**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934 

**Forthe fiscal year ended January 31, 2007**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934 

**Forthe transition period from                    to                    **

**Commissionfile number: 000-32377**

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**OPSWARE INC.**

**(Exact name of registrant asspecified in its charter)**

| **Delaware**                                                    |   | **94-3340178**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification Number) |

 

**599 N. Mathilda Avenue,Sunnyvale, California 94085**

(Address, including zip code, of Registrant’s principalexecutive offices)

**(408) 744-7300**

Registrant’s telephone number, including area code

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**Securitiesregistered pursuant to Section 12(b) of the Act:**

**None**

**Securitiesregistered pursuant to Section 12(g) of the Act:**

**Common Stock, parvalue $0.001 per share**

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Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.   YES o   NO x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) ofthe Act.   YES o  NO x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   YES x   NO o

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.

o  Large accelerated filer      x  Accelerated filer      o  Non-accelerated filer

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act). YES o    NO x

The aggregate market value of the voting stock held bynon-affiliates of the registrant, based upon the closing price as reported bythe NASDAQ Global Market of the registrant’s Common Stock on July 31,2006, the last business day of the registrant’s most recently completed secondfiscal quarter, was approximately $545 million. Shares of voting stock held byeach officer and director and by each person who owns 5% or more of theoutstanding voting stock have been excluded in that such persons may be deemedto be affiliates. This determination of affiliate status is not necessarily aconclusive determination for other purposes.

As of April 1, 2007, 102,297,720 shares of theregistrant’s Common Stock were outstanding.

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**DOCUMENTSINCORPORATED BY REFERENCE**

Part III of thisAnnual Report on Form 10-K incorporates certain information byreference from the registrant’s definitive proxy statement for the registrant’sAnnual Meeting of Stockholders, scheduled for June 26, 2007.

 

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**TABLEOF CONTENTS**
| PART I        |   |                                                                                                               |   |   |   |
|--------------------|--------|--------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| ITEM 1.       |   | BUSINESS                                                                                                           |   | 2      |   |
| ITEM 1A.      |   | RISK FACTORS                                                                                                       |   | 10     |   |
| ITEM 1B.      |   | UNRESOLVED STAFF COMMENTS                                                                                          |   | 24     |   |
| ITEM 2.            |   | PROPERTIES                                                                                                         |   | 24     |   |
| ITEM 3.            |   | LEGAL PROCEEDINGS                                                                                                  |   | 24     |   |
| ITEM 4.            |   | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |   | 24     |   |
| PART II       |   |                                                                                                               |   |   |   |
| ITEM 5.            |   | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |   | 25     |   |
| ITEM 6.            |   | SELECTED CONSOLIDATED FINANCIAL DATA                                                                               |   | 27     |   |
| ITEM 7.            |   | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                        |   | 28     |   |
| ITEM 7A.      |   | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                          |   | 39     |   |
| ITEM 8.            |   | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                        |   | 40     |   |
| ITEM 9.            |   | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                         |   | 71     |   |
| ITEM 9A.      |   | CONTROLS AND PROCEDURES                                                                                            |   | 71     |   |
| ITEM  9B.          |   | OTHER  INFORMATION                                                                                                 |   | 72     |   |
| PART III      |   |                                                                                                               |   |   |   |
| ITEM 10.           |   | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                             |   | 73     |   |
| ITEM 11.           |   | EXECUTIVE COMPENSATION                                                                                             |   | 73     |   |
| ITEM 12.           |   | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    |   | 73     |   |
| ITEM 13.           |   | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND  DIRECTOR INDEPENDENCE                                          |   | 73     |   |
| ITEM 14.           |   | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                             |   | 73     |   |
| PART IV       |   |                                                                                                               |   |   |   |
| ITEM 15.      |   | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                         |   | 74     |   |
| POWER OF  ATTORNEY |   | 77                                                                                                                 |   |

 

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**CautionaryStatement Regarding Forward-Looking Statements**

This Annual Report on Form 10-K containsforward-looking statements within the meaning of the federal securities laws.These statements relate to our, and in some cases our customers’ or partners’, futureplans, objectives, expectations, intentions and financial performance and theassumptions that underlie these statements. These forward-looking statementsinclude, but are not limited to, statements regarding anticipated market trendsand uncertainties, expected financial and operating results, anticipatedcapital expenditures, international sales expansion, expected revenue generatedfrom the sale of our software products, including the impact of our license andmaintenance agreement with EDS and our distribution arrangement with Cisco, theimpact of applying SFAS 123(R), the adequacy of our capital resources to fundour operations, the anticipated increase in customer expansion of our targetmarkets, the timing of new product releases, our expectations regarding ongoingdevelopment of our software products and other technical capabilities,formation of strategic partnerships and expansion in our direct and indirectsales organizations.

These statements involve known and unknown risks,uncertainties and other factors that may cause industry trends or our actualresults, level of activity, performance or achievements to be materiallydifferent from the outcomes expressed or implied by these statements. Thesefactors include those listed in Item 1A “Risk Factors and elsewhere in thisAnnual Report on Form 10-K.

Although we believe that expectations reflected in theforward-looking statements are reasonable, we cannot guarantee future results,levels of activity, performance or achievements. We assume no obligation toupdate the information in this report after the date of this report, whether asa result of new information, future events or otherwise. You should not placeundue reliance on these forward-looking statements, which apply only as of thedate of this Annual Report on Form 10-K.

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**PART I**

**ITEM 1.**                BUSINESS

**Overview**

We are a provider of data center automation softwareproducts for enterprises, government agencies and service providers seeking toreduce the cost and improve the quality of their data center operations. Oursoftware automation suite automates data center operations across servers,software, applications and network devices and discovers and tracks assetsacross the data center environment by automating formerly manual,time-consuming and error-prone tasks such as discovering, provisioning,changing, auditing, patching, reporting, configuring, scaling, securing andrecovering of servers, software, business applications and network devices.

The Opsware Systemincludes the following principal products:

·       **Opsware Server Automation System (OSAS)**.**  **OSASautomates key server, software and application operations.

·       **Opsware Network Automation System (ONAS)**.**  **ONAS automates network device operations for largedata centers and remote locations.

·       **Opsware Visual Application Manager (VAM)**.**  **VAM visually maps interdependencies betweencomponents including server, network and application components.

·       **Opsware Operational Management Database (OMDB)**.**  **OMDB is the central data repository for alloperational, configuration and change activity data.

·       **The Opsware Network (TON).  **TON is a real-time serviceoffering up-to-date content for security vulnerabilities and compliancepolicies.

·       **Opsware Orchestrator.  **Opsware Orchestrator automatesIT operational processes that span IT groups and span disparate IT systems,manages resolution of alerts and facilitates incident management in NetworkOperation Centers (NOCs) and Server Operation Centers (SOCs).

·       **Opsware Asset Management System (OAMS)**.**  **OAMSenables IT organizations to discover IT hardware and software assets, trackthese assets on an ongoing basis and reduce costs of excess hardware andsoftware purchases, unnecessary maintenance renewals, and underutilization ofidle and redundant assets.

Our products work across geographically disparatelocations and heterogeneous data center environments consisting of UNIX, Linuxand Windows servers and servers virtualized with VMware, Microsoft and SunSolaris technologies, as well as a wide range of software infrastructure andapplications, as well as network devices including switches, routers, loadbalancers and firewalls. By using our data center automation software, webelieve customers can lower their data center operational costs, more quicklydeploy new servers, applications and network infrastructure, speed operations torespond faster to changing business needs, increase the efficiency of serverand network administrators, achieve higher service quality and security andimprove tracking of IT assets.

Businesses and government agencies are increasinglyturning to data center automation solutions to reduce operational costs,improve data center efficiencies, centralize and remotely manage operations,ensure continuity of operations and reduce the costs of disaster recovery.Demand for our software is driven by the rapid growth of servers and networkdevices across IT organizations that is resulting from the migration ofclient-server based applications to web-based applications, the increase in thenumbers of Windows and virtualized servers, the rapid adoption of the Linux platform,the growth of Intel-based servers and the increase in the number of networkdevices within data center environments. Rapid server 

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growth in data centers andat remote locations and increasing application complexity across the datacenter environment have resulted in a corresponding escalation in labor costs,a degradation in operations quality and a security crisis within ITorganizations. In addition, we believe that several other factors are drivingthe demand for our products, including the need to protect servers and networkinfrastructure from security vulnerabilities, to quickly and morecost-effectively deploy servers, applications and network infrastructure, totrack hardware and software assets and labor costs, to manage frequent changesacross servers and network devices and the need to ensure servers, networkdevices and applications comply with corporate and regulatory compliancepolicies such as the Sarbanes-Oxley Act, HIPAA, COSO, PCI/CISP and COBIT, aswell as enable enforcement of best practices such as the Information TechnologyInfrastructure Library (ITIL). Our products provide customers with a softwaresolution that is reliable, secure, and scalable and allows them to reduceoperational costs, increase data center efficiencies and improve operationsquality.

We were incorporated in September 1999as a Delaware corporation. Prior to August 2002, we primarily providedmanaged Internet services for corporations and government agencies thatoperated mission-critical Internet applications. We referred to this businessas our Managed Services Business. On August 15, 2002, we sold our ManagedServices Business to Electronic Data Systems Corporation (“EDS”). We developedour proprietary Opsware automation technology for the Managed Services Business,and have since developed this technology into certain of our software products.

**Products andServices**

*Opsware ServerAutomation System*

OSAS automates key server,software infrastructure and application operations in data centers for bothphysical and virtualized environments and remote locations, includingdiscovering, provisioning, changing, patching, reporting, configuring, scaling,securing, recovering, auditing, remediating, and reallocating servers andbusiness applications across geographically disparate locations andheterogeneous IT environments.

*Opsware NetworkAutomation System*

ONAS automates key networkdevice operations including the management of switches, routers, firewalls andload balancers in data centers and remote locations. ONAS automates the fulllifecycle of network infrastructure operations including discovering,provisioning, changing, auditing, patching, reporting, configuring, scaling,securing and recovering network devices across geographically disparatelocations and heterogeneous IT environments.

*The Opsware Network*

The Opsware Network (TON)is a subscription-based service that complements our software products. TONprovides critical on-going (or real-time) content  including security alerts and fixes to automate vulnerability management;compliance policies for compliance management; automation packs to automate additional functions; and device drivers tosupport new infrastructure across servers and network devices. TON, in combinationwith our other products, helps customers maximize the benefits of theirinvestment in IT automation by keeping customers up-to-date on technologysupport, compliance policies, security vulnerabilities and automationcapabilities.

*Opsware VisualApplication Manager*

The Opsware Visual ApplicationManager (VAM) allows IT organizations to gain greater visibility and controlover their data center environments. VAM provides an easy-to-understand visualmap that can 

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be usedfor improved compliance auditing, troubleshooting complex business applicationsand as a basis for change impact analysis.

*OpswareOrchestrator*

Opsware Orchestratorautomates IT processes that span IT groups and span disparate IT systems. Inaddition to core data center processes, Orchestrator also automates alertresolution and facilitates incident management in Network Operation Centers(NOCs) and Service Operation Centers (SOCs). Orchestrator is availableintegrated with the OSAS, ONAS and also available stand-alone for processautomation and incident management.

*Opsware OperationalManagement Database*

Many of today’s ITorganizations use configuration management databases to keep comprehensive andaccurate records of their data center infrastructure. The Opsware OperationalManagement Database (OMDB) automates the process of discovering and maintainingan entire data center’s infrastructure data, configuration items and changeactivity. Integrated with OSAS and ONAS, OMDB users can directly executechanges to configure or remediate their data center infrastructure. In addition,OMDB tracks operational data associated with the change to provide users withthe ability to audit and ensure compliance.

*Opsware AssetManagement System*

Our OAMS product enablesIT organizations to discover IT hardware and software assets, track assets onan ongoing basis and reduce the expense resulting from excess hardware andsoftware purchases, unnecessary maintenance renewals, and underutilization ofidle and redundant assets. OAMS also enables IT organizations to accuratelytrack and report on enterprise wide hardware and software asset deployment andutilization, and provides help desk staff with detailed visibility into currentand historical hardware and software configuration and usage information,aiding in rapid problem diagnosis, troubleshooting and problem resolution.

*Customer Support*

We believe that superiorcustomer support is critical to retaining our customer base.  Our customer support organization providespost-sales support to customers via telephone, email and remote access. Ourmaintenance and support packages entitle customers to technical support andunspecified future maintenance releases and updates and upgrades to theversions of our products licensed by them, if and when commercially released.From time to time, our customers request additional support services on a timeand materials basis.

*ProfessionalServices*

Our professional servicesorganization consists of a worldwide team of experienced software consultantswho provide product training, consulting and implementation services related toour software products. By easing the implementation of our products, theseservices help our customers accelerate the time to value. By improving theoverall customer experience, these services also help drive future softwarelicense transactions with customers.

**Customers**

We license our suite ofsoftware automation products to enterprises, government agencies and serviceproviders seeking to reduce costs and increase the quality of data centeroperations. Our customers are in various vertical market segments, includingthe financial services, government, retail, health care, media, 

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industrial,telecommunication, biotechnology/pharmaceutical service providers andhigh-technology sectors. For the fiscal year ended January 31, 2007, EDSaccounted for 21% of our net revenues. We expect that our operating resultswill be largely dependent on our relationship with EDS for the foreseeablefuture. The loss of EDS as a customer would have a material adverse effect uponour business and financial condition.

**IndustryRelationships**

*CiscoSystems.**  *InFebruary 2006, we entered into a worldwide distribution agreement withCisco to distribute our ONAS product under the Cisco Systems brand name. Thisagreement represents a significant expansion of our sales channel and marketreach for our ONAS product, and provides additional sales opportunities forother products in our software automation suite, including our OSAS product.

*Nortel.*   Ourdistribution relationship with Nortel allows all resellers in their SelectProduct Program to purchase and resell ONAS.

We also have various strategic alliances with leadingsoftware, networking and services companies. Our strategy includes workingclosely with these and other companies to promote industry advancement,accelerate new markets and add value for our customers by integrating oursolutions with other software and networking applications. Our TechnologyAlliance Partner (TAP) program with leading global technology companies helpsfacilitates seamless automation efficiencies for our customers and prospects.  TAP memberscomplement the Opsware System automation software suite by offering integratedand complementary software and hardware solutions.

In addition, we have anumber of relationships with resellers and system integrators to support oursales efforts and professional services obligations with our U.S. governmentcustomers.

**Research andDevelopment**

Our research and development organization designs,develops and tests the technologies that we offer to our customers as well asthe services that we use internally to streamline customer deployment andsupport processes. A primary goal of this organization is to bring new productsand new versions of existing products to market quickly in order to keep pacewith customer demands and remain competitive in the marketplace. During thefiscal years ended January 31, 2007, 2006 and 2005, our research anddevelopment expenses were $31.3 million, $22.0 million and $14.3 million,respectively.

**Sales and Marketing**

We sell and market our products and services worldwidethrough a direct sales force and multiple indirect channels. During our 2007fiscal year, we substantially increased the size of our direct sales force inorder to enhance our geographic and vertical market segment coverage. We intendto continue to increase our sales force during fiscal 2008.

As discussed above in “Industry Relationships,” wehave agreements in place with corporate partners, such as distributors,value-added resellers, hardware providers and systems integrators that enablethese companies to market and resell our products.

For the fiscal year ended January 31, 2007, wegenerated approximately 13% of our net revenues from customers in the Europe,Middle East and Africa (“EMEA”) region and Asia Pacific (“APAC”) region. Weexpect these international markets to provide increased opportunities for ourproducts and services in the future. Our current international efforts arefocused on strengthening our direct sales and marketing presence in EMEA andAPAC, and generating more revenues from these regions.

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We focus our marketingefforts on sales force enablement, brand recognition, market awareness and leadgeneration. We intend to continue to invest in building our brand recognitionand sales pipeline through lead generation programs, public relations programs,industry analysts, trade shows and industry and partner conferences.

**Competition**

Our competitors include large software, hardware andsystems companies as well as small, privately-held companies. The market forour technology is relatively new and therefore subject to rapid and significantchange. While we believe our technology is more comprehensive than and superiorto that of our competitors, we cannot assure you of the success of our strategygoing forward.

Our competitors may succeed in developing technologiesand products that are more effective than our software, which could render ourproducts obsolete and noncompetitive. Some of our competitors havesubstantially greater financial, technical and marketing resources, largercustomer bases, longer operating histories, more developed infrastructures,greater brand recognition, larger international presence and more establishedrelationships in the industry than we have, each of which may allow them togain greater market share. As a result, some of our competitors may be able todevelop and expand their technology offerings more rapidly, adapt to new oremerging technologies and changes in customer requirements more quickly, takeadvantage of acquisitions and other opportunities more readily, achieve greatereconomies of scale, devote greater resources to the marketing and sale of theirtechnology and adopt more aggressive pricing policies than we can. Some of ourcompetitors have lower priced offerings and offer point solutions that may be easierto sell and demonstrate to prospective customers. In addition, certain largecompetitors may be able to distribute their software products at minimal costor free of charge to customers. Furthermore, the open source community maydevelop competing software products which could erode our market share andforce us to lower our prices.

Our market isintensely competitive. We believe that some of the principal competitivefactors identified by customers in the data center automation market include:

·       breadthof technologies supported,

·       functionalityof product offerings,

·       qualityand extent of customer support and maintenance,

·       priceand demonstrable return on investment,

·       thevendor’s reputation, leadership team and financial stability,

·       performance,security, scalability, flexibility and reliability of the product offerings,and

·       easeof integration with customers’ existing applications, infrastructure andoperational processes and controls.

Because some of our current competitors havepre-existing relationships with our current and potential customers, we mightnot be able to achieve sufficient market penetration to achieve or sustainprofitability. These existing relationships can also make it difficult for usto obtain additional customers due to the substantial investment that thesepotential customers might have already made based on our competitors’technology. Furthermore, our competitors may be able to devote substantialresources aimed at preventing us from establishing or enhancing our customerrelationships.

Our competitors and othercompanies may form strategic relationships with each other to compete with us.These relationships may take the form of strategic investments, joint-marketingagreements, licenses or other contractual arrangements, any of which mayincrease our competitors’ ability to address customer needs with their productofferings. Our competitors and other companies may consolidate with 

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oneanother or acquire other technology providers, enabling them to offer a broaderarray of products and more effectively compete with us. This consolidationcould affect prices and other competitive factors in ways that could impede ourability to compete successfully and harm our business. In addition, to theextent that we seek to expand our product lines through acquisitions, the trendin the software industry toward consolidation may result in our encounteringcompetition, and paying higher prices, for acquired businesses.

**IntellectualProperty**

We rely on a combination of patent, trademark, tradesecret, copyright and other laws and contractual restrictions to protect theproprietary aspects of our products and services. These legal provisions mayafford only limited protection. It is difficult to monitor unauthorized use ofour technology, particularly in foreign countries where the laws may notprotect our proprietary rights as fully as in the United States, and ourcompetitors may independently develop non-infringing technology similar toours. We will continue to assess the necessity for additional intellectualproperty protections for those aspects of our technology that we believeconstitute innovations providing significant competitive advantages.

We routinely require ouremployees, customers and business partners to enter into confidentiality andnondisclosure agreements before we disclose any sensitive aspects of ourtechnology, services or business plans. In addition, we require employees toassign to us any proprietary information, inventions and other intellectualproperty they generate while employed by us. Despite our efforts to protect ourproprietary rights through confidentiality and license agreements, unauthorizedparties may attempt to copy or otherwise obtain and use our services ortechnology. These precautions may not prevent misappropriation or infringementof our intellectual property.

**Employees**

As of January 31,2007, we had 452 full-time employees. We plan to hire additional personnel forthe foreseeable future as we continue to execute on our growth plan. Our futuresuccess will depend upon our ability to attract, integrate, retain and motivatehighly qualified technical and management personnel, for whom competition canbe intense. None of our employees is covered by a collective bargainingagreement. We believe our relations with our employees are good.

