------------------------- |  | ------- | -------
|                                                                                                                     |  |         |        
|                                                                                                                     |  | 2004    |        
|                                                                                                                     |  |         |        
|ASSETS                                                                                                               | 
|                                                                                                                     |  |         |        
|Current assets:                                                                                                      |  |         |        
|Cash
  and cash equivalents                                                                                          |  | $       | 92,245 
|Short-term
  investments                                                                                             |  |         | 25,256 
|Trade
  accounts receivable, net of allowance for doubtful accounts of $2,131
         and $1,720                    |  |         | 31,807 
|Deferred
  tax assets                                                                                                |  |         | 2,482  
|Prepaid
  and other assets                                                                                           |  |         | 4,636  
|                                                                                                                     |  |         |        
|Total
  current assets                                                                                               |  |         | 156,426
|Property and equipment, net                                                                                          |  |         | 4,272  
|Long-term investments                                                                                                |  |         | 84,248 
|Deferred tax assets                                                                                                  |  |         | 17,884 
|Intangible assets, net                                                                                               |  |         | 24,854 
|Goodwill                                                                                                             |  |         | 55,824 
|Other assets                                                                                                         |  |         | 573    
|                                                                                                                     |  |         |        
|Total
  assets                                                                                                       |  | $       | 344,081
|                                                                                                                     |  |         |        
|LIABILITIES                                                                                                          | 
|                                                                                                                     |  |         |        
|Current liabilities:                                                                                                 |  |         |        
|Accounts
  payable                                                                                                   |  | $       | 2,855  
|Accrued
  compensation                                                                                               |  |         | 10,086 
|Income
  tax payable                                                                                                 |  |         | 4,214  
|Deferred
  purchase payment                                                                                          |  |         | 3,066  
|Other
  accrued liabilities                                                                                          |  |         | 5,043  
|Deferred
  revenue                                                                                                   |  |         | 21,421 
|                                                                                                                     |  |         |        
|Total
  current liabilities                                                                                          |  |         | 46,685 
|                                                                                                                     |  |         |        
|                                                                                                                     |  |         |        
|Other non-current liabilities:                                                                                       |  |         |        
|Deferred purchase payment                                                                                            |  |         | 570    
|                                                                                                                     |  |         |        
|Total
  liabilities                                                                                                  |  |         | 47,255 
|                                                                                                                     |  |         |        
|                                                                                                                     |  |         |        
|STOCKHOLDERS
  EQUITY                                                                                               | 
|                                                                                                                     |  |         |        
|Preferred stock, $0.001 par
  value:                                                                                 |  |         |        
|Authorized:
  2,000 shares                                                                                           |  |         |        
|Issued
  and outstanding: none                                                                                       |  |         |        
|Common stock, $0.001 par
  value:                                                                                    |  |         |        
|Authorized:
  200,000 shares in ; issued and
         outstanding: 37,280 shares in 2004
  and 37,560 shares in 2003 |  |         | 37     
|Additional paid-in capital                                                                                           |  |         | 259,245
|Accumulated other
  comprehensive income                                                                             |  |         | 2,249  
|Deferred stock compensation                                                                                          |  |         | (88    
|Retained earnings                                                                                                    |  |         | 35,383 
|                                                                                                                     |  |         |        
|Total
  stockholders equity                                                                                         |  |         | 296,826
|                                                                                                                     |  |         |        
|Total
  liabilities and stockholders equity                                                                         |  | $       | 344,081
|                                                                                                                     |  |         |        

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

46

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---

VERITY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)

|                                              |  | Year Ended
  May 31, |        
|--------------------------------------------- |  | -------------------- | -------
|                                              |  |                      |        
|                                              |  | 2004                 |        
|                                              |  |                      |        
|Revenues:                                     |  |                      |        
|Software
  products                           |  | $                    | 71,999 
|Service
  and other                           |  |                      | 52,311 
|                                              |  |                      |        
|Total
  revenues                              |  |                      | 124,310
|                                              |  |                      |        
|                                              |  |                      |        
|Costs of
  revenues:                          |  |                      |        
|Software
  products                           |  |                      | 2,270  
|Service
  and other                           |  |                      | 14,467 
|Amortization
  of purchased intangible assets |  |                      | 3,456  
|                                              |  |                      |        
|Total
  costs of revenues                     |  |                      | 20,193 
|                                              |  |                      |        
|Gross profit                                  |  |                      | 104,117
|                                              |  |                      |        
|Operating
  expenses:                         |  |                      |        
|Research
  and development                    |  |                      | 20,211 
|Marketing
  and sales                         |  |                      | 50,006 
|General
  and administrative                  |  |                      | 12,057 
|In-process
  research and development charge  |  |                      | 3,472  
|Restructuring
  charges                       |  |                      | 1,226  
|Charitable
  contribution                     |  |                      |       
|                                              |  |                      |        
|Total
  operating expenses                    |  |                      | 86,972 
|                                              |  |                      |        
|Income (loss) from operations                 |  |                      | 17,145 
|                                              |  |                      |        
|Interest income                               |  |                      | 4,851  
|Interest expense                              |  |                      | (51    
|Other expense, net                            |  |                      | (681   
|                                              |  |                      |        
|Income before provision for
  income taxes    |  |                      | 21,264 
|Provision for income taxes                    |  |                      | 9,655  
|                                              |  |                      |        
|Net income                                    |  | $                    | 11,609 
|                                              |  |                      |        
|                                              |  |                      |        
|Net income per share  basic                  |  | $                    | 0.31   
|                                              |  |                      |        
|Net income per share  diluted                |  | $                    | 0.29   
|                                              |  |                      |        
|                                              |  |                      |        
|Number of shares  basic                      |  |                      | 37,625 
|                                              |  |                      |        
|Number of shares  diluted                    |  |                      | 39,666 
|                                              |  |                      |        

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

47

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---

VERITY, INC.

CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS EQUITYFor the years ended May 31, 2004, 2003 and
2002 (in thousands)

|                                                        |  |              |        | Additional
  Paid-In
  Capital |  | Deferred
  Stock
  Compensation |    | Accumulated
  Other
  Comprehensive
  Income |  | Retained
  Earnings |   | Total
  Stockholders
  Equity |  
|------------------------------------------------------- |  | ------------ | ------ | ------------------------------ |  | ------------------------------- | -- | -------------------------------------------- |  | ------------------- | - | ------------------------------ | -
|                                                        |  |              |        |                                |  |                                 |    |                                             
|                                                        |  | Common Stock |        |                                |  |                                 |    |                                             
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                    
|                                                        |  | Shares       |        | Amount                         |  |                                 |    |                                              |  |                    
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Balances, May 31, 2001                                  |  |              | 35,158 |                                |  |                                 | 35 |                                              |  |                     |   | 252,733                        |  
|Issuance of common stock:                               |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Upon exercise of stock options                          |  |              | 1,769  |                                |  |                                 | 2  |                                              |  |                     |   | 14,533                         |  
|Under employee stock purchase plan                      |  |              | 350    |                                |  |                                 |   |                                              |  |                     |   | 2,852                          |  
|Repurchase
  of common stock                            |  |              | (1,502 | )                              |  |                                 | (1 | )                                            |  |                     |   | (19,985                        | )
|Unrealized gain on investments                          |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Effect of foreign currency translation
    adjustments  |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Net income                                              |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Balances, May 31, 2002                                  |  |              | 35,775 |                                |  | $                               | 36 |                                              |  |                     | $ | 250,133                        |  
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Issuance of common stock:                               |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Common shares issued outside of
  plans                 |  |              | 2      |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Upon exercise of stock options                          |  |              | 3,826  |                                |  |                                 | 4  |                                              |  |                     |   | 32,795                         |  
|Under employee stock purchase plan                      |  |              | 407    |                                |  |                                 |   |                                              |  |                     |   | 3,273                          |  
|Deferred tax benefit from disqualified
    dispositions |  |              |       |                                |  |                                 |   |                                              |  |                     |   | 7006                           |  
|Repurchase of common stock                              |  |              | (2,450 | )                              |  |                                 | (2 | )                                            |  |                     |   | (28,562                        | )
|Unrealized gain on investments                          |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Effect of foreign currency translation
    adjustments  |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Net income                                              |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Balances, May 31, 2003                                  |  |              | 37,560 |                                |  | $                               | 38 |                                              |  |                     | $ | 264,645                        |  
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Issuance of common stock:                               |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Upon exercise of stock options                          |  |              | 3,040  |                                |  |                                 | 3  |                                              |  |                     |   | 28,997                         |  
|Under employee stock purchase plan                      |  |              | 375    |                                |  |                                 |   |                                              |  |                     |   | 3,664                          |  
|Deferred tax benefit from disqualified
    dispositions |  |              |       |                                |  |                                 |   |                                              |  |                     |   | 8,167                          |  
|Repurchase of common stock                              |  |              | (3,695 | )                              |  |                                 | (4 | )                                            |  |                     |   | (49,996                        | )
|Stock options assumed in businesscombinations           |  |              |       |                                |  |                                 |   |                                              |  |                     |   | 3,768                          |  
|Unrealized loss on investments                          |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Deferred stock compensation                             |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Amortization of deferred stock
  compensation           |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Effect of foreign currency translation
    adjustments  |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|Net income                                              |  |              |       |                                |  |                                 |   |                                              |  |                     |   |                               |  
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  
|Balances, May 31, 2004                                  |  |              | 37,280 |                                |  | $                               | 37 |                                              |  |                     | $ | 259,245                        |  
|                                                        |  |              |        |                                |  |                                 |    |                                              |  |                     |   |                                |  

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

48

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VERITY, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS(in thousands)

|                                                                                    |  | Year Ended May 31, |         
|----------------------------------------------------------------------------------- |  | ------------------ | --------
|                                                                                    |  |                    |         
|                                                                                    |  | 2004               |         
|                                                                                    |  |                    |         
|                                                                                    |  |                    |         
|Cash flows from operating activities:                                               |  |                    |         
|Net income                                                                          |  | $                  | 11,609  
|Adjustments to reconcile net income to net cash provided by operating
  activities: |  |                    |         
|Depreciation and amortization                                                       |  |                    | 6,857   
|Noncash restructuring charges                                                       |  |                    | 144     
|Provision for bad debt expense                                                      |  |                    | 319     
|Deferred income taxes                                                               |  |                    | 751     
|Write-off of in-process research and
  development                                  |  |                    | 3,472   
|Amortization of premium on securities,
  net                                        |  |                    | 837     
|Changes in operating assets and liabilities:                                        |  |                    |         
|Trade accounts receivable                                                           |  |                    | (6,902  
|Prepaid and other assets                                                            |  |                    | 2,642   
|Accounts payable                                                                    |  |                    | (1,828  
|Accrued compensation                                                                |  |                    | (2,510  
|Other accrued liabilities                                                           |  |                    | 6,494   
|Deferred revenue                                                                    |  |                    | 1,063   
|                                                                                    |  |                    |         
|Net cash
  provided by operating activities                                         |  |                    | 22,948  
|                                                                                    |  |                    |         
|Cash flows from investing activities:                                               |  |                    |         
|Acquisition of property and equipment                                               |  |                    | (1,976  
|Purchases of investments                                                            |  |                    | (686,198
|Maturity of investments                                                             |  |                    | 185,140 
|Proceeds from sale of investments                                                   |  |                    | 554,447 
|Purchase of businesses, net of cash acquired                                        |  |                    | (50,949 
|                                                                                    |  |                    |         
|Net cash
  provided by (used in) investing activities                               |  |                    | 464     
|                                                                                    |  |                    |         
|Cash flows from financing activities:                                               |  |                    |         
|Proceeds from the sale of common stock,
  net of issuance costs                     |  |                    | 32,664  
|Repurchase of common stock                                                          |  |                    | (50,000 
|                                                                                    |  |                    |         
|Net cash
  provided by (used in) financing activities                               |  |                    | (17,336 
|                                                                                    |  |                    |         
|Effect of exchange rate changes on cash and cash equivalents                        |  |                    | 498     
|                                                                                    |  |                    |         
|Net
  decrease in cash and cash equivalents                                         |  |                    | 6,573   
|Cash and cash equivalents, beginning of period                                      |  |                    | 85,672  
|                                                                                    |  |                    |         
|Cash and cash equivalents, end of period                                            |  | $                  | 92,245  
|                                                                                    |  |                    |         
|Supplemental disclosure of cash flow
  information:                                 |  |                    |         
|Cash paid for interest                                                              |  | $                  | 51      
|Cash paid for income taxes                                                          |  | $                  | 1,418   

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

49

---

---

VERITY, INC.

CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME(in thousands)

| |                                                                 |  | Year Ended May 31, |       
| | --------------------------------------------------------------- |  | ------------------ | ------
| |                                                                 |  |                    |       
| |                                                                 |  | 2004               |       
| |                                                                 |  |                    |       
| | Net income                                                      |  | $                  | 11,609
| |                                                                 |  |                    |       
| | Unrealized gain (losses) on available for sale investments, net |  |                    | (1,343
| | Cumulative effect of foreign currency translation adjustments   |  |                    | 418   
| |                                                                 |  |                    |       
| | Net change in comprehensive income                              |  |                    | (925  
| |                                                                 |  |                    |       
| | Comprehensive income                                            |  | $                  | 10,684
| |                                                                 |  |                    |       

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

50

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---

VERITY, INC.

NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

1. Nature of Operations

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

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

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

2. Summary of
Significant Accounting Policies

Basis of
consolidation

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

Cash and cash
equivalents

Cash and cash
equivalents consist of highly liquid investments with an original or remaining
maturity of 90 days or less as of the date of purchase. Cash
equivalents are stated at amortized cost plus accrued interest, which
approximates fair value. Cash equivalents consist primarily of money market
instruments and certificates of deposit, which amounted to $61.5 million and
$66.5 million at May 31, 2004 and 2003, respectively.

Use of estimates

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

51

---

---

Investments

The Company has
classified its investments as available-for-sale. Such investments are recorded
at fair value and unrealized gains and losses 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.

Property and
equipment

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

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

Research and
development costs

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

Revenue recognition

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

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

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

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

52

---

---

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

Allowance for doubtful accounts

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

Stock-based compensation

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

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

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

Proforma stock-based
compensation

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

| |                                                                                                                                                     |  | Fiscal Years |        
| | --------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------
| |                                                                                                                                                     |  |              |        
| |                                                                                                                                                     |  | 2004         |        
| |                                                                                                                                                     |  |              |        
| | Net income  as reported                                                                                                                            |  | $            | 11,609 
| |                                                                                                                                                     |  |              |        
| | Add:  Stock compensation
  expense included in reported net income, net of
  related tax effects                                                    |  |              | 6      
| |                                                                                                                                                     |  |              |        
| | Deduct: Total stock-based employee compensation expense determined
  under
  the fair value based method for all awards, net of related tax effects |  |              | (32,881
| |                                                                                                                                                     |  |              |        
| | Net loss  pro forma                                                                                                                                |  | $            | (21,266
| |                                                                                                                                                     |  |              |        
| | Net income per share  basic  as reported                                                                                                          |  | $            | 0.31   
| |                                                                                                                                                     |  |              |        
| | Net income per share  diluted  as reported                                                                                                        |  | $            | 0.29   
| |                                                                                                                                                     |  |              |        
| | Net loss per share  basic  pro forma                                                                                                              |  | $            | (0.57  
| |                                                                                                                                                     |  |              |        
| | Net loss per share  diluted  pro forma                                                                                                            |  | $            | (0.57  
| |                                                                                                                                                     |  |              |        

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

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

53

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Accounting for income taxes

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

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

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

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

Goodwill and other long lived intangible
assets

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

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

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

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

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

54

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

Certain risks and concentrations

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

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

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

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

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

Foreign currency

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

Fair value of
financial instruments

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

Computation of net
income per share

Basic earnings
per share are computed using the weighted average number of common shares
outstanding during the period. Diluted earnings per share are computed using
the weighted average number of shares of common stock and potential common
shares outstanding during the period. Dilutive potential common shares consist
of stock options.

55

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Comprehensive income

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

Reclassification

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

3. Recent Accounting
Pronouncements

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

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

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

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

In
January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). FIN 46 requires that if an entity has a
controlling financial interest in a variable interest entity, the assets,
liabilities and results of activities of the variable interest entity should be
included in the consolidated financial statements of the entity. FIN 46
requires that its provisions are effective immediately for all arrangements
entered into after January 31, 2003. We do not have any variable interest
entities.

56

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

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

In
November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. FIN 45 requires that a liability be
recorded in the guarantors balance sheet upon issuance of certain guarantees
or indemnifications. In addition, FIN 45 requires disclosures about the
guarantees or indemnifications that an entity has issued, including a
reconciliation of changes in the entitys product warranty liabilities. The
initial recognition and initial measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees or indemnifications issued or modified
after December 31, 2002, irrespective of the guarantors fiscal year-end. The
disclosure requirements are effective for financial statements for interim or
annual periods issued after December 15, 2002.

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

4. Business Combination

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

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

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

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

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

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

57

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

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

Identifiable
intangible assets acquired (Useful life (years))

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

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

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

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

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

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

58

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

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

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

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

|(in thousands, except
        per share data) |  | Year Ended May 31, |        
|--------------------------------------------- |  | ------------------ | -------
|                                              |  |                    |        
|                                              |  | 2004               |        
|                                              |  |                    |        
|                                              |  | (unaudited)        |        
|Total revenues                                |  | $                  | 144,778
|                                              |  |                    |        
|                                              |  |                    |        
|Net income                                    |  | $                  | 9,618  
|                                              |  |                    |        
|Net income per share  basic                  |  | $                  | .26    
|                                              |  |                    |        
|Net income per share  diluted                |  | $                  | .24    
|                                              |  |                    |        
|Number of shares  basic                      |  |                    | 37,625 
|                                              |  |                    |        
|Number of shares  diluted                    |  |                    | 39,755 
|                                              |  |                    |        

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

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

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

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

59

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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5. Investments

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

|                            |  | Amortized
  Cost |   | Gross
  Unrealized
  Gains
  (Losses) |  | Fair
  Value | 
|--------------------------- |  | ---------------- | - | ------------------------------------- |  | ------------ | 
|                            |  |                  |   |                                       |  |              | 
|Short-term investments:     |  |                  |   |                                       |  |              | 
|Market
  Auction Securities |  |                  |   | 4,000                                 |  |              | 
|Municipal
  Securities      |  |                  |   | 1,000                                 |  |              | 
|Corporate
  Notes           |  |                  |   | 13,729                                |  |              | 
|Government
  Securities     |  |                  |   | 6,500                                 |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Short-term
  investments    |  |                  |   | 25,229                                |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Long-term investments:      |  |                  |   |                                       |  |              | 
|Municipal
  Securities      |  |                  |   | 2,375                                 |  |              | 
|Corporate
  Notes           |  |                  |   | 6,122                                 |  |              | 
|Government
  Securities     |  |                  |   | 76,506                                |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Long-term
  investments     |  |                  |   | 85,003                                |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Total
  investments         |  |                  | $ | 110,232                               |  |              | 
|                            |  |                  |   |                                       |  |              | 

