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

                                   FORM 10-K

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

                     FOR THE FISCAL YEAR ENDED MAY 31, 2001
                         COMMISSION FILE NUMBER 0-26880
                            ------------------------

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

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

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

        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                         COMMON STOCK, $0.001 PAR VALUE
                                (TITLE OF CLASS)
                            ------------------------

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

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

     The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing price of the Common Stock on July 31,
2001, as reported on Nasdaq National Market was approximately $361,490,000.
Excludes approximately 14,945,000 shares of Common Stock held collectively by
the executive officers and directors of the registrant and by each person who
owned 5% or more of the outstanding Common Stock as of such date. Exclusion of
shares held by any person should not be construed to indicate that such person
is an affiliate of the registrant.

     The number of shares of the registrant's Common Stock outstanding on July
31, 2001 was 35,531,414.

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                               TABLE OF CONTENTS

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                                                                            PAGE
                                                                            ----
  <S>         <C>                                                           <C>
  PART I..................................................................    1
       Item
         1.   Business....................................................    1
       Item
         2.   Properties..................................................   22
       Item
         3.   Legal Proceedings...........................................   22
       Item
         4.   Submission of Matters to a Vote of Securities Holders.......   23
  PART II.................................................................   24
       Item
         5.   Market for the Registrant's Common Stock and Related
              Stockholder Matters.........................................   24
       Item
         6.   Selected Financial Data.....................................   25
       Item
         7.   Management's Discussion and Analysis of Financial Condition
              and
              Results of Operations.......................................   26
       Item
         7A.  Quantitative and Qualitative Disclosures About Market
              Risk........................................................   32
       Item
         8.   Financial Statements and Supplementary Data.................   32
       Item
         9.   Changes in and Disagreements with Accountants on Accounting
              and Financial Matters.......................................   32
  PART III................................................................   33
       Item
         10.  Directors and Executive Officers of the Registrant..........   33
       Item
         11.  Executive Compensation......................................   33
       Item
         12.  Security Ownership of Certain Beneficial Owners and
              Management..................................................   33
       Item
         13.  Certain Relationships and Related Transactions..............   33
  PART IV.................................................................   34
       Item
         14.  Exhibits, Financial Statement Schedules, and Reports on Form
              8-K.........................................................   34
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                                     PART I

ITEM 1. BUSINESS

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

     You should carefully read the information in this Annual Report on Form
10-K, including our consolidated financial statements and related notes
beginning on page 36 of this Annual Report on Form 10-K. Our business involves
significant risks. You should carefully consider the information under the
heading "-- Risk Factors" below. In addition, this Annual Report contains
forward-looking statements that relate to future events or future financial
performance. See "Forward-Looking Statements" at the end of this Item 1
regarding information that readers should be aware of in reading these
forward-looking statements.

OVERVIEW

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

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

     We develop, market and support products for corporate intranets, extranets,
corporate portals, online publishers and e-commerce providers, and original
equipment manufacturer (OEM) toolkits for independent software vendors (ISVs).
Our comprehensive and integrated product family enables numerous enterprise-
wide functionalities all from the same underlying Verity information index. Our
products organize and provide simple, single-point access to information across
the entire enterprise. By doing so, our products create business portals, which
leverage the value of existing investments in Internets, intranets and network
infrastructure.

     Our software has been licensed directly to over 1,500 corporations,
government agencies, software developers, information publishers and e-commerce
vendors. We focus on several core markets, including intranet-based applications
for large corporate and government organizations, information retrieval
solutions for e-commerce merchants, Internet sites and electronic publishers and
OEM toolkits for ISVs. We pursue sales opportunities within organizations and
government agencies through the efforts of our direct sales force and our
products are also sold indirectly through a network of value added resellers
(VARs) and system integrators, and as OEM toolkits through ISVs that embed
Verity technology in their products or services.

     From 1988 to 1994, we derived substantially all of our revenues from the
license of custom search and retrieval applications and consulting and other
services related to such applications. In 1995, we began refining and enhancing
our core technology to add functionality and facilitate incorporation of our
technology in a variety of markets. Recently, we have begun offering solutions
and technology that address the business portal market. For more information on
the development of our business, see "Item 7 -- Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview" in this
Annual Report for a further description of the development of our business.

     We were organized as a California corporation in March 1988 and
reincorporated in Delaware in September 1995. Our principal executive offices
are located at 894 Ross Drive, Sunnyvale, California 94089, and our telephone
number is (408) 541-1500. We maintain a web site on the World Wide Web at
"verity.com." The reference to our web address does not constitute incorporation
by reference of the information contained at the site.

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THE VERITY SOLUTION

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

     Our cross-platform knowledge retrieval product suite is scalable and is
designed to solve the knowledge retrieval problems of enterprise and commerce
sites. Our products use a combination of full text, metadata and rule-based
methods to index and retrieve information stored in a variety of formats and
systems across corporate intranets, extranets and portals and the Internet. Our
products organize and rank the relevance of selected information, enabling users
to filter and evaluate information personalized to their specific needs and
interests. Our products enable user-initiated queries, and also enable the
construction of automated software agents that actively and continuously monitor
Internet and intranet information sources such as web sites, news feeds and file
systems for new information or changes in content matching user profiles. Our
products enable the high-speed classification of information, the organization
of information into taxonomies and the visual navigation of information. Our
products deliver the ability to filter most common file formats for viewing, and
to convert most common file formats to HTML and XML. Additionally, our products
allow organizations to build hybrid online and offline information distribution
systems by publishing information on CD-ROM and DVD-ROM, maintaining links to
active web sites and enabling automatic synchronization between the Web and a
user's local computer.

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

     Corporate Intranets and Extranets and Portals. We market an integrated
product suite enabling public and private organizations to index, search,
retrieve, classify, organize, navigate, disseminate and publish textual
information residing in many document formats and in web and file servers
distributed across the enterprise. Verity K2 Enterprise, Verity Portal One,
Verity Information Server, Verity Agent Server, Verity Knowledge Organizer,
Verity Intelligent Classifier and Verity Document Navigator are designed to
serve as the foundation of a well-designed corporate portal. Verity K2
Enterprise provides enhanced portal return on investment through advanced search
and Intelligent Classification. Verity Portal One provides a suite of portal
components that can be selected to build custom portals. Verity Information
Server creates a searchable index to information across the enterprise. Verity
Agent Server notifies users when documents matching their personal information
needs are added to this index and sends them electronic notices via email or
personal web page. With Verity Knowledge Organizer, data from different systems
and sources can be grouped together logically and navigated visually, reducing
content management costs and increasing the usability of corporate intangible
assets. Verity Intelligent Classifier lets users quickly and easily build,
share, reuse, test and modify the business rules Verity solutions use to
automatically classify information. For especially long or complex documents,
Verity Document Navigator provides a publishing tool, which turns long, awkward
documents into rich Web publications that users can easily search and navigate.
Users can search and traverse an automatically generated table of contents, and
efficiently find valuable information hidden within large documents. Users can
create these searchable publications from any format Verity supports, including
Microsoft Word, HTML and PDF.

     Electronic Commerce and Publishing. E-commerce vendors, including online
stores and publishers, demand fast and accurate searches across large bodies of
content. Our Internet products are designed to provide e-commerce vendors and
online information publishers with an integrated solution enabling their users
to efficiently navigate product catalogs, news services and document
repositories, whether online or from a

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remote, disconnected location. Through the use of our knowledge retrieval
products, vendors have the ability to convert more site visitors into buyers and
more buyers into repeat customers. Our product offerings include Verity K2
Catalog and Verity Publisher. Verity K2 Catalog is designed for scalability to
support the largest commercial Internet sites and to enable millions of products
and documents to be searched and indexed by hundreds of users simultaneously.
Verity Publisher allows high-volume commercial and corporate publishers to use
web-based information offline or from a low cost, searchable alternative media.

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

PRODUCTS

     Our product suite enables organizations to turn corporate intranets and
extranets into a powerful knowledge base or corporate portal, making business
information accessible and reusable across the enterprise. Our comprehensive and
integrated product family enables enterprise-wide document indexing,
classification, search and retrieval, and personalized information dissemination
all from the same underlying Verity index. Because our products are designed to
work together, customers may begin by deploying basic retrieval technology and
can later incorporate more sophisticated classification and dissemination
technology as their business needs expand. Additionally, because we offer
enterprise and departmental solutions, our customer's investment is preserved by
our capability to expand to support the largest document repositories and
corporate intranets and extranets.

  Enterprise Business Portal Products:

     Verity K2 Enterprise. Verity K2 Enterprise is business portal
infrastructure that indexes, searches and retrieves information on web and file
servers located across an enterprise, including corporate intranets, portals,
extranets, research and development, executive messaging and business
intelligence systems. K2 Enterprise utilizes the Verity K2 architecture to
deliver Intelligent Classification, rapid integration, limitless scalability,
fault-tolerant operation and global support including support for multiple
languages through best-of-breed locales.

     Verity K2 Catalog. Verity K2 Catalog is e-business infrastructure that
indexes, searches and retrieves information in Business-to-Customer and
Business-to-Business environments. K2 Catalog utilizes the Verity K2
architecture to deliver Intelligent Merchandising based on Verity's Intelligent
Classification technology, profitable site stickiness, rapid integration,
adaptive personalization, limitless scalability, fault-tolerant operation and
global support, including support for multiple languages through best-of-breed
locales.

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

     Verity Portal One Special Edition. Verity Portal One SE indexes, searches
and retrieves information on web and file servers located across an enterprise,
including corporate intranets, portals, extranets, online retail catalogs,
research and development, executive messaging and business intelligence systems.
Portal One SE includes the Verity Webtop to provide a single point-of-access to
all enterprise information and applications.

     Verity Information Server. Verity Information Server indexes, searches and
retrieves information on web and file servers located across an enterprise,
including corporate intranets, portals, extranets, online retail catalogs,
research and development, executive messaging and business intelligence systems.
Information Server includes a powerful search navigation facility, which
includes document clustering, automatic

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summarization and query by example. Information Server has the power and
flexibility to enable any business to organize and integrate heterogeneous
information repositories into a coherent index.

     Verity K2 Spider. Verity K2 Spider crawls, filters and indexes web and file
servers, located internally or externally, in real time, using a distributed
architecture. This enables the indexing process to be configured with numerous
crawlers and indexers that are managed by a controller, so that performance can
be optimized and the indexing process can scale infinitely. In conjunction with
Verity K2 solutions, K2 Spider provides end-to-end fault tolerance, scalability,
flexibility and accuracy.

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

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

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

     Verity Intelligent Classifier. Verity Intelligent Classifier lets
administrators quickly and easily create, reuse, share, modify and test the
business rules used by Verity solutions to automatically classify information.
This allows humans to augment automatic classification results to organize
information assets the way their business is organized with extreme accuracy.

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

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

     Verity Publisher. Verity Publisher is a hybrid CD-ROM/DVD-ROM-Web
information publishing system. Publisher is designed to publish the contents of
a web site on CD-ROM and DVD-ROM while maintaining links to web sites. 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.

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  OEM and Custom Application Development Tools:

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

     Verity K2 Developer. Verity K2 Developer combines the precision of the
Verity Developer's Kit with fault tolerance and scalability. K2 Developer is
designed to enable organizations to build scalable, fault-tolerant applications
to allow thousands of users to search hundreds of millions of unstructured
documents online yielding quick and efficient results. The K2 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 Kit. Verity Profiler Kit enables users to develop
applications that use content and metadata to classify information automatically
and trigger business events. Profiler Kit enables developers to build
specialized applications, using Verity's patented technology, to disseminate
information accurately to users, to notify users about critical new information,
or to classify documents into specific categories.

     Verity Export. Verity Export provides on-demand, server-side conversion of
documents to valid XML using a predefined Verity document type definition (DTD).
The resulting XML can be indexed and searched, and viewed using cascading style
sheets or extensible style language. Verity 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 Filter SDK. The Verity Filter SDK is designed to allow independent
software vendors to embed Verity's filtering functionality within their own
applications. This allows their applications to index and search multiple file
formats by extracting text and converting it to a data stream or ASCII text
file.

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

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

SERVICES

     We make extensive technical support and training services available for our
customers, and provide consulting services designed to assist our customers in
utilizing Verity software to develop custom search and retrieval applications.
As of May 31, 2001, we employed 30 people in our technical support organization,
50 people in our consulting group and two people focused on developing and
coordinating training services.

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

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

     Training. We provide training services at our own training facilities
located in Sunnyvale, California, as well as at the facilities of our customers,
value added resellers and system integrators worldwide. We also provide training
through certain authorized third parties. We have developed an extensive set of
courses and materials for presentation by our professional instructors. We
believe our training helps assure increased

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customer satisfaction while enhancing our ability to make additional sales to
our existing customer base. Customers typically pay for training services on a
course or fee basis.

CUSTOMERS

     Our software has been licensed directly to over 1,500 corporations,
government agencies, software developers, information publishers and e-commerce
vendors. We focus on several core markets, including intranet-based applications
for large corporate and government organizations, information retrieval
solutions for e-commerce and electronic publishers, and OEM toolkits for ISVs.
See Note 11 of Notes to Consolidated Financial Statements beginning on page 53
of this Annual Report on Form 10-K for a discussion of our international
revenues, income from operations and long-lived assets by geographic region.

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 suite of products to integrate information residing
within the organization over a variety of sources such as word processing
documents, relational database document repositories and web and file servers.
Our direct sales force also targets online service providers and publishers of
information stored on both the Internet and CD-ROM/DVD-ROM. We maintain direct
sales offices or personnel in a number of metropolitan areas across the United
States, including Falls Church, Burlington, Chicago, Dallas, New York, Newport
Beach, Sunnyvale and Washington, D.C. European direct sales operations are
located in London, Utrecht, Munich, Paris and Stockholm. We also have direct
sales offices located in Singapore, Mexico, South Africa and Australia.