**Executive Officers**

Ourexecutive officers and key employees and their ages as of April 1, 2007are as follows (in alphabetical order):

| **Name**               | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                            | ** ** |
|------------------------|------------|------------|------------|---------|------------|---------------------------------------------------------|------------|
| James E. Adkins        |       |       | 45         |    |       | Executive  Vice President of Products                   |       |
| Jordan J. Breslow      |       |       | 51         |    |       | General  Counsel and Secretary                          |       |
| David F. Conte         |       |       | 41         |    |       | Chief  Financial Officer                                |       |
| Mark D. Cranney        |       |       | 43         |    |       | Executive  Vice President of Worldwide Field Operations |       |
| Benjamin A.  Horowitz  |       |       | 40         |    |       | President  and Chief Executive Officer                  |       |
| Timothy A. Howes       |       |       | 43         |    |       | Chief  Technical Officer                                |       |
| John L. O’Farrell |       |       | 48         |    |       | Executive  Vice President of Business Development       |       |
| Sharmila N. Shahani    |       |       | 41         |    |       | Executive Vice President  of Marketing                  |       |

 

*James E. Adkins*hasserved as our Executive Vice President of Products since November 2005 andpreviously served as our Senior Vice President of Engineering for the OpswareServer Automation System and Opsware Asset Management System products from December 2004to November 2005. Prior to joining Opsware, Mr. Adkins was SeniorVice President of the Rational Suites Group at Rational 

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Software, a provider ofsoftware development life-cycle tools and infrastructure products that wasacquired by IBM in 2003, from February 2001 to February 2004. Mr. Adkinsjoined Rational following its acquisition of Catapulse, a provider of hosteddevelopment services, where he was Senior Vice President of Products from February 2000to February 2001. Prior to Catapulse, Mr. Adkins served as the VicePresident of the Commerce Exchange division at Netscape Communications and wasresponsible for the ECXpert and TradingXpert electronic commerce softwareproducts from June 1996 to February 2000. From 1985 to 1996, Mr. Adkinsheld management and engineering positions within the General Electric Company. Mr. Adkinsholds a B.S. in Biochemistry from David Lipscomb University, and an M.B.A fromBelmont University.

*Jordan J. Breslow*hasserved as our General Counsel and Secretary since August 2001. Mr. Breslowalso served as our Chief Counsel from January 2000 to August 2001.Prior to joining Opsware, Mr. Breslow served as Vice President and GeneralCounsel of Geoworks, a software company, from 1990 to 1998 where he also servedas Managing Director of European Operations, from 1997 to 1998. From 1998 to1999, Mr. Breslow was co-chair of the intellectual property practice groupat Foster, Pepper and Shefelman, a law firm. From 1982 to 1989, Mr. Breslowwas a partner at Stewart, Stewart & Breslow, a law firm. Mr. Breslowholds a B.A. in anthropology from San Francisco State University and J.D. fromHastings College of Law.

*David F. Conte* has served ourChief Financial Officer since July 2006.  Mr. Conte joined Opsware in 1999 shortlyafter the company’s inception and previously served as Vice President ofFinance from March 2003 to July 2006 and Corporate Controller from October 1999to March 2006. Prior to joining Opsware, Mr. Conte worked at Ernst &Young LLP in their High Technology practice. Mr. Conte is a CertifiedPublic Accountant and has a degree in business economics from the University ofCalifornia, Santa Barbara.

*Mark D. Cranney*hasserved as our Executive Vice President of Worldwide Field Operations since November 2005and as our Executive Vice President of Sales from May 2004 to November 2005.Prior to joining Opsware, Mr. Cranney served as Senior Division VicePresident-Americas at Parametric Technology Corp., a provider of productlife-cycle management enterprise software and consulting solutions, from April 1998to September 2003. From April 1996 to April 1998, Mr. Cranneyserved as a Vice President of Sales and Marketing at DxU, a privately-heldmedical device company. Prior to DxU, Mr. Cranney served as a nationalsales manager for the Patient Care Division of C.R. Bard, Inc., a medicaldevice manufacturer, and started his career in sales and sales managementpositions at Lanier Worldwide. Mr. Cranney holds a B.S. degree in BusinessAdministration and Marketing from Southern Utah University.

*Benjamin A. Horowitz* is aco-founder of Opsware and has served as our President and Chief ExecutiveOfficer and as a director since September 1999. Prior to co-foundingOpsware, Mr. Horowitz served as Vice President and General Manager of theE-Commerce Platform division of America Online, Inc. from April 1999to September 1999. From July 1995 to April 1999, Mr. Horowitzwas a vice president at Netscape Communications. Mr. Horowitz serves onthe board of directors of MIPS Technologies, Inc. Mr. Horowitz holdsa B.A. in computer science from Columbia University and an M.S. in computerscience from the University of California, Los Angeles.

*Timothy A. Howes*isa co-founder of Opsware and has served as our Chief Technical Officer since September 1999and our Executive Vice President of Development from October 2001 to December 2004Prior to co-founding Opsware, Dr. Howes served as Vice President ofTechnology at America Online, Inc. from April 1999 to September 1999.From February 1998 to April 1999, Dr. Howes was Chief TechnologyOfficer of the Server Product division at Netscape Communications. From April 1996to February 1998, Dr. Howes was Principal Engineer, DirectingArchitect of several server products at Netscape Communications. From September 1994to April 1996, Dr. Howes was Project Director, Principal 

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Investigator and SeniorSystems Research Programmer at the University of Michigan. Dr. Howesserves on the board of directors of Blue Coat Systems, Inc. Dr. Howesholds a Ph.D. in computer science, a B.S.E. in aerospace engineering and anM.S.E. in computer science and engineering from the University of Michigan.

*John L. O’Farrell*hasserved as our Executive Vice President of Business Development since March 2001.Prior to joining Opsware, Mr. O’Farrell served as Executive VicePresident, International for At Home Corporation, a provider of broadbandInternet access and media services, from March 2000 to March 2001,and as Senior Vice President, International from April 1997 to March 2000,including after its acquisition of Excite Inc. in May 1999. From August 1995to April 1997, he was President of US WEST Interactive Services, anInternet content development and investment company. Prior to that time, Mr. O’Farrellserved as Vice President, Corporate Strategy of US WEST Inc., a telephone andcable network operator, from May 1994 to August 1995, and asExecutive Director, Corporate Strategy from March 1992 to May 1994.Before joining US WEST Inc., Mr. O’Farrell held general management,marketing and consulting positions in the United States and Europe with TelecomIreland (Ireland), Booz, Allen and Hamilton (U.S.), the Commission of theEuropean Communities (Luxembourg), Digital Equipment Corporation and Siemens AG(both Germany). Mr. O’Farrell holds a B.E. degree from University CollegeDublin, Ireland, and an M.B.A. from the Stanford Graduate School of Business.

*Sharmila N. Shahani* has served asour Executive Vice President of Marketing since February 2006 and as ourSenior Vice President of Marketing from May 2002 to February 2006.Prior to joining Opsware, Ms. Shahani served as Vice President ofMarketing and Business Development for Totality, a managed IT servicesprovider, from June 2000 to May 2002. From November 1999 to June 2000,Ms. Shahani served as a Vice President of Product Marketing for AmericaOnline’s E-commerce Services group. Prior to America Online, Ms. Shahaniserved as Vice President of Product Marketing for Netscape Communications from November 1997to November 1999. Prior to Netscape, Ms. Shahani led marketing forKiva Software, an application server company, from May 1996 to November 1997.Prior to Kiva, Ms. Shahani held multiple managerial positions at GeneralMagic, a software company, Microsoft Corporation and Hewlett Packard. Ms. Shahaniholds a B.A. in business and economics and a B.S. in computer science fromNorthwestern University and an M.A. in management from the Kellogg GraduateSchool of Business.

**AvailableInformation**

Our Internet website is located athttp://www.opsware.com. The information on our website is not a part of thisannual report. We make available free of charge on our website our annualreport on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K and amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the SecuritiesExchange Act of 1934, as soon as reasonably practicable after we electronicallyfile such material with, or furnish it to, the Securities and ExchangeCommission.

The public may also read and copy any materials wefile with the Securities and Exchange Commission at the Securities and ExchangeCommission’s Public Reference Room at 450 Fifth Street, N.W., Washington,D.C. 20549. The public may obtain information on the operation of the PublicReference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330.The Securities and Exchange Commission also maintains an Internet website thatcontains reports, proxy and information statements and other informationregarding issuers that file electronically with the Securities and ExchangeCommission. The Securities and Exchange Commission’s Internet website islocated at http://www.sec.gov.

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**ITEM 1A.**        RISKFACTORS

Set forth below andelsewhere in this Annual Report on Form 10-K and in other documentswe file with the Securities and Exchange Commission are risks and uncertaintiesthat could cause actual results to differ materially from the resultscontemplated by the forward-looking statements contained in this Annual Reporton Form 10-K.

**We have relativelylimited experience operating as a software company, which makes it difficult toevaluate our future prospects.**

As a result of thesale of our Managed Services Business to EDS in fiscal 2003, our business modelshifted from providing managed Internet services to primarily licensing oursoftware products. We have relatively limited experience operating as asoftware company. As a result, we have limited ability to forecast futuredemand for our products and there is limited financial data upon which you mayevaluate our business and prospects. Our potential for future profitabilitymust be considered in light of the risks, uncertainties and difficultiesfrequently encountered by companies in their early stages of development,particularly companies in new and rapidly evolving markets. Some of these risksrelate to our potential inability to:

·       signcontracts with a sufficient number of customers in the time frame we anticipatein order to meet our financial goals, including our bookings, revenue andearnings targets;

·       providehigh levels of support for our products and support the deployment of a highervolume of our products;

·       developnew product offerings and extend the functionality of our existingtechnologies;

·       developand extend our software products to effectively support a wide range ofhardware, software and operating systems to meet the diverse needs ofcustomers;

·       integrateacquired businesses and technologies;

·       developeffective direct sales and indirect channels to license our suite of softwareproducts;

·       developadditional strategic partnerships to facilitate our ability to market andlicense our software products;

·       developthe capability that permits our software products to be integrated with thevariety of existing management systems that customers may already havedeployed; and

·       establishawareness of our brand.

If we do not successfullyaddress these risks, we may not realize sufficient revenue to reach or sustainprofitability.

**Our financialresults may fluctuate significantly, which could cause our stock price todecline.**

Our revenue andoperating results could vary significantly from period to period. Thesefluctuations could cause our stock price to fluctuate significantly or decline.Important factors that could cause our quarterly and annual financial resultsto fluctuate include:

·       ourability to obtain new customers and retain and generate expanded business fromour existing customers;

·       changesin the mix of higher-margin software products versus lower-margin integrationand support services, and in the mix of sales through our direct versusindirect channels;

·       thetiming of signing contracts with customers;

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·       thatfor the foreseeable future, whether we meet our sales targets will depend onclosing a small number of relatively large deals each quarter;

·       thetiming and magnitude of operating expenses and capital expenditures;

·       theeffect of any non-cash stock-based compensation;

·       thetiming of our satisfaction of revenue recognition criteria;

·       changesin our pricing policies or those of our competitors;

·       thetiming of product releases or upgrades by us or by our competitors;

·       costsrelated to the various third-party technologies we may incorporate into ourtechnology and services; and

·       anydownturn in our customers’ and potential customers’ businesses or in economicconditions generally.

We are planning to increase our operating expenses andcapital expenditures in order to support our growth plans and based on ourestimates of future revenue. We believe that these expenditures are necessaryin order to position our company for growth, but there is no assurance thatthese investments will result in sales and revenue substantial enough tocompensate for these expenses. We may not be able to adjust spending in atimely manner to compensate for any unexpected revenue shortfall, and anysignificant shortfall in revenue relative to planned expenditures couldnegatively impact our business and results of operations.

Our quarterly sales have historically reflected apattern in which a disproportionate percentage of a quarters’ total sales haveoccurred toward the end of that quarter. This makes predicting our revenue,earnings and cash flows for each financial period more difficult and increasesthe risk of unanticipated variations in our financial results.

In addition, during our fiscal year 2007, the bulk ofour license sales for the year occurred in the latter two fiscal quarters, andwe believe this pattern will continue in fiscal year 2008. This seasonalitycould make it more difficult to predict or understand our financial results,which could have an adverse impact on the trading price of our common stock.

Due to these and otherfactors, period-to-period comparisons of our operating results may not bemeaningful. You should not rely on our results for any one period as anindication of our future performance. In future periods, our operating resultsmay fall below the expectations of market analysts or investors. If thisoccurs, the market price of our common stock would likely decline.

**Our business dependson closing a small number of relatively large transactions each quarter, whichcan lead to significant fluctuations in our financial results.**

Our quarterly sales tocustomers other than EDS, and consequently the revenues that we recognize incurrent or subsequent quarters, are especially subject to fluctuation, becausethey normally depend on the completion of a small number of relatively largelicense transactions. This dependence on large orders makes our net revenue andoperating results more likely to vary from quarter to quarter, and moredifficult to predict, because the loss or delay of any particular large orderis significant. As a result, our operating results could be adversely impactedif any large orders are delayed or canceled in any future period.

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**Sales of ourproducts generally involve lengthy sales cycles, which may cause our financialresults to suffer.**

We focus our salesefforts on enterprises, government agencies and service providers. Sales of ourproducts to these entities generally involve a long sales cycle. The length ofthe average sales cycle could make it more difficult for us to predict revenueand plan expenditures accordingly. The sales cycle associated with the purchaseof our products is subject to a number of significant risks over which we havelittle or no control, such as:

·       customers’budget cycles, budgetary constraints and internal acceptance procedures;

·       thelimited experience and customer references we have from operating as a softwarecompany;

·       concernsabout the introduction or announcement of new products or enhancements by ourcustomers or us; and

·       potentialdownturns in the IT market and in economic conditions generally.

In addition, the time ittakes to demonstrate and deploy our software with these accounts may be longerthan a non-enterprise customer given the complexity of their operations, whichmay delay our ability to recognize revenue from sales to these accounts and mayaffect customer satisfaction.

**The data centerautomation market is relatively new and our business will suffer if the marketdoes not develop as we expect.**

The market for ourproducts and services is relatively new and may not grow as we expect or besustainable. Potential customers may choose not to purchase data centerautomation software from a third-party provider due to concerns about security,reliability, vendor stability and viability, cost or system compatibility. Itis possible that our products may never achieve broad market acceptance. Wewill incur operating expenses based to an extent on anticipated revenue trendsthat are difficult to predict given the recent emergence of the data centerautomation software market. If this market does not develop, or develops moreslowly than we expect, we may not achieve significant market acceptance for oursoftware, our rate of revenue growth may be constrained and our operatingresults may suffer.

**The market for ourtechnology and services is competitive and we may not have the resourcesrequired to compete effectively.**

The market for our technology is relatively new andtherefore subject to rapid and significant change and we cannot assure you of thesuccess of our strategy going forward. Our competitors may succeed indeveloping technologies and products that are more effective than our software,which could render our products obsolete and noncompetitive. Some of ourcompetitors have substantially greater financial, technical and marketingresources, larger customer bases, longer operating histories, more developedinfrastructures, greater brand recognition, greater international presence andmore established relationships in the industry than we have, each of which mayallow them to gain greater market share. As a result, some of our competitorsmay be able to develop and expand their technology offerings more rapidly,adapt to new or emerging technologies and changes in customer requirements morequickly, take advantage of acquisitions and other opportunities more readily,achieve greater economies of scale, devote greater resources to the marketingand sale of their technology and adopt more aggressive pricing policies than wecan. Some of our competitors have lower priced offerings and offer solutionsthat may be easier to sell and demonstrate to prospective customers. Inaddition, certain large competitors, including hardware manufacturers, may beable to distribute their software products at minimal cost or free of charge tocustomers. Furthermore, the open source community may develop competingsoftware products which could erode our market share and force us to lower ourprices. Our competitors include large software and systems companies as well assmall privately-held companies.

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Because some of our current competitors havepre-existing relationships with our current and potential customers, we mightnot be able to achieve sufficient market penetration to achieve or sustainprofitability. These existing relationships can also make it difficult for usto obtain additional customers due to the substantial investment that thesepotential customers might have already made based on our competitors’technology. Furthermore, our competitors may be able to devote substantialresources aimed at preventing us from establishing or enhancing our customerrelationships.

Our competitors and othercompanies may form strategic relationships with each other to compete with us. Theserelationships may take the form of strategic investments, joint-marketingagreements, licenses or other contractual arrangements, any of which mayincrease our competitors’ ability to address customer needs with their productofferings. Our competitors and other companies may consolidate with one anotheror acquire other technology providers, enabling them to offer a broader arrayof products and more effectively compete with us. This consolidation couldaffect prices and other competitive factors in ways that could impede ourability to compete successfully and harm our business. In addition, to theextent that we seek to expand our product lines, managerial and technicalpersonnel skills and capacity through acquisitions, the trend in the softwareindustry toward consolidation may result in our encountering competition, andpaying higher prices, for acquired businesses.

**If we fail tomaintain or achieve benefits from our existing distribution channels and failto develop additional channels in the future, our financial results may suffer.**

We generate a portion of our revenue from sales of ourproducts and services through our network of indirect channel partners,including through our distribution agreement with Cisco Systems that isdiscussed below. We may not experience increased revenue from new channels andmay see a decrease in revenue from our existing channels, which could harm ourbusiness. The loss of one or more of our channel partners, or any reduction ordelay in their sales of our products and services could result in reductions inour revenue in future periods. In addition, our ability to increase our revenuein the future depends on our ability to expand our indirect distributionchannels.

Our dependence onindirect distribution channels presents a number of risks, including:

·       ourchannel partners may cease marketing our products and services with limited orno notice and with little or no penalty;

·       ourchannel partners are generally not subject to minimum sales requirements or anyobligation to market our products to their customers;

·       wemay face conflicts between the activities of our indirect channels and ourdirect sales and marketing activities; and

·       ourchannel partners in some cases may not give priority to the marketing of ourproducts and services as compared to our competitors’ products or their ownproducts.

In addition, we haveformed in the past, and intend to continue to form in the future, strategicrelationships with other technology companies in order to obtain a broaderreach for our products and services. We cannot guarantee that any new customerrelationships or revenue, or other anticipated benefits, will result from thesestrategic relationships. In addition, in the event that our strategic partnersexperience financial difficulties, we may not continue to realize existingbenefits from these relationships.

**There is noassurance that we will achieve the benefits we anticipate from our newrelationship with Cisco Systems.**

We entered into adistribution agreement in February 2006 with Cisco Systems to distributeour ONAS product under the Cisco Systems brand name to customers directly orthrough Cisco’s distributors 

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andresellers. The initial term of this agreement is three years, although it maybe terminated earlier in certain circumstances. If Cisco terminates theagreement early or does not renew the agreement, our business and operatingresults may be adversely affected. There is no assurance that we will fullyrealize the benefits anticipated under this agreement, such as additionalopportunities to cross-sell our OSAS product, and the amount and timing ofrevenue recognized as a result of sales under this arrangement are uncertain. Inaddition, this relationship with Cisco has displaced, and may continue todisplace, some sales that might otherwise occur through our direct sales forceor other indirect sales channels. Since our margins on sales under the Ciscoagreement may be lower than under our existing distribution arrangements withother partners, we would need to generate a higher volume of sales under theCisco agreement than we would with our other distribution partners.

**Our operatingresults are and will continue to be highly dependent upon our relationship withEDS and any deterioration of our relationship with EDS could adversely affectthe success of our business.**

Our operating results are largely dependent on ourrelationship with EDS and will continue to be so for the foreseeable future. InAugust 2002, we entered into a three-year, $52.0 million license andmaintenance agreement with EDS. In August 2004, we entered into anamendment of our license and maintenance agreement with EDS whereby EDS agreedto extend the term of the agreement through March 2008 and committed topay minimum additional license and maintenance fees of approximately $50.0million over the term of the extended license. For the year ended January 31,2007, EDS accounted for 21% of our net revenue. If our relationship with EDSwere to deteriorate, or if EDS’s own financial position were to deteriorate,our business and results of operations would be adversely affected.