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

| | Within one year                       |  | $ | 25,256  | 
| | ------------------------------------- |  | - | ------- | 
| | After one year through two
  years    |  |   | 37,177  | 
| | After two years through three
  years |  |   | 47,071  | 
| | After three years                     |  |   |        | 
| |                                       |  |   |         | 
| |                                       |  | $ | 109,504 | 
| |                                       |  |   |         | 

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

|                            |  | Amortized
  Cost |   | Gross
  Unrealized
  Gains
  (Losses) |  | Fair
  Value | 
|--------------------------- |  | ---------------- | - | ------------------------------------- |  | ------------ | 
|                            |  |                  |   |                                       |  |              | 
|Short-term investments:     |  |                  |   |                                       |  |              | 
|Market
  Auction Securities |  |                  |   | 2,000                                 |  |              | 
|Municipal
  Securities      |  |                  |   | 600                                   |  |              | 
|Corporate
  Notes           |  |                  |   | 48,592                                |  |              | 
|Government
  Securities     |  |                  |   | 1,000                                 |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Short-term
  investments    |  |                  |   | 52,192                                |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Long-term investments:      |  |                  |   |                                       |  |              | 
|Municipal
  Securities      |  |                  |   | 1,375                                 |  |              | 
|Corporate
  Notes           |  |                  |   | 14,031                                |  |              | 
|Government
  Securities     |  |                  |   | 95,965                                |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Long-term
  investments     |  |                  |   | 111,371                               |  |              | 
|                            |  |                  |   |                                       |  |              | 
|Total
  investments         |  |                  | $ | 163,563                               |  |              | 
|                            |  |                  |   |                                       |  |              | 

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

| | Within one year                       |  | $ | 52,993  | 
| | ------------------------------------- |  | - | ------- | 
| | After one year through two
  years    |  |   | 45,940  | 
| | After two years through three
  years |  |   | 66,139  | 
| | After three years                     |  |   |        | 
| |                                       |  |   |         | 
| |                                       |  | $ | 165,072 | 
| |                                       |  |   |         | 

62

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6. Restructuring Charge

The Company had two restructuring activities in fiscal 2004.  As a result of the Cardiff Software acquisition, a
$0.3 million restructuring charge was recorded related to positions identified to be
redundant in the quarter ended May 31, 2004. In November 2003, the Company implemented a worldwide restructuring to focus on reducing expenses and
improving efficiency due to continued macro-economic and capital spending
issues affecting the software industry. In connection with the restructuring,
a $1.0 million restructuring charge was recorded in the quarter ended November 30 2003,
of which approximately $0.9 million was related to severance costs associated
with the reduction in the worldwide workforce by approximately 40 employees and
approximately $0.1 million to legal and other outside services.

In
November 2002, the Company implemented a worldwide restructuring to focus on reducing
expenses and improving efficiency due to continued macro-economic and capital
spending issues affecting the software industry. In connection with the
restructuring, the Company recorded in the quarter ended November 30, 2002, a $1.0
million restructuring charge, of which approximately $0.7 million was related
to severance costs associated with the reduction in the worldwide workforce by
approximately 50 employees, approximately $0.1 million to legal and other
outside services in connection with the restructuring, and approximately $0.2
million to other costs associated with the restructuring. The restructuring
impacted operations in the U.S., Canada and the Netherlands and was
concentrated in research and development and, to a lesser extent, sales and
marketing.

During
November 2001, the Company implemented a worldwide restructuring and recorded a $1.6
million restructuring charge, of which approximately $1.2 million was related
to severance costs associated with the reduction in the worldwide workforce by
65 employees, approximately $0.3 million to legal and other outside services in
connection with the restructuring and approximately $0.1 million to other costs
associated with the restructuring. The restructuring impacted operations in the
U.S., Canada, the U.K., Germany, France, the Netherlands, Sweden and South
Africa, primarily in marketing and sales, and research and development.

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

| |                         |  | Severance |       | Facilities
        and other |  | Legal
        and
        outside
        services |     | Total | 
| | ----------------------- |  | --------- | ----- | ---------------------------- |  | -------------------------------------------------- | --- | ----- | 
| |                         |  |           |       |                              |  |                                                    |     |       | 
| | At
        May 31, 2002 |  |           | -     |                              |  |                                                    | -   |       | 
| | Charges                 |  |           | 664   |                              |  |                                                    | 210 |       | 
| | Paid                    |  |           | (664  | )                            |  |                                                    | (40 | )     | 
| | At
        May 31, 2003 |  |           | -     |                              |  |                                                    | 170 |       | 
| | Charges                 |  |           | 1,200 |                              |  |                                                    | -   |       | 
| | Adjustments             |  |           | -     |                              |  |                                                    | -   |       | 
| | Paid                    |  |           | (941  | )                            |  |                                                    | (67 | )     | 
| | At
        May 31, 2004 |  |           | 259   |                              |  |                                                    | 103 |       | 

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

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7. Balance Sheet Detail

Property and equipment

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

|                                |  | May 31, |        
|------------------------------- |  | ------- | -------
|                                |  |         |        
|                                |  | 2004    |        
|                                |  |         |        
|Computer equipment &
  software |  | $       | 14,067 
|Furniture and fixtures          |  |         | 2,422  
|Leasehold improvements          |  |         | 6,305  
|                                |  |         |        
|                                |  |         | 22,794 
|Less accumulated depreciation   |  |         | (18,522
|                                |  |         |        
|                                |  | $       | 4,272  
|                                |  |         |        

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

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

Intangible assets

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

|                            |  | May 31, |       
|--------------------------- |  | ------- | ------
|                            |  |         |       
|                            |  | 2004    |       
|                            |  |         |       
|Developed technology        |  | $       | 18,669
|Patents/core technology     |  |         | 1,960 
|Maintenance agreements      |  |         | 1,260 
|Customer base/relationships |  |         | 2,354 
|Tradenames                  |  |         | 611   
|                            |  |         |       
|                            |  | $       | 24,854
|                            |  |         |       

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

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

8. Commitments and Contingencies

Commitments

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

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

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

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

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

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

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

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

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

65

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

9. Stockholders Equity

1995 Stock Option Plan

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

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

Common
shares purchased under the 1995 Stock Option Plan are subject to the Companys
right of repurchase, which generally lapses as to 12.5% of the shares six
months from the grant date and thereafter ratably over the remainder of a 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, 2004, 2003
and 2002, no shares were subject to the Companys right to repurchase. As of
May 31, 2004, 522,314 shares of common stock were available for grant under the
1995 Stock Option Plan and options for 4,593,000 shares of common stock were
outstanding.