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

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

     - groupware (Intraspect, Lotus);

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

     - enterprises resource planning systems (SAP, PeopleSoft);

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

     - product data management solutions;

     - e-commerce; and

     - personal productivity (Adobe, Corel, Qualcomm).

     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 and OEM applications. Our marketing
efforts include participation in tradeshows, conferences and industry events,
Verity seminars, industry speaking engagements, and advertising and direct mail
campaigns targeting specific markets such as corporate portal developers,
intranet web site and content managers, and online catalog developers. Certain
of our OEM contracts also provide for brand name exposure concerning the ISV'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, 2001, our sales and marketing organizations consisted of 232 employees.

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TECHNOLOGY

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

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

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

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

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

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

     Intelligent Classification. Verity's Intelligent Classification technology
augments highly accurate automatic classification with business rules that can
be reused, shared, modified and tested by humans. Existing taxonomies can be
reused, or documents can be classified according to metadata, pathnames, URLs or
new taxonomies created with business rules. This allows companies to organize
their information assets the same way they organize their business. When
combined with Verity's advanced search, users are equipped with the tools they
need to quickly and intuitively discover relevant information across the
enterprise or in e-business catalogs. Searches can be limited to specific
directories, or users can drill down through familiar directories and
sub-directories to find the information for which they are searching.

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

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

PRODUCT DEVELOPMENT

     Our development efforts are focused on expanding our suite of products,
designing enhancements to our core technology, and addressing additional
technical challenges inherent in developing new applications for enterprise,
e-commerce, OEM and sophisticated offline publishing markets. Our research and
development is focused on enhancing core indexing and search performance and
precision, data access and security gateways, enterprise scalability, business
portal functionality, programmable application programming interfaces, and
product deployability. As of May 31, 2001, there were 172 employees on our
research and development staff. Our research and development expenditures in
fiscal 1999, fiscal 2000 and fiscal 2001 were $13.7 million, $16.0 million and
$21.6 million, respectively, which represented 21.3%, 16.7% and 14.9% of total
revenues, respectively. We expect that we will continue to commit substantial
resources to product development in the future.

COMPETITION

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

     - product quality;

     - performance and price;

     - vendor and product reputation;

     - product architecture;

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<PAGE>   11

     - strategic alliances;

     - product functionality and features; and

     - ease of use and quality of support.

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

     - application servers;

     - document management systems;

     - groupware applications;

     - Internet products; and

     - operating systems to include text search and retrieval features.

     Many of our existing competitors have significantly greater financial,
technical and marketing resources than we do. Although we believe that our
products and technologies compete favorably with respect to the factors outlined
above, we cannot assure you that we will be able to compete successfully against
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 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 Nextpage, Enigma and
Dataware.

PROPRIETARY RIGHTS

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

     - the technological and creative skills of our personnel;

     - new product developments;

     - frequent product enhancements;

     - name recognition; and

     - reliable product maintenance.

     We presently have one issued patent, relating to our search and retrieval
technology, which will expire in January 2016, and two patent applications
pending. We cannot assure you that other companies will not develop technologies
that are similar or superior to our technology. The source code for our
proprietary software is protected both as a trade secret and as a copyrighted
work. Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use our products or technology without authorization, or to
develop similar technology independently. In addition, effective copyright and
trade secret protection may be unavailable or limited in some foreign countries.
                                        9
<PAGE>   12

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

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

EMPLOYEES

     As of May 31, 2001, we had a total of 524 employees, including 172 in
research and development, 206 in sales, 26 in marketing, 82 in customer support
and professional services, 33 in administration and 5 in manufacturing. Of these
employees, 320 were located in the United States, 85 in Europe, 106 in Canada, 7
in Australia, 2 in South Africa, 2 in Mexico and 2 in Singapore. 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.

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<PAGE>   13

                                  RISK FACTORS

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

                         RISKS RELATED TO OUR BUSINESS

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

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

     - increase market acceptance of our products;

     - respond effectively to competitive developments;

     - attract, retain and motivate qualified personnel; and

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

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

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

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

     - the downturn in capital spending by customers as a result of the recent
       economic slowdown;

     - the size and timing of orders;

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

     - increased competition in the software and Internet industries;

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

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

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

     - changes in operating expenses and personnel;

     - the overall trend toward industry consolidation; and

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<PAGE>   14

     - changes in general economic 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
have a material adverse impact on our operations and financial results, and
consequently our stock price.

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

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

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

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

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

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

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

     During the past few years, management and other personnel have focused on
modifying and enhancing our core technology to support a broader set of search
and retrieval solutions for use on enterprise-wide systems, over online
services, the Internet and on CD-ROM. In order for our strategy to succeed and
to remain competitive, we must leverage our core technology to develop new
product offerings by us and by our original equipment manufacturer, or OEM,
customers that address the needs of these new markets. These development efforts
are expensive. If these products do not generate substantial revenues, our
business and

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<PAGE>   15

results of operations will be adversely affected. We cannot assure you that such
products will be successfully completed on a timely basis or at all, will
achieve market acceptance or will generate significant revenues.

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

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

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

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

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

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

     Regent Pacific Management Corporation, a management firm of which Gary J.
Sbona is chief executive officer, provides management services for our company.
The management services provided under our agreement with Regent Pacific include
the services of Mr. Sbona, as chairman of the board and chief executive officer,
and other Regent Pacific personnel as part of Verity's management team. Gary J.
Sbona is also deemed an employee of our company under common law. On March 12,
2001 we extended our agreement with Regent Pacific Management Corporation
through August 31, 2002. This is the fourth amendment to the retainer agreement
between Regent Pacific Management Corporation and Verity, Inc. since the
original agreement dated July 31, 1997. Under this amended agreement, Regent
Pacific continues to provide the services of Gary J. Sbona as Chairman and Chief
Executive Officer of Verity, and continues to provide additional Regent Pacific
management services to our company. The agreement provides us with an option to
further extend the term of this agreement through February 2003. This agreement
may be cancelled at the option of the board after February 2003. If the
agreement with Regent Pacific were canceled or not renewed, the loss of the
Regent Pacific personnel could have a material adverse effect on our operations,
especially during the transition phase to a new management. Similarly, if any
adverse change in Verity's relationship

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<PAGE>   16

with Regent Pacific occurs, it could hinder management's ability to direct our
business and materially and adversely affect our results of operations and
financial condition.

OUR BUSINESS MAY SUFFER DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES

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

     - difficulties in complying with regulatory requirements and standards;

     - tariffs and other trade barriers;

     - costs and risks of localizing products for foreign countries;

     - reliance on third parties to distribute our products;

     - longer accounts receivable payment cycles;

     - potentially adverse tax consequences;

     - limits on repatriation of earnings; and

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

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

     Service and other revenues derived from foreign operations accounted for
6.4%, 6.7% and 6.3% of total revenues, respectively, in fiscal 1999, 2000 and
2001. Our export sales consist primarily of products licensed for delivery
outside of the United States. In fiscal years 1999, 2000 and 2001, export sales
accounted for 27.1%, 19.0% and 26.0% of total revenues. We expect that revenues
derived from foreign operations and export sales will continue to account for a
significant percentage of our revenues for the foreseeable future. These
revenues may fluctuate significantly as a percentage of revenues from period to
period. In addition, a portion of these revenues was derived from sales to
foreign government agencies, which may be subject to risks similar to those
described immediately below. See Note 11 of Notes to Consolidated Financial
Statements beginning on page 53 of this Annual Report on Form 10-K for a
discussion of our international revenues, income from operations and long-lived
assets by geographic region.

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

     Revenues derived from sales to the federal and state governments and their
agencies were 8.1%, 7.8% and 7.4% of total revenues in fiscal years 1999, 2000
and 2001, respectively. Future reductions in United States spending on
information technologies could have a material adverse effect on our operating
results. Sales to government agencies declined as a percentage of revenues
during these periods, and may decline in the future. In recent years, budgets of
many government agencies have been reduced, causing certain customers and
potential customers of our products to re-evaluate their needs. These budget
reductions are expected to continue over at least the next several years.
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<PAGE>   17

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

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

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

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

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

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

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

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

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<PAGE>   18

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

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

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

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

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

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

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

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

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

     Some of the technology used by our products is licensed from third parties,
generally on a nonexclusive basis. We believe that there are alternative sources
for each of the material components of technology we license from third parties.
However, the termination of any of these licenses, or the failure of the
third-party licensors to adequately maintain or update their products, could
result in delay in our ability to ship these products while we seek to implement
technology offered by alternative sources. Any required replacement
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<PAGE>   19

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

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

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

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

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

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

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

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

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

     - the assumption of unforeseen liabilities of the acquired company.

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

                         RISKS RELATED TO OUR INDUSTRY

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

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

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

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

                                        17
<PAGE>   20

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

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

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

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

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

     - delayed development of enabling technologies and performance
       improvements;

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

     - increased governmental regulation.

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

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

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

SECURITY RISKS EXPOSE US TO ADDITIONAL COSTS AND TO LITIGATION

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

                 RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK

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

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

     - future announcements concerning Verity or its competitors;

     - quarterly variations in operating results;

     - announcements of technological innovations;
                                        18
<PAGE>   21

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

     - proprietary rights or other litigation; and

     - changes in earnings estimates by analysts or other factors.

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

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

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

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

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

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

     - limitations on who may call special meetings of stockholders;

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

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

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

                                        19
<PAGE>   22

                           FORWARD-LOOKING STATEMENTS

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

     Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of such statements. We
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.

                      EXECUTIVE OFFICERS OF THE REGISTRANT

     As of June 30, 2001, our executive officers and certain other key employees
were as follows:

<Table>
<Caption>
            NAME               AGE                               POSITION
            ----               ---                               --------
<S>                            <C>   <C>
Gary J. Sbona................  57    Chief Executive Officer and Chairman of the Board
Anthony J. Bettencourt.......  40    President and Director
Stephen W. Young.............  52    Chief Operating Officer
Todd K. Yamami...............  34    Vice President, Chief Financial Officer and Assistant Secretary
Dr. Ashok K. Chandra.........  52    Senior Vice President, Development and New Business Activities
Michael T. Zuckerman.........  45    Vice President, Marketing
Joseph J. Lawless............  47    Vice President, North American and International Sales
Sunil D. Nagdev..............  37    Vice President, Professional Services and Technical Support
Michael D. Mooney............  40    Vice President, Business Development
Dr. Prabhakar Raghavan.......  40    Vice President and Chief Technology Officer
Hugo L. Sluimer..............  48    Vice President, European Operations
</Table>

     GARY J. SBONA has served as our Chief Executive Officer since July 1997, a
director since May 1998 and the Chairman of our Board of Directors since March
1999. Mr. Sbona also served as our President from July 1997 to September 1999.
Mr. Sbona currently serves as Chairman and Chief Executive Officer of Auspex
Systems Inc., a provider of network attached storage solutions, and Accelerated
Networks Inc., a developer of multi service broadband access solutions for
communications service providers. In addition, Mr. Sbona serves as a director of
3D Systems Corporation, a solid imaging and mass customization company, and as a
director of Calico Commerce, Inc., a provider of interactive selling software
for organizations selling complex products or services over the Internet. Since
1974, Mr. Sbona also serves as Chairman and Chief Executive Officer of Regent
Pacific Management Corporation, a professional services firm that is currently
providing our company with management services.

     ANTHONY J. BETTENCOURT joined our company in July 1995 as Vice President of
North American sales. He was subsequently promoted to Vice President of
Worldwide Sales and Marketing and served in this position until his departure in
December 1996. Mr. Bettencourt rejoined our company in September 1997 as Senior
Vice President, Worldwide Sales and Product Marketing and was appointed to the
position of President in September 1999. Prior to initially joining our company,
Mr. Bettencourt served as vice president of sales for Versant Object Technology
from 1992 to June 1995 and as director of U.S. sales for Versant Object
Technology from July 1990 to 1992. From December 1988 to July 1990, Mr.
Bettencourt served as Vice

                                        20
<PAGE>   23

President of Sales for Rockwell CMC. Prior to rejoining us, Mr. Bettencourt
served as an officer of OnLive! Technologies, a private technology company. Mr.
Bettencourt holds a B.A. from Santa Clara University.

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

     TODD K. YAMAMI joined our company as Accounting Manager in June 1995, and
in November 1997 he was promoted to Director, Finance and Accounting. In
February 1999, Mr. Yamami was appointed to the position of Corporate Controller
and was subsequently promoted to Vice President, Corporate Controller and Chief
Accounting Officer in June 2000. In March 2001, Mr. Yamami was appointed to the
position of Vice President, Chief Financial Officer and Assistant Secretary. Mr.
Yamami holds a B.S. in Finance and a M.B.A. from Santa Clara University.

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

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

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

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

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

     DR. PRABHAKAR RAGHAVAN joined our company as Chief Scientist and Vice
President of Emerging Technologies in April 2000. In June 2001, Dr. Raghavan was
elected to serve as our Vice President and Chief Technology Officer. Prior to
Verity, he was the head of the Computer Science Principles department at IBM's
Almaden Research Center, a computer software and hardware research center, since
1995 and was a Research
                                        21
<PAGE>   24

Staff Member from 1986 to 1994 at IBM T.J. Watson Research Center, also a
computer software and hardware research center. Dr. Raghavan is Consulting
Professor of Computer Science at Stanford University and holds an undergraduate
degree in Electrical Engineering from I.I.T. Madras and a Ph.D. in Electrical
Engineering and Computer Science from University of California at Berkeley.