Although we extended ourlicense and maintenance agreement with EDS through March 2008, we cannotassure you that EDS will renew the license beyond the extended term or that ifEDS does renew the license beyond the extended term, it will do so on the termscontemplated in the agreement. Whether or not EDS continues to license oursoftware may depend, in large part, on its level of customer satisfaction andits own financial position. In addition, we cannot assure you that EDS willachieve the benefits they expect from our software products or that they willbe able to continue to deploy our software successfully or in the time framescontemplated by the license agreement. Each of these factors may affect EDS’willingness to renew the license. If EDS does not renew the license, ourbusiness and operating results may be adversely affected and this maynegatively impact our reputation and our ability to license our softwareproducts to other customers. In addition to these risks, the occurrence of anyof the adverse events discussed elsewhere in these Risk Factors couldnegatively impact our relationship with EDS and, consequently, our business.

**If we do notdevelop our direct sales organization, we will have difficulty acquiringcustomers.**

Our products require asophisticated sales effort targeted at a limited number of key people withinour prospective customers’ organizations. Because the market for our technologyand services is new, many prospective customers are unfamiliar with theproducts we offer. As a result, our sales effort requires highly trained salespersonnel. During fiscal 2007, we substantially increased the size of ourdirect sales force in order to enhance our geographic and vertical marketsegment coverage, and we intend to continue to increase our sales force duringthe remainder of fiscal 2008. Competition for these individuals is intense, andwe may not be able to hire and retain the type and number of sales personnel weneed. Moreover, even after we hire these individuals, they require extensivetraining and time to become productive, and there is no guarantee that theywill produce at the levels that we anticipate. If we decide, but are unable, toexpand our direct sales force and train new sales personnel as rapidly asnecessary, we may not be able to increase market awareness and sales of ourproducts, which may prevent us from growing our revenue and achieving andmaintaining profitability.

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**If we are unable tomanage rapid growth and change, our operating results could be adverselyaffected.**

We are currently experiencing a period of rapid growthin our headcount and operations, which has placed, and will continue to place asignificant strain on our management, administrative, operational and financialinfrastructure. We anticipate that further growth will be required to addressincreases in our customer base, as well as our expansion into new geographicareas. To successfully manage this growth, we will need to continue to implementadditional management information systems, continue the development of ouroperating, administrative, financial and accounting systems and controls andmaintain close coordination among our executive, engineering, finance, legal,marketing, sales and operations organizations. Any failure by us to properlymanage growth could impair our ability to attract and service customers andcould cause us to incur higher operating costs and experience delays in theexecution of our business plan.

In particular, we are inthe process of implementing a new Enterprise Resource Planning system, or ERPsystem. If we are unable to implement the ERP system in a timely and efficientmanner, management’s attention may be diverted from other business concerns andwe may encounter difficulties in accurately reporting on our financialperformance on a timely basis, either of which could have a material adverseeffect on our business, financial condition and results of operations.

**Our operatingresults and financial condition may be materially harmed if we are notsuccessful at managing and expanding our international sales.**

Revenue from internationalcustomers accounts for a meaningful portion of our revenue, and we plan toincrease our international sales efforts in the future. Revenue frominternational customers accounted for 13% of our net revenue during the yearended January 31, 2007. Expanding internationally requires significantmanagement attention and financial resources, and we may not generatesufficient revenues to cover these expenses. For any such expansion, we willalso need to, among other things, expand our international sales force andoperations, expand our international sales channel management and supportorganizations and develop relationships with international service providersand additional distributors and system integrators. In addition, asinternational operations become a larger part of our business, we couldencounter, on average, greater difficulty with collecting accounts receivable,longer sales cycles and collection periods, greater seasonal reductions inbusiness activity and increased tax rates. Furthermore, products may need to belocalized or customized to meet the needs of local users, before they can besold in certain foreign countries. Developing localized versions of ourproducts for foreign markets is difficult and could take longer than weanticipate.

**The expansion ofour international operations subjects our business to additional risks thatcould have an adverse impact on our business.**

In addition,international business activities may subject us to a variety of risks andchallenges, including the following:

·                    management,communication and integration problems resulting from cultural differences andgeographic dispersion;

·                    compliancewith foreign laws and adoption or changes in foreign laws, includingrequirements for export or import clearances in connection with thedistribution of our products;

·                    competitionfrom companies with international operations;

·                    difficultiesin protecting intellectual property rights in international jurisdictions;

·                    politicaland economic instability in some international markets;

·                    currencyfluctuations and exchange rates; and

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·                    potentiallyadverse tax consequences or inability to realize tax benefits.

We may not succeed in ourefforts to expand our international presence as a result of the factorsdescribed above or other factors that may have an adverse impact on our overallfinancial condition and results of operations.

**Unfavorableeconomic conditions and reductions in information technology spending couldlimit our ability to grow our business.**

Our business and operating results are subject to theeffects of changes in general economic conditions and changes in theinformation technology market. In addition, fears of recession or economicslowdown, war and acts of terrorism may impact global economies negatively. Webelieve that, during the past few years, poor U.S. economic conditions, as wellas a decline in worldwide economic conditions, led to reduced IT spending. Ifthese conditions resurface, demand for our products may be reduced.

Our management is requiredto make forecasts with respect to economic trends and general businessconditions in order to develop budgets, plan research and development strategiesand perform a wide variety of general management functions. To the extent thatour forecasts are incorrect, our performance may suffer because of a failure toproperly align our corporate strategy with economic conditions.

**The rates we chargeour customers for our software products may decline or the terms of ourcustomer contracts upon renewal may be changed over time, either of which couldreduce our revenue and affect our financial results.**

As our business modelattracts the attention of competitors, we may experience pressure to decreasethe fees we charge for our software products, which could adversely affect ourrevenue, gross margins and profitability. If we are unable to license oursoftware at acceptable prices, or if we fail to offer additional products withsufficient profit margins, our revenue growth could slow, our margins may notimprove and our business and financial results could suffer. In addition, wemay choose to enter into new contracts with existing customers to betterachieve our business objectives, and any new contracts could affect the mannerin which we report our results of operations as well as the historicalaccounting treatment for any such contracts.

**We must satisfy thecriteria for revenue recognition in order to recognize the fees generated underour license agreements as revenue.**

In order to recognize the fees generated under ourlicense agreements as revenue, we must demonstrate that the license arrangementsatisfies the criteria for revenue recognition including persuasive evidencethat an arrangement exists, delivery has occurred, the fee is fixed ordeterminable and collectibility is probable. If we are unable to satisfy thecriteria for revenue recognition, our operating results may suffer or mayfluctuate significantly from period to period. In addition, the timing of ourrecognition of revenue will depend upon the mix of revenue that is recognizedin connection with multi-year licenses under the residual method or ratablypursuant to the American Institute of Certified Public Accountants (AICPA) SOP97-2 and SOP 98-9, under the percentage of completion or completedcontract method of accounting, pursuant to SOP 81-1.

In addition, if we are notable to achieve or maintain vendor specific objective evidence (VSOE) of fairvalue for any of our current or future product lines (other than softwarelicenses, for which VSOE is not applicable), we could be required, in certaincircumstances, to recognize all license, maintenance and professional servicesrevenues for a particular deal ratably over the maintenance period or defer allrevenue recognition until professional services are delivered. Our revenuerecognition treatment, and accordingly the length of time between execution ofa sales contract and recognition of revenue, varies 

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amongour products. As a result, the mix of sales of particular products could impactour recognition of revenues from these sales in future quarters.

**We may continue toincur operating losses and negative cash flow in future periods.**

We may be required to spend significant funds tocontinue developing our software products, and to expand our research anddevelopment and sales and marketing organizations to fit the needs of ourbusiness. We have incurred significant operating and net losses and negativecash flow in the past and have not achieved profitability on a GAAP basis. Ifour revenue grows more slowly than we anticipate or if our operating expensesincrease by more than we expect, our cash flow and operating results willsuffer. Consequently, it is possible that we will never achieve profitabilityon a GAAP basis. Even if we do achieve positive cash flow or profitability inany one quarter, we may not sustain or increase positive cash flow orprofitability on a quarterly or annual basis in the future.

In addition, any decisionto restructure our operations, to exit any activity or to eliminate any excesscapacity could result in significant accounting charges. Future businesscombinations may also result in restructuring or other accounting charges. Thesecharges could result in greater net losses, could transform an otherwiseprofitable quarter into a net loss in future periods, or could materiallyimpair earnings should we achieve profitability in the future.

**Our revenue andoperating results will be highly dependent upon our ability to provide highlevels of customer satisfaction.**

Our products must integrate with many existingcomputer systems and software programs used by our customers. In addition,integration requires adaptation to each customer environment, both in terms ofinteroperability and to meet the particular goals and objectives of eachcustomer for our products. This integration can be complex, costly and timeconsuming, and can cause delays in the deployment of our products for customers.Customers could become dissatisfied with our products if deployments withincustomer environments prove to be difficult, costly or time consuming, and thiscould negatively impact our ability to sell our products in the future.

We provide technical support to our customers pursuantto contracts that are generally renewable annually. Our customers’ willingnessto renew their maintenance and support agreements, enter into new contracts foradditional products and act as a reference account will depend in large part onour ability to provide high levels of customer service. If we fail to providethe level of support demanded by our customers or if the capabilities of ourproducts do not match our customers’ expectations, they may not renew theirmaintenance and support agreements or enter into new contracts for additionalproducts and may not act as a reference account, each of which could have amaterial adverse impact on our revenue and operating results.

**We makeacquisitions from time to time, which may place a strain on our resources,cause dilution to our stockholders and harm our operating results.**

From time to time we make acquisitions of othercompanies in an effort to increase our customer base, broaden our productofferings or expand our technology platform. For example, in March 2007,we announced a definitive agreement to acquire iConclude Co. (“iConclude”), aprivate company engaged in developing IT process automation solutions andlocated in Bellevue, Washington. The closing of the iConclude acquisitionremains subject to certain closing conditions which must be satisfied by us andiConclude. There is no assurance that the sale of iConclude’s products willcontribute to our results to the extent that we expect for a number of reasons,including the integration risks described below

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If we fail toevaluate and execute acquisitions successfully, they may seriously harm ourbusiness. We may not realize anticipated benefits from acquisitions if we areunable to do the following:

·       effectivelymarket and sell the newly acquired products, and capitalize on cross-sellingopportunities;

·       effectivelyprovide services to any newly acquired customers;

·       accuratelyforecast the financial impact of the transaction, including but not limited to,the risk that revenues from acquired companies, products and technologies donot meet our expectations.

·       managethe expenses of the acquired business;

·       integrateand retain personnel;

·       effectivelydevelop new products based upon acquired technologies;

·       managegeographically dispersed operations; and

·       addressunforeseen liabilities or risks associated with the acquired company.

Integrating acquired businesses has been and willcontinue to be a complex, time consuming and expensive process. To integrateacquired businesses, we must implement our technology systems in the acquiredoperations and integrate and manage the personnel of the acquired operations. Oursuccess in completing the integration of acquired businesses may impact themarket acceptance of such acquisitions, and our willingness to acquire additionalbusinesses in the future. Other challenges of integration include our abilityto incorporate acquired products and business technology into our existingproduct lines, including consolidating technology with duplicativefunctionality or designed on a different technological architecture, and ourability to sell the acquired products through our existing or acquired saleschannels. Further, the difficulties of integrating acquired businesses coulddisrupt our ongoing business, distract our management focus from otheropportunities and challenges, and increase our expenses and working capitalrequirements.

Future acquisitions mayresult in entering into markets or acquiring technologies in areas in which wehave little experience. Future acquisitions also may result in customerdissatisfaction, new competitors, performance problems with an acquired companyand its technology, dilutive issuances of equity securities, the use of asubstantial portion of our cash and investment balances, the incurrence ofadditional debt, large one-time write-offs and the creation of goodwill orother intangible assets that could result in significant impairment charges oramortization expense. Any of the foregoing and other factors could harm ourability to achieve anticipated levels of profitability from acquired businessesor to realize other anticipated benefits of acquisitions. Mergers andacquisitions of high technology companies are inherently risky, and noassurance can be given that our previous or future acquisitions will besuccessful or will not materially adversely affect our business, operatingresults, or financial condition.

**Our business issubject to various laws and regulations that have increased both our costs andthe risk of noncompliance, which could subject us to future claims andlitigation that could harm our business.**

Our business is subject to various regulations andlaws relating to issues such as employment practices, privacy and datasecurity, corporate governance and intellectual property ownership andinfringement. We may incur substantial liabilities for expenses necessary tocomply with these regulations and laws or penalties for any failure to comply. Ourbusiness could also be adversely affected if new laws are implemented orexisting laws are changed.

Our efforts to comply with regulations applicable tous have resulted in, and are likely to continue to result in, increased generaland administrative expenses and a diversion of management time and attentionfrom revenue-generating activities to compliance activities. Any failure tocomply with the reforms 

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required by these laws andregulations could significantly harm our business, operating results andfinancial condition

In the course of ourbusiness, any actual or perceived noncompliance with laws and regulations maysubject us to claims and litigation The expense of defending such litigation,regardless of its merits, may be costly and divert management’s attention fromthe day-to-day operations of our business, which could have an adverse impacton our business, operating results and financial condition. In addition, theoutcome of any claims or litigation may be difficult to predict and could havean adverse impact on our business, operating results and financial condition.

**Future changes inaccounting standards or our interpretation of current standards could causeunexpected fluctuations in  our financialresults.**

Future changes inaccounting standards or our interpretation of current standards, particularlythose affecting revenue recognition, could require us to change our accountingpolicies. These changes could cause unexpected fluctuations in our financialresults. For example, changes affecting revenue recognition could cause us todefer revenue recognized in current periods to subsequent periods or toaccelerate recognition of deferred revenue to current periods, each of whichcould impair our ability to meet securities analysts’ and investors’expectations, which could cause a decline in our stock price.

**The new accountingtreatment for stock options has significantly impacted our results ofoperations and may lead to changes in our equity compensation strategy thatcould negatively impact our ability to attract and retain employees.**

The new accounting treatment for stock options requiresus to account for employee stock options as compensation expense on ourfinancial statements for the periods following February 1, 2006. This hashad a significant impact and is expected to continue to have a significantimpact, on our reported results of operations and our timing to achieveprofitability on a GAAP basis.

We have historically usedstock options as a key component of our employee compensation program in orderto align employees’ interests with the interests of our stockholders, encourageemployee retention, and provide competitive compensation packages. The newregulatory landscape makes it more expensive for us to grant stock options toemployees. In light of this, we may modify our equity compensation strategy toemphasize equity incentives other than stock options, including increased useof certain performance-related features. If employees believe that theincentives that they would receive under a modified strategy are lessattractive, we may find it difficult to attract, retain and motivate employees.We may incur increased compensation costs, further change our equitycompensation strategy or find it increasingly difficult to attract, retain andmotivate employees, each of which could materially and adversely affect ourbusiness, financial condition or results of operations.

**If we do notdevelop and maintain productive relationships with systems integrators, ourability to deploy our software, generate sales leads and increase our revenuesources may be limited.**

We intend to develop andmaintain productive relationships with a number of computing and systemsintegration firms to enhance our sales, support, service and marketing efforts,particularly with respect to the implementation and support of our products, aswell as to help generate sales leads and assist in the sales process. Many suchfirms have similar, and often more established, relationships with ourcompetitors. These systems integrators may not be able to provide the level andquality of service required to meet the needs of our customers. If we areunable to develop and maintain effective relationships with systemsintegrators, or if they fail to meet the needs of our customers, our businesscould be adversely affected.

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**Because our successdepends on our proprietary technology, if third parties infringe ourintellectual property or if we are unable to rely upon the legal protectionsfor our technology, we may be forced to expend significant resources enforcingour rights or suffer competitive injury.**

Our success depends in large part on our proprietarytechnology. We have a number of issued patents and pending patent applications,and we currently rely on a combination of copyright, trademark, trade secretand other laws and restrictions on disclosure to protect our intellectualproperty rights. These legal protections afford only limited protection, andour means of protecting our proprietary rights may not be adequate. Inaddition, defending our intellectual property rights might entail significantexpense. Our intellectual property rights may be challenged by others orinvalidated through administrative process or litigation.

Our intellectual property may be subject to evengreater risk in foreign jurisdictions, as the laws of many countries do notprotect proprietary rights to the same extent as the laws of the United States.If we cannot adequately protect our intellectual property, our competitiveposition may suffer.

We may be required tospend significant resources to monitor and police our intellectual property rights.We may not be able to detect infringement and may lose our competitive positionin the market before we are able to ascertain any such infringement. Inaddition, competitors may design around our proprietary technology or developcompeting technologies. Litigation may be necessary in the future to enforceour intellectual property rights, to protect our trade secrets, to determinethe validity and scope of the proprietary rights of others or to defend againstclaims of infringement. Any such litigation could result in significant costsand diversion of resources, including the attention of senior management.

**If our productsinfringe on the intellectual property rights of others, we could face costlylitigation, which could cause us to pay substantial damages and ongoingroyalties, and limit our ability to use our technology or license some or allof our products.**

Other companies,including our competitors, may obtain patents or other proprietary rights thatcould prevent, limit or interfere with our ability to make, use or license ourproducts. As a result, we may be found to infringe on the proprietary rights ofothers. Intellectual property litigation or claims could force us to do one ormore of the following:

·       engagein costly litigation and pay substantial damages to third parties;

·       indemnifycertain customers or commercial partners;

·       stoplicensing technologies that incorporate the challenged intellectual property;

·       terminateexisting contracts with customers or with channel partners;

·       contributeportions of our proprietary technology to the open source community;

·       obtaina license from the holder of the infringed intellectual property right, whichmay not be available on reasonable terms or at all; or

·       redesignour technology and products, if feasible.

If we are forced to take any of the foregoing actions,our business and financial condition may be seriously harmed. In addition, theoccurrence of any of these conditions could have the effect of increasing ourcosts and reducing our revenue. Our insurance for potential claims of this typemay not be adequate or available to indemnify us for all liability that may beimposed.

We use what we believe tobe open source software in our products and may use more of this software inthe future. As a result, we could be subject to suits by third parties claimingownership of what we believe to be open source software or we could be found tobe non-compliant with the terms and 

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conditionsof the open source licenses that we use. Any non-compliance could result inlitigation or loss of the right to use this software. In addition, potentialcustomers may delay or decline a purchase of technology involving open sourcesoftware, and open source license terms may result in unanticipated obligationsfor us or our customers.

**Our business willsuffer if we do not enhance our products or introduce new products and upgradesto meet changing customer requirements.**

The market for our products and services ischaracterized by rapid technological change, uncertain product life cycles,changes in customer demands, evolving industry standards and increasedcomplexity and interdependence of our applications. Any delays in responding tothese changes and developing and releasing enhanced or new products andupgrades could hinder our ability to retain existing and obtain new customers. Inparticular, our technology is designed to support a variety of hardware andsoftware products that we believe to be proven and among the most widely used. Wecannot be certain, however, that present and future customers will continue touse these products. Even if they do, new versions of these products are likelyto be released and we will need to adapt our technology to these new versions. Wemust, therefore, constantly modify and enhance our technology to keep pace withchanges made to our customers’ hardware and software configurations. If we failto promptly modify or enhance our technology in response to evolving customerneeds and demands, fail to introduce new products and upgrades or fail to fullydevelop our new product offerings, our technology may not achieve widespreadacceptance and could become obsolete, which would significantly harm ourbusiness.

As we introduce newproducts or technologies into existing customer environments, we may experienceperformance and functionality problems associated with incompatibility amongdifferent versions of hardware, software and networking products. To the extentthat such problems occur, we may face adverse publicity, loss of sales, loss ofcustomer satisfaction and delay in market acceptance of our products orcustomer claims against us, any of which could harm our business.

**We rely onthird-party software to develop and deliver our products to our customers, andthe loss of access to this software could harm our business.**

As part of our normaloperations in connection with the development and delivery of our software, welicense software from third-party commercial vendors. These products may notcontinue to be available on commercially reasonable terms, or at all. The lossof these products could result in delays in the sale of our software untilequivalent technology, if available, is identified, procured and integrated,and these delays could result in lost revenue. Further, to the extent that weincorporate these products into our software and the vendors from whom wepurchase these products increase their prices, our gross margins could benegatively impacted.