Outside Directors Plan

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

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

1996 Nonstatutory Stock Option Plan

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

66

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

1997
Stock Option Plan for Verity Canada

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

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

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

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

Activity
under stock option plans

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

| |                                        |  | Year Ended May 31, | 
| | -------------------------------------- |  | ------------------ | 
| |                                        |  |                    | 
| |                                        |  | 2004               | 
| |                                        |  |                    | 
| |                                        |  | Shares             | 
| |                                        |  |                    | 
| | Outstanding
  at beginning of period   |  |                    | 
| | Options
  assumed via acquisition      |  |                    | 
| | Granted                                |  |                    | 
| | Exercised                              |  |                    | 
| | Cancelled                              |  |                    | 
| |                                        |  |                    | 
| | Outstanding
  at end of period         |  |                    | 
| |                                        |  |                    | 
| | Options
  exercisable at end of period |  |                    | 
| |                                        |  |                    | 

Common stock option
plans

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

| |                            |  | Options Outstanding        |  | Options Exercisable                                         | 
| | -------------------------- |  | -------------------------- |  | ----------------------------------------------------------- | 
| |                            |  |                            |  |                                                             | 
| | Range of 
  Exercise Price |  | Number at
  May 31,
  2004 |  | Weighted
  Average
  Remaining
  Contractual
  Life (Years) | 
| |                            |  |                            |  |                                                             | 
| | $   0.75  $4.99           |  |                            |  | 2                                                           | 
| | $   5.00  $16.49          |  |                            |  | 15,640                                                      | 
| | $ 16.50  $29.99           |  |                            |  | 1,454                                                       | 
| | $ 30.00  $53.00           |  |                            |  | 5,309                                                       | 
| |                            |  |                            |  |                                                             | 
| |                            |  |                            |  | 22,405                                                      | 
| |                            |  |                            |  |                                                             | 

67

---

---

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

Employee
stock purchase plan

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

Preferred
stock purchase rights plan

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

Preferred
stock and common stock

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

Stock
Based Compensation

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

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

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

68

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---

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

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

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

Stock
Repurchase Program

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

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

10.
Income Taxes

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

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

|         |  | Fiscal Years |  
|-------- |  | ------------ | -
|         |  |              |  
|         |  | 2004         |  
|         |  |              |  
|Domestic |  |              | $
|Foreign  |  |              |  
|         |  |              |  
|         |  |              | $
|         |  |              |  

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

|          |  | May 31, |  
|--------- |  | ------- | -
|          |  |         |  
|          |  | 2004    |  
|          |  |         |  
|Current:  |  |         |  
|Federal   |  |         | $
|State     |  |         |  
|Foreign   |  |         |  
|          |  |         |  
|          |  |         |  
|          |  |         |  
|Deferred: |  |         |  
|Federal   |  |         |  
|State     |  |         |  
|Foreign   |  |         |  
|          |  |         |  
|          |  |         |  
|          |  |         |  
|          |  |         | $
|          |  |         |  

69

---

---

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

|                                          |  | Fiscal Years |     
|----------------------------------------- |  | ------------ | ----
|                                          |  |              |     
|                                          |  | 2004         |     
|                                          |  |              |     
|                                          |  |              |     
|Income tax benefit at statutory rates     |  |              | 35.0
|State income taxes net of federal benefit |  |              | 3.9 
|Non-deductible expenses                   |  |              | 1.8 
|Foreign taxes                             |  |              | 0.2 
|Research and development credit           |  |              | (.9 
|In process research and development       |  |              | 5.4 
|                                          |  |              |     
|Effective tax rate                        |  |              | 45.4
|                                          |  |              |     

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

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

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

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

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

70

---

---

11.
Related Party Transactions

On July 31, 1997, Mr. Gary J. Sbona was appointed
as the Companys President and Chief Executive Officer, and the Company entered
into an agreement with Regent Pacific Management Corporation, a management
services firm of which Mr. Sbona is the Chairman and Chief Executive Officer.
Pursuant to the original agreement, Regent Pacific agreed to provide management
services to the Company, at a fee of $50,000 per week, including the services
of Mr. Sbona as Chief Executive Officer and President and other Regent Pacific
personnel as part of the Companys management team. The agreement had a
one-year term and could be canceled by the Company after expiration of the
initial 26-week period, with a minimum compensation to Regent Pacific of $1.3
million for that initial period.

The agreement
requires that the Company indemnify Regent Pacific and Mr. Sbona for certain
liabilities arising out of the performance of services under the agreement. Mr.
Sbona became an employee of the Company effective February 16, 1998. On April
13, 1998, the Company and Regent Pacific agreed to amend the agreement to
provide that Regent Pacific personnel continued to serve as part of the
Companys management team. The amendment also served to extend the term of the
agreement until August 31, 1999, and to extend the noncancelable period of the
agreement until February 28, 1999.