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

ITEM 2. PROPERTIES

     Our principal administrative, sales, marketing and research and development
facilities occupy approximately 60,500 square feet in Sunnyvale, California. Our
operating lease agreement for this facility commenced in June 1996 and expires
in March 2005. In addition, we also lease sales offices in California, Virginia,
New York, Texas, Illinois, Massachusetts, England, Netherlands, France, Germany,
Sweden, Australia, Mexico, Singapore and a development and technical support
office in Canada. Our average annual lease payments, based on the total 96,000
square feet of leased property, are scheduled to be approximately $2.3 million.

ITEM 3. LEGAL PROCEEDINGS

     In December 1999, a number of complaints were filed in the United States
District Court for Northern District of California seeking an unspecified amount
of damages on behalf of an alleged class of persons who purchased shares of our
common stock during the period between December 1 and December 14, 1999. The
complaints name as defendants Verity and certain of its directors and officers,
asserting that they violated federal securities laws by misrepresenting Verity's
business and earnings growth ability to continue to achieve profitable growth,
and failing to disclose certain information about our business. The complaints
were consolidated into a single action, and in August 2000, the complaint was
dismissed without prejudice with leave to amend. The plaintiffs re-filed an
amended complaint, and Verity filed a motion to dismiss this amended complaint
on October 27, 2000. By order dated February 13, 2001, the court granted the
motion in part and denied it in part. The court dismissed with prejudice all
claims except a single claim relating to alleged communications with a
securities analyst near the end of Verity's second fiscal 2000 quarter. On July
24, 2001, council for plaintiffs agreed to voluntarily dismiss the action with
prejudice, and without an award of costs or fees to any party. The court ordered
the case dismissed on July 27, 2001.

     On June 7, 2001, Verity filed a complaint in federal district court in the
Northern District of California, San Jose Division, against BroadVision, Inc.
(Case No. C01-20501-PVT-ADR). BroadVision is a software company that Verity in
the past has licensed to distribute Verity's copyrighted software known as the
Verity Developer Kit ("VDK"). Verity alleges in its complaint that under the
terms of the parties' licenses, BroadVision was authorized to distribute certain
limited portions of VDK as an embedded component of specified software
applications of BroadVision. Verity further alleges that BroadVision has
distributed portions of VDK that it was not authorized to distribute, failed to
prevent end users from accessing unlicensed functions and encouraged end users
to make use of unlicensed functions of VDK. Verity further alleges that it
terminated its license with BroadVision on April 24, 2001 and that BroadVision
no longer has any right to distribute any portion of VDK.

     Based on the foregoing allegations, Verity has asserted claims against
BroadVision for copyright infringement, declaratory relief, unfair competition,
interference with economic advantage, breach of contract, and breach of the
implied covenant of good faith and fair dealing. Verity seeks by its complaint,
among other things, an injunction to prohibit BroadVision from further
distribution of VDK, damages, including statutory damages, according to proof
based on BroadVision's unauthorized distribution of VDK and attorneys' fees.

     BroadVision answered Verity's complaint on June 28, 2001 and denied the
material allegations of the Complaint and asserted affirmative defenses to
Verity's claims. BroadVision also asserted a counterclaim alleging that Verity
had breached the parties' license and the implied covenant of good faith and
fair dealing contained therein (1) by failing to pay BroadVision referral fees
that it claims Verity owes to BroadVision for
                                        22
<PAGE>   25

BroadVision's efforts in securing the sale of Verity Advanced K-2 Search
Modules; and (2) by failing to provide support to BroadVision for VDK after
Verity terminated the parties' license. BroadVision seeks by its complaint,
among other things, damages according to proof, a declaration that BroadVision
has not breached the parties' license and attorneys' fees.

     Verity answered BroadVision's counterclaim on July 23, 2001 and denied the
material allegations of the counterclaim and asserted various affirmative
defenses to BroadVision's claims.

     The action is currently in the early stages and no formal discovery has yet
been conducted. A case management conference has been set for October 9, 2001 at
which time the Court will likely enter a scheduling order and set a trial date.

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

     Not Applicable.

                                        23
<PAGE>   26

                                    PART II

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

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

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

<Table>
<Caption>
                                                              HIGH      LOW
                                                             ------    ------
<S>                                                          <C>       <C>
Fiscal Year ended May 31, 2000
  First Quarter............................................  $54.18    $35.38
  Second Quarter...........................................   59.56     22.63
  Third Quarter............................................   56.38     26.13
  Fourth Quarter...........................................   60.00     24.25
Fiscal Year ended May 31, 2001
  First Quarter............................................  $45.75    $35.50
  Second Quarter...........................................   46.13     14.56
  Third Quarter............................................   31.25     13.94
  Fourth Quarter...........................................   25.21     15.21
</Table>

     As of May 31, 2001, there were approximately 152 holders of record of our
common stock and 35,158,479 shares of our common stock outstanding.

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

                                        24
<PAGE>   27

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

<Table>
<Caption>
                                                            FISCAL YEAR ENDED MAY 31,
                                               ---------------------------------------------------
                                                 1997       1998      1999       2000       2001
                                               --------   --------   -------   --------   --------
                                                      (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                            <C>        <C>        <C>       <C>        <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues:
  Software products..........................  $ 34,934   $ 28,658   $48,327   $ 69,655   $108,705
  Service and other..........................     7,737     10,200    16,098     26,445     36,330
                                               --------   --------   -------   --------   --------
          Total revenues.....................    42,671     38,858    64,425     96,100    145,035
                                               --------   --------   -------   --------   --------
Costs of revenues:
  Software products..........................     2,688      2,426     1,218        880      1,655
  Service and other..........................     3,892      5,178     4,660      8,357     11,821
                                               --------   --------   -------   --------   --------
          Total costs of revenues............     6,580      7,604     5,878      9,237     13,476
                                               --------   --------   -------   --------   --------
Gross profit.................................    36,091     31,254    58,547     86,863    131,559
                                               --------   --------   -------   --------   --------
Operating expenses:
  Research and development...................    14,310     15,544    13,711     16,017     21,639
  Acquisition of in-process research and
     development and other...................    14,894         --        --         --         --
  Marketing and sales........................    21,505     22,757    26,860     38,742     56,637
  General and administrative.................     4,864      7,610     6,323      6,847     10,636
  Restructuring charges......................        --      3,006        --         --         --
                                               --------   --------   -------   --------   --------
          Total operating expenses...........    55,573     48,917    46,894     61,606     88,912
                                               --------   --------   -------   --------   --------
Income/(loss) from operations................   (19,482)   (17,663)   11,653     25,257     42,647
Other income, net............................     1,943      1,553     1,085      5,623     11,343
Interest expense.............................      (212)      (100)       (8)       (20)        (8)
                                               --------   --------   -------   --------   --------
Income/(loss) before provision for income
  taxes......................................   (17,751)   (16,210)   12,730     30,860     53,982
Income tax provision/(benefit)...............       180        300       600     (2,150)    20,222
                                               --------   --------   -------   --------   --------
Net income/(loss)............................  $(17,931)  $(16,510)  $12,130   $ 33,010   $ 33,760
                                               ========   ========   =======   ========   ========
Net income/(loss) per share -- basic.........  $  (0.83)  $  (0.74)  $  0.50   $   1.10   $   1.00
                                               ========   ========   =======   ========   ========
Net income/(loss) per share -- diluted.......  $  (0.83)  $  (0.74)  $  0.44   $   0.95   $   0.92
                                               ========   ========   =======   ========   ========
Number of shares used in per share
  calculation -- basic.......................    21,680     22,450    24,198     30,026     33,634
                                               ========   ========   =======   ========   ========
Number of shares used in per share
  calculation -- diluted.....................    21,680     22,450    27,700     34,886     36,649
                                               ========   ========   =======   ========   ========
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents....................  $  2,934   $  5,505   $ 7,907   $  7,183   $ 12,210
Working capital..............................    18,676     15,912    33,282    134,527    164,093
Total assets.................................    49,443     41,449    65,026    213,378    303,599
Long-term obligations, net of current
  portion....................................       167          2        --         --         --
Stockholders' equity.........................    37,273     24,055    43,419    183,634    264,145
</Table>

     During fiscal 1998, we implemented a worldwide restructuring of our
corporate operations, which resulted in workforce reductions and business
consolidations. In connection with the restructuring, we recorded over $3.0
million in restructuring costs.

     See Note 2 of Notes to Consolidated Financial Statements beginning on page
40 of this Annual Report on Form 10-K for an explanation of the method used to
determine the number of shares used to compute per share amounts.

                                        25
<PAGE>   28

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

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

OVERVIEW

     From 1988 to 1994, we derived substantially all of our revenues from the
license of custom search and retrieval applications and consulting and other
services related to such applications. In 1995, we began refining and enhancing
our core technology to add functionality and facilitate incorporation of our
technology in a variety of markets. We now offer solutions and technology that
address the business portal market. The business portal market includes
corporate portals used for sharing information within an enterprise, e-commerce
portals for online selling and market exchange portals for business-to-business
activities. Business portals provide personalized information to employees,
partners, customers and suppliers. We expect that for the foreseeable future we
will continue to derive the largest portion of our revenues from licensing our
technology for enterprise applications and business portal solutions.

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

     Our restructuring and renewed focus, during fiscal 1998, contributed to
significantly improved results during the second half of fiscal 1998 and during
fiscal years 1999, 2000 and 2001. During the quarterly periods ended August 31,
1997 to August 31, 1999 and February 29, 2000 to May 31, 2001, we experienced
increased revenues on a quarterly basis. In addition, during the thirteen
consecutive quarterly periods ended May 31, 2001, we experienced twelve quarters
of record revenues. Due to a delay in closing three large transactions, revenues
for the quarter ended November 30, 1999 were lower than expected. In fiscal
years 1999, 2000 and 2001, we achieved net income of $12.1 million, $33.0
million and $33.8 million, respectively. While our goal is to increase revenue
and generate net income in future periods, we cannot assure you that our
strategy will be successful, that we will experience the rate of revenue growth
we experienced from August 31, 1997 to May 31, 2001 in future periods, or that
we will continue to maintain positive cash flow or profitability.

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

     For agreements with multiple elements, such as license, maintenance,
training and consulting services, we allocate revenue to all undelivered
elements usually maintenance and other services, based on objective
                                        26
<PAGE>   29

evidence of its fair value, which is specific to us. Any remaining amount is
allocated to the delivered elements and recognized as revenue when the
conditions set forth above are met. We recognize revenue allocated to
maintenance fees for ongoing customer support and product updates ratably over
the period of the maintenance contract, which is typically twelve months.
Payments for maintenance fees are generally made in advance and are
non-refundable. For revenue allocated to training and consulting services, we
recognize revenue as the related services are performed.

RESULTS OF OPERATIONS

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

<Table>
<Caption>
                                                      FISCAL YEAR ENDED MAY 31,
                                                      --------------------------
                                                       1999      2000      2001
                                                      ------    ------    ------
<S>                                                   <C>       <C>       <C>
Revenues:
  Software products.................................   75.0%     72.5%     75.0%
  Service and other.................................   25.0      27.5      25.0
                                                      -----     -----     -----
          Total revenues............................  100.0     100.0     100.0
                                                      -----     -----     -----
Costs of revenues:
  Software products.................................    1.9       0.9       1.1
  Service and other.................................    7.2       8.7       8.2
                                                      -----     -----     -----
          Total costs of revenues...................    9.1       9.6       9.3
                                                      -----     -----     -----
Gross margin........................................   90.9      90.4      90.7
                                                      -----     -----     -----
Operating expenses:
  Research and development..........................   21.3      16.7      14.9
  Marketing and sales...............................   41.7      40.3      39.1
  General and administrative........................    9.8       7.1       7.3
                                                      -----     -----     -----
          Total operating expenses..................   72.8      64.1      61.3
                                                      -----     -----     -----
Income from operations..............................   18.1      26.3      29.4
Other income, net...................................    1.7       5.8       7.8
                                                      -----     -----     -----
Income before provision for income taxes............   19.8      32.1      37.2
Income tax provision/(benefit)......................    1.0      (2.2)     13.9
                                                      -----     -----     -----
Net income..........................................   18.8%     34.3%     23.3%
                                                      =====     =====     =====
</Table>

YEARS ENDED MAY 31, 1999, 2000 AND 2001

  Revenues

     Our total revenues increased 49.2% from $64.4 million in fiscal 1999 to
$96.1 million in fiscal 2000 and increased 50.9% to $145.0 million in fiscal
2001. The increase from fiscal years 1999 to 2000 was due primarily to higher
revenues from licensing Topic tools and enterprise products. The increase from
fiscal years 2000 to 2001 was due primarily to increased revenues from our
business portal solutions and our enterprise application businesses and, to a
lesser extent, an increase in maintenance and consulting revenues. Software
product revenues decreased as a percentage of total revenues from 75.0% in
fiscal 1999 to 72.5% in fiscal 2000 and increased to 75.0% in fiscal 2001.
Service and other revenues increased as a percentage of total revenues from
25.0% in fiscal 1999 to 27.5% in fiscal 2000 and decreased to 25.0% in fiscal
2001.

     Software products revenues. Our software products revenues increased 44.1%
from $48.3 million in fiscal 1999 to $69.7 million in fiscal 2000 and increased
56.1% to $108.7 million in fiscal 2001. The increase from fiscal 1999 to fiscal
2000 was due primarily to higher revenues from licensing Topic tools and
enterprise products. The increase from fiscal 2000 to fiscal 2001 was due
principally to revenues from our business portal solutions and our enterprise
applications businesses.