**Defects or securityflaws in our products or claims asserted against us could result in the loss ofcustomers, a decrease in revenue, unexpected expenses, loss of competitivemarket share and liability claims.**

Our products dependon complex software, both internally developed and licensed from third parties.Also, our customers may use our products with other companies’ products thatalso contain complex software. If our software does not meet performancerequirements, our customer relationships will suffer. Complex software oftencontains errors and is susceptible to computer viruses and may contain securityvulnerabilities. Any failure or poor performance of our software or the thirdparty software with which it is integrated could result in:

·       delayedor diminished market acceptance of our software products;

·       delaysin product shipments;

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·       unexpectedexpenses and diversion of resources to identify the source of errors or tocorrect errors;

·       damageto our reputation; or

·       liabilityclaims and loss of future revenue.

To the extent that our product releases, such as ourOpsware System integrated suite, contain incompatibility problems, defects,security flaws or other performance flaws, we may encounter one or more of theharms listed above and our operating results may be materially impacted.

Although our agreementswith customers generally contain provisions designed to limit our exposure topotential liability claims, these provisions may not be effective to the extentwarranty exclusions or similar limitations of liability are unenforceable. Inaddition, the extent of these limitations may require negotiation. If any claimis made against us, we may be required to expend significant cash resources indefense and settlement of the claim.

**If we are unable toretain our executive officers or key technical personnel, we may not be able tosuccessfully manage our business or achieve our objectives.**

Our business andoperations are substantially dependent on the performance of our key employees,all of whom are employed on an at-will basis. If we lose the services of one ormore of our executive officers or key technical employees, in particular, MarcL. Andreessen, our Chairman, Benjamin A. Horowitz, our President and ChiefExecutive Officer, or Timothy A. Howes, our Chief Technical Officer, or if oneor more of them decides to join a competitor or otherwise compete directly orindirectly with us, we may not be able to successfully manage our business orachieve our business objectives.

**Our business willsuffer if we are unable to hire and retain highly qualified employees.**

Our future success depends on our ability to hire andretain highly qualified technical, sales and managerial personnel. Our failureto hire and retain qualified personnel could seriously disrupt our operationsand increase our costs by forcing us to use more expensive outside consultantsand by reducing the rate at which we can increase revenue. As our customer baseand revenue have grown, we have needed to hire additional qualified personnel. Competitionfor qualified personnel can be intense, and we may not be able to attract,train, integrate or retain a sufficient number of qualified personnel in thefuture.

An important component ofthe compensation of our personnel is stock options, which typically vest over afour-year period. We may face significant challenges in retaining our employeesif they do not believe their stock options are a valuable component of theirtotal compensation. To retain our employees, we expect to continue to grant newoptions subject to vesting schedules, which will be dilutive to the investmentsof our existing stockholders. Some of our employees hold options with exerciseprices that are higher than the price at which our common stock is currentlytrading. If our stock price does not increase in the future, we may need toexchange options for new options or restricted stock, issue new options orgrant additional shares of stock to motivate and retain our employees. To theextent we issue additional options or shares of restricted stock, existingstockholders will experience dilution.

**Our stock price hasbeen volatile and could decline.**

The market price of our common stock has fluctuatedsignificantly in the past, will likely continue to fluctuate in the future andmay decline. The market for technology stocks has been extremely volatile, andhas from time to time experienced significant price and volume fluctuationsthat bear little relationship to the past or present operating performance ofthose companies. Furthermore, our common stock is relatively thinly traded,which contributes significantly to the volatility of our stock price. Due tothe relatively low trading volume of our stock, stockholders may not be able topurchase or sell shares, 

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particularly large blocksof shares, as quickly and as inexpensively as if the trading volume were higher.This could result in greater volatility in our stock price.

Among the factorsthat could affect our stock price are:

·       actualor anticipated variations in our quarter-to-quarter operating results;

·       theloss of any of our significant customers or distribution partners, or ourfailure to obtain new customers or renew existing contracts;

·       failureof our distribution relationships to provide results at anticipated levels;

·       announcementsby us or our competitors of significant contracts, new or enhanced products orservices, acquisitions, distribution partnerships, joint ventures or capitalcommitments;

·       changesin our financial estimates or investment recommendations by securities analystsfollowing our business;

·       oursale of common stock or other securities in the future;

·       changesin economic and capital market conditions for companies in our sector;

·       changesin the enterprise software markets;

·       changesin market valuations or earnings of our competitors;

·       changesin business or regulatory conditions;

·       interestrates and other factors affecting the capital markets;

·       fluctuationsin the trading volume of our common stock; and

·       theoccurrence of any of the adverse events discussed elsewhere in these RiskFactors.

In addition, if ourstockholders sell substantial amounts of our common stock in the public market,or if any of our officers or directors were to sell shares of our common stockheld by them, the market price of our common stock could fall.

**We may requireadditional capital to fund our operations or may elect to raise additionalcapital if the market permits.**

We believe that ourcurrent cash balances, including cash and cash equivalents, and cash flow fromoperations will be sufficient to meet our working capital and capitalexpenditure requirements for at least the next 12 months. However, if ourlicensing revenue does not meet our expectations, if we encounter unforeseenexpenses, if our business plan changes, or if we wish to acquire complementarybusinesses or technologies, we may require additional equity or debt financing.In addition, we may elect to raise additional capital if market conditionspermit in order to increase our cash balance and expand our business. If weelect to raise additional capital in the future, we cannot be sure that we willbe able to secure additional financing on acceptable terms, or at all. If weelect to raise additional capital through means of an equity financing,existing holders of our common stock will suffer dilution. Additionally,holders of any future debt instruments or preferred stock may have rightssenior to those of the holders of our common stock. Any debt financing we raisecould involve substantial restrictions on our ability to conduct our businessand to take advantage of new opportunities.

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**Insiders havesubstantial control over us and this could delay or prevent a change in controland could negatively affect your investment.**

As of April 1, 2007,our officers and directors and their affiliates beneficially own, in theaggregate, approximately 23% of our common stock. These stockholders are ableto exercise significant influence over all matters requiring stockholderapproval, including the election of directors and approval of significantcorporate transactions, which could have the effect of delaying or preventing athird party from acquiring control over us and could affect the market price ofour common stock. In addition, the interests of certain large stockholders maynot always coincide with our interests or the interests of other stockholders,and, accordingly, these stockholders could approve transactions or agreementsthat would not otherwise be approved by other stockholders generally.

**We have implementedanti-takeover provisions that could make it more difficult to acquire us.**

Our certificate ofincorporation, our bylaws and Delaware law contain provisions that could makeit more difficult for a third party to acquire us without the consent of ourboard of directors, even if doing so would be beneficial to our stockholders. Theseprovisions include:

·       classifyingour board of directors into three groups so that the directors in each groupwill serve staggered three-year terms, which would make it difficult for apotential acquirer to gain immediate control of our board of directors;

·       authorizingthe issuance of shares of undesignated preferred stock without a vote ofstockholders;

·       prohibitingstockholder action by written consent; and

·       limitations on stockholders’ability to call special stockholder meetings.

**ITEM 1B.**    UNRESOLVEDSTAFF COMMENTS 

None.

**ITEM 2.**                PROPERTIES

Our corporate headquartersare located in Sunnyvale, California, where we rent approximately 75,000 squarefeet under a lease expiring in 2010. As a result of past acquisitions, we alsooccupy a facility in Cary, North Carolina, consisting of approximately 28,000square feet under a lease that terminates in 2017 and a facility in Redmond,Washington, consisting of approximately 12,000 square feet under a lease thatterminates in 2011. In addition, we have a number of operating leases for fieldsales offices in various locations worldwide. We believe that our facilitiesare adequate to meet current requirements.

**ITEM 3.**                LEGALPROCEEDINGS 

We currently have nopending or threatened material litigation. In the future, we may bring, or besubject to, lawsuits. Any litigation, even if successful for us, could resultin substantial costs and divert management’s attention and other resources awayfrom the operation of our business.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS 

None.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES 

**Market for OurCommon Stock**

Ourcommon stock is listed on the NASDAQ Global Market under the symbol “OPSW.” Thefollowing table sets forth for each of the two preceding fiscal years the highand low intraday sales prices per share of our common stock as reported by theNASDAQ Global Market for each full quarterly period within the two most recentfiscal years. 

| **Fiscal year ended January 31, 2007:** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                                    |       | $          | 9.25       |     | $          | 6.55    |       |
| Second Quarter                                                   |       | 9.08       |       | 6.25     |       |
| Third Quarter                                                    |       | 9.68       |       | 6.32     |       |
| Fourth Quarter                                                   |       | 9.90       |       | 7.50     |       |
|                                                                  |            |            |            |          |            |         |            |  |  |

 

| **Fiscal year ended January 31, 2006:** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                                    |       | $          | 6.07       |     | $          | 4.22    |       |
| Second Quarter                                                   |       | 6.00       |       | 3.90     |       |
| Third Quarter                                                    |       | 5.51       |       | 4.17     |       |
| Fourth Quarter                                                   |       | 7.55       |       | 4.91     |       |
|                                                                  |            |            |            |          |            |         |            |  |  |

 

We have never paid cashdividends and do not plan to do so in the foreseeable future. According to therecords of our transfer agent, at April 1, 2007, there were approximately890 stockholders of record of our common stock. Because many brokers and otherinstitutions hold stock on behalf of our stockholders, the total number ofbeneficial holders of our common stock is greater than that represented bythese record holders. Neither we nor any affiliated purchaser repurchased anyof our equity securities in the fourth quarter of fiscal year 2007.

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**STOCK PERFORMANCEGRAPH**

The following shall not be deemed incorporated byreference into any of our other filings under the Securities Exchange Act of1934, as amended, or the Securities Act of 1933, as amended, except to theextent we specifically incorporate it by reference into such filing.

The graph below compares the quarterly percentagechange in the cumulative total stockholder return of our common stock, theNasdaq Global Market and the Goldman Sachs Software Index for the periodbeginning on March 9, 2001 (the date our common stock commenced trading onthe Nasdaq Global Market) through January 31, 2007, assuming an initialinvestment of $100. Data for the Goldman Sachs Software Index and the NasdaqGlobal Market assume reinvestment of dividends.

The comparisons in thegraph below are based upon historical data and are not indicative of, norintended to forecast, future performance of our common stock.

**COMPARISONOF CUMULATIVE TOTAL RETURN AMONG OPSWARE INC., THENASDAQ STOCK MARKET (U.S.) COMPOSITE INDEX, AND THE GOLDMAN SACHSSOFTWARE INDEX**

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**ITEM 6.**                SELECTEDCONSOLIDATED FINANCIAL DATA 

The selected consolidated financial data below shouldbe read together with Item 7 “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and the consolidated financial statementsand related notes thereto in Item 8 “Financial Statements and SupplementaryData.”

Priorto August 2002 (fiscal year ending January 31, 2003), we primarilyprovided managed internet services, which we referred to as our ManagedServices Business. On August 15, 2002, we completed the sale of ourManaged Services Business to EDS. As a result, a portion of the historicalfinancial information relating to fiscal year ending and January 31, 2003is not related to our current software business and is not indicative of futureactual results from our current software business.

| ** **                                                                          | ** ** | **Year Ended January 31,**                             | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                          | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Consolidated Statement of  Operations Data:**                                     | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                                                         |       | $                                                                     | 101,726    |   | $ | 61,077 |   | $ | 37,792 |   | $ | 18,050 |   | $ | 37,703 |   |
| Restructuring  costs (recoveries), net                                              |       | —                                                                |       | (18 | ) | (1,085 | ) | 1,028 |   | 19,682 |   |
| Amortization  (reversal) of deferred stock compensation                             |       | —                                                                |       | 1,282 |   | (131 | ) | 606 |   | (14,303 | ) |
| Total costs and  expenses                                                           |       | 122,556                                                               |       | 78,732 |   | 49,718 |   | 32,277 |   | 99,008 |   |
| Loss from  operations                                                               |       | (20,830                                                               | )          | (17,655 | ) | (11,926 | ) | (14,227 | ) | (61,305 | ) |
| Gain from  retirement of senior discount notes                                      |       | —                                                                |       | — |   | — |   | — |   | 8,736 |   |
| Gain (loss) on  sale of assets and liabilities related to Managed Services Business |       | 329                                                                   |       | (69 | ) | 4,165 |   | 1,252 |   | 50,660 |   |
| Net loss                                                                            |       | $                                                                     | (16,069    | ) | $ | (14,751 | ) | $ | (7,246 | ) | $ | (8,409 | ) | $ | (3,247 | ) |
| Basic and diluted  net loss per share                                               |       | $                                                                     | (0.16      | ) | $ | (0.15 | ) | $ | (0.09 | ) | $ | (0.11 | ) | $ | (0.05 | ) |

 

| ** **                                           | ** ** | **As of January 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2007**                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **(in thousands)**              | ** ** |
| **Consolidated Balance Sheet  Data:**                | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash, cash  equivalents and restricted cash          |       | $                                    | 93,219     |   | $ | 104,194 |   | $ | 121,355 |   | $ | 58,116 |   | $ | 66,983 |   |
| Working capital                                      |       | 80,045                               |       | 83,199 |   | 101,204 |   | 39,882 |   | 43,378 |   |
| Total assets                                         |       | 182,045                              |       | 169,752 |   | 143,591 |   | 70,807 |   | 75,879 |   |
| Long-term  obligations, net of current portion       |       | 2,195                                |       | 3,102 |   | — |   | — |   | 23 |   |
| Accrued  restructuring costs, net of current portion |       | 817                                  |       | 1,190 |   | 1,466 |   | 2,154 |   | 7,840 |   |
| Stockholders’ equity                            |       | 130,776                              |       | 123,538 |   | 116,662 |   | 47,225 |   | 46,138 |   |
|                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.**             MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussionshould be read together with the financial statements and the related notesincluded in this Form 10-K. The following discussion containsforward-looking statements that involve risks and uncertainties, includingthose described in Item 1A “Risk Factors”. Our actual results may differmaterially from those projected in the forward-looking statements as a resultof these risks and uncertainties. See also “Cautionary Statement RegardingForward-Looking Statements.” The financial statement data contained hereinreflects our results as they existed for the periods presented.

**Overview**

We are a provider of data center automation softwarefor enterprises, government agencies and service providers seeking to reducethe cost and improve the quality of data center operations. Our softwareautomates data center operations across servers, software, applications andnetwork devices and discovers and tracks assets across the data centerenvironment. Our software products automate formerly manual, time-consuming anderror-prone tasks, including the provisioning, changing, auditing, patching,reporting, configuring, scaling, securing and recovering of servers, software,applications and network devices.

Opsware licenses its comprehensive data centerautomation solution suite as individual components and as an integratedsoftware suite called the Opsware System.  This suite includes the Opsware ServerAutomation System (OSAS), Opsware Network Automation System (ONAS), OpswareAsset Management System (OAMS), Opsware Visual Application Manager (VAM), TheOpsware Network (TON), Opsware Operational Management Database (OMDB) andOpsware Orchestrator. OSAS automates key server, software and applicationoperations across geographically disparate locations and heterogeneous datacenter environments. ONAS automates network device operations for data centersand remote locations. OAMS enables IT organizations to discover IT hardware andsoftware assets, track these assets on an ongoing basis and reduce costs ofexcess hardware and software purchases, unnecessary maintenance renewals andunderutilization of idle and redundant assets. VAM is a discovery andapplication mapping product that renders a complete picture of servers,software and network elements and their interdependencies, which allows ITorganizations to execute change actions and manage potential change conflicts.  TON is a real-time service offering up-to-datecontent for security vulnerabilities and compliance policies. OMDB is thecentral data repository for all operational, configuration and change activitydata. Opsware Orchestrator automates IT operational processes that span ITgroups and span disparate IT systems, manages resolution of alerts andfacilitates incident management in Network Operation Centers (NOCs) and ServerOperation Centers (SOCs).

We derive a significant portion of our revenue fromsales of software licenses. We license our products principally through ourdirect sales force and, to a lesser extent, through indirect channels withcorporate partners, such as distributors, value-added resellers, hardwareproviders and systems integrators. We intend to increase our sales effortsthrough indirect channels in the future, in part due to our distributionagreement with Cisco Systems that is discussed below. We also derive revenuefrom sales of items that are complementary to our software automation suite,including annual support and maintenance agreements, professional services, andtraining.

Our fiscal year ends on January 31. References tofiscal 2007, for example, refer to the fiscal year ended January 31, 2007.

In view of the rapidlychanging nature of our business, we believe that period-to-period comparisonsof revenues and operating results should not be relied upon as indications offuture performance, growth or financial results. Additionally, historicaltrends may not be indicative of future growth or financial results.

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*Relationship withEDS*

In August 2002, we sold our Managed ServicesBusiness to EDS for a total purchase price of $63.5 million in cash and enteredinto a separate agreement with EDS pursuant to which we granted EDS a licenseto use our software products. Under this license agreement, EDS agreed to payus a minimum license and maintenance fee of $52.0 million in the aggregate overa term of three years.

In August 2004, EDS agreed to extend the term ofthe agreement through March 2008 and committed to pay additional licenseand maintenance fees of approximately $50.0 million over the term of theextended license. These payments are in addition to the initial $52.0 millioncommitment. Pursuant to this amendment, (a) EDS is required to pay $2.0million per month from August 15, 2004 through August 14, 2005 and$1.6 million per month thereafter through March 2008, (b) EDS’monthly payments are no longer dependent upon the number of devices beingmanaged by our software products, (c) EDS receives rights to license allfuture products released by us, when and if available for commercial release,for no additional fee, (d) we deposited funds into an escrow account thatallowed EDS to periodically purchase certain third-party equipment and softwarefor EDS’ use in connection with our software products, and (e) dedicatedOpsware support personnel will continue to be provided to EDS for the durationof the extended term. Following the extended term, the agreement willautomatically renew at a fee of $1.6 million per month for five successiveone-year terms unless terminated six months in advance by EDS. Revenue underthis arrangement will continue to be recognized ratably over the term of thearrangement, but in no case earlier than when monthly payments become due overthe extended term of the amended agreement.

For the fiscal years 2007,2006, and 2005, net revenues from our license and maintenance agreement withEDS were 21%, 35%, and 54% of total net revenues, respectively. Although thepercentage of our net revenues coming from customers other than EDS hasincreased in recent quarters, we expect that our operating results willcontinue to be significantly dependent on our relationship with EDS for theforeseeable future.

*StrategicRelationship with Cisco*

In February 2006, weentered into a worldwide distribution agreement with Cisco Systems todistribute our ONAS product under the Cisco Systems brand name. This agreementrepresents a significant expansion of our sales channel and market reach andprovides additional sales opportunities for other products in our softwareautomation suite, including our OSAS product. The three year term of thisagreement commenced in May 2006 and renews automatically thereafter forone year terms, although it may be terminated earlier in certain circumstances.There can be no assurance that we will realize the full benefits anticipated bythis agreement.

*Recent Acquisitions*

In March 2007, we entered into a definitiveagreement for the acquisition of iConclude Co. (“iConclude”), a company engagedin the development of IT process automation solutions located in Bellevue,Washington. We agreed to acquire all of iConclude’s outstanding capital stockin exchange for approximately $30 million in cash and approximately 3.39million shares of our common stock, subject to certain adjustments. Inaddition, iConclude’s remaining cash at closing, after certain adjustments,will be distributed to its stockholders at closing in the form of a dividend,which is expected to be approximately $7 million. A portion of the cashconsideration paid to iConclude stockholders will be deposited in escrow atclosing for 12 months as security against breaches of representations,warranties and covenants and other indemnification obligations by iConcludepursuant to the merger agreement. Completion of this transaction is subject tocustomary closing conditions.

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In August 2006, we completed our acquisition ofCreekPath Systems, Inc. (“CreekPath Systems”), a developer of storagemanagement software located in Boulder, Colorado. We paid $10.2 million in cashat the closing in exchange for all of the outstanding capital stock ofCreekPath Systems, plus approximately $357,000 in related direct acquisitioncosts. Under an earnout provision, additional contingent consideration of up to$5.0 million in cash may be payable by us following the one-year anniversary ofthe closing.  We are building upon thetechnology acquired from CreekPath Systems and using it as the foundation forour upcoming application storage automation solution. See Note 5, “Acquisitions”in the notes to the consolidated financial statements for a further descriptionof this transaction.

In February 2005, wecompleted our acquisition of Rendition Networks, a provider of network deviceautomation software located in Redmond, Washington. In this acquisition, weacquired our ONAS product. The transaction was valued at approximately $34.3million, which included 2.53 million shares of our common stock valued at $16.4million, cash of $15.0 million, assumed options and unvested restricted stockwith a fair value of $2.2 million and approximately $700,000 of directacquisition costs.