In connection
with Mr. Sbonas service as President, CEO and an employee of the Company, the
Compensation Committee of the Companys Board of Directors also granted to him
an option to purchase 700,000 shares of the Companys common stock, at an
exercise price of $2.563 per share. In October 1998, the Companys Board
granted Mr. Sbona another option to purchase 520,000 additional shares of the
Companys common stock, at an exercise price of $3.813 per share. In May 1999,
the Companys Board granted Mr. Sbona another option to purchase 420,000
additional shares of the Companys common stock, at an exercise price of
$16.250 per share. In October 1999 and January 2000, the Companys Board
granted Mr. Sbona options to purchase 606,000 and 394,000 of the Companys
common stock, at an exercise price of $30.75 and $31.75 per share,
respectively. In July and December 2000, the Companys Board granted Mr. Sbona
options to purchase 407,000 and 400,000 of the Companys common stock, at an
exercise price of $36.38 and $13.94 per share, respectively. In September 2001,
the Companys Board granted Mr. Sbona an option to purchase 1,000,000 shares of
the Companys common stock, at an exercise price of $8.74 per share. In July
2002, the Companys Board granted Mr. Sbona an option to purchase 1,000,000
shares of the Companys common stock, at an exercise price of $9.75 per share.
In October 2003, the Companys Board granted Mr. Sbona an option to purchase
77,000 shares of the Companys common stock, at an exercise price of $14.69 per
share. The shares subject to such options will vest entirely upon certain
change of control transactions or upon a termination of Mr. Sbona without
cause. The options will also remain exercisable for one year following the
termination of Mr. Sbonas services.

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

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

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

71

---

---

In January
2004, the Company and Regent Pacific entered into the seventh amendment to the
Retainer Agreement providing for a 75% reduction in weekly fees payable by the
Company under the Retainer Agreement, beginning in March 2004, as well as an
extension of the non-cancelable period of the Retainer Agreement from February
28, 2004 to February 28, 2005. As a result of the amendment, the services to be
rendered by Regent Pacific to the Company under the Retainer Agreement were
reduced. In addition, pursuant to the amendment, Gary J. Sbona continues to
serve as the Companys Executive Chairman of the Board, but Stephen W. Young
ceased to serve as the Companys Chief Operating Officer effective as of March
1, 2004.

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

12. Employee Benefit
Plan

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

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

13. Computation of
Net Income Per Share

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

| |                                                        |  | Fiscal Years |  
| | ------------------------------------------------------ |  | ------------ | -
| |                                                        |  |              |  
| |                                                        |  | 2004         |  
| |                                                        |  |              |  
| | Basic:                                                 |  |              |  
| | Weighted average common shares
  outstanding (basic)   |  |              |  
| | Net income                                             |  |              | $
| | Net income per share                                   |  |              | $
| | Diluted:                                               |  |              |  
| | Weighted average common shares
  outstanding (basic)   |  |              |  
| | Dilutive effect of common stock options                |  |              |  
| |                                                        |  |              |  
| | Weighted average common shares
  outstanding (diluted) |  |              |  
| |                                                        |  |              |  
| | Net income                                             |  |              | $
| | Net income per share                                   |  |              | $

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

72

---

---

14. Foreign Sales and Segment Reporting

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

The
Companys chief operating decision-maker is considered to be the Chief
Executive Officer. The Chief Executive Officer reviews financial information
presented on a consolidated basis, accompanied by disaggregated information
about revenues by geographic region for purposes of making operating decisions
and assessing financial performance. On this basis, the Company is organized
and operates in a single segment: develops, markets and supports infrastructure
products for corporate intranets, extranets, web sites, corporate portals,
business applications, online publishers and e-commerce providers and original
equipment manufacturer toolkits for independent software vendors:

The
Company has sales and marketing operations located outside the United States in
the Netherlands, the United Kingdom, France, Germany, South Africa, Mexico and
Australia, Brazil and a development and technical support operation in Canada.
Foreign branch and subsidiary revenues consist primarily of maintenance and
consulting services and are being allocated based on foreign branch and
subsidiary location. Disclosed in the table below is geographic information for
any country comprising greater than ten percent of total revenues.

|Financial
        Data by
        Geographical Area (in thousands) |  | US |        | United
        Kingdom |  | Other
        Europe |        | Other
        Foreign |  | Total
        International |   | Eliminations |   | Total | 
|------------------------------------------------------------------ |  | -- | ------ | ---------------------- |  | -------------------- | ------ | --------------------- |  | --------------------------- | - | ------------ | - | ----- | 
|                                                                   |  |    |        |                        |  |                      |        |                       |  |                             |   |              |   |       | 
|Revenues:                                                          |  |    |        |                        |  |                      |        |                       |  |                             |   |              |   |       | 
|2004                                                               |  | $  | 81,442 |                        |  | $                    | 15,344 |                       |  |                             | $ | 18,559       |   |       | 
|2003                                                               |  | $  | 63,877 |                        |  | $                    | 13,002 |                       |  |                             | $ | 18,606       |   |       | 
|2002                                                               |  | $  | 60,354 |                        |  | $                    | 9,523  |                       |  |                             | $ | 17,434       |   |       | 
|Income
        (loss) from operations:                             |  |    |        |                        |  |                      |        |                       |  |                             |   |              |   |       | 
|2004                                                               |  | $  | 9,956  |                        |  | $                    | 7,265  |                       |  |                             | $ | 8,515        |   |       | 
|2003                                                               |  | $  | 12,754 |                        |  | $                    | 6,737  |                       |  |                             | $ | (5,140       | ) |       | 
|2002                                                               |  | $  | 6,900  |                        |  | $                    | 3,566  |                       |  |                             | $ | (1,082       | ) |       | 
|Long-lived
        assets: (1)                                     |  |    |        |                        |  |                      |        |                       |  |                             |   |              |   |       | 
|2004                                                               |  | $  | 84,379 |                        |  | $                    | 189    |                       |  |                             | $ | 253          |   |       | 
|2003                                                               |  | $  | 30,950 |                        |  | $                    | 190    |                       |  |                             | $ | 424          |   |       | 
|2002                                                               |  | $  | 4,509  |                        |  | $                    | 308    |                       |  |                             | $ | 530          |   |       | 

(1) Excluding financial instruments and deferred tax assets.

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

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

73

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---

SCHEDULE II 
VERITY, INC.