                                        27
<PAGE>   30

     Service and other revenues. Our service and other revenues consist
primarily of fees for software maintenance, consulting and training. Service and
other revenues increased 64.3% from $16.1 million in fiscal 1999 to $26.4
million in fiscal 2000 and increased 37.4% to $36.3 million in fiscal 2001. The
increase in service revenues during fiscal years 1999, 2000 and 2001 was due
primarily to an increase in maintenance and consulting revenues. Consulting and
maintenance revenues increased between the comparable years primarily due to a
growth in customer base.

     Revenues derived from foreign operations accounted for 6.4%, 6.8% and 6.3%
of total revenues, respectively, in fiscal 1999, 2000 and 2001. Our export sales
consist primarily of products licensed for delivery outside of the United
States. In fiscal years 1999, 2000 and 2001, export sales accounted for 27.1%,
19.0% and 26.0% of total revenues, respectively.

     No single customer accounted for 10% or more of our revenues during fiscal
years 1999, 2000 or 2001. Revenues derived from sales to the federal government
and its agencies were 8.1%, 7.8% and 7.4% of total revenues in fiscal years
1999, 2000 and 2001, respectively. Sales to government agencies declined as a
percentage of revenues from fiscal 1999 to fiscal 2001, and may continue to
decline in the future.

  Costs of Revenues

     Costs of software products. The cost of our software products consist
primarily of product media, duplication, manuals, packaging materials, shipping
expenses and royalties, and in certain instances, licensing of third-party
software incorporated in our products. Costs of our software products decreased
27.8% from $1.2 million in fiscal 1999 to $880,000 in fiscal 2000 and increased
88.1% to $1.7 million in fiscal 2001, representing 2.5%, 1.3% and 1.5%,
respectively, of software product revenues. The decrease in absolute dollars
from fiscal 1999 through fiscal 2000 was principally related to decreasing costs
of third party software components in fiscal 2000. The decrease as a percentage
of software product revenue was due primarily to increased software product
revenue. The increase in costs and as a percentage of software revenues from
fiscal 2000 to fiscal 2001 was primarily attributable to increasing costs of
third party software components and costs associated with the introduction of
our Portal One and K2 Catalog products. In fiscal 1999, fiscal 2000 and fiscal
2001, we did not capitalize any software development costs since such costs were
not material.

     Costs of service and other. Our costs of service and other consists of
costs incurred in providing consulting services, customer training, telephone
support and product upgrades to customers. Costs of service and other increased
79.3% from $4.7 million in fiscal 1999 to $8.4 million in fiscal 2000 and
increased 41.5% to $11.8 million in fiscal 2001. As a percentage of service and
other revenue, these costs represented 29.0%, 31.6% and 32.5% in fiscal years
1999, 2000 and 2001, respectively. The increase in costs of service and other
and as a percentage of service and other revenue from fiscal 1999 through fiscal
2001 was primarily related to an increase in the staffing of our technical
support and professional services organizations, and to a lesser extent, an
increase in training services.

  Operating Expenses

     Research and development. Research and development expenses increased 16.8%
from $13.7 million in fiscal 1999 to $16.0 million in fiscal 2000 and increased
35.1% to $21.6 million in fiscal 2001, representing 21.3%, 16.7% and 14.9% of
total revenues, respectively. The increase in absolute dollars from fiscal 1999
through fiscal 2001 was primarily due to a significant increase in research and
development personnel and outside consulting services to focus on enhancement of
existing products and development of new products addressing the business portal
market. The decrease in costs as a percentage of revenues during the comparison
years was principally related to the increased revenues. We believe that
research and development expenses will continue to increase in the future
primarily due to the introduction of new products and other anticipated product
development efforts. Our future research and development expenses may vary as a
percentage of total revenues.

     Marketing and sales. Our marketing and sales expenses consist primarily of
salaries and commissions of sales and marketing personnel, advertising and
promotion expenses, trade shows, pre-sales customer service and support costs.
Marketing and sales expenses increased 44.2% from $26.9 million in fiscal 1999
to
                                        28
<PAGE>   31

$38.7 million in fiscal 2000 and increased 46.2% to $56.6 million in fiscal
2001, representing 41.7%, 40.3% and 39.1% of total revenues, respectively. These
increases in absolute dollars were primarily related to the continuous expansion
of our marketing and sales organizations, continued development of our sales
distribution channels in the United States and Europe, and outbound marketing
activities associated with the branding and advertising of our company. The
decrease in costs as a percentage of total revenues during these comparable
years was primarily due to the increased revenues. We anticipate that we will
continue to make significant investments in marketing and sales.

     General and administrative. General and administrative expenses increased
8.3% from $6.3 million in fiscal 1999 to $6.8 million in fiscal 2000 and
increased 55.3% to $10.6 million in fiscal 2001, representing 9.8%, 7.1% and
7.3% of total revenues, respectively. The increase in absolute dollars from
fiscal 1999 to fiscal 2001 was primarily due to increases in professional
service fees required to support our continued growth, and increased allowances
for doubtful accounts associated with higher revenues. The decrease in costs as
a percentage of total revenues from fiscal 1999 to fiscal 2000 was principally
due to an increase in total revenues. The increase in costs as a percentage of
total revenues from fiscal 2000 to fiscal 2001 was generally related to the
increased costs in professional services rendered for various tax studies.

INCOME TAXES

     Income tax expense includes U.S. and international income taxes, as well as
the provision for U.S. taxes on undistributed earnings of international
subsidiaries. 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.

     Prior to the quarter ended May 31, 2000, we established a valuation
allowance against our deferred tax assets due to the uncertainty surrounding the
realization of such assets. On a quarterly basis, we review the recoverability
of the deferred tax assets. At May 31, 1999, we had a valuation allowance
totaling $18.9 million against our deferred tax assets. On a regular basis we
assess the realizability of net deferred tax assets and at May 31, 2000, we
assessed that the realizability of the deferred tax assets was more likely than
not and the entire valuation allowance was reversed.

     During the year ended May 31, 2001, we assessed the qualification of our
research and development expenses for state and federal research and development
tax credits. We expected the tax savings for fiscal 2001 due to research and
development tax credits would result in a significantly lower effective tax
rate, and accordingly, applied an effective tax rate of 37.5% to the result of
our year ended May 31, 2001. We are currently assessing the impact of our
research and development expenses on our effective tax rate in future periods.

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, 2001. 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 -- Risk Factors."

                                        29
<PAGE>   32

<Table>
<Caption>
                                                                                 QUARTER ENDED
                                              -----------------------------------------------------------------------------------
                                              AUG. 31,   NOV. 30,   FEB. 29,   MAY 31,   AUG. 31,   NOV. 30,   FEB. 28,   MAY 31,
                                                1999       1999       2000      2000       2000       2000       2001      2001
                                              --------   --------   --------   -------   --------   --------   --------   -------
                                                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                           <C>        <C>        <C>        <C>       <C>        <C>        <C>        <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues:
  Software products.........................  $14,474    $10,093    $22,514    $22,574   $22,798    $25,558    $28,722    $31,627
  Service and other.........................    5,291      6,624      6,706      7,824     8,492      8,962      9,293      9,583
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total revenues......................   19,765     16,717     29,220     30,398    31,290     34,520     38,015     41,210
                                              -------    -------    -------    -------   -------    -------    -------    -------
Costs of revenues:
  Software products.........................      144        173        254        309       347        385        378        545
  Service and other.........................    1,620      2,290      2,050      2,397     2,558      2,978      3,074      3,211
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total costs of revenues.............    1,764      2,463      2,304      2,706     2,905      3,363      3,452      3,756
                                              -------    -------    -------    -------   -------    -------    -------    -------
Gross profit................................   18,001     14,254     26,916     27,692    28,385     31,157     34,563     37,454
                                              -------    -------    -------    -------   -------    -------    -------    -------
Operating expenses:
  Research and development..................    3,726      3,736      4,018      4,537     4,585      4,827      5,849      6,378
  Marketing and sales.......................    8,064      8,718     10,589     11,371    12,024     13,800     14,733     16,080
  General and administrative................    1,580      1,600      1,779      1,888     2,170      2,530      2,949      2,987
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total operating expenses............   13,370     14,054     16,386     17,796    18,779     21,157     23,531     25,445
                                              -------    -------    -------    -------   -------    -------    -------    -------
Income from operations......................    4,631        200     10,530      9,896     9,606     10,000     11,032     12,009
Other income, net...........................      629      1,490      1,800      1,684     2,271      2,834      3,417      2,813
                                              -------    -------    -------    -------   -------    -------    -------    -------
Income before provision for income taxes....    5,260      1,690     12,330     11,580    11,877     12,834     14,449     14,822
Income tax provision/(benefit)..............      150        150        150     (2,600)    4,632      4,684      5,274      5,632
                                              -------    -------    -------    -------   -------    -------    -------    -------
Net income..................................  $ 5,110    $ 1,540    $12,180    $14,180   $ 7,245    $ 8,150    $ 9,175    $ 9,190
                                              =======    =======    =======    =======   =======    =======    =======    =======
Net income per share -- basic...............  $  0.19    $  0.05    $  0.39    $  0.45   $  0.22    $  0.24    $  0.27    $  0.26
                                              =======    =======    =======    =======   =======    =======    =======    =======
Net income per share -- diluted.............  $  0.16    $  0.04    $  0.34    $  0.39   $  0.20    $  0.23    $  0.25    $  0.25
                                              =======    =======    =======    =======   =======    =======    =======    =======
Number of shares used in per share
  calculation -- basic......................   26,972     30,514     31,159     31,460    32,369     33,449     33,948     34,769
                                              =======    =======    =======    =======   =======    =======    =======    =======
Number of shares used in per share
  calculation -- diluted....................   31,612     35,357     36,306     36,269    36,916     35,846     37,000     36,833
                                              =======    =======    =======    =======   =======    =======    =======    =======
</Table>

<Table>
<Caption>
                                                                       AS A PERCENTAGE OF TOTAL REVENUES
                                              -----------------------------------------------------------------------------------
<S>                                           <C>        <C>        <C>        <C>       <C>        <C>        <C>        <C>
Revenues:
  Software products.........................     73.2%      60.4%      77.0%      74.3%     72.9%      74.0%      75.6%      76.7%
  Service and other.........................     26.8       39.6       23.0       25.7      27.1       26.0       24.4       23.3
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total revenues......................    100.0      100.0      100.0      100.0     100.0      100.0      100.0      100.0
                                              -------    -------    -------    -------   -------    -------    -------    -------
Costs of revenues:
  Software products.........................      0.7        1.0        0.9        1.0       1.1        1.1        1.0        1.3
  Service and other.........................      8.2       13.7        7.0        7.9       8.2        8.6        8.1        7.8
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total costs of revenues.............      8.9       14.7        7.9        8.9       9.3        9.7        9.1        9.1
                                              -------    -------    -------    -------   -------    -------    -------    -------
Gross profit................................     91.1       85.3       92.1       91.1      90.7       90.3       90.9       90.9
                                              -------    -------    -------    -------   -------    -------    -------    -------
Operating expenses:
  Research and development..................     18.9       22.3       13.8       14.9      14.7       14.0       15.4       15.5
  Marketing and sales.......................     40.8       52.2       36.2       37.4      38.4       40.0       38.8       39.0
  General and administrative................      8.0        9.6        6.1        6.2       6.9        7.3        7.7        7.2
                                              -------    -------    -------    -------   -------    -------    -------    -------
        Total operating expenses............     67.7       84.1       56.1       58.5      60.0       61.3       61.9       61.7
                                              -------    -------    -------    -------   -------    -------    -------    -------
Income from operations......................     23.4        1.2       36.0       32.6      30.7       29.0       29.0       29.2
Other income, net...........................      3.2        8.9        6.2        5.5       7.3        8.2        9.0        6.8
                                              -------    -------    -------    -------   -------    -------    -------    -------
Income before provision for income taxes....     26.6       10.1       42.2       38.1      38.0       37.2       38.0       36.0
Income tax provision/(benefit)..............      0.7        0.9        0.5       (8.5)     14.8       13.6       13.9       13.7
                                              -------    -------    -------    -------   -------    -------    -------    -------
Net income..................................     25.9%       9.2%      41.7%      46.6%     23.2%      23.6%      24.1%      22.3%
                                              =======    =======    =======    =======   =======    =======    =======    =======
</Table>

                                        30
<PAGE>   33

LIQUIDITY AND CAPITAL RESOURCES

     As of May 31, 2001, we had $231.1 million in cash and cash equivalents and
available-for-sale securities compared to $154.3 million at May 31, 2000.

     Our operating activities provided cash of $14.9 million, $8.2 million and
$47.7 million in fiscal 1999, 2000 and 2001, respectively. Cash provided by
operations in fiscal 1999 was primarily due from our net income, an increase in
accrued compensation and other accrued liabilities and depreciation and
amortization expense partially offset by an increase in accounts receivable.
Cash provided in connection with operating activities in fiscal 2000 was
principally due from our net income, depreciation and amortization expense, an
increase in deferred revenue and accrued compensation and other accrued
liabilities, offset mainly by an increase in accounts receivable and the release
of the deferred tax assets. Cash provided by operating activities in fiscal 2001
was generally due from our net income, depreciation and amortization expense, an
increase in deferred taxes, deferred revenue and accrued compensation and other
liabilities, partially offset by an increase in accounts receivable and prepaid
and other current assets.