**Results ofOperations**

*License revenue.**  *License revenue consists of feesfor term and perpetual licenses. 

| ** **                    | ** ** | **Year Ended January 31,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **($ in thousands)**            | ** ** |
| License revenues              |       | $                                         | 71,582     |   | $ | 43,138 |   | $ | 26,699 |   |
| Percentage of total  revenues |       | 70                                        | %          | 71 | % | 71 | % |
|                               |            |                                           |            |  |  |  |  |  |  |  |

 

License revenue increased by 66% during fiscal 2007 ascompared with the prior year. The increase was primarily due to the followingfactors:  greater market acceptance ofour products, an increase in our customer base and increased sales to existingcustomers. During fiscal 2007, we expanded our product offerings andexperienced an increase in purchases of multiple components of our integratedsuite of products as compared to the prior year. License revenue from customersother than EDS increased approximately 108% during fiscal 2007 as compared tofiscal 2006.

License revenue increased by 62% during fiscal 2006 ascompared with the prior year. The increase was due to an increase in ourcustomer base, an increase in sales to existing customers, sales of our ONASproduct following our acquisition of Rendition Networks and the establishmentof vendor specific objective evidence (VSOE) of fair value, which allowed us torecognize revenue using the residual method.

Due to our revenue recognition policy, a substantialportion of the revenue that we recognize in a particular fiscal period may notbe based on, and therefore not necessarily indicative of, sales activity duringthat period, but instead may relate to sales executed in prior periods. Pleasesee the section titled “Critical Accounting Policies” for a description ofour revenue recognition policy.

*Services revenue.**  *Services revenue consists of feesfor annual support and maintenance and professional services.

| ** **                    | ** ** | **Year Ended January 31,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **($ in thousands)**            | ** ** |
| Services revenue              |       | $                                         | 30,144     |   | $ | 17,939 |   | $ | 11,093 |   |
| Percentage of total  revenues |       | 30                                        | %          | 29 | % | 29 | % |
|                               |            |                                           |            |  |  |  |  |  |  |  |

 

Services revenue increased 68% in fiscal 2007 whencompared with the prior year. The increase in fiscal 2007 was primarily due toincreases in sales of professional services and annual maintenance contracts,each resulting from the growth of our installed customer base.

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The increase in fiscal2006 was primarily due to the growth of our installed customer base, therenewal of support and maintenance contracts and an increase in sales ofprofessional services.

**Costs and Expenses**

Prior to fiscal 2007, we elected to recognizestock-based compensation expense under Accounting Principles Board Opinion No. 25(“APB 25”) and provided pro forma disclosures of the impact on our operatingresults as if we had accounted for stock-based compensation in accordance withthe Statement of Financial Accounting Standards No. 123, “Accounting forStock-Based Compensation” (“SFAS 123”). Beginning in fiscal 2007, we beganrecognizing compensation expense for equity awards to employees in accordancewith SFAS No. 123R, “Share-Based Payment.” Accordingly, the followingexpense line items include stock-based compensation expense beginning in fiscal2007: “Cost of services revenue”; “Research and development”; “Sales andmarketing”; and “General and administrative”.

*Cost of license revenue.**  *Cost of license revenue generallyconsists of royalties related to third-party technologies included in oursoftware.

| ** **                            | ** ** | **Year Ended January 31,** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **($ in thousands)**            | ** ** |
| Cost of license  revenue              |       | $                                         | 1,576      |   | $ | 1,185 |   | $ | 4,439 |   |
| Percentage of total  license revenues |       | 2                                         | %          | 3 | % | 17 | % |
|                                       |            |                                           |            |  |  |  |  |  |  |  |

 

The increase from fiscal 2006 to fiscal 2007 inabsolute dollars in comparison to the prior year was primarily due to anincrease in royalties paid to third party vendors as a result of increasedlicense revenue. The level of royalty costs in future periods will be dependentupon our ability to obtain favorable licensing terms for our products thatinclude third party technology and the extent to which we include such thirdparty technology in our product offerings.

The decrease in fiscal 2006 in absolute dollars and asa percentage of license revenue in comparison to the prior year was primarilydue to a $4.0 million one-time payment made to EDS in fiscal 2005, pursuant tothe terms of our amended license agreement effective August 2004, to fundEDS’ purchase of equipment required to support the deployment of our softwareproducts in its facilities.

*Cost of services revenue.**  *Cost of services revenue consistsprimarily of salaries and other personnel related expenses, fees for outsourcedcontractors, facility costs and travel expenses.

| ** **                            | ** ** | **Year Ended January 31,** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **($ in thousands)**            | ** ** |
| Cost of service  revenue              |       | $                                         | 20,845     |   | $ | 13,036 |   | $ | 8,183 |   |
| Percentage of total  service revenues |       | 69                                        | %          | 73 | % | 74 | % |
|                                       |            |                                           |            |  |  |  |  |  |  |  |

 

The increase from fiscal 2006 to fiscal 2007 inabsolute dollars was primarily due to an increase in service-related headcountfrom 72 on January 31, 2006 to 96 on January 31, 2007, and increasedoutsourced contractor fees, each of which was necessary to fulfill serviceobligations resulting from an increase in our customer base, as well asstock-based compensation expense of $1.5 million that was charged to cost ofservices revenue in connection with our initial application of SFAS 123R infiscal 2007.

The increase from fiscal 2005 to fiscal 2006 inabsolute dollars was primarily due to increased salaries and related personnelexpenses due to an increase in services-related headcount from 42 on January 31,2005 to 72 on January 31, 2006, which resulted from additional hiring, andincreased outsourced contractor fees, each to fulfill service obligations as aresult of the increase in our customer base.

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*Amortization of developedtechnology.*   As a result of our previousacquisitions, we are amortizing that portion of the purchase price that wasallocated to the acquired company’s developed technology.

| ** **                            | ** ** | **Year Ended January 31,** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                            | ** ** | ** **                                | ** ** | **($in thousands)** | ** ** | ** ** | ** ** |
| Amortization of  developed technology |       | $2,347                                    |       |   | $ | 1,640 |   |   | $ | 675 |   |
| Percentage of total net  revenues     |       | 2                                         | %          |   | 3 | % |   | 2 | % |
|                                       |            |                                           |            |  |  |  |  |  |  |  |  |

 

The increase from fiscal 2006 to fiscal 2007 inabsolute dollars was due to our acquisition of CreekPath Systems during fiscal2007. As a result of this acquisition, we began amortizing purchased developedtechnology beginning in the third quarter of fiscal 2007. The value assigned todeveloped technology was approximately $5.6 million, which is being amortizedon a straight-line basis over a four-year estimated life at a rate ofapproximately $349,000 per quarter.

The increase from fiscal 2005 to fiscal 2006 inabsolute dollars and as a percentage of net revenues was due to our acquisitionof Rendition during the fiscal 2006.

*Research and development.**  *Research and development expensesconsist primarily of salaries and other personnel   related expenses, fees for consultingservices and facility costs.

| ** **                        | ** ** | **Year Ended January 31,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **($ in thousands)**            | ** ** |
| Research and  development         |       | $                                         | 31,315     |   | $ | 22,043 |   | $ | 14,323 |   |
| Percentage of total net  revenues |       | 31                                        | %          | 36 | % | 38 | % |
|                                   |            |                                           |            |  |  |  |  |  |  |  |

 

The increase from fiscal 2006 to fiscal 2007 inabsolute dollars was primarily due to stock-based compensation expense of $5.2million charged to research and development in connection with our initialapplication of SFAS 123R in fiscal 2007, increased salaries and relatedpersonnel expenses resulting from an increase in headcount from 130 on January 31,2006 to 166 on January 31, 2007, which increase reflects employees assumedin connection with our CreekPath Systems acquisition as well as additionalhiring necessary to meet the current needs of our business. The decrease as apercentage of net revenue was primarily due to a greater increase in revenuerelative to the increase in expenses incurred during fiscal 2007.

The increase from fiscal 2005 to fiscal 2006 inabsolute dollars was primarily due to increased salaries and related personnelexpenses resulting from an increase in headcount from 90 on January 31,  2005 to 130 on January 31, 2006, whichincludes employees assumed in connection with our Rendition acquisition as wellas additional hiring necessary to meet the current needs of our business.

*Sales and marketing.**  *Sales and marketing expensesconsist primarily of salaries, commissions and other personnel relatedexpenses, travel expenses, advertising expenses, promotional expenses andfacility costs.

| ** **                        | ** ** | **Year Ended January 31,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **($ in thousands)**            | ** ** |
| Sales and  marketing              |       | $                                         | 47,796     |   | $ | 24,795 |   | $ | 15,015 |   |
| Percentage of total net  revenues |       | 47                                        | %          | 41 | % | 40 | % |
|                                   |            |                                           |            |  |  |  |  |  |  |  |

 

The increase from fiscal 2006 to fiscal 2007 inabsolute dollars and as a percentage of revenues was primarily due to increasedsalaries and other personnel related expenses, as our sales and marketingdepartment headcount increased from 92 on January 31, 2006 to 129 on January 31,2007 to meet the 

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current needs of ourbusiness. The increase in fiscal 2007 is also attributable to increasedcommissions, and a stock-based compensation expense of $5.1 million charged tosales and marketing, in connection with our initial application of SFAS 123R infiscal 2007.

The increase from fiscal 2005 to fiscal 2006 inabsolute dollars was primarily due to increased salaries, commissions, andrelated personnel expenses, and to a lesser extent, increases in advertisingand promotional activities. Our sales and marketing department headcountincreased from 54 on January 31, 2005 to 92 on January 31, 2006, tomeet the current needs of our business.

*General and administrative.**  *General and administrative expensesconsist primarily of salaries and other personnel related expenses, fees foroutside professional services and facility costs.

| ** **                        | ** ** | **Year Ended January 31,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **($ in thousands)**            | ** ** |
| General and  administrative       |       | $                                         | 17,346     |   | $ | 12,277 |   | $ | 7,092 |   |
| Percentage of total net  revenues |       | 17                                        | %          | 20 | % | 19 | % |
|                                   |            |                                           |            |  |  |  |  |  |  |  |

 

The increase from fiscal 2006 to fiscal 2007 inabsolute dollars was primarily due to stock-based compensation expense chargedto general and administrative of $4.2 million in connection with our initialapplication of SFAS 123R in the fiscal 2007, as well as increased salaries andrelated personnel expenses. General and administrative headcount increased from42 on January 31, 2006 to 56 on January 31, 2007 to meet the currentneeds of our business. The decrease as a percentage of net revenue wasprimarily due to a greater increase in revenue relative to the increase inexpenses incurred during fiscal 2007.

The increase from fiscal 2005 to fiscal 2006 inabsolute dollars was primarily due to increased salaries and related personnelexpenses and increased costs incurred related to Sarbanes-Oxley compliance. Generaland administrative headcount increased from 27 on January 31, 2005 to 42on January 31, 2006, to meet the current needs of our business. Theincrease as a percentage of total net revenues from fiscal 2005 to fiscal 2006was due in part to a non-cash compensation charge (recovery) related to equityawards, which resulted in a benefit equal to 2% of net revenues in fiscal 2005but an expense equal to 1% of net revenues in fiscal 2006.

*In-processresearch and development charges.*   We expensed$1.2 million in fiscal 2006 and $610,000 in fiscal 2005 of in-process researchand development (IPR&D) acquired in the purchase of Rendition Networks andTangram Enterprise Solutions, respectively. Products that qualify for IPR&Drepresent those that have not reached technical feasibility and for which noalternative future uses exist at the time of an acquisition. Accordingly, theseIPR&D amounts were expensed on the respective acquisition date of each ofthe acquired companies. We did not expense any IPR&D in fiscal 2007.

*Amortization of otheracquisition-related intangibles.*   Amortization ofother acquisition-related intangibles consists of the amortization of a portionof the purchase price of our previous acquisitions that was allocated tocustomer relationships.

| ** **                                             | ** ** | **Year Ended January 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **($ in thousands)**            | ** ** |
| Amortization of  other acquisition-related intangibles |       | $                                         | 1,331      |   | $ | 1,302 |   | $ | 597 |   |
| Percentage of total net  revenues                      |       | 1                                         | %          | 2 | % | 2 | % |
|                                                        |            |                                           |            |  |  |  |  |  |  |  |

 

The increase in amortization of otheracquisition-related intangibles in absolute dollars during from fiscal 2005 to fiscal2006 was due to our acquisition of Rendition in February 2005.

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*Gain(loss) on sale of assets and liabilities from Managed Services Business.**  *In May 2004, we entered into a settlement withQwest following arbitration of Qwest’s claim that we breached agreements thatwe entered into with them in fiscal 2002. Prior to this settlement, we hadaccrued a liability related to our Managed Services Business in the amount of$6.8 million in connection with Qwest’s claim. As a result of the settlement,we reversed approximately $4.3 million of previously accrued data center facilitycosts and recognized the gain as a component of the sale of assets andliabilities from the Managed Services Business in the consolidated statementsof operations in fiscal 2005. However, we did not reverse as a gain thecomponent of the accrual for potential future settlement of any claims eitherparty may have under the guaranteed term agreement between the parties, up toan aggregate maximum of $300,000, because it was reasonably possible certainclaims under that agreement could be made against us. As no claims were madewithin the specified time period, we reversed the $300,000 liability andrecognized the gain as a component of the sale of assets and liabilities fromthe Managed Services Business in the consolidated statements of operations infiscal 2007

*Interestincome and other expense, net.**  *Interest income and other expense,net, increased to $4.7 million in fiscal 2007 from approximately $3.2 millionin fiscal 2006, primarily due to an increase in interest income during fiscal2007 as a result of an increase in interest rates. Interest income and otherexpense, net, increased to approximately $3.1 million in fiscal 2006 fromincome of $903,000 in fiscal 2005 as a result of the $61.8 million net proceedsfrom the sale of our common stock in December 2004.

*Provision for income taxes.**  *During fiscal 2007, we recordedforeign withholding taxes of $218,000. During fiscal 2006, we recorded a statetax provision of $64,000 and paid foreign withholding taxes of $129,000. Duringfiscal 2005, we recorded an income tax provision of $356,000 for foreignwithholding taxes paid in connection with the sale of a software license to oneof our customers, and a state tax provision of $32,000.

**Liquidity andCapital Resources**

Since inception, we havefinanced our operations primarily through customer revenue, the sale of oursecurities, the sale of our Managed Services Business, and, to a lesser extent,operating equipment lease financing and capital equipment lease financing. Asof January 31, 2007, we had approximately $91 million in cash and cashequivalents.

*OperatingActivities*

Net cash used in operating activities for fiscal 2007of $3.4 million was primarily the result of our net operating loss of $16.1million, an increase in accounts receivable of $13.9 million, offset bystock-based compensation expense of $16.0 million, an increase in accruedcompensation and other liabilities of $5.3 million and amortization ofintangibles of $3.7 million.

Net cash used in operating activities for fiscal 2006of $2.7 million was primarily the result of our net operating loss of $14.8million, an increase in accounts receivable of $12.8 million, an increase inprepaid expenses, other current assets and other assets of $3.1 million, offsetby a net increase in advances from customers and deferred revenue of $12.4million, and an increase in accrued compensation of $4.6 million.

Net cash used in operatingactivities for fiscal 2005 of $1.0 million was primarily the result of our netoperating loss of $7.2 million (including the $4.0 million one-time paymentrelated to our amended license and maintenance agreement with EDS and a $2.0million payment to settle the Qwest litigation), $933,000 decrease in ouraccrued restructuring liability in connection with an amendment to our leasedfacilities, and $521,000 increase in accounts receivable, offset by a $10.8million net increase in deferred revenue and advances from customers and $3.8million of depreciation and amortization expense.

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*InvestingActivities*

Net cash used in investing activities for fiscal 2007of $15.0 million consisted of the cash paid to acquire CreekPath Systems andrelated acquisition costs and $4.7 million of capital equipment purchases.

Net cash used in investing activities for fiscal 2006of $16.8 million consisted of the cash paid to acquire Rendition Networks andrelated acquisition costs and $2.3 million of capital equipment purchases.

Net cash used in investingactivities for fiscal 2005 of $2.8 million consisted of purchases primarily ofcapital equipment and net direct acquisition costs paid related to theacquisition of Tangram.

*FinancingActivities*

Net cash provided by financing activities for fiscal2007 and 2006 of $7.4 million and $2.8 million, respectively, was primarilyattributable to proceeds received from the exercises of stock options.

Net cash provided byfinancing activities for fiscal 2005 of $67.3 million was primarilyattributable to net proceeds received from the issuance of 10 million shares ofcommon stock as well as proceeds received from the exercise of stock options.

*Commitments*

As of January 31,2007, our principal commitments consisted of obligations outstanding underoperating leases for facilities and capital leases. The following summarizesour contractual obligations at January 31, 2007 and the effect suchobligations are expected to have on our liquidity and cash flow in future fiscalperiods (in thousands):
| Contractual Obligations        | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|
| Capital leases                      |       | $        | 36         |     | $          | 36       |       | $        | 35         |     | $          | —         |       | $         | — |   |   | $ | — |   |   | $ | 107 |
| Operating leases                    |       | 3,401    |       | 3,075    |       | 3,083    |       | 1,638    |       | 726      |       |           | 3,536      |      |   | 15,459 |
| Total contractual cash  obligations |       | $        | 3,437      |     | $          | 3,111    |       | $        | 3,118      |     | $          | 1,638          |       | $         | 726 |   |   | $ | 3,536 |   |   | $ | 15,566 |

 

We do not have any other off balance sheetarrangements or contractual obligations to pay cash.

We believe that ourcurrent cash balances, including cash and cash equivalents and cash flows fromoperations, will be sufficient to meet our working capital and capitalexpenditure requirements for at least the next 12 months. Nevertheless, we mayseek additional capital through the issuance of public and/or private equity ifthe market permits, equipment lease facilities, bank financings or arrangementswith strategic partners to expand our business. Capital requirements will dependon many factors, including the rate of sales growth, market acceptance of ourproducts, costs of providing our products and services, the timing and extentof research and development projects and increases in our operating expenses orshortfalls in revenue. To the extent that existing cash and cash equivalentsbalances and any cash flows from operations are insufficient to fund our futureactivities, we may need to raise additional funds through public or privateequity or debt financing. We cannot be sure that additional financing will beavailable if necessary or available on reasonable terms. We may from time totime evaluate potential acquisitions of other businesses, services, productsand technologies, which could increase our capital requirements.

**Critical AccountingPolicies and Estimates**

The methods, estimates and judgments we use inapplying our most critical accounting policies have a significant impact on theresults we report in our consolidated financial statements. Actual resultscould differ from these estimates. In addition, our estimates may change basedupon changed circumstances and as we reassess our underlying assumptions fromtime to time. The Securities and Exchange Commission 

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has described the mostcritical accounting policies as the ones that are most important to theportrayal of our financial condition and results, and require us to make ourmost difficult and subjective judgments, often as a result of the need to makeestimates of matters that are inherently uncertain.

We believe the following are our critical accountingpolicies, which affect our more significant judgments and estimates used in thepreparation of our consolidated financial statements.

*RevenueRecognition.*   Werecognize software revenue in accordance with the American Institute ofCertified Public Accountants’ (“AICPA”) Statement of Position No. 97-2(“SOP 97-2”), “Software Revenue Recognition,” Statement of Position No. 98-9,“Modification of SOP 97-2 with Respect to Certain Transactions” (“SOP 98-9”),and EITF 00-21, “Revenue Arrangements with Multiple Deliverables.”  For each transaction, we determine whetherevidence of an arrangement exists, delivery has occurred, the fee is fixed ordeterminable, and collectibility of the fee is probable. If any of thesecriteria are not met, revenue recognition is deferred until such time as allcriteria are met. We consider all arrangements with payment terms extendingbeyond ninety days not to be fixed or determinable in which case revenue isrecognized when the payment becomes due. No customer has a right of returnprivilege.