VALUATION AND QUALIFYING ACCOUNTS
(in thousands)

|Description                                                           |  | Balance at
  Beginning
  of Year |   | Amounts
  Charged to
  Profit and
  Loss |  | Addition
  due to
  Cardiff
  Acquisition |  | Deductions |       | Balance
  at End
  of Year | 
|--------------------------------------------------------------------- |  | -------------------------------- | - | ---------------------------------------- |  | ----------------------------------------- |  | ---------- | ----- | -------------------------- | 
|                                                                      |  |                                  |   |                                          |  |                                           |  |            |       |                            | 
|Allowance for doubtful accounts:                                      |  |                                  |   |                                          |  |                                           |  |            |       |                            | 
|Year ended
  May 31, 2004
         
  Allowance for doubtful accounts |  |                                  | $ | 1,720                                    |  |                                           |  | $          | 319   |                            | 
|Year ended
  May 31, 2003
          Allowance for doubtful accounts   |  |                                  | $ | 1,640                                    |  |                                           |  | $          | 563   |                            | 
|Year ended
  May 31, 2002
          Allowance for doubtful accounts   |  |                                  | $ | 1,418                                    |  |                                           |  | $          | 1,137 |                            | 

74

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---

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: August 13, 2004 | By:     /s/          ANTHONY J. BETTENCOURT | 
|                      |                                             | 
|                      | (President and
  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.

|Signature                         |  | Title                                                                              |  | Date           
|--------------------------------- |  | ---------------------------------------------------------------------------------- |  | ---------------
|                                  |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        GARY J. SBONA          |  | Executive Chairman of the Board                                                    |  | August 13, 2004
|                                  |  |                                                                                    |  |                
|Gary J.
  Sbona                   |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        ANTHONY J. BETTENCOURT |  | President and Chief Executive Officer and Director
  (Principal Executive Officer) |  | August 13, 2004
|                                  |  |                                                                                    | 
|Anthony
  J. Bettencourt          |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        STEVEN R. SPRINGSTEEL  |  | Senior Vice President of Finance and Administration
  and Chief Financial Officer  |  | August 13, 2004
|                                  |  |                                                                                    | 
|Steven R.
  Springsteel           |  | (Assistant Secretary and Principal Financial Officer)                              |  |                
|                                  |  |                                                                                    |  |                
|/s/        STEVEN M. KRAUSZ       |  | Director                                                                           |  | August 13, 2004
|                                  |  |                                                                                    |  |                
|Steven M.
  Krausz                |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        STEPHEN A. MACDONALD   |  | Director                                                                           |  | August 13, 2004
|                                  |  |                                                                                    |  |                
|Stephen
  A. MacDonald            |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        CHARLES P. WAITE, JR.  |  | Director                                                                           |  | August 13, 2004
|                                  |  |                                                                                    |  |                
|Charles
  P. Waite, Jr.           |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        KARL C. POWELL         |  | Director                                                                           |  | August 13, 2004
|                                  |  |                                                                                    |  |                
|Karl C.
  Powell                  |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        JOHN G. SCHWARZ        |  | Director                                                                           |  | August 13, 2004
|                                  |  |                                                                                    |  |                
|John G.
  Schwarz                 |  |                                                                                    |  |                
|                                  |  |                                                                                    |  |                
|/s/        VICTOR A. COHN         |  | Director                                                                           |  | August 13, 2004
|                                  |  |                                                                                    |  |                
|Victor A.
  Cohn                  |  |                                                                                    |  |                

75

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INDEX TO EXHIBITS

|Exhibit
  Number |  | Description of Document                                                                                                                                                                                                                    
|---------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                 |  |                                                                                                                                                                                                                                            
|2.1              |  | Asset Purchase Agreement among Inktomi Corporation, Quiver, Inc.,
  Ultraseek Corporation, Quiver Ltd. and
  Verity, Inc., dated November 13, 2002. (1)                                                                                    
|2.2              |  | Amendment No. 1 to Asset Purchase Agreement between Inktomi
  Corporation, Quiver, Inc., Ultraseek
  Corporation, Quiver Ltd. and Verity, Inc., dated December 17, 2002, amending
  Asset Purchase Agreement dated
  November 13, 2002. (1)
|2.3              |  | Agreement
  and Plan of Merger, dated February 2, 2004, by and among the Company, Colt
  Acquisition Corp.,
  Cardiff Software, Inc. and Robert Wadsworth. (2)                                                                             
|3.1              |  | Restated Certificate of Incorporation of the Company. (3)                                                                                                                                                                                  
|3.2              |  | By-Laws of the Company. (3)                                                                                                                                                                                                                
|4.1              |  | Amended and Restated Rights Agreement dated August 1, 1995, as
  amended. (4)                                                                                                                                                              
|4.2              |  | Form of Rights Agreement between Verity, Inc. and First National Bank
  of Boston dated September 18, 1996. (5)                                                                                                                            
|4.3              |  | First Amendment to Rights Agreement dated as of July 23, 1999 among
  Verity, Inc. and BankBoston, N.A. (6)                                                                                                                                
|10.1             |  | Form of Indemnification Agreement for directors and officers. (4),(7)                                                                                                                                                                      
|10.2             |  | Amended and Restated 1995 Stock Option Plan and forms of agreements
  thereunder. (7),(8)                                                                                                                                                  
|10.4             |  | 1995 Outside Directors Stock Option Plan, as amended, and forms of
  agreement thereunder. (7),(9)                                                                                                                                         
|10.5             |  | 1996 Non-Statutory Stock Option Plan, as amended, and form of
  agreement thereunder. (7),(10)                                                                                                                                             
|10.6             |  | 1997 Non-Statutory Stock Option Plan for Verity, Canada, as amended.
  (7),(11)                                                                                                                                                            
|10.7             |  | Offer letter, dated March 6, 2003, between Verity, Inc. and Victor A.
  Cohn. (7)(12)                                                                                                                                                      
|10.8             |  | Offer letter, dated March 6, 2003, between Verity, Inc. and John G.
  Schwarz. (7)(12)                                                                                                                                                     
|10.9             |  | Cardiff
  Software, Inc. 1997 Equity Incentive Plan, as amended. (7)(13)                                                                                                                                                                   
|10.10            |  | Cardiff
  Software, Inc. 2000 Stock Option Plan. (7)(13)                                                                                                                                                                                   
|10.11            |  | First
  Amendment to 894 Ross Drive Lease dated June 20, 1996. (25)                                                                                                                                                                        
|10.12            |  | Second
  Amendment to 894 Ross Drive Lease dated November 5, 1996. (25)                                                                                                                                                                    
|10.13            |  | Third
  Amendment to 894 Ross Drive Lease dated January 17, 1997. (25)                                                                                                                                                                     
|10.14            |  | Fourth
  Amendment to 894 Ross Drive Lease dated March 15, 2004. (25)                                                                                                                                                                      
|10.15            |  | First
  Amendment to 892 Ross Drive Lease dated March 15, 2004. (25)                                                                                                                                                                       
|10.18            |  | Lease Agreement between Ross Drive Investors and the Company dated
  January 22, 1996. (14)                                                                                                                                                
|10.19            |  | Retainer Agreement between Regent Pacific Management Corporation and
  Verity, Inc. dated July 31, 1997.
  (7),(15)                                                                                                                        
|10.23            |  | Amendment to Retainer Agreement between Regent Pacific Management
  Corporation and Verity, Inc. dated April
  13, 1998. (7),(16)                                                                                                          
|10.26            |  | Amendment to Retainer Agreement between Regent Pacific Management
  Corporation and Verity, Inc. dated
  March 12, 1999. (7),(17)                                                                                                          
|10.27            |  | Amendment to Retainer Agreement between Regent Pacific Management
  Corporation and Verity, Inc. dated
  February 9, 2000. (7),(18)                                                                                                        
|10.29            |  | Amendment to Retainer Agreement between Regent Pacific Management
  Corporation and Verity, Inc. dated
  March 12, 2001. (7),(19)                                                                                                          
|10.34            |  | Amendment to Retainer Agreement between Regent Pacific Management Corporation
  and Verity, Inc. dated June
  10, 2002. (7),(20)                                                                                                           
|10.35            |  | 1995 Employee Stock Purchase Plan, as amended October 1, 2001.
  (7),(20)                                                                                                                                                                  
|10.36            |  | Loan Agreement, dated December 24, 1999, between Verity Benelux B.V.
  and Hugo Sluimer. (7),(21)                                                                                                                                          
|10.37            |  | Loan Agreement, dated December 24, 1999, between Verity Benelux B.V.
  and Hugo Sluimer. (7),(21)                                                                                                                                          
|10.38            |  | Loan Agreement, dated April 19, 2000, between Verity Benelux B.V. and
  Hugo Sluimer. (7),(21)                                                                                                                                             
|10.39            |  | Loan Agreement, dated September 11, 2000, between Verity Benelux B.V.
  and Hugo Sluimer. (7),(21)                                                                                                                                         
|10.40            |  | Amendment to Employment Agreement between Anthony J. Bettencourt and
  the Company dated September 1,
  2002.(7)(22)                                                                                                                       
|10.41            |  | Amendment to Retainer Agreement between Regent Pacific Management
  Corporation and Verity, Inc. dated
  March 4, 2003. (7),(12)                                                                                                           
|10.42            |  | Employment Arrangement between Anthony J. Bettencourt and Verity,
  Inc. effective as of March 4, 2003. (7)(23)                                                                                                                            
|10.43            |  | Seventh
  Amendment to Retainer Agreement between Regent Pacific Management Corporation
  and Verity, Inc.                                                                                                                                 