     Cash used in investing activities in fiscal 1999, 2000 and 2001 was $19.6
million, $116.5 million and $76.9 million, respectively, consisting primarily of
the purchase of marketable securities partially offset by the sale and maturity
of marketable securities.

     Cash provided by financing activities was $7.1 million, $107.6 million and
$34.2 million in fiscal 1999, 2000 and 2001, respectively. In fiscal 1999, such
financing activities consisted primarily of the sale of common stock to
employees through our employee stock purchase plan and proceeds from the
exercise of stock options. Financing activities in fiscal 2000 consisted
principally of net proceeds of $71.0 million from a public offering of our
common stock, the exercise of stock options and the sale of common stock to
employees through our employee stock purchase plan. Cash provided by financing
activities for fiscal 2001 was primarily due to the exercise of stock options
and the sale of common stock to employees through our employee stock purchase
plan.

     At May 31, 2001, our principal sources of liquidity were our cash and cash
equivalents and short-term investments of $138.9 million. As of May 31, 2001, we
had no outstanding debt obligations.

     Capital expenditures, including capital leases, were approximately
$577,000, $1.9 million, and $6.2 million in fiscal 1999, 2000 and 2001,
respectively. In fiscal 1999, these expenditures consisted principally of
purchases of property and equipment, primarily for computer hardware and
software. In fiscal 2000, the increase was due principally to the purchases of
property and equipment, primarily for computer hardware and software as a result
of our increase in headcount during the fiscal year. The increase in capital
expenditures in fiscal 2001 was primarily due to the purchases of property and
equipment, particularly computer hardware and software. Under our operating
leases, we have minimum rental payments of approximately $2.3 million for each
of our fiscal years through fiscal 2006. See Note 5 of Notes to our Consolidated
Financial Statements.

     We believe that our current cash and cash equivalents and our future cash
provided by operations, if any, will provide adequate liquidity to meet our
capital and operating requirements for at least the next twelve months.
Thereafter, or if our spending plans change, we may find it necessary to seek to
obtain additional sources of financing to support our capital needs, but we
cannot assure you that such financing will be available on commercially
reasonable terms, or at all.

RECENT PRONOUNCEMENTS

     SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as
amended by SFAS 137, Accounting for Derivative Instruments and Hedging
Activities -- Deferral of the Effective Date of FASB Statement No. 133, and SFAS
138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities, is effective for us as of June 1, 2001. SFAS 133 requires that an
entity recognize all derivatives as either assets or liabilities measured at
fair value. The accounting for changes in the fair value of a derivative depends
on the use of the derivative. We believe the adoption of this statement will not
have a material impact on our statement of operations.

                                        31
<PAGE>   34

IMPACT OF EUROPEAN MONETARY CONVERSION

     We are aware of the issues associated with the changes in Europe resulting
from the formation of a European economic and monetary union ("EMU"). One change
resulting from this union required EMU member states to irrevocably fix their
respective currencies to a new currency, the euro, as of January 1, 1999, at
which date the euro became a functional legal currency of these countries.
Through January 1, 2002, business in the EMU member states will be conducted in
both the existing national currencies, such as the French franc or the Deutsche
mark, and the euro. As a result, companies operating or conducting business in
EMU member states will need to ensure that their financial and other software
systems are capable of processing transactions and properly handling these
currencies, including the euro. The adoption of the euro by EMU member states
has had no material impact on our operations or financial results.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Interest Rate Risk. The primary objective of our investment activities is
to preserve the principal while at the same time maximizing yields without
significantly increasing risk. To achieve this objective, we maintain our
portfolio of cash equivalents and investments in a variety of securities,
including both government and corporate obligations and money market funds. As
of May 31, 2001, approximately 58% of our total portfolio matures in one year or
less, with the remainder maturing in less than three years. We do not use
derivative financial instruments in our investment portfolio. We place our
investments with high credit quality issuers and, by policy, limit the amount of
credit exposure to any one issuer.

     The following table presents the amounts of our cash equivalents and
investments that are subject to interest rate risk by year of expected maturity
and average interest rates as of May 31, 2001:

<Table>
<Caption>
                                         FY2002     FY2003     FY2004      TOTAL      FAIR VALUE
                                        --------    -------    -------    --------    ----------
                                                             (IN THOUSANDS)
<S>                                     <C>         <C>        <C>        <C>         <C>
Cash equivalents......................  $ 12,210         --         --    $ 12,210     $ 12,210
Average interest rate.................       3.3%
Short-term investments................  $126,688         --         --    $126,688     $126,688
Average interest rate.................       5.5%
Long-term investments.................        --    $66,940    $25,308    $ 92,248     $ 92,248
Average interest rates................                  5.1%       5.7%
</Table>

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

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     Our Consolidated Financial Statements and Notes thereto, and related
Financial Schedule, appear on pages 36 to 55 of this Annual Report on Form 10-K
and are incorporated by reference herein. Supplementary financial information
for the eight quarters ended May 31, 2001 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
herein.

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

     Not applicable.

                                        32
<PAGE>   35

                                    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 2001 annual meeting of stockholders to be
filed with the Commission pursuant to Regulation 14A not later than 120 days
after the end of the fiscal year covered by this Form (the "Proxy Statement")
under the captions "PROPOSAL 1, ELECTION OF DIRECTORS" and "SECTION 16(A)
BENEFICIAL OWNERSHIP REPORTING COMPLIANCE."

ITEM 11. EXECUTIVE COMPENSATION

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

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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

                                        33
<PAGE>   36

                                    PART IV

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

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

<Table>
<Caption>
                                                                       PAGE
                                                                      NUMBER
                                                                      ------
    <S> <C>                                                           <C>
    1.  Financial Statements:
        Report of Independent Accountants...........................    35
        Consolidated Balance Sheets -- As of May 31, 2001 and
          2000......................................................    36
        Consolidated Statements of Operations -- For the Years Ended
          May 31, 2001, 2000 and 1999...............................    37
        Consolidated Statements of Changes in Stockholders'
          Equity -- For the Years Ended May 31, 2001, 2000 and
          1999......................................................    38
        Consolidated Statements of Cash Flows -- For the Years Ended
          May 31, 2001, 2000 and 1999...............................    39
        Notes to Consolidated Financial Statements..................    40
    2.  Financial Statement Schedules -- For the Years Ended May 31,
          1999, 2000 and 2001:
        Schedule II -- Valuation and Qualifying Accounts............    55
        All other schedules are omitted because they are not
          applicable or the required information is shown in the
          consolidated financial statements or notes thereto
    3.  Exhibits: See Index to Exhibits on page 57. The Exhibits
          listed in the accompanying Index to Exhibits are filed or
          incorporated by reference as part of this report
</Table>

(b) Reports on Form 8-K:

     None.

                                        34
<PAGE>   37

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
Verity, Inc.

     In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 34 present fairly, in all material
respects, the financial position of Verity, Inc. and its subsidiaries at May 31,
2001 and 2000, and the results of their operations and their cash flows for each
of the three years in the period ended May 31, 2001, in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 14(a)(2) on page 34 presents fairly, in all material
respects, the information set forth herein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with 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.

PricewaterhouseCoopers LLP

San Jose, California
June 15, 2001

                                        35
<PAGE>   38

                                  VERITY, INC.

                          CONSOLIDATED BALANCE SHEETS
                (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

                                     ASSETS

<Table>
<Caption>
                                                                    MAY 31,
                                                              --------------------
                                                                2001        2000
                                                              --------    --------
<S>                                                           <C>         <C>
Current assets:
  Cash and cash equivalents.................................  $ 12,210    $  7,183
  Short-term investments....................................   126,687     109,472
  Trade accounts receivable, net............................    37,741      23,418
  Deferred tax assets.......................................    20,121      20,210
  Prepaid and other current assets..........................     6,788       3,988
                                                              --------    --------
     Total current assets...................................   203,547     164,271
Equipment and leasehold improvements, net...................     7,804       4,773
Long-term investments.......................................    92,248      37,616
Deferred tax assets.........................................        --       6,562
Other assets................................................        --         156
                                                              --------    --------
          Total assets......................................  $303,599    $213,378
                                                              ========    ========

                       LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................  $  6,790    $  6,488
  Accrued compensation......................................    11,799       9,327
  Other accrued liabilities.................................     3,793       1,198
  Deferred revenue..........................................    17,073      12,731
                                                              --------    --------
     Total liabilities......................................    39,455      29,744
                                                              --------    --------
Commitments and contingencies (Note 5)
Stockholders' equity:
Preferred stock, $.001 par value:
  Authorized: 2,000,000 shares in 2001 and 2000
  Issued and outstanding: none
Common stock, $.001 par value:
  Authorized: 200,000,000 shares in 2001 and 100,000,000
     shares in 2000
  Issued and outstanding: 35,158,000 shares in 2001 and
     31,606,000 shares in 2000..............................        35          31
Additional paid-in capital..................................   252,733     207,040
Other comprehensive income (loss)...........................       652        (401)
Retained earnings/(accumulated deficit).....................    10,724     (23,036)
                                                              --------    --------
     Total stockholders' equity.............................   264,144     183,634
                                                              --------    --------
          Total liabilities and stockholders' equity........  $303,599    $213,378
                                                              ========    ========
</Table>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                        36
<PAGE>   39

                                  VERITY, INC.

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

<Table>
<Caption>
                                                                    YEAR ENDED MAY 31,
                                                              ------------------------------
                                                                2001       2000       1999
                                                              --------    -------    -------
<S>                                                           <C>         <C>        <C>
REVENUES:
  Software products.........................................  $108,705    $69,655    $48,327
  Service and other.........................................    36,330     26,445     16,098
                                                              --------    -------    -------
     Total revenues.........................................   145,035     96,100     64,425
                                                              --------    -------    -------
COSTS OF REVENUES:
  Software products.........................................     1,655        880      1,218
  Service and other.........................................    11,821      8,357      4,660
                                                              --------    -------    -------
     Total costs of revenues................................    13,476      9,237      5,878
                                                              --------    -------    -------
Gross profit................................................   131,559     86,863     58,547
                                                              --------    -------    -------
OPERATING EXPENSES:
  Research and development..................................    21,639     16,017     13,711
  Marketing and sales.......................................    56,637     38,742     26,860
  General and administrative................................    10,636      6,847      6,323
                                                              --------    -------    -------
     Total operating expenses...............................    88,912     61,606     46,894
                                                              --------    -------    -------
Income from operations......................................    42,647     25,257     11,653
Other income, net...........................................    11,343      5,623      1,085
Interest expense............................................        (8)       (20)        (8)
                                                              --------    -------    -------
Income before provision for income taxes....................    53,982     30,860     12,730
Income tax provision/(benefit)..............................    20,222     (2,150)       600
                                                              --------    -------    -------
Net income..................................................  $ 33,760    $33,010    $12,130
                                                              ========    =======    =======
Net income per share -- basic...............................  $   1.00    $  1.10    $  0.50
                                                              ========    =======    =======
Net income per share -- diluted.............................  $   0.92    $  0.95    $  0.44
                                                              ========    =======    =======
Number of shares used in per share calculation -- basic.....    33,634     30,026     24,198
                                                              ========    =======    =======
Number of shares used in per share calculation -- diluted...    36,649     34,886     27,700
                                                              ========    =======    =======
</Table>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                        37
<PAGE>   40

                                  VERITY, INC.

           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                FOR THE YEARS ENDED MAY 31, 2001, 2000 AND 1999
                                 (IN THOUSANDS)

<Table>
<Caption>
                                                                                        OTHER         RETAINED
                                                      COMMON STOCK     ADDITIONAL   COMPREHENSIVE     EARNINGS         TOTAL
                                                     ---------------    PAID-IN        INCOME       (ACCUMULATED   STOCKHOLDERS'
                                                     SHARES   AMOUNT    CAPITAL        (LOSS)         DEFICIT)        EQUITY
                                                     ------   ------   ----------   -------------   ------------   -------------
<S>                                                  <C>      <C>      <C>          <C>             <C>            <C>
Balances, May 31, 1998.............................  23,130    $ 24     $ 92,200       $    7         $(68,176)      $ 24,055
Issuance of common stock:
  Upon exercise of stock options...................   1,806       2        5,338           --               --          5,340
  Under employee stock purchase plan...............     676      --        1,820           --               --          1,820
Stock compensation.................................      --      --           54           --               --             54
Unrealized gain on investments.....................      --      --           --           20               --             20
Net income.........................................      --      --           --           --           12,130         12,130
                                                     ------    ----     --------       ------         --------       --------
Balances, May 31, 1999.............................  25,612      26       99,412           27          (56,046)        43,419
Issuance of common stock:
  Upon exercise of stock options...................   2,293       2       10,577           --               --         10,579
  Under employee stock purchase plan...............     402      --        3,074           --               --          3,074
  Secondary offering...............................   3,279       3       69,309           --               --         69,312
Deferred tax benefit from disqualified
  dispositions.....................................      20      --       24,668           --               --         24,668
Unrealized loss on investments.....................      --      --           --         (428)              --           (428)
Net income.........................................      --      --           --           --           33,010         33,010
                                                     ------    ----     --------       ------         --------       --------
Balances, May 31, 2000.............................  31,606      31      207,040         (401)         (23,036)       183,634
Issuance of common stock:
  Upon exercise of stock options...................   3,393       4       30,364           --               --         30,368
  Under employee stock purchase plan...............     159      --        3,733           --               --          3,733
  Secondary offering...............................      --      --           20           --               --             20
Deferred tax benefit from disqualified
  dispositions.....................................      --      --       11,576           --               --         11,576
Unrealized gain on investments.....................      --      --           --        1,053               --          1,053
Net income.........................................      --      --           --           --           33,760         33,760
                                                     ------    ----     --------       ------         --------       --------
Balances, May 31, 2001.............................  35,158    $ 35     $252,733       $  652         $ 10,724       $264,144
                                                     ======    ====     ========       ======         ========       ========
</Table>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                        38
<PAGE>   41