Most of our arrangements involve multiple elements(for example, license fees, maintenance and support, and professionalservices), and we allocate revenue to each component of the arrangement usingthe residual method, as prescribed by Statement of Position 98-9, “Modificationof SOP 97-2 With Respect to Certain Transactions,” based on our vendorspecific objective evidence (VSOE) of fair value of the undelivered elements. Thismeans that we defer revenue from the arrangement fee equivalent to the fairvalue of the undelivered elements. The residual arrangement fee is thenallocated to the delivered element or elements, which is generally softwarelicense fees. VSOE of fair value for the ongoing maintenance and supportobligations (post contract support or PCS) within an arrangement is based uponthe price charged the customer when PCS is sold separately, or in the absenceof separate sales, upon substantive renewal rates stated in the contracts. VSOEof fair value of consulting and training services is based upon hourly ratesand per unit pricing, respectively, charged under separate sales of theseservices to other customers in stand alone transactions. VSOE of the fair valueof TON is determined by reference to the price paid by our customers when TONis sold separately. In the absence of separate sales, VSOE is determined uponsubstantive renewal rates stated in the contracts.

License revenue consists of license fees charged forthe use of our products under perpetual or term license arrangements. Werecognize license revenue for perpetual licenses using the residual methodafter all elements other than PCS and professional services have been delivered,provided that all of the criteria for revenue recognition, as discussed above,are met. Generally, these criteria are met at the time of delivery of thesoftware to the customer. We recognize revenue under term licenses on astraight-line basis over the term of the arrangement once the criteria forrevenue recognition have been met. If an arrangement includes an acceptanceprovision, revenue is deferred until the earlier of receipt of written customeracceptance or expiration of the acceptance period.

Services revenue consists of revenue from PCS, TON andprofessional services agreements. PCS agreements include ongoing customersupport and rights to product updates and upgrades, if-and-when-available. TONis a subscription service that complements certain of our software products byproviding ongoing updates, when-and-if-available, of security alerts. Revenueunder PCS and TON arrangements is recognized ratably using the straight-linemethod over the period that PCS and TON are provided (generally, one year). Professionalservices revenue consists of fees charged for product training and consultingservices. Consulting services are generally accounted for separately from thesoftware license because the services qualify for separate accounting under SOP97-2. The more significant factors considered in determining whether theservices should be accounted for separately include the nature of services(i.e., consideration of whether the services are essential to the functionalityof the licensed product), degree of risk, availability of services from othervendors, timing of payments and impact of 

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service milestones oracceptance criteria on the realizability of the software license fee. Revenuesfor consulting services that qualify for separate accounting are generallyrecognized as the services are performed. If services do not qualify forseparate accounting, the software license revenue is generally recognizedtogether with the consulting services using contract accounting (proportionalperformance or the completed-contract method). In any event, contractaccounting is applied to any arrangements: (1) that include milestones orcustomer specific acceptance criteria that may affect collection of thesoftware license fees; (2) where services include significant modificationor customization of the software; or (3) where the software licensepayment is tied to the performance of consulting services.

We recognize revenue associated with software licensesand services sold to distributors, system integrators and value added resellers(collectively, “resellers”) upon satisfaction of all revenue recognitioncriteria unless it is aware that a reseller does not have a purchase order orother contractual agreement with an end user to purchase the software. Inconnection with sales to resellers, there is no right of return.

For all periods included in our consolidatedfinancials statements, we recognize perpetual license revenue from OAMS andONAS arrangements using the residual method after all elements other than maintenanceand non-essential services have been delivered, provided that all of thecriteria for revenue recognition discussed above are met. Generally, thesecriteria are met at the time of delivery. For OSAS arrangements entered intoprior to May 1, 2005, which was the date when we determined it hadestablished VSOE of the fair value of maintenance and professional services forOSAS, we recognized both license and services revenue from a transactionratably over the remaining post-contract maintenance and support period oncedeployment of our software had been completed and all other elements of thearrangement had been delivered. For OSAS arrangements entered into on or after May 1,2005, we recognize revenue from perpetual licenses using the residual method.

*Impairmentof Long-Lived Assets and Intangible Assets.*   We periodically review thecarrying value of long-lived assets, including property and equipment and otheridentified intangible assets, to determine whether there are any indications ofimpairment. Some indicators of impairment could include a decrease in themarket price of a long-lived asset, an adverse change in the extent or mannerin which a long-lived asset is being used, a change in the business climatethat could affect the value of a long-lived asset, or a current-periodoperating or cash flow loss combined with a history of operating or cash flowlosses. According to our accounting policy, when such indicators are present,if the undiscounted cash flows expected to be generated from operations fromthose long-lived assets are less than the carrying value of those long-livedassets, we compare the fair value of the assets (estimated using discountedfuture net cash flows to be generated from the lowest common level ofoperations utilizing the assets) to the carrying value of the long-lived assetsto determine any impairment charges. We reduce the carrying value of thelong-lived assets if the carrying value of the long-lived assets is greaterthan their fair value. The new carrying value is then depreciated over theremaining estimated useful lives of the assets. The determination as to whetherimpairment exists involves significant judgment and the assumptions supportingthe estimated future cash flows reflect management’s best estimates. There wereno impairment charges recorded during the year ended January 31, 2007.

*Impairmentof Goodwill.*   Weaccount for goodwill in accordance with Statement of Financial AccountingStandards No. 142, “Goodwill and Intangible Assets” (“SFAS 142”). Inaccordance with SFAS 142, goodwill will not be amortized, but instead will betested for impairment at least annually and more frequently if certainindicators are present. Circumstances that could trigger an impairment testinclude, but are not limited to, a significant adverse change in the businessclimate or legal factors, unanticipated competition and loss of key personnel. Theassessment of impairment is made by comparing the fair value of the reportingunit to which the goodwill has been assigned by management to its carryingvalue. To the extent that an impairment is indicated (fair value is less thancarrying value), we must perform a second test to measure the amount of theimpairment. The determination as to whether a write down of goodwill isnecessary involves significant judgment based on the short-term and long-termprojections of future 

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performance. Theassumptions supporting the estimated future cash flows, including the discountrate used and estimated terminal value, reflects management’s best estimates. Inthe event we determine that goodwill has been impaired, we will incur anaccounting charge related to the impairment during the fiscal quarter in whichsuch impairment determination is made. We review for indicators of potentialimpairment of goodwill annually. No goodwill impairment charges were recordedduring the year ended January 31, 2007.

*Accountingfor Stock-Based Compensation.**  *Effective February 1, 2006, weadopted the fair value recognition provisions of SFAS No. 123 (revised2004), Share-Based Payment (“SFAS 123R”), using the modified-prospectivetransition method and therefore we have not restated financial results forprior periods. SFAS 123R requires all share-based payments to employees,including grants of stock options, to be recognized as expense in the statementof operations based on their fair values and vesting periods. We recognizecompensation expense for stock option awards on a straight-line basis over thevesting period of the award.

As a result of implementing SFAS 123R, werecognized stock-based compensation expense of $16.0 million during the yearended January 31, 2007.

The full impact of SFAS123R in the future is dependent upon, among other things, the timing of when wehire additional employees, the effect of any new long-term incentive strategiesinvolving stock awards, the total number of stock awards granted, the fairvalue of the stock awards at the time of grant and the tax benefit that we mayor may not receive from stock-based expenses. Additionally, the application ofSFAS 123R requires the use of an option-pricing model, such as theBlack-Scholes model, to determine the fair value of stock option awards. Thisdetermination of fair value is affected by our stock price as well asassumptions regarding a number of highly complex and subjective variables,including our expected stock price volatility over the term of the awards.

**Recent AccountingPronouncements**

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued FASB Interpretation No. 48, Accounting forUncertainty in Income Taxes, (“FIN 48”). FIN 48 clarifies the accounting foruncertainty in income taxes by prescribing the minimum recognition threshold atax position is required to meet before being recognized in the financialstatements FIN 48 also provides guidance on derecognition, measurement,classification, interest and penalties, accounting in interim periods,disclosure and transition, and clearly scopes income taxes out of FinancialAccounting Standards Board Statement No. 5, Accounting for Contingencies (“FAS5”). FIN 48 will be effective for fiscal years beginning after December 15,2006. We are currently evaluating what impact, if any, the adoption of FIN 48will have on its financial position and results of operations.

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. SFAS No. 157 applies toother accounting pronouncements that require or permit fair value measurements,with certain exceptions, including FAS 123(R), among other pronouncements. Theprovisions of SFAS No. 157 are effective for financial statements issuedfor fiscal years beginning after November 15, 2007. We have not determinedwhether the adoption of SFAS No. 157 will have a material effect on itsconsolidated financial position or results of operations.

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**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

*InterestRate Risk.**  *We havelimited exposure to financial market risks, including changes in interestrates. An increase or decrease in interest rates would not significantlyincrease or decrease interest expense on our debt obligations due to the fixednature of our debt obligations. Our interest income is sensitive to changes inthe general level of U.S. interest rates, particularly since we primarilyinvest in money market instruments. However, due to the short-term nature ofour investments, we believe that we are not subject to any material market riskexposure. A hypothetical 100 basis point change in interest rates would resultin less than a $100,000 change (less than 1%) in our cash balance.

*ForeignCurrency Risk.**  *As weexpand into foreign markets, our financial results could be affected by factorssuch as changes in foreign currency exchange rates or weak economic conditionsin the foreign markets we plan to target. To date, our exposure to foreigncurrency risk has not been material. Most of our sales are currently made inU.S. dollars. Strengthening of the dollar could make our services lesscompetitive in the foreign markets we may target in the future.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA 

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**
|                                                           | ** ** | **Page** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|
| Reports of Independent Registered Public Accounting  Firm |       |     | 41         |   |   |
| Consolidated Balance Sheets                               |       |     | 43         |   |   |
| Consolidated Statements of Operations                     |       |     | 44         |   |   |
| Consolidated Statements of Stockholders’ Equity      |       |     | 45         |   |   |
| Consolidated Statements of Cash Flows                     |       |     | 47         |   |   |
| Notes to  Consolidated Financial Statements               |       |     | 48         |   |   |

 

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

The Board of Directors and Stockholders of OpswareInc.

We have audited the accompanying consolidated balancesheets of Opsware Inc. as of January 31, 2007 and 2006, and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows foreach of the three years in the period ended January 31, 2007. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

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

In our opinion, the financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof Opsware Inc. at January 31, 2007 and 2006, and the consolidated resultsof its operations, and its cash flows for each of the three years in the periodended January 31, 2007, in conformity with U.S. generally acceptedaccounting principles.

As discussed in Note 1 to the consolidated financialstatements, in fiscal year ended January 31, 2007, Opsware Inc. changedits method of accounting for stock-based compensation in accordance withguidance provided in Statement of Financial Accounting Standards No. 123R,Share-Based Payment.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of Opsware Inc.’sinternal control over financial reporting as of January 31, 2007, based oncriteria established in Internal Control-Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated April 10, 2007 expressed an unqualified opinion thereon.
|                      | /s/ ERNST & YOUNG  LLP |
|----------------------|---------------------------------|
| San Jose, California |                            |
| April 10, 2007  |                            |

 

41

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

The Board of Directors and Stockholders of OpswareInc.

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control Over FinancialReporting, that Opsware Inc. maintained effective internal control overfinancial reporting as of January 31, 2007, based on criteria establishedin Internal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). Opsware Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment that OpswareInc. maintained effective internal control over financial reporting as of January 31,2007, is fairly stated, in all material respects, based on the COSO criteria.Also, in our opinion, Opsware Inc. maintained, in all material respects,effective internal control over financial reporting as of January 31,2007, based on the COSO criteria**.**

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the 2007 consolidated financialstatements of Opsware Inc. and our report dated April 10, 2007 expressedan unqualified opinion thereon.
|                      | /s/ ERNST & YOUNG LLP |
|----------------------|--------------------------------|
| San Jose, California |                           |
| April 10,  2007 |                           |

 

42

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**OPSWARE INC.CONSOLIDATED BALANCE SHEETS(in thousands, except par value amounts)**

| ** **                                                                                                                                                                                      | ** ** | **As of January 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                                                                                                 | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| **ASSETS**                                                                                                                                                                                      | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                                 | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                                                                                                                                                       |       | $                                    | 90,940     |   | $ | 101,898 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $393 and $219 at January 31, 2007 and 2006, respectively                                                                   |       | 31,748                               |       | 17,867 |   |
| Prepaids and other current assets                                                                                                                                                               |       | 6,431                                |       | 6,546 |   |
| Total current assets                                                                                                                                                                            |       | 129,119                              |       | 126,311 |   |
| Property and  equipment, net                                                                                                                                                                    |       | 5,898                                |       | 3,944 |   |
| Restricted cash                                                                                                                                                                                 |       | 2,279                                |       | 2,296 |   |
| Prepaid rent and  other assets                                                                                                                                                                  |       | 1,798                                |       | 1,920 |   |
| Intangible  assets, net                                                                                                                                                                         |       | 9,705                                |       | 7,613 |   |
| Goodwill                                                                                                                                                                                        |       | 33,246                               |       | 27,668 |   |
| Total assets                                                                                                                                                                                    |       | $                                    | 182,045    |   | $ | 169,752 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                   | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                                            | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Accounts payable                                                                                                                                                                                |       | $                                    | 2,612      |   | $ | 1,217 |   |
| Accrued compensation                                                                                                                                                                            |       | 11,246                               |       | 6,895 |   |
| Other accrued liabilities                                                                                                                                                                       |       | 5,928                                |       | 4,494 |   |
| Advances from customers                                                                                                                                                                         |       | —                               |       | 721 |   |
| Deferred revenue, current portion                                                                                                                                                               |       | 28,924                               |       | 29,473 |   |
| Accrued restructuring costs, current portion                                                                                                                                                    |       | 345                                  |       | 298 |   |
| Capital lease obligations, current portion                                                                                                                                                      |       | 19                                   |       | 14 |   |
| Total current liabilities                                                                                                                                                                       |       | 49,074                               |       | 43,112 |   |
| Capital lease,  net of current portion                                                                                                                                                          |       | 55                                   |       | 74 |   |
| Deferred revenue,  net of current portion                                                                                                                                                       |       | 1,323                                |       | 1,838 |   |
| Accrued  restructuring costs, net of current portion                                                                                                                                            |       | 817                                  |       | 1,190 |   |
| Total liabilities                                                                                                                                                                               |       | $                                    | 51,269     |   | $ | 46,214 |   |
| Commitments and  contingencies (See Note 6)                                                                                                                                                     |       |                                 |       |   |   |
| **Stockholders’  equity:**                                                                                                                                                                 | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Preferred stock, $0.001 par value, 15,000 shares  authorized at January 31, 2007 and 2006, no shares issued or outstanding                                                                 |       | —                               |       | — |   |
| Common stock, $0.001 par value, 200,000 shares  authorized at January 31, 2007 and 2006; 101,681 and 99,596 shares  issued and outstanding at January 31, 2007 and 2006, respectively |       | 102                                  |       | 100 |   |
| Additional  paid-in capital                                                                                                                                                                     |       | 630,282                              |       | 609,455 |   |
| Deferred stock  compensation                                                                                                                                                                    |       | —                               |       | (2,606 | ) |
| Accumulated  deficit                                                                                                                                                                            |       | (499,339                             | )          | (483,270 | ) |
| Accumulated other  comprehensive loss                                                                                                                                                           |       | (269                                 | )          | (141 | ) |
| Total stockholders’ equity                                                                                                                                                                 |       | 130,776                              |       | 123,538 |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                |       | $                                    | 182,045    |   | $ | 169,752 |   |

 

See accompanying notes.

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**OPSWARE INC.CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)**

| ** **                                                                    | ** ** | **Year Ended January 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
|                                                                               | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenue:                                                                  |       |                                      |       |   |   |   |   |
| License revenue                                                               |       | $                                         | 71,582     |   | $ | 43,138 |   | $ | 26,699 |   |
| Services revenue                                                              |       | 30,144                                    |       | 17,939 |   | 11,093 |   |
| Net revenue                                                                   |       | 101,726                                   |       | 61,077 |   | 37,792 |   |
| Costs and expenses:                                                           |       |                                      |       |   |   |   |   |
| Cost of license revenue                                                       |       | 1,576                                     |       | 1,185 |   | 4,439 |   |
| Cost of services revenue*                                                     |       | 20,845                                    |       | 13,036 |   | 8,183 |   |
| Amortization of developed technology                                          |       | 2,347                                     |       | 1,640 |   | 675 |   |
| Research and development*                                                     |       | 31,315                                    |       | 22,043 |   | 14,323 |   |
| Sales and marketing*                                                          |       | 47,796                                    |       | 24,795 |   | 15,015 |   |
| General and administrative*                                                   |       | 17,346                                    |       | 12,277 |   | 7,092 |   |
| In-process research and development charges                                   |       | —                                    |       | 1,190 |   | 610 |   |
| Restructuring costs (recoveries), net                                         |       | —                                    |       | (18 | ) | (1,085 | ) |
| Amortization of other acquisition related  intangibles                        |       | 1,331                                     |       | 1,302 |   | 597 |   |
| Amortization (reversal) of deferred stock  compensation, net                  |       | —                                    |       | 1,282 |   | (131 | ) |
| Total costs and expenses                                                      |       | 122,556                                   |       | 78,732 |   | 49,718 |   |
| Loss from  operations                                                         |       | (20,830                                   | )          | (17,655 | ) | (11,926 | ) |
| Gain (loss) on sale of assets and liabilities from  Managed Services Business |       | 329                                       |       | (69 | ) | 4,165 |   |
| Interest income and other expense, net                                        |       | 4,650                                     |       | 3,166 |   | 903 |   |
| Loss before  income taxes                                                     |       | (15,851                                   | )          | (14,558 | ) | (6,858 | ) |
| Provision for  income taxes                                                   |       | 218                                       |       | 193 |   | 388 |   |
| Net loss                                                                      |       | $                                         | (16,069    | ) | $ | (14,751 | ) | $ | (7,246 | ) |
| Basic and diluted  net loss per share                                         |       | $                                         | (0.16      | ) | $ | (0.15 | ) | $ | (0.09 | ) |
| Shares used in  computing basic and diluted net loss per share                |       | 100,150                                   |       | 98,115 |   | 84,733 |   |

----

*                    For fiscal2007, the following stock-based compensation expense amounts are includedwithin the respective captions below. For fiscal 2006 and 2005, stock-basedcompensation expense (recovery) amounts are excluded from the respectivecaptions below as such expense (recovery) is instead included in the captionabove noted as “Amortization (reversal) of deferred stock compensation, net”(see Note 1, “Accounting for Stock-Based Compensation” for more information):

| Cost of services revenue                     |   | $     | 1,500  |   | $      | 8     |   | $ | (177 | ) |
|----------------------------------------------|--------|-------|--------|--------|--------|-------|--------|---|------|---|
| Research and development                     |   | 5,195 |   | 1,106  |   | 15    |   |
| Sales and marketing                          |   | 5,127 |   | 107    |   | 4     |   |
| General and administrative                   |   | 4,207 |   | 61     |   | 27    |   |
| Stock-based  compensation expense (recovery) |   | $     | 16,029 |   | $      | 1,282 |   | $ | (131 | ) |

 

See accompanying notes.