76

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|Exhibit
  Number |  | Description of Document                                                                                                                                                                                      
|---------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                 |  |                                                                                                                                                                                                              
|                 |  | dated January 9, 2004. (7),(24)                                                                                                                                                                              
|21.1             |  | Subsidiaries of the Company.(25)                                                                                                                                                                             
|23.1             |  | Consent of Independent Registered Public
        Accounting Firm, KPMG LLP.(25)                                                                                                                              
|23.2             |  | Consent of Independent Accountants, PricewaterhouseCoopers LLP.(25)                                                                                                                                          
|31.1             |  | Certification of Principal Executive Officer Required
  Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities
  Exchange Act of 1934.(25)                                                                 
|31.2             |  | Certification of Principal Financial Officer Required
  Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities
  Exchange Act of 1934.(25)                                                                 
|32               |  | Certification
  of Principal Executive Officer and Principal Financial Officer Required Under
  Rule 13a-14(b) or
  Rule 15d-14(b) of the Securities Exchange Act of 1934, and 18 U.S.C.
  Section 1350. (25)

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

(2)          Incorporated
by reference from the exhibits with corresponding names from the Companys Form
8-K filed with the Securities and Exchange Commission on February 5, 2004
(Commission No. 000-26880).

(3)          Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-Q for the quarter ended November 30, 2000 (Commission No.
000-26880).

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

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

(6)          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 (Commission
No. 000-26880).

(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 10.3 to the Companys Form 10-Q for the quarter ended
February 28, 2003 (Commission No. 000-26880). 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 (Commission
No. 000-26880).

(9)          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 26, 1999 (Registration No. 333-89701). 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.

(10)        With
respect to the 1996 Non-Statutory Stock Option Plan, as amended, incorporated
by reference to Exhibit 10.6 to the Companys Form 10-Q for the quarter ended
February 28, 2003 (Commission No. 000-26880).  The
form of agreement under the 1996 Non-Statutory Stock Option Plan, as amended,
is filed herewith.

(11)        Incorporated
by reference to Exhibit 10.7 to the Companys Form 10-Q for the quarter ended
February 28, 2003 (Commission No. 000-26880).

(12)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-K for the year ended May 31, 2003 (Commission No.
000-26880).

(13)        Incorporated
by reference from the exhibit with the corresponding name from the Companys
Registration Statement on Form S-8 filed March 19, 2004 (Registration No.
333-113776).

77

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(14)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-Q for the quarter ended February 29, 1996 (Commission No.
000-26880).

(15)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-K for the year ended May 31, 1997 (Commission No.
000-26880).

(16)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-K for the year ended May 31, 1998 (Commission No.
000-26880).

(17)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-Q for the quarter ended February 28, 1999 (Commission No.
000-26880).

(18)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-Q for the quarter ended February 29, 2000 (Commission No.
000-26880).

(19)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-Q for the quarter ended February 28, 2001 (Commission No.
000-26880).

(20)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-K for the year ended May 31, 2002 (Commission No.
000-26880).

(21)        Incorporated
by reference from the exhibits with corresponding numbers from the Companys
Form 10-K/A filed on August 29, 2002 for the year ended May 31, 2002 (Commission
No. 000-26880).

(22)        Incorporated
by reference from the exhibit with corresponding number from the Companys Form
10-Q for the quarter ended August 31, 2002 (Commission No.
000-26880).

(23)        Incorporated
by reference from the exhibit with corresponding number from the Companys
Amendment No. 1 on Form 10-K/A to the Form 10-K for the year ended May 31, 2003
(Commission No. 000-26880).

(24)        Incorporated
by reference from the exhibit 10.41 from the Companys Form 10-Q for the
quarter ended November 30, 2003 with the Securities and Exchange Commission on
January 9, 2004. (Commission No. 000-26880).

(25)        Filed herewith.

78

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