                                  VERITY, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<Table>
<Caption>
                                                                     YEAR ENDED MAY 31,
                                                              --------------------------------
                                                                2001        2000        1999
                                                              ---------   ---------   --------
<S>                                                           <C>         <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income................................................  $  33,760   $  33,010   $ 12,130
  Adjustments to reconcile net income to net cash provided
     by operating activities:
     Depreciation and amortization..........................      3,185       2,797      2,646
     Noncash restructuring charges..........................         --        (229)      (514)
     Provision for doubtful accounts........................      1,163         621        639
     Deferred income taxes..................................     19,336     (26,772)        --
     Amortization of discount on securities.................     (1,030)       (286)      (963)
     Changes in operating assets and liabilities:
       Trade accounts receivable............................    (15,966)     (7,062)    (3,026)
       Prepaid and other current assets.....................     (2,887)     (2,565)       345
       Accounts payable.....................................        381       2,757         40
       Accrued compensation and other accrued liabilities...      5,438       2,383      3,243
       Deferred revenue.....................................      4,350       3,556        327
                                                              ---------   ---------   --------
          Net cash provided by operating activities.........     47,730       8,210     14,867
                                                              ---------   ---------   --------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Acquisition of equipment and leasehold improvements.......     (6,184)     (1,873)      (577)
  Purchases of investments..................................   (640,872)   (465,554)   (99,664)
  Maturity of investments...................................    323,692     219,531     52,775
  Proceeds from sale of investments.........................    246,438     131,408     27,852
                                                              ---------   ---------   --------
          Net cash used in investing activities.............    (76,926)   (116,488)   (19,614)
                                                              ---------   ---------   --------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from the sale of common stock net of issuance
     costs..................................................     34,155     107,633      7,214
  Principal payments on notes payable and capital lease
     obligations............................................         --          --       (151)
                                                              ---------   ---------   --------
          Net cash provided by financing activities.........     34,155     107,633      7,063
                                                              ---------   ---------   --------
Effect of exchange rate changes on cash.....................         68         (79)        86
                                                              ---------   ---------   --------
Net increase (decrease) in cash and cash equivalents........      5,027        (724)     2,402
Cash and cash equivalents, beginning of period..............      7,183       7,907      5,505
                                                              ---------   ---------   --------
Cash and cash equivalents, end of period....................  $  12,210   $   7,183   $  7,907
                                                              =========   =========   ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid during the period for interest..................  $       4   $      20   $      8
  Cash paid during the period for income taxes..............  $     286   $     237   $     82
</Table>

  The accompanying notes are an integral part of these consolidated financial
                                  statements.
                                        39
<PAGE>   42

                                  VERITY, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 1. NATURE OF OPERATIONS

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

 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

  Basis of consolidation

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

  Stock split

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

  Accounting estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Examples include provisions for returns, concessions and bad debts, and
the length of product life cycles. Actual results could differ from those
estimates.

  Cash and cash equivalents

     Cash and cash equivalents consist of highly liquid investments with an
original or remaining maturity of 90 days or less as of the date of purchase.

  Investments

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

  Equipment and leasehold improvements

     Equipment and leasehold improvements are stated at cost less accumulated
depreciation and amortization. Equipment is depreciated on a straight-line basis
over the estimated useful lives of the related assets;

                                        40
<PAGE>   43
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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

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

  Intangible assets

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

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

  Research and development costs

     Costs related to research, design and development of products are charged
to research and development expense as incurred. Software development costs are
capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release to
customers. Such costs are amortized using the greater of the amount computed
using the ratio that current gross revenues for a product bear to the total of
current and anticipated future gross revenues for that product, or on a straight
line basis over 12 to 18 months. The Company regularly evaluates estimated net
realizable value of costs and records write-downs for any product for which the
net book value is in excess of discounted cashflows. In fiscal 1999, 2000 and
2001, the Company did not capitalize any software development costs since such
costs were not significant.

  Revenue recognition

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

     The Company recognizes revenues in accordance with the provisions of
American Institute of Certified Public Accountants Statement of Position No.
97-2, "Software Revenue Recognition," as amended. The Company records revenue
from licensing of software products when evidence of an arrangement exists, the
fee is fixed and determinable, collection is probable and delivery of the
product has occurred. For agreements, which include multiple elements, such as
license, maintenance, training and consulting services, the Company allocates
revenue to all undelivered elements, usually maintenance and other services,
based on objective

                                        41
<PAGE>   44
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

evidence of its fair value, which is specific to the Company. Any remaining
amount is allocated to the delivered elements and recognized as revenue when the
conditions set forth above are met. The Company recognizes revenue allocated to
maintenance fees for ongoing customer support and product updates ratably over
the period of the maintenance contract, which is typically twelve months.
Payments for maintenance fees are generally made in advance and are
non-refundable. For revenue allocated to training and consulting services, the
Company recognizes revenue as the related services are performed. The Company
recognizes product revenue from royalty payments upon receipt of quarterly
royalty reports from OEMs related to their product sales for the previous
quarter.

  Income taxes

     Income tax expense includes U.S. and international income taxes, as well as
the provision for U.S. taxes on undistributed earnings of international
subsidiaries. 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.

     Verity recognizes deferred taxes under the asset and liability method of
accounting for income taxes. Under the asset and liability method, deferred
income taxes are recognized for differences between the financial statement and
tax basis of assets and liabilities at enacted statutory tax rates in effect for
the years in which the differences are expected to reverse. The effect on
deferred taxes of a change in tax rate is recognized in income in the period
that includes the enactment date. Valuation allowances are established when
necessary to reduce deferred tax assets to the amounts expected to be realized.

     During the year ended May 31, 2001, the Company assessed the qualification
of its research and development expenses for state and federal research and
development tax credits. The Company expected the tax savings for fiscal 2001
due to research and development tax credits would result in a significantly
lower effective tax rate, and accordingly, applied an effective tax rate of
37.5% to the result of its year ended May 31, 2001. The Company is currently
assessing the impact of its research and development expenses on its effective
tax rate in future periods.

  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.

     Revenue is mainly derived from relatively large sales to a limited number
of customers, representing significant 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.

                                        42
<PAGE>   45
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     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 makes 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 year ended May 31, 2000, one customer accounted for 26.0% of
total accounts receivable balance. Three customers accounted for 14.1%, 13.9%
and 13.0% of total accounts receivable balance at May 31, 2001. No customer
accounted for more than 10% of the total revenue in any period reported.

  Foreign currency translation

     The Company translates the accounts of its foreign branches and
subsidiaries using historical rates for nonmonetary assets and current rates for
monetary assets. Remeasurement gains and losses from the translation of these
branches and those that arise from exchange rate changes on transactions
denominated in a currency other than the local currency are included in the
statements of operations. The Company's foreign branches and subsidiaries use
the U.S. dollar as their functional currency as the U.S. parent exclusively
funds the branches and subsidiaries' operations with U.S. dollars and has
substantive control over local operations. The net gain (loss) on foreign
currency remeasurement and exchange rate changes for fiscal years 2001, 2000 and
1999, which is included in other income (expense) net on the accompanying
statements of operations, was ($772,000), ($440,000) and $175,000, respectively.

  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 3.

  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 common
stock equivalent shares outstanding during the period. Dilutive common stock
equivalent shares consist of stock options.

  Comprehensive income

     The Company has adopted 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.

  Reclassification

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

  Recent accounting pronouncements

     SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as
amended by SFAS 137, Accounting for Derivative Instruments and Hedging
Activities -- Deferral of the Effective Date of FASB Statement No. 133, and SFAS
138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities, is effective for the Company as of June 1, 2001. SFAS 133 requires
that an entity recognize all

                                        43
<PAGE>   46
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

derivatives as either assets or liabilities measured at fair value. The
accounting for changes in the fair value of a derivative depends on the use of
the derivative. The adoption of this statement will not have a material impact
on the Company's statement of operations.

 3. INVESTMENTS

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

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

     As of May 31, 2001, available-for-sale securities consist of the following
(in thousands):

<Table>
<Caption>
                                                            GROSS
                                             AMORTIZED    UNREALIZED      FAIR
                                               COST         GAINS        VALUE
                                             ---------    ----------    --------
<S>                                          <C>          <C>           <C>
Corporate commercial paper -- short-term...  $126,085       $  602      $126,687
Corporate commercial paper -- long-term....    91,687       $  561        92,248
                                             --------       ------      --------
          Total investments................  $217,772       $1,163      $218,935
                                             ========       ======      ========
</Table>

     At May 31, 2001, scheduled maturities of investments classified as
available-for-sale are as follows (in thousands):

<Table>
<S>                                                           <C>
Within one year.............................................  $126,687
After one year through three years..........................    92,248
                                                              --------
                                                              $218,935
                                                              ========
</Table>

 4. BALANCE SHEET DETAIL

  Trade receivables

     As of May 31, 2001 and 2000, the balance of trade receivables is as follows
(in thousands):

<Table>
<Caption>
                                                               MAY 31,
                                                         --------------------
                                                           2001        2000
                                                         --------    --------
<S>                                                      <C>         <C>
Trade receivables......................................  $ 39,091    $ 24,318
Allowance for doubtful accounts........................    (1,350)       (900)
                                                         --------    --------
                                                         $ 37,741    $ 23,418
                                                         ========    ========
</Table>

                                        44
<PAGE>   47
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

  Equipment and leasehold improvements

     As of May 31, 2001 and 2000, equipment and leasehold improvements consist
of the following (in thousands):

<Table>
<Caption>
                                                               MAY 31,
                                                         --------------------
                                                           2001        2000
                                                         --------    --------
<S>                                                      <C>         <C>
Computer equipment.....................................  $ 15,090    $ 12,201
Furniture and fixtures.................................     5,321       4,243
Leasehold improvements.................................     5,310       3,644
                                                         --------    --------
                                                           25,721      20,088
Less accumulated depreciation and amortization.........   (17,917)    (15,315)
                                                         --------    --------
                                                         $  7,804    $  4,773
                                                         ========    ========
</Table>

     Depreciation expense for fiscal years 2001, 2000 and 1999 was $3,185,000,
$2,797,000 and $2,444,000, respectively.

     At May 31, 2000 and 2001, there were no assets under capital leases.

 5. COMMITMENTS AND CONTINGENCIES

  Commitments

     The Company leases various facilities and vehicles under noncancelable
operating leases expiring through November 2005. 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 2002.

     At May 31, 2001, future minimum rental payments and receipts under the
operating leases are as follows (in thousands):

<Table>
<Caption>
                                                            RENTAL     SUBLEASE
               FISCAL YEAR ENDING MAY 31,                  PAYMENTS     INCOME
               --------------------------                  --------    --------
<S>                                                        <C>         <C>
2002.....................................................  $ 3,260      $1,088
2003.....................................................    2,811          --
2004.....................................................    2,523          --
2005.....................................................    2,132          --
2006.....................................................      992          --
                                                           -------      ------
                                                           $11,718      $1,088
                                                           =======      ======
</Table>

     Rent expense, excluding sublease income, for fiscal years 2001, 2000 and
1999 was $1,849,000, $1,522,000, and $1,346,000 respectively.

  Contingencies

     In December 1999, a number of complaints were filed in the United States
District Court for Northern District of California seeking an unspecified amount
of damages on behalf of an alleged class of persons who purchased shares of our
common stock during the period between December 1 and December 14, 1999. The
complaints name as defendants the Company and certain of its directors and
officers, asserting that they violated federal securities laws by
misrepresenting the Company's business and earnings growth ability to continue
to achieve profitable growth, and failing to disclose certain information about
our business. The

                                        45
<PAGE>   48
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

complaints were consolidated into a single action, and in August 2000, the
complaint was dismissed without prejudice with leave to amend. The plaintiffs
re-filed an amended complaint, and the Company filed a motion to dismiss this
amended complaint on October 27, 2000. By order dated February 13, 2001, the
court granted the motion in part and denied it in part. The court dismissed with
prejudice all claims except a single claim relating to alleged communications
with a securities analyst near the end of the Company's second fiscal 2000
quarter. The court restricted pretrial discovery to the single remaining claim.
On July 24, 2001, council for plaintiffs agreed to voluntarily dismiss the
action with prejudice, and without an award of costs or fees to any party. The
court ordered the case dismissed on July 27, 2001.

     On June 7, 2001, the Company filed a complaint in federal district court in
the Northern District of California, San Jose Division, against BroadVision,
Inc. BroadVision is a software company that the Company in the past has licensed
to distribute the Company's copyrighted software known as the Verity Developer
Kit ("VDK"). The Company alleges in its complaint that under the terms of the
parties' licenses, BroadVision was authorized to distribute certain limited
portions of VDK as an embedded component of specified software applications of
BroadVision. The Company further alleges that BroadVision has distributed
portions of VDK that it was not authorized to distribute, failed to prevent end
users from accessing unlicensed functions and encouraged end users to make use
of unlicensed functions of VDK. The Company further alleges that it terminated
its license with BroadVision on April 24, 2001 and that BroadVision no longer
has any right to distribute any portion of VDK.

     Based on the foregoing allegations, the Company has asserted claims against
BroadVision for copyright infringement, declaratory relief, unfair competition,
interference with economic advantage, breach of contract, and breach of the
implied covenant of good faith and fair dealing. The Company seeks by its
complaint, among other things, an injunction to prohibit BroadVision from
further distribution of VDK, damages, including statutory damages, according to
proof based on BroadVision's unauthorized distribution of VDK and attorneys'
fees.