44

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**OPSWAREINC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(in thousands)**

| ** **                                                                                              | ** ** | **Common Stock** | ** ** | **Additional   Paid-In  Capital** | ** ** | **Notes   Receivable   from   Stockholders** | ** ** | **Deferred   Stock   Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated   Other   Comprehensive   Income (Loss)** | ** ** | **Total   Stockholders’  Equity** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------|------------|-----------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                              | ** ** | **Shares**            | ** ** | **Amount**                             | ** ** | ** **                                                  | ** ** | ** **                                    | ** ** | ** **               | ** ** |
| Balance at January 31, 2002                                                                        |       |                  | 75,894     |                                   |       |                                                        | $          | 76                                            |       |                     |       | $                                                                           | 534,590    |                                        |       |   | $ | (3,022 | ) |   |   | $ | (24,539 | ) |   |   | $ | (449,606 | ) |   |   | $ | (23 | ) |   |   | $ | 57,476 |   |   |
| Balance at January 31, 2004                                                                        |       |                  | 81,537     |                                   |       |                                                        | $          | 82                                            |       |                     |       | $                                                                           | 509,202    |                                        |       |   | $ | (328 | ) |   |   | $ | (462 | ) |   |   | $ | (461,273 | ) |   |   | $ | 4 |   |   |   | $ | 47,225 |   |   |
| Exercise of stock options by employees, net of  repurchases                                             |       |                  | 1,903      |                                   |       |                                                        | 2          |                                          |       |                     | 4,136      |                                                                        |       |                                        | 13         |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 4,151 |   |   |
| Issuance of common stock in connection with the  Employee Stock Purchase Program                        |       |                  | 713        |                                   |       |                                                        | —     |                                          |       |                     | 1,080      |                                                                        |       |                                        | 0          |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,080 |   |   |
| Secondary offering of common stock in  December 2004 (less issuance costs of $2,200)               |       |                  | 10,000     |                                   |       |                                                        | 10         |                                          |       |                     | 61,791     |                                                                        |       |                                        |       |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 61,801 |   |   |
| Repayment of note receivable                                                                            |       |                  |       |                                   |       |                                                        | —     |                                          |       |                     |       |                                                                        |       |                                        | 314        |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 314 |   |   |
| Charge for accelerated vesting of options to  terminated employees                                      |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | 3          |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 3 |   |   |
| Amortization of deferred stock compensation                                                             |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | 103 |   |   |   | — |   |   |   | — |   |   |   | 103 |   |   |
| Reversal of deferred compensation based on straight  line vs. graded                                    |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | (234       | )                                                                           |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (234 | ) |   |
| Common Stock issued in connection with Tangram  acquisition                                             |       |                  | 1,121      |                                   |       |                                                        | 1          |                                          |       |                     | 10,000     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 10,001 |   |   |
| Reversal related to unamortized portion of deferred  stock compensation related to terminated employees |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | (7         | )                                                                           |       |                                        | —     |   |   |   | 7 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Impact of variable accounting related to replacement  stock option                                      |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | (730       | )                                                                           |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (730 | ) |   |
| Issuance of restricted stock option award                                                               |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     |       |                                                                        |       |                                        | —     |   |   |   | 246 |   |   |   | — |   |   |   | — |   |   |   | 246 |   |   |
| Repurchase of common stock                                                                              |       |                  | (17        | )                                      |       |                                                        | —     |                                          |       |                     | (14        | )                                                                           |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (14 | ) |   |
| Retirement of common stock                                                                              |       |                  | (3         | )                                      |       |                                                        | —     |                                          |       |                     | (23        | )                                                                           |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (23 | ) |   |
| Components of comprehensive loss                                                                        |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net loss                                                                                                |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | (7,246 | ) |   |   | — |   |   |   | (7,246 | ) |   |
| Translation adjustment                                                                                  |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | (15 | ) |   |   | (15 | ) |   |
| Total comprehensive loss                                                                                |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (7,261 | ) |   |
| Balance at January 31, 2005                                                                        |       |                  | 95,254     |                                   |       |                                                        | $          | 95                                            |       |                     |       | $                                                                           | 585,204    |                                        |       |   | $ | (1 | ) |   |   | $ | (106 | ) |   |   | $ | (468,519 | ) |   |   | $ | (11 | ) |   |   | $ | 116,662 |   |   |
| Exercise of stock options by employees, net of  repurchases                                             |       |                  | 886        |                                   |       |                                                        | 1          |                                          |       |                     | 1,050      |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,051 |   |   |
| Issuance of common stock in connection with the  Employee Stock Purchase Program                        |       |                  | 524        |                                   |       |                                                        | 1          |                                          |       |                     | 1,538      |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,539 |   |   |
| Repayment of notes receivable                                                                           |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | (1         | )                                                                           |       |                                        | 1          |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Charge for accelerated vesting of options to  terminated employees                                      |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | 12         |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 12 |   |   |
| Amortization of deferred stock compensation                                                             |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     |       |                                                                        |       |                                        | —     |   |   |   | 1,320 |   |   |   | — |   |   |   | — |   |   |   | 1,320 |   |   |
| Reversal of deferred compensation based on straight  line vs. graded                                    |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | (40        | )                                                                           |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (40 | ) |   |
| Common Stock issued in connection with Rendition  acquisition                                           |       |                  | 2,532      |                                   |       |                                                        | 3          |                                          |       |                     | 18,559     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 18,562 |   |   |
| Deferred Compensation related to Rendition  acquisition                                                 |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | (1,505 | ) |   |   | — |   |   |   | — |   |   |   | (1,505 | ) |   |
| Reversal related to unamortized portion of deferred  stock compensation related to terminated employees |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | (74        | )                                                                           |       |                                        | —     |   |   |   | 74 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Impact of variable accounting related to replacement  stock option                                      |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | 395        |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 395 |   |   |
| Issuance of restricted stock option award                                                               |       |                  | 400        |                                   |       |                                                        |       |                                          |       |                     | 2,812      |                                                                        |       |                                        |       |   |   |   | (2,389 | ) |   |   | — |   |   |   | — |   |   |   | 423 |   |   |
| Components of comprehensive loss                                                                        |       |                  |       |                                   |       |                                                        |       |                                          |       |                     |       |                                                                        |       |                                        |       |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net loss                                                                                                |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | (14,751 | ) |   |   | — |   |   |   | (14,751 | ) |   |
| Translation adjustment                                                                                  |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | (130 | ) |   |   | (130 | ) |   |
| Total comprehensive loss                                                                                |       |                  | —     |                                   |       |                                                        | —     |                                          |       |                     | —     |                                                                        |       |                                        | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | (14,881 | ) |   |
| Balance at  January 31, 2006                                                                       |       |                  | 99,596     |                                   |       |                                                        | $          | 100                                           |       |                     |       | $                                                                           | 609,455    |                                        |       |   | $ | — |   |   |   | $ | (2,606 | ) |   |   | $ | (483,270 | ) |   |   | $ | (141 | ) |   |   | $ | 123,538 |   |   |

 

See accompanying notes.

45

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**OPSWAREINCCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY—(Continued)(in thousands)**

| ** **                                                                       | ** ** | **Common Stock** | ** ** | **Additional   Paid-In   Capital** | ** ** | **Notes   Receivable  from   Stockholders** | ** ** | **Deferred   Stock   Compensation** | ** ** | **Accumulated   Deficit** | ** ** | **Accumulated   Other  Comprehensive   Income   (Loss)** | ** ** | **Total   Stockholders’   Equity** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------|------------|-------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                       | ** ** | **Shares**            | ** ** | **Amount**                                   | ** ** | ** **                                            | ** ** | ** **                                    | ** ** | ** **                     | ** ** |
| Balance at January 31, 2006                                                 |       | 99,596                |       |                                         | $          | 100                                                   |       |                                          |       | $                              | 609,455    |                                                                    |       |                                              | $          | — |   |   |   | $ | (2,606 | ) |   |   | $ | (483,270 | ) |   |   | $ | (141 | ) |   |   | $ | 123,538 |   |   |
| Exercise of stock options by employees, net of  repurchases                      |       | 1419                  |       |                                         | 1          |                                                  |       |                                          | 4,630      |                           |       |                                                                    | —     |                                              |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 4,631 |   |   |
| Issuance of common stock in connection with the  Employee Stock Purchase Program |       | 666                   |       |                                         | 1          |                                                  |       |                                          | 2,774      |                           |       |                                                                    | —     |                                              |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 2,775 |   |   |
| Charge related to stock-based compensation                                       |       | —                |       |                                         | —     |                                                  |       |                                          | 16,029     |                           |       |                                                                    | —     |                                              |       |   | — |   |   |   | — |   |   |   | 16,029 |   |   |   |   |   |   |
| Reversal of deferred compensation as a result of adoption  of FAS123R            |       | —                |       |                                         | —     |                                                  |       |                                          | (2,606     | )                              |       |                                                                    | —     |                                              |       |   | 2,606 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Components of comprehensive loss                                                 |       |                  |       |                                         |       |                                                  |       |                                          | —     |                           |       |                                                                    | —     |                                              |       |   | — |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                         |       | —                |       |                                         | —     |                                                  |       |                                          | —     |                           |       |                                                                    | —     |                                              |       |   | — |   |   |   | (16,069 | ) |   |   | — |   |   |   | (16,069 | ) |   |
| Translation adjustment                                                           |       | —                |       |                                         | —     |                                                  |       |                                          | —     |                           |       |                                                                    | —     |                                              |       |   | — |   |   |   | — |   |   |   | (128 | ) |   |   | (128 | ) |   |
| Total comprehensive loss                                                         |       | —                |       |                                         | —     |                                                  |       |                                          | —     |                           |       |                                                                    | —     |                                              |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (16,197 | ) |   |
| Balance at  January 31, 2007                                                |       | 101,681               |       |                                         | $          | 102                                                   |       |                                          |       | $                              | 630,282    |                                                                    |       |                                              | $          | — |   |   |   | $ | — |   |   |   | $ | (499,339 | ) |   |   | $ | (269 | ) |   |   | $ | 130,776 |   |   |

 

See accompanying notes.

46

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**OPSWARE INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**

| ** **                                                                                         | ** ** | **Year ended January 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
|                                                                                                    | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Operating activities:                                                                              |       |                                      |       |   |   |   |   |
| Net  loss                                                                                          |       | $                                         | (16,069    | ) | $ | (14,751 | ) | $ | (7,246 | ) |
| Adjustments to reconcile  loss to net cash used in operating activities:                           |       |                                      |       |   |   |   |   |
| Depreciation                                                                                       |       | 2,610                                     |       | 2,666 |   | 2,577 |   |
| Amortization  of intangibles                                                                       |       | 3,678                                     |       | 2,942 |   | 1,272 |   |
| Charge  (benefit) related to stock-based compensation agreements                                   |       | —                                    |       | 828 |   | (481 | ) |
| Amortization  (reversal) of deferred stock compensation                                            |       | —                                    |       | 1,282 |   | (131 | ) |
| Loss  (recovery) on disposal of property and equipment                                             |       | 100                                       |       | (4 | ) | (6 | ) |
| Stock-based  compensation expense                                                                  |       | 16,029                                    |       | (130 | ) | (15 | ) |
| Translation  adjustment                                                                            |       | (128                                      | )          | — |   | — |   |
| In-process  research and development charges                                                       |       | —                                    |       | 1,190 |   | 610 |   |
| Changes in operating assets  and liabilities:                                                      |       |                                      |       |   |   |   |   |
| Accounts  receivable, net                                                                          |       | (13,881                                   | )          | (12,819 | ) | (521 | ) |
| Prepaids,  other current assets and other assets                                                   |       | (264                                      | )          | (3,073 | ) | 195 |   |
| Prepaid  rent                                                                                      |       | 539                                       |       | 645 |   | 816 |   |
| Accounts  payable                                                                                  |       | 1,289                                     |       | 335 |   | 229 |   |
| Accrued  compensation                                                                              |       | 3,989                                     |       | 4,561 |   | 393 |   |
| Other  accrued liabilities                                                                         |       | 1,297                                     |       | 1,413 |   | (6,629 | ) |
| Advances  from customers                                                                           |       | (721                                      | )          | (8,134 | ) | 4,620 |   |
| Deferred  revenue                                                                                  |       | (1,585                                    | )          | 20,579 |   | 4,208 |   |
| Accrued  restructuring costs                                                                       |       | (326                                      | )          | (211 | ) | (933 | ) |
| Net  cash used in operating activities                                                             |       | (3,443                                    | )          | (2,681 | ) | (1,042 | ) |
| **Investing activities:**                                                                          | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases  of property and equipment                                                               |       | (4,650                                    | )          | (2,278 | ) | (2,843 | ) |
| Restricted  cash                                                                                   |       | 17                                        |       | 444 |   | 171 |   |
| Proceeds  from sale of assets                                                                      |       | —                                    |       | — |   | 6 |   |
| Direct  acquisition costs paid, net of cash acquired                                               |       | (10,274                                   | )          | (15,006 | ) | (169 | ) |
| Net  cash used in investing activities                                                             |       | (14,907                                   | )          | (16,840 | ) | (2,835 | ) |
| **Financing activities:**                                                                          |       |                                      |       |   |   |   |   |
| Proceeds  from issuance of common stock, net of repurchases                                        |       | 7,406                                     |       | 2,715 |   | 66,996 |   |
| Receipt  of (principal payments on) capital lease obligations                                      |       | (14                                       | )          | 88 |   | (23 | ) |
| Proceeds  from repayment of notes receivable                                                       |       | —                                    |       | 1 |   | 314 |   |
| Net  cash provided by financing activities                                                         |       | 7,392                                     |       | 2,804 |   | 67,287 |   |
| Net  increase (decrease) in cash and cash equivalents                                              |       | (10,958                                   | )          | (16,717 | ) | 63,410 |   |
| Cash  and cash equivalents at beginning of period                                                  |       | 101,898                                   |       | 118,615 |   | 55,205 |   |
| Cash  and cash equivalents at end of period                                                        |       | $                                         | 90,940     |   | $ | 101,898 |   | $ | 118,615 |   |
| **Supplemental schedule of  non-cash investing and financing activities:**                         | ** ** | ** **                                |       |   |   |   |   |
| Reversal  of unamortized portion of deferred stock compensation related to terminated  employees   |       | $                                         | —     |   | $ | 75 |   | $ | 7 |   |
| Equipment  purchased under capital lease                                                           |       | —                                    |       | 98 |   | — |   |
| Cancellation  of stockholder notes receivable for terminated employees related to unvested  awards |       | —                                    |       | — |   | 13 |   |
| Common  stock issued in connection with the acquisition of Tangram                                 |       | —                                    |       | — |   | 10,000 |   |
| Common  stock issued in connection with the acquisition of Rendition                               |       | —                                    |       | 18,562 |   | — |   |
| **Supplemental  disclosures:**                                                                     | ** ** | ** **                                |       |   |   |   |   |
| Cash  paid for interest                                                                            |       | $                                         | 21         |   | $ | 20 |   | $ | — |   |
| Cash paid for taxes                                                                                |       | 195                                       |       | 161 |   | 29 |   |

 

See accompanying notes.

47

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTSOPSWARE INC.**

**1.   Summary of theCompany and Significant Accounting Policies**

*Nature ofOperations*

Opsware Inc. (“Opsware” or“the Company”) was incorporated on September 9, 1999 in the state ofDelaware. The Company licenses its data center automation software suite to enterprises,government agencies and service providers seeking to reduce costs and increasethe quality of their data center operations. This suite, which the Companylicenses as individual components and as an integrated software suite calledthe Opsware System, includes the Opsware Server Automation System (OSAS),Opsware Network Automation System (ONAS), Opsware Asset Management System(OAMS), Opsware Visual Application Manager (VAM), the Opsware OperationalManagement Database (OMDB), Opsware Orchestrator and The Opsware Network (TON).The Company’s software products automate key network, server and softwareoperations in data centers, including provisioning, changing, patching,reporting, configuring, scaling, securing, recovering, auditing and reallocatingservers, network devices and applications. The Company’s products work acrossgeographically disparate locations and heterogeneous data center environmentsconsisting of UNIX, Linux and Windows servers, virtualized servers, as well asa wide range of software infrastructure and applications, as well as networkdevices including switches, routers, load balancers and firewalls.

*Basis ofPresentation*

The consolidated financialstatements include accounts of the Company and its wholly owned subsidiaries.All intercompany balances have been eliminated.

*Use of Estimates*

The preparation of consolidated financial statementsin conformity with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that materially affect the amountsreported in the consolidated financial statements. Actual results could differmaterially from these estimates. The methods, estimates and judgments theCompany uses in applying its most critical accounting policies have asignificant impact on the results reported in its financial statements

Certain reclassificationshave been made to prior fiscal year amounts in order to conform to the currentfiscal year presentation.

*SignificantAccounting Policies*

*Revenue Recognition*

The Company recognizes software revenue in accordancewith the American Institute of Certified Public Accountants’ (“AICPA”)Statement of Position No. 97-2 (“SOP 97-2”), “Software RevenueRecognition,” Statement of Position No. 98-9, “Modification of SOP 97-2with Respect to Certain Transactions” (“SOP 98-9”), and EITF 00-21,“Revenue Arrangements with Multiple Deliverables.”  For each transaction, the Company determineswhether evidence of an arrangement exists, delivery has occurred, the fee isfixed or determinable, and collectibility of the fee is probable. If any ofthese criteria are not met, revenue recognition is deferred until such time asall criteria are met. The Company considers all arrangements with payment termsextending beyond ninety days not to be fixed or determinable in which caserevenue is recognized when the payment becomes due. No customer has a right ofreturn privilege.

48

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Most of the Company’s arrangements involve multipleelements (for example, license fees, maintenance and support, and professionalservices), and the Company allocates revenue to each component of thearrangement using the residual method, as prescribed by Statement of Position 98-9,“Modification of SOP 97-2 With Respect to Certain Transactions,” based onthe Company’s vendor specific objective evidence (VSOE) of fair value of theundelivered elements. This means that the Company defers revenue from thearrangement fee equivalent to the fair value of the undelivered elements. Theresidual arrangement fee is then allocated to the delivered element orelements, which is generally software license fees. VSOE of fair value for theongoing maintenance and support obligations (post contract support or PCS)within an arrangement is based upon the price charged to the customer when PCSis sold separately, or in the absence of separate sales, upon substantiverenewal rates stated in the contracts. VSOE of fair value of consulting andtraining services is based upon hourly rates and per unit pricing,respectively, charged under separate sales of these services to other customersin stand alone transactions. VSOE of the fair value of TON is determined byreference to the price paid by the Company’s customers when TON is soldseparately. In the absence of separate sales, VSOE is determined uponsubstantive renewal rates stated in the contracts.

License revenue consists of license fees charged forthe use of the Company’s products under perpetual or term license arrangements.The Company recognizes license revenue for perpetual licenses using theresidual method after all elements other than PCS and professional serviceshave been delivered, provided that all of the criteria for revenue recognition,as discussed above, are met. Generally, these criteria are met at the time ofdelivery of the software to the customer. The Company recognizes revenue underterm licenses on a straight-line basis over the term of the arrangement oncethe criteria for revenue recognition have been met. If an arrangement includesan acceptance provision, revenue is deferred until the earlier of receipt ofwritten customer acceptance or expiration of the acceptance period.

Services revenue consists of revenue from PCS, TON andprofessional services agreements. PCS agreements include ongoing customersupport and rights to product updates and upgrades, if and when available. TONis a subscription service that complements certain of our software products byproviding ongoing updates, when-and-if-available, of security alerts. Revenueunder PCS and TON arrangements is recognized ratably using the straight-linemethod over the period that PCS and TON are provided (generally, one year). Professionalservices revenue consists of fees charged for product training and consultingservices. Consulting services are generally accounted for separately from thesoftware license because the services qualify for separate accounting under SOP97-2. The more significant factors considered in determining whether theservices should be accounted for separately include the nature of services(i.e., consideration of whether the services are essential to the functionalityof the licensed product), degree of risk, availability of services from othervendors, timing of payments and impact of service milestones or acceptancecriteria on the realizability of the software license fee. Revenues forconsulting services that qualify for separate accounting are generallyrecognized as the services are performed. If services do not qualify forseparate accounting, the software license revenue is generally recognizedtogether with the consulting services using contract accounting (proportionalperformance or the completed-contract method). In any event, contractaccounting is applied to any arrangements: (1) that include milestones orcustomer specific acceptance criteria that may affect collection of thesoftware license fees; (2) where services include significant modificationor customization of the software; or (3) where the software licensepayment is tied to the performance of consulting services.

The Company recognizes revenue associated withsoftware licenses and services sold to distributors, system integrators andvalue added resellers (collectively, “resellers”) upon satisfaction of allrevenue 

49

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

recognition criteriaunless it is aware that a reseller does not have a purchase order or othercontractual agreement with an end user to purchase the software. In connectionwith sales to resellers, there is no right of return.

For all periods includedin the Company’s consolidated financials statements, the Company recognizesperpetual license revenue from OAMS and ONAS arrangements using the residualmethod after all elements other than maintenance and non-essential serviceshave been delivered, provided that all of the criteria for revenue recognitiondiscussed above are met. Generally, these criteria are met at the time ofdelivery. For OSAS arrangements entered into prior to May 1, 2005, whichwas the date when the Company determined it had established VSOE of the fairvalue of maintenance and professional services for OSAS, the Company recognizedboth license and services revenue from a transaction ratably over the remainingpost-contract maintenance and support period once deployment of the Company’ssoftware had been completed and all other elements of the arrangement had beendelivered. For OSAS arrangements entered into on or after May 1, 2005, theCompany recognizes revenue from perpetual licenses using the residual method.