     BroadVision answered the Company's complaint on June 28, 2001 and denied
the material allegations of the Complaint and asserted affirmative defenses to
the Company's claims. BroadVision also asserted a counterclaim alleging that the
Company had breached the parties' license and the implied covenant of good faith
and fair dealing contained therein (1) by failing to pay BroadVision referral
fees that it claims the Company owes to BroadVision for BroadVision's efforts in
securing the sale of Verity Advanced K-2 Search Modules; and (2) by failing to
provide support to BroadVision for VDK after the Company terminated the parties'
license. BroadVision seeks by its complaint, among other things, damages
according to proof, a declaration that BroadVision has not breached the parties'
license and attorneys' fees.

     The Company answered BroadVision's counterclaim on July 23, 2001 and denied
the material allegations of the counterclaim and asserted various affirmative
defenses to BroadVision's claims.

     The action is currently in the early stages and no formal discovery has yet
been conducted. A case management conference has been set for October 9, 2001 at
which time the Court will likely enter a scheduling order and set a trial date.

     While management intends to defend the actions against the Company
vigorously, there can be no assurance that an adverse result or settlement with
regards to these lawsuits would not have a material adverse effect on the
Company's financial condition or results of operations.

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

                                        46
<PAGE>   49
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

 6. STOCKHOLDERS' EQUITY

  1995 Stock Option Plan

     In July 1995, the Company adopted the Amended and Restated 1995 Stock
Option Plan, which amended and restated the 1988 Stock Option Plan. In September
1998, September 1999 and September 2000, the Company's stockholders approved an
increase to the number of shares reserved under the 1995 Stock Option Plan to a
total of 8,122,000, 10,122,000 and 12,122,000 shares, respectively.

     Under the terms of the Plan, incentive options may be granted at prices not
lower than the fair market value at the date of grant, while nonqualified
options may be granted at prices not lower than 85% of fair market value at the
date of grant as determined by the Board of Directors. 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.

     Common shares purchased under the Plan are subject to the Company's right
of repurchase, which generally lapses as to 12.5% of the shares six months from
the 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, 2001, 2000 and 1999, the
Company had 84, 9,793 and 1,156 shares, respectively, subject to the Company's
right to repurchase. As of May 31, 2001, 517,000 shares of common stock were
available for grant under the 1995 Stock Option Plan.

  1996 Nonstatutory Stock Option Plan

     In February 1996, the Company's Board of Directors approved the 1996
Nonstatutory Stock Option Plan. The terms of the 1996 Nonstatutory Stock Option
Plan are substantially the same as those of the 1995 Stock Option Plan. In
fiscal years 1999, 2000 and 2001, the Company increased the number of shares
reserved under the Plan to 5,720,000, 8,420,000 and 12,700,000 shares of common
stock, respectively, for issuance to certain employees and consultants of the
Company. As of May 31, 2001, 691,000 shares of common stock were available for
grant under the 1996 Nonstatutory Stock Option Plan.

  Outside Directors Plan

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

     At the initiation of the Plan, each current outside director was
automatically granted an option to purchase 40,000 shares of common stock at the
following annual meeting of stockholders. Each new outside director is
automatically granted an option to purchase shares of the Company's common stock
at the time of annual meeting following their appointment. Thereafter, at each
annual meeting of the stockholders, outside directors who have previously
received options will receive a new option to purchase 40,000 shares of the
Company's common stock. The exercise price of the options in all cases will be
equal to the fair market value of the Company's common stock at the date of
grant. Options granted under the Director's Plan are immediately exercisable,
but vest over four years and generally must be exercised within ten years. In
September 1999, the Company's stockholders approved an increase to the number of
shares reserved under the Outside Director's Plan to a total of 1,000,000
shares. As of May 31, 2001, 540,000 shares of common stock were available for
grant under this plan.

                                        47
<PAGE>   50
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

  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. In May and October 1999, the Company increased the number of shares
reserved under the 1997 Plan to a total of 1,180,000 and 1,480,000 shares,
respectively. In June and December 2000, the Company increased the number of
shares reserved under the 1997 Plan to a total of 1,980,000 and 2,250,000
shares, respectively. As of May 31, 2001, 415,000 shares of common stock were
available for grant under the 1997 Stock Option Plan for Verity Canada.

  Activity under stock option plans

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

<Table>
<Caption>
                                                            OPTIONS OUTSTANDING
                                                  ---------------------------------------
                                                                WEIGHTED
                                                                 AVERAGE
                                      SHARES                    PRICE PER
                                    AVAILABLE       SHARES        SHARE         TOTAL
                                    ----------    ----------    ---------    ------------
<S>                                 <C>           <C>           <C>          <C>
Balances, May 31, 1998............   3,468,000     5,914,000     $ 2.91      $ 17,229,000
  Shares reserved under plans.....   3,900,000
  Options granted.................  (5,604,000)    5,604,000     $ 9.78        54,802,000
  Options canceled................     618,000      (618,000)    $ 3.60        (2,223,000)
  Options exercised...............          --    (1,806,000)    $ 2.96        (5,339,000)
                                    ----------    ----------                 ------------
Balances, May 31, 1999............   2,382,000     9,094,000     $ 7.09        64,469,000
  Shares reserved under plans.....   5,600,000
  Options granted.................  (6,567,000)    6,567,000     $31.99       210,075,000
  Options canceled................     648,000      (648,000)    $12.34        (7,999,000)
  Options exercised...............          --    (2,293,000)    $ 4.61       (10,577,000)
                                    ----------    ----------                 ------------
Balance, May 31, 2000.............   2,063,000    12,720,000     $20.12       255,968,000
  Shares reserved under plans.....   7,051,000
  Options granted.................  (8,418,000)    8,418,000     $23.69       199,341,000
  Options canceled................   1,467,000    (1,467,000)    $24.41       (35,806,000)
  Options exercised...............          --    (3,394,000)    $ 8.95       (30,366,000)
                                    ----------    ----------                 ------------
Balances, May 31, 2001............   2,163,000    16,277,000     $23.91      $389,137,000
                                    ==========    ==========                 ============
</Table>

  Common stock option plans

     The following table summarizes information with respect to stock options
outstanding at May 31, 2001:

<Table>
<Caption>
                         OPTIONS OUTSTANDING             OPTIONS NOT SUBJECT TO
                 ------------------------------------   REPURCHASE UPON EXERCISE
                                WEIGHTED                ------------------------
                                AVERAGE      WEIGHTED                  WEIGHTED
                 NUMBER AT     REMAINING     AVERAGE     NUMBER AT     AVERAGE
   RANGE OF       MAY 31,     CONTRACTUAL    EXERCISE     MAY 31,      EXERCISE
EXERCISE PRICE      2001      LIFE (YEARS)    PRICE        2001         PRICE
--------------   ----------   ------------   --------   -----------   ----------
<S>              <C>          <C>            <C>        <C>           <C>
$ 1.00 - $ 4.99..  1,545,000      4.93        $ 3.40     1,055,000      $ 3.39
$ 5.00 - $16.49..  5,079,000      7.00        $14.35     1,961,000      $14.88
$16.50 - $29.99..  2,081,000      7.10        $24.38       741,000      $26.29
$30.00 - $53.00..  7,572,000      6.80        $34.37     3,854,000      $33.67
                 ----------       ----        ------     ---------      ------
                 16,277,000       6.46        $19.13     7,611,000      $19.56
                 ==========                              =========
</Table>

                                        48
<PAGE>   51
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

  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, respectively. 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 offering period or the last day of the purchase period. As
of May 31, 2001, 2,511,000 shares of the Company's common stock have been issued
under the plan and 1,489,000 shares remained available for purchase.

  Pro forma stock-based compensation

     The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 (SFAS No. 123), Accounting for
Stock-Based Compensation. Accordingly, no compensation cost has been recognized
for the Company's stock option plans or Employee Stock Purchase Plan. Had
compensation cost for the Company's stock option plans and Employee Stock
Purchase Plan been determined based on the fair value at the grant date for
awards in fiscal years 2001, 2000 and 1999 consistent with the provisions of
SFAS No. 123, the Company's net income (loss) and net income (loss) per share
for fiscal years 2001, 2000 and 1999 would have been increased to the pro forma
amounts indicated below (in thousands, except per share amounts):

<Table>
<Caption>
                                                               FISCAL YEARS
                                                      -------------------------------
                                                        2001        2000       1999
                                                      --------    --------    -------
<S>                                                   <C>         <C>         <C>
Net income applicable to common stockholders -- as
  reported..........................................  $ 33,760    $ 33,010    $12,130
                                                      ========    ========    =======
Net income applicable to common stockholders -- pro
  forma.............................................  $(67,098)   $(25,148)   $ 1,929
                                                      ========    ========    =======
Net income per share -- basic -- as reported........  $   1.00    $   1.10    $  0.50
                                                      ========    ========    =======
Net income per share -- diluted -- as reported......  $   0.92    $   0.95    $  0.44
                                                      ========    ========    =======
Net income per share -- basic -- pro forma..........  $  (1.99)   $  (0.84)   $  0.08
                                                      ========    ========    =======
Net income per share -- diluted -- pro forma........  $  (1.99)   $  (0.84)   $  0.07
                                                      ========    ========    =======
</Table>

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

     The aggregate fair value and weighted average fair value of each option
granted in fiscal years 2001, 2000 and 1999 were $140.2 million, $145.9 million
and $36.8 million, and $16.65, $21.13 and $13.14, respectively. The fair value
of each option grant is estimated on the date of grant using the Black-Scholes
Option Pricing Model with the following weighted average assumptions for fiscal
years 2001, 2000 and 1999:

<Table>
<Caption>
                                                          2001        2000       1999
                                                        ---------    -------    -------
<S>                                                     <C>          <C>        <C>
Expected volatility...................................        100%       100%        90%
Risk-free interest rate...............................        5.4%       6.8%       5.7%
Expected life.........................................  3.5 years    3 years    4 years
Expected dividend yield...............................        0.0%       0.0%       0.0%
</Table>

                                        49
<PAGE>   52
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     The Company has also estimated the fair value for the purchase rights under
the Employee Stock Purchase Plan using the Black-Scholes Model with the
following assumptions for fiscal years 2001, 2000 and 1999:

<Table>
<Caption>
                                               2001               2000               1999
                                         ----------------   ----------------   ----------------
<S>                                      <C>                <C>                <C>
Expected volatility....................        100%               100%               90%
Risk-free interest rate................        5.4%               6.8%               5.7%
Expected life..........................  .50 - 1.00 years   .50 - 1.00 years   .50 - 1.00 years
Expected dividend yield................        0.0%               0.0%               0.0%
</Table>

  Preferred stock purchase rights plan

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

 7. INCOME TAXES

     Income tax expense includes U.S. and international income taxes, as well as
the provision for U.S. taxes on undistributed earnings of international
subsidiaries. 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.

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

<Table>
<Caption>
                                                        FISCAL YEARS
                                                -----------------------------
                                                 2001       2000       1999
                                                -------    -------    -------
<S>                                             <C>        <C>        <C>
Domestic......................................  $52,689    $28,669    $ 9,899
Foreign.......................................    1,293      2,191      2,831
                                                -------    -------    -------
                                                $53,982    $30,860    $12,730
                                                =======    =======    =======
</Table>

     Details of the income tax provision (benefit) for fiscal years 2001, 2000
and 1999 consist of the following (in thousands):

<Table>
<Caption>
                                                            MAY 31,
                                                   --------------------------
                                                    2001       2000      1999
                                                   -------    -------    ----
<S>                                                <C>        <C>        <C>
Current:
  Federal........................................  $14,095    $    --    $243
  State..........................................    1,476         20      55
  Foreign........................................      598        600     302
                                                   -------    -------    ----
                                                    16,169        620     600
                                                   -------    -------    ----
Deferred:
  Federal........................................    3,650     (2,392)     --
  State..........................................      403       (346)     --
  Foreign........................................       --        (32)     --
                                                   -------    -------    ----
                                                     4,053     (2,770)     --
                                                   -------    -------    ----
                                                   $20,222    $(2,150)   $600
                                                   =======    =======    ====
</Table>

                                        50
<PAGE>   53
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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

<Table>
<Caption>
                                                           FISCAL YEARS
                                                      -----------------------
                                                      2001     2000     1999
                                                      -----    -----    -----
<S>                                                   <C>      <C>      <C>
Income tax benefit at statutory rates...............   35.0%    35.0%    34.0%
State income taxes net of federal benefit...........    3.5      3.2      0.4
Non-deductible expenses.............................    2.6      0.6      0.1
Foreign taxes.......................................    0.1      2.5      0.1
Release of valuation allowance......................    0.0    (44.5)      --
Research and development credit.....................   (5.2)    (3.7)      --
Net operating loss (benefited) not benefited........    1.5       --    (29.7)
                                                      -----    -----    -----
Effective tax rate..................................  37.50%    (6.9)%    4.9%
                                                      =====    =====    =====
</Table>

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

<Table>
<Caption>
                                                                MAY 31,
                                                           ------------------
                                                            2001       2000
                                                           -------    -------
<S>                                                        <C>        <C>
Deferred tax assets:
  Accumulated depreciation...............................  $ 2,272    $ 2,237
  Accrued compensation...................................    1,831      1,115
  Other accruals and allowance for doubtful accounts.....      851      1,065
  Research and development credits.......................    8,338      4,262
  Net operating loss carryforwards.......................    6,829     18,093
                                                           -------    -------
     Net deferred........................................  $20,121    $26,772
                                                           =======    =======
</Table>

     As of May 31, 2001, the Company had approximately $18,720,000 and
$5,543,000 of net operating loss carryforwards for federal and California
purposes, respectively, to offset future taxable income. The tax benefits
associated with these net operating loss carry forwards has been recorded to
additional paid-in-capital account as they arose from the exercise and/or
disposition of stock options.

     Under the Tax Reform Act of 1986, the amounts of benefits from net
operating loss carryforwards may be impaired or limited in the future if the
Company incurs a cumulative ownership change of more than 50%, as defined, over
a three year period. The Company also has federal and state research and
development tax credit carryforwards of approximately $5,836,000 and $2,502,000,
respectively, at May 31, 2001. These carryforwards expire in the years 2001 to
2021 if not utilized.

     During fiscal year 2000, the entire valuation allowance was reversed, due
to the increased earnings of the Company. Based on management's assessment, it
is more likely than not that all the net deferred tax assets will be realized
through future taxable earnings.

 8. RELATED PARTY TRANSACTIONS

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

                                        51
<PAGE>   54
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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

     In connection with Mr. Sbona's service as President and CEO, an employee of
the Company, the Compensation Committee of the Company's Board also granted to
him an option to purchase 700,000 shares of the Company's common stock, at an
exercise price of $2.563 per share. In October 1998, the Company's Board granted
Mr. Sbona another option to purchase additional 520,000 shares of the Company's
common stock, at an exercise price of $3.813 per share. In May 1999, the
Company's Board granted Mr. Sbona another option to purchase additional 420,000
shares of the Company's common stock, at an exercise price of $16.250 per share.
In October 1999 and January 2000, the Company's Board granted Mr. Sbona options
to purchase 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. The shares subject to such options will vest entirely upon certain
change of control transactions or upon a termination of Mr. Sbona without cause.
The options will also remain exercisable for one year following the termination
of Mr. Sbona's services.

     On March 12, 1999, the Company extended its agreement with Regent Pacific
Management Corporation until August 31, 2000. Under this amended agreement,
Regent Pacific continues to provide certain services to the Company at a fee of
$50,000 per week. The new agreement provides Verity with an option to further
extend the term of this agreement through February 2001. Additionally, the
parties agree that Mr. Sbona became an employee of the Company effective
February 16, 1998. Furthermore, on March 12, 1999, Mr. Sbona was appointed as
the Chairman of the Board of Directors of the Company. Mr. Sbona has been
Verity's President and Chief Executive Officer since July 1997 and has been a
Board member since May 1998.

     On February 10, 2000, the Company extended its agreement with Regent
Pacific Management Corporation through August 31, 2001. This is the third
amendment to the retainer agreement between Regent Pacific Management
Corporation and Verity, Inc. since the original agreement dated July 31, 1997.
Under this amended agreement, Regent Pacific continues to provide the services
of Gary J. Sbona as Chairman and Chief Executive Officer of Verity, and
continues to provide additional Regent Pacific management services to the
Company. The agreement provides Verity with an option to further extend the term
of this agreement through February 2002.

     On March 12, 2001, the Company extended its agreement with Regent Pacific
Management Corporation until August 31, 2002. This is the fourth amendment to
the retainer agreement between Regent Pacific Management Corporation and Verity,
Inc. since the original agreement dated July 31, 1997. Under this amended
agreement, Regent Pacific continues to provide the services of Gary J. Sbona as
Chairman and Chief Executive Officer of Verity, and continues to provide
additional Regent Pacific management services to The Company. The agreement
provides Verity with an option to further extend the term of this agreement
through February 2003. This agreement may be cancelled at the option of the
board after February 2003.

 9. EMPLOYEE BENEFIT PLAN

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

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

                                        52
<PAGE>   55
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10. COMPUTATION OF NET INCOME PER SHARE

     Basic and diluted net income per share are calculated as follows for fiscal
years 2001, 2000 and 1999 (in thousands, except per share amounts):

<Table>
<Caption>
                                                        FISCAL YEARS
                                                -----------------------------
                                                 2001       2000       1999
                                                -------    -------    -------
<S>                                             <C>        <C>        <C>
Basic:
  Weighted average common shares outstanding
     (basic)..................................   33,634     30,026     24,198
  Net income applicable to common
     stockholders.............................  $33,760    $33,010    $12,130
  Net income per share........................  $  1.00    $  1.10    $  0.50
Diluted:
  Weighted average common shares outstanding
     (basic)..................................   33,634     30,026     24,198
  Dilutive effect of common stock equivalent
     shares...................................    3,015      4,860      3,502
                                                -------    -------    -------
  Weighted average common shares outstanding
     (diluted)................................   36,649     34,886     27,700
                                                =======    =======    =======
  Net income applicable to common
     stockholders.............................  $33,760    $33,010    $12,130
  Net income per share........................  $  0.92    $  0.95    $  0.44
</Table>

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

     The Company operates in one business segment and develops, markets and
supports products for corporate intranets, extranets, corporate portals, online
publishers and e-commerce providers, and original equipment manufacturer (OEM)
toolkits for independent software vendors (ISVs). Verity's comprehensive and
integrated product family enables enterprise-wide document indexing,
classification, search and retrieval, organization and navigation, viewing,
personalized dissemination, and hybrid online and CD/DVD publishing all from the
same underlying Verity information index.

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

<Table>
<Caption>
        FINANCIAL DATA BY           UNITED                OTHER
        GEOGRAPHICAL AREA           STATES     EUROPE    FOREIGN    ELIMINATIONS     TOTAL
        -----------------           -------    ------    -------    ------------    -------
                                                        (IN THOUSANDS)
<S>                                 <C>        <C>       <C>        <C>             <C>
Revenues:
  1999............................   60,334    4,091         --            --        64,425
  2000............................   89,666    6,434         --            --        96,100
  2001............................  136,336    8,699         --            --       145,035
Income from operations:
  1999............................   21,018    2,800         73       (12,238)       11,653
  2000............................   36,638    2,673       (156)      (13,898)       25,257
  2001............................   61,652    3,324      1,913       (24,241)       42,648
Long-lived assets:
  1999............................    5,204      414        387            --         6,005
  2000............................    4,125      350        453            --         4,928
  2001............................    5,211      951      1,642            --         7,804
</Table>

                                        53
<PAGE>   56
                                  VERITY, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     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.

     Included in software product revenues for the United States are export
sales of approximately $37,710,000, $18,307,000 and $17,464,000 in fiscal years
2001, 2000 and 1999, respectively.

     No single customer accounted for 10% or more of the Company's revenue
during fiscal years 2001, 2000 and 1999. Revenues from the federal government
and its agencies were $10,729,000, $7,467,000 and $5,216,000 for fiscal years
2001, 2000 and 1999, respectively.

                                        54
<PAGE>   57

                          SCHEDULE II -- VERITY, INC.

                       VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

<Table>
<Caption>
                                                                  AMOUNTS
                                                   BALANCE AT    CHARGED TO                  BALANCE
                                                   BEGINNING     PROFIT AND                  AT END
                   DESCRIPTION                      OF YEAR         LOSS       DEDUCTIONS    OF YEAR
                   -----------                     ----------    ----------    ----------    -------
<S>                                                <C>           <C>           <C>           <C>
Allowance for Bad Debts:
  Year ended May 31, 1999
     Allowance for doubtful accounts.............   $   706       $    639       $(445)      $   900
  Year ended May 31, 2000
     Allowance for doubtful accounts.............   $   900       $    621       $(621)      $   900
  Year ended May 31, 2001
     Allowance for doubtful accounts.............   $   900       $  1,163       $(713)      $ 1,350

Allowance for Deferred Tax Assets:
  Year ended May 31, 1999
     Valuation Allowance.........................   $17,004       $  1,883       $  --       $18,887
  Year ended May 31, 2000
     Valuation Allowance.........................   $18,887       $(18,887)      $  --       $    --
  Year ended May 31, 2001
     Valuation Allowance.........................   $    --       $     --       $  --       $    --
</Table>

                                        55
<PAGE>   58

                                   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 6, 2001                      By:       /s/ GARY J. SBONA
                                            ------------------------------------
                                                 (Chief Executive Officer)

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

<Table>
<Caption>
                     SIGNATURE                                     TITLE                      DATE
                     ---------                                     -----                      ----
<C>                                                  <C>                                 <S>
                 /s/ GARY J. SBONA                      Chief Executive Officer and      August 6, 2001
---------------------------------------------------        Chairman of the Board
                   Gary J. Sbona                       (Principal Executive Officer)

            /s/ ANTHONY J. BETTENCOURT                     President and Director        August 6, 2001
---------------------------------------------------
              Anthony J. Bettencourt

                /s/ TODD K. YAMAMI                    Vice President, Chief Financial    August 6, 2001
---------------------------------------------------               Officer
                  Todd K. Yamami                          and Assistant Secretary
                                                      (Principal Financial Officer and
                                                       Principal Accounting Officer)

               /s/ STEVEN M. KRAUSZ                               Director               August 6, 2001
---------------------------------------------------
                 Steven M. Krausz

             /s/ STEPHEN A. MACDONALD                             Director               August 6, 2001
---------------------------------------------------
               Stephen A. MacDonald

             /s/ CHARLES P. WAITE, JR.                            Director               August 6, 2001
---------------------------------------------------
               Charles P. Waite, Jr.

                /s/ KARL C. POWELL                                Director               August 6, 2001
---------------------------------------------------
                  Karl C. Powell
</Table>

                                        56
<PAGE>   59

                               INDEX TO EXHIBITS

<Table>
<Caption>
EXHIBIT
NUMBER                       DESCRIPTION OF DOCUMENT
-------                      -----------------------
<C>        <S>
 3.1       Restated Certificate of Incorporation of the Company.(20)
 3.2       By-Laws.(20)
 3.3       Certificate of Retirement of Series of Preferred Stock.(2)
 3.4       Certificate of Designation, Preferences and Rights of Series
           A Preferred Stock.(2)
 3.5       Certificate of Amendment of Certificate of Incorporation of
           Verity, Inc., dated September 21, 1999 and filed with the
           Secretary of State of the State of Delaware.(13)
 4.1       Amended and Restated Rights Agreement dated August 1, 1995,
           as amended.(1)
 4.2       Form of Rights Agreement between Verity, Inc. and First
           National Bank of Boston dated September 18, 1996.(3)
 4.3       First Amendment to Rights Agreement dated as of July 23,
           1999 among Verity, Inc. and BankBoston, N.A.(15)
10.1       Form of Indemnification Agreement for directors and
           officers.(1),(4)
10.2       Amended and Restated 1995 Stock Option Plan and forms of
           agreements thereunder.(4),(5)
10.3       1995 Employee Stock Purchase Plan, as amended.(4),(21)
10.4       1995 Outside Directors Stock Option Plan, as amended, and
           forms of agreement thereunder.(4),(17)
10.5       1996 Non-Statutory Stock Option Plan, as amended.(4),(19)
10.6       1997 Non-Statutory Stock Option Plan for Verity, Canada, as
           amended.(4),(19)
10.18      Lease Agreement between Ross Drive Investors and the Company
           dated January 22, 1996.(6)
10.19      Retainer Agreement between Regent Pacific Management
           Corporation and Verity, Inc. dated July 31, 1997.(4),(7)
10.21      Employment Agreement between Anthony J. Bettencourt and the
           Company dated August 28, 1997.(4),(8)
10.22      Security and Loan Agreement between Imperial Bank and the
           Company dated November 30, 1997.(9)
10.23      Amendment to Retainer Agreement between Regent Pacific
           Management Corporation and Verity, Inc. dated April 13,
           1998.(4),(10)
10.24      Amendment to Security and Loan Agreement between Imperial
           Bank and the Company dated November 15, 1998.(11)
10.25      Amendment to Employment Agreement between Anthony J.
           Bettencourt and the Company dated October 6, 1998.(4),(11)
10.26      Amendment to Retainer Agreement between Regent Pacific
           Management Corporation and Verity, Inc. dated March 12,
           1999.(4),(12)
10.27      Amendment to Retainer Agreement between Regent Pacific
           Management Corporation and Verity, Inc. dated February 9,
           2000.(4),(14)
10.28      Amendment to Employment Agreement between Anthony J.
           Bettencourt and the Company dated September 23,
           1999.(4),(18)
10.29      Amendment to Retainer Agreement between Regent Pacific
           Management Corporation and Verity, Inc. dated March 12,
           2001.(4),(19)
10.30      Promissory Note dated January 2, 2001 given by Anthony
           Bettencourt in favor of Verity, Inc.(4),(19)
10.31      Promissory Note dated January 2, 2001 given by Todd Yamami
           in favor of Verity, Inc.(4),(19)
10.32      Amendment to Employment Agreement between Anthony J.
           Bettencourt and the Company dated September 29, 2000.(4)
21.1       Subsidiaries of the Company.
23.1       Consent of PricewaterhouseCoopers LLP.
</Table>

---------------
 (1) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Registration Statement (No. 33-96228), declared effective on
     October 5, 1995.
                                        57
<PAGE>   60

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

 (3) 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.

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

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

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

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

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

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

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

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

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

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

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

(15) 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.

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

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

(18) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-K for the year ended May 31, 2000.

(19) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended February 28, 2001.

(20) Incorporated by reference from the exhibits with corresponding numbers from
     the Company's Form 10-Q for the quarter ended November 30, 2000.

(21) Incorporated by reference to Exhibit 99.1 to the Company's Registration
     Statement on Form S-8 filed December 11, 2000.

                                        58