*Impairment ofLong-Lived Assets and Intangible Assets*

The Company periodicallyreviews the carrying value of long-lived assets, including property andequipment and other identified intangible assets, to determine whether thereare any indicators of impairment. Some indicators of impairment could include adecrease in the market price of a long-lived asset, an adverse change in theextent or manner in which a long-lived asset is being used, a change in thebusiness climate that could affect the value of a long-lived asset or acurrent-period operating or cash flow loss combined with a history of operatingor cash flow losses. According to the Company’s accounting policy, when suchindicators are present, if the undiscounted cash flows expected to be generatedfrom operations from those long-lived assets are less than the carrying valueof those long-lived assets, the Company compares the fair value of the assets(estimated using discounted future net cash flows to be generated from thelowest common level of operations utilizing the assets) to the carrying valueof the long-lived assets to determine any impairment charges. The Companyreduces the carrying value of the long-lived assets if the carrying value ofthe long-lived assets is greater than their fair value. The new carrying valueis then depreciated over the remaining estimated useful lives of the assets. Thedetermination as to whether impairment exists involves significant judgment andthe assumptions supporting the estimated future cash flows reflect management’sbest estimates. There were no impairment charges recorded during the year endedJanuary 31, 2007.

*Impairment ofGoodwill*

The Company accounts forgoodwill in accordance with Statement of Financial Accounting Standards No. 142,“Goodwill and Intangible Assets” or “SFAS 142”. In accordance with SFAS 142,goodwill is not amortized, but instead will be tested for impairment at leastannually and more frequently if certain indicators are present. Circumstancesthat could trigger an impairment test include, but are not limited to, asignificant adverse change in the business climate or legal factors,unanticipated competition and loss of key personnel. The assessment ofimpairment is made by comparing the fair value of the reporting unit to whichthe goodwill has been assigned by management to its carrying value. To theextent that an impairment is indicated (fair value is less than carryingvalue), the Company must perform a second test to measure the amount of theimpairment. The Company operates as a single segment for reporting purposes. Thedetermination as to whether a write down of goodwill is necessary involvessignificant 

50

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

judgmentbased on the short-term and long-term projections of future performance. Theassumptions supporting the estimated future cash flows, including the discountrate used and estimated terminal value, reflects the Company’s best estimates. Inthe event the Company determines that goodwill has been impaired, the Companywill incur an accounting charge related to the impairment during the reportingperiod in which such impairment determination is made. The Company reviews forindicators of potential impairment of goodwill at least annually. No goodwillimpairment charges have been recorded through January 31, 2007.

*ContingencyAccruals*

The Company evaluatescontingent liabilities including threatened or pending litigation in accordancewith SFAS No. 5, “Accounting for Contingencies” or “SFAS 5”. If thepotential loss from any claim or legal proceedings is considered probable andthe amount can be estimated, the Company accrues a liability for the estimatedloss. Because of uncertainties related to these matters, accruals are basedupon management’s judgment and the best information available to management atthe time. As additional information becomes available, the Company reassessesthe potential liability related to its pending claims and litigation and mayrevise its estimates.

*Cash and CashEquivalents*

The Company considers all highly liquid investmentsecurities with a maturity date from the date of purchase of three months orless to be cash equivalents. Cash and cash equivalents, which primarily consistof cash on deposit with banks and money market funds, are stated at cost, whichapproximates fair value.

Management determines theappropriate classification of debt and equity securities at the time of purchaseand evaluates such designation as of each balance sheet date. To date, all debtsecurities have been classified as available-for-sale and are carried at fairvalue with unrealized gains and losses, if any, included in stockholders’equity. Interest and dividends on all securities are included in interestincome.

*Concentrations ofCredit Risk and Significant Customers*

Financial instruments that potentially subject theCompany to concentrations of credit risk consist principally of cash, cashequivalents, restricted cash and accounts receivable. The Company places all ofits cash, cash equivalents and restricted cash with high-credit quality issuers.Carrying amounts of financial instruments held by the Company, which includecash equivalents, restricted cash and accounts receivable, approximate fairvalue due to their short duration. The Company performs ongoing creditevaluations, as warranted, and maintains allowances for potential losses onaccounts receivable.

For the years ended January 31,2007 and 2006, EDS accounted for 21% and 35% of the Company’s net revenues,respectively. For the year ended January 31, 2005, EDS and anothercustomer accounted for 54% and 11% of the Company’s net revenues, respectively.As of January 31, 2007, no customers accounted for more than 10% of theCompany’s accounts receivable balance. As of January 31, 2006, onecustomer accounted for 15% of the Company’s accounts receivable balance andanother customer accounted for 11% of such balance. As of January 31,2005, EDS accounted for 53% of the Company’s accounts receivable balance.

51

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

*Allowance forDoubtful Accounts*

The Company maintains anallowance for doubtful accounts for estimated losses resulting from theinability of its customers to make required payments. The allowance fordoubtful accounts is based on specifically identified customers and as apercentage of accounts receivable based on historical write-offs for theCompany. As of January 31, 2007, 2006 and 2005, the allowance for doubtfulaccounts was $393,000, $219,000 and $125,000, respectively. Additions to theallowance for doubtful accounts were $185,000, $131,000, and $131,000 for theyears ended January 31, 2007, 2006, and 2005, respectively. Deductionsagainst the allowance were $11,000, $37,000, and $59,000 for the years ended January 21,2007, 2006, and 2005, respectively. If the financial condition of the Company’scustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required. In addition, under theCompany’s accounting policy, it continually assesses the balance of itsallowance for doubtful accounts based on, among other things, its customers’payment history and financial condition, including a review of the customers’balance sheets, statements of operations, statements of cash flows and creditreports. If actual write-offs were greater than the Company’s estimates, itwould increase its allowance for doubtful accounts, which would increase itsbad debt expense.

*Accounting forStock-Based Compensation*

Effective February 1, 2006, the Company adoptedthe fair value recognition provisions of SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”),using the modified-prospective transition method and therefore the Company hasnot restated financial results for prior periods. SFAS 123R requires allshare-based payments to employees, including grants of stock options, to berecognized as expense in the statement of operations based on their fair valuesand vesting periods. As a result of implementing SFAS 123R, the Companyrecognized stock-based compensation expense of $16.0 million during the yearended January 31, 2007.

Under the modified-prospective transition method,stock-based compensation for fiscal 2007 includes expense for all equity awardsgranted prior to, but not yet vested as of February 1, 2006, based on thegrant date fair value estimated in accordance with the original provision ofSFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).Expense for all stock-based compensation awards granted after February 1,2006 is based on the grant date fair value estimated in accordance with theprovisions of SFAS 123R. The Company recognizes compensation expense forstock option awards on a straight-line basis over the vesting period of theaward.

Prior to the adoption of SFAS 123R, the Companyrecognized stock-based compensation expense in accordance with AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees” (“APB 25”). Under APB 25, compensation expense of fixed stockoptions was based on the difference between the deemed fair value of theCompany’s stock on the date of the grant and the exercise price of the option.The Company’s deferred compensation balance of $2.6 million as of January 31,2006, which was accounted for under APB 25, was reversed out of additionalpaid-in-capital upon the adoption of SFAS 123R.

As a result of adopting SFAS 123R, the Company’s lossfrom operations, loss before taxes and net loss for the year ended January 31,2007 is $16.0 million higher than if it had continued to account forstock-based compensation under APB 25. Basic and diluted loss per share for theyear ended January 31, 2007 would have been $0.00 if the Company had notadopted SFAS 123R, compared to reported basic and diluted loss per share of$0.16.

52

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Net cash proceeds from the exercise of stock optionswere $4.6 million, $1.1 million and $4.1 million for the years ended January 31,2007, 2006 and 2005, respectively. The Company did not realize any income taxbenefit from stock option exercises during fiscal years 2007, 2006, and 2005.In accordance with SFAS 123R, the Company presents excess tax benefits from theexercise of stock options, if any, as financing cash flows rather than operatingcash flows.

Underboth SFAS 123 and SFAS 123R, the fair value of each option grant was estimatedon the date of grant using the Black-Scholes option pricing model with thefollowing weighted-average assumptions:

| ** **                                       | ** ** | **Stock Awards**                     | ** ** | **Employee Stock   Purchase Plan** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                       | ** ** | **Year Ended January 31,** | ** ** | **Year Ended January 31,**         | ** ** |
| ** **                                       | ** ** | **2007**                                  | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Risk-free  interest yield                        |       | 4.8                                       | %          | 4.0                                               | %          | 3.6 | % | 4.8 | % | 3.5 | % | 1.9 | % |
| Expected life  (years)                           |       | 5.5                                       |       | 4.0                                               |       | 4.0 |   | 2.0 |   | 2.0 |   | 2.0 |   |
| Volatility                                       |       | 89                                        | %          | 73                                                | %          | 81 | % | 50 | % | 68 | % | 112 | % |
| Dividend yield                                   |       | 0                                         | %          | 0                                                 | %          | 0 | % | 0 | % | 0 | % | 0 | % |
| Weighted-average fair  value per share of grants |       | $                                         | 5.88       |                                              | $          | 3.40 |   | $ | 4.47 |   | $ | 2.82 |   | $ | 2.19 |   | $ | 1.69 |   |
|                                                  |            |                                           |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The expected life represents the weighted-averageperiod that an equity award is expected to remain outstanding and is based onthe actual and expected time for either post-vesting exercise or forfeitures ofoptions by employees. The Company uses historical volatility in deriving itsexpected volatility assumption. The risk-free interest rate assumption is basedupon observed interest rates appropriate for the term of the Company’s equityawards. The expected dividend assumption is based on the Company’s history andexpectation of dividend payouts.

As stock-based compensation expense recognized in theConsolidated Statement of Operations in fiscal 2007 is based on awardsultimately expected to vest, the expense amount has been reduced for estimatedforfeitures. SFAS 123R requires forfeitures to be estimated at the time ofgrant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those estimates. Forfeitures were estimated based on historicalexperience. In the Company’s pro forma information required under SFAS 123for the periods prior to February 1, 2006, the Company accounted for forfeituresas they occurred.

53

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

If theCompany had adopted SFAS 123R during the fiscal years 2006 and 2005, theCompany’s net loss for these years would have resulted in the pro forma amountsindicated below (in thousands, except per share data):

| ** **                                                                                                    | ** ** | **Year Ended January 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
| As reported net  loss                                                                                         |       | $                                         | (14,751    | ) | $ | (7,246 | ) |
| Stock-based  compensation expense (reversal) included in reported net loss                                    |       | 2,097                                     |       | (615 | ) |
| Total stock-based  employee compensation expense determined under the fair value based method  for all awards |       | (14,033                                   | )          | (10,251 | ) |
| Pro forma net loss                                                                                            |       | $                                         | (26,687    | ) | $ | (18,112 | ) |
| Net loss per  share:                                                                                          |       |                                      |       |   |   |
| As reported net  loss per share—basic and diluted                                                        |       | $                                         | (0.15      | ) | $ | (0.09 | ) |
| Pro forma net loss per share—basic and diluted                                                           |       | $                                         | (0.27      | ) | $ | (0.21 | ) |

 

*Property andEquipment*

Property and equipment isstated at cost, net of accumulated depreciation. Depreciation is calculatedusing the straight-line method over the estimated useful lives of the assets,or two years for software, three years for computer and office equipment andfive years for furniture and fixtures. The Company amortizes capital leases andleasehold improvements using the straight-line method over the lesser of theasset’s estimated useful life or remaining lease term (typically three to fiveyears).

*AdvertisingExpenses*

All advertising expensesare expensed as incurred. Advertising expenses were $30,000, $90,000, and$80,000 for the fiscal years ended January 31, 2007, 2006, and 2005,respectively.

*Research andDevelopment Costs*

Research and developmentexpenditures are charged to operations as incurred. Statement of FinancialAccounting Standards No. 86, “Accounting for the Costs of ComputerSoftware to Be Sold, Leased or Otherwise Marketed,” (“SFAS 86”) requires thecapitalization of certain software development costs subsequent to theestablishment of technological feasibility. Based on the Company’s productdevelopment process, technological feasibility is established upon thecompletion of a working model. Costs incurred by the Company between thecompletion of the working model and the point at which the product is ready forgeneral release have been insignificant. Accordingly, the Company has chargedall such costs to research and development expense in the accompanyingstatements of operations. As a result, research and development expendituresare not reflected in the accompanying balance sheets of the Company.

*Guarantees andIndemnifications*

Financial Accounting Standards Board Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others” (“FIN 45”), requires that theCompany recognize and record the fair value of guarantee and 

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

indemnificationarrangements issued or modified by the Company after December 31, 2002, ifthese arrangements are within the scope of FIN 45. In addition, the Companymust continue to monitor the conditions that are subject to the guarantees andindemnifications, as required under previously existing generally acceptedaccounting principles, in order to identify if a loss has occurred. If theCompany determines it is probable that a loss has occurred then any suchestimable loss would be recognized under those guarantees and indemnifications.

In some cases, the Companymay provide warranties or indemnification with respect to its softwareproducts. Consistent with FIN 45, the Company will accrue for known warranty orindemnification claims if a loss is probable and can be reasonably estimatedand will accrue for estimated but unidentified warranty or indemnificationclaims based on historical activity. To date, the Company has had no warrantyclaims. As a result, the Company has not recorded a warranty accrual. Inaddition, there has been no history of indemnification claims related to theCompany’s software and the Company has not recorded an indemnification accrual.

*ComprehensiveIncome (Loss)*

Under Statement ofFinancial Accounting Standards No. 130, “Reporting Comprehensive Income” (“SFAS130”), the Company is required to display comprehensive income (loss) and itscomponents as part of the financial statements. Other comprehensive income(loss) includes foreign currency translation adjustments and unrealizedgains/losses on available-for-sale securities that are excluded from loss andis reported in the accompanying consolidated statement of stockholders’ equity.

*Income Taxes*

The Company accounts forincome taxes using the liability method under which deferred tax assets andliabilities are determined based on differences between financial reporting andtax bases of assets and liabilities and are measured using the enacted taxrates and laws that will be in effect when the differences are expected toreverse. A valuation allowance is recorded to reduce the carrying amounts of deferredtax assets if it is more likely than not that those assets will not berealized.

*Recent AccountingPronouncements*

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes,” (“FIN 48”). FIN 48 clarifies the accounting foruncertainty in income taxes by prescribing the minimum recognition threshold atax position is required to meet before being recognized in the financialstatements. FIN 48 also provides guidance on derecognition, measurement,classification, interest and penalties, accounting in interim periods,disclosure and transition, and clearly scopes income taxes out of FinancialAccounting Standards Board Statement No. 5, Accounting for Contingencies (“FAS5”). FIN 48 will be effective for fiscal years beginning after December 15,2006. The Company is currently evaluating what impact, if any, the adoption ofFIN 48 will have on its financial position and results of operations.

55

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**OPSWARE INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements.” SFAS No. 157 defines fair value, establishes a frameworkfor measuring fair value and expands disclosures about fair value measurements.SFAS No. 157 applies to other accounting pronouncements that require orpermit fair value measurements, with certain exceptions, including FAS 123(R),among other pronouncements. The provisions of SFAS No. 157 are effectivefor financial statements issued for fiscal years beginning after November 15,2007. The Company is currently evaluating what impact, if any, the adoption ofSFAS No. 157 will have on its financial position and results ofoperations.

**2.**   Cashand cash equivalents 

Thefollowing table summarizes the estimated fair value of financial instruments atthe dates indicated (in thousands):

| ** **                   | ** ** | **Year Ended January 31,** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| ** **                   | ** ** | **2007**                                  | ** ** | **2006** | ** ** |
| Cash and money  market funds |       | $                                         | 93,219     |   | $ | 104,194 |   |
| Reported as:                 |       |                                      |       |   |   |
| Cash and cash  equivalents   |       | $                                         | 90,940     |   | $ | 101,898 |   |
| Restricted cash              |       | 2,279                                     |       | 2,296 |   |
|                         |       | $                                         | 93,219     |   | $ | 104,194 |   |

 

Realized gains and lossesfrom the sale of financial instruments were not material for fiscal 2007 and2006. See Note 6 for discussion of the restricted cash.

**3.**   Propertyand Equipment

Propertyand equipment consist of the following (in thousands): 

| ** **                                                        | ** ** | **Year Ended January 31,** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                        | ** ** | **2007**                                  | ** ** | **2006** | ** ** |
| Computer and  other related equipment                             |       | $                                         | 10,686     |   | $ | 8,358 |   |
| Office equipment,  leasehold improvements, furniture and fixtures |       | 11,465                                    |       | 10,417 |   |
| Software                                                          |       | 11,331                                    |       | 10,506 |   |
|                                                              |       | 33,482                                    |       | 29,281 |   |
| Less: accumulated  depreciation and amortization                  |       | (27,584                                   | )          | (25,337 | ) |
| Property and equipment,  net                                      |       | $                                         | 5,898      |   | $ | 3,944 |   |

 

Depreciation andamortization expense amounted to $2.6 million, $2.7 million, and $2.6 millionfor the years ended January 31, 2007, 2006, and 2005, respectively. As of January 31,2007, 2006 and 2005 property and equipment under capital leases totaled$81,000, $104,000 and $6,000 with related accumulated amortization of $35,000,$23,000 and $5,000, respectively.

**4.**   Goodwilland Intangible assets

In August 2006, the Company completed itsacquisition of CreekPath Systems. For the year ended January 31, 2007, theCompany recorded $5.7 million of goodwill in connection with this acquisition.

56

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**OPSWARE INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Thechange in the carrying amount of goodwill is as follows (in thousands):

| ** **                           | ** ** | **Goodwill** | ** ** |
|--------------------------------------|------------|--------------|------------|
| Balance as of  January 31, 2006 |       | $            | 27,668     |   |
| Acquisition of  CreekPath Systems    |       | 5,715        |       |
| Other adjustments                    |       | (137         | )          |
| Balance as of  January 31, 2007 |       | $            | 33,246     |   |

 

Other adjustments to Goodwill primarily relate toclaims the Company made during fiscal 2007 against the indemnificationobligations of the former Rendition stockholders,

TheCompany is amortizing the intangible assets on a straight-line basis over anaverage estimated life of four years. Amortization expense for these intangibleassets was $3.7 million for the year ended January 31, 2007. Totalintangible assets subject to amortization are as follows (in thousands):

| ** **              | ** ** | **January 31, 2007**  | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Gross carrying  amount** | ** ** | **Accumulated  amortization** | ** ** | **Net carrying  amount** | ** ** |
| Developed  technology   |       |                            | $          | 12,182 |   |   |   | $ | (4,661 | ) |   |   | $ | 7,521 |   |   |
| Customer  relationships |       |                            | 5,415      |   |   |   | (3,231 | ) |   |   | 2,184 |   |   |
| Intangible assets, net  |       |                            | $          | 17,597 |   |   |   | $ | (7,892 | ) |   |   | $ | 9,705 |   |   |

 

| ** **              | ** ** | **January 31, 2006**  | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **Gross carrying  amount** | ** ** | **Accumulated  amortization** | ** ** | **Net carrying  amount** | ** ** |
| Developed  technology   |       |                            | $          | 6,592 |   |   |   | $ | (2,314 | ) |   |   | $ | 4,278 |   |   |
| Customer  relationships |       |                            | 5,235      |   |   |   | (1,900 | ) |   |   | 3,335 |   |   |
| Intangible assets, net  |       |                            | $          | 11,827 |   |   |   | $ | (4,214 | ) |   |   | $ | 7,613 |   |   |

 

Theaggregate estimated annual intangible amortization expense through July 31,2010 is as follows (in thousands):

| **Fiscal Year** | ** ** | ** ** | ** ** | **Amortization** | ** ** |
|----------------------|------------|------------|------------|------------------|------------|
| 2008                 |       |       | $          | 4,400            |       |   |
| 2009                 |       |       | 3,129      |             |       |
| 2010                 |       |       | 1,456      |             |       |
| 2011                 |       |       | 720        |             |       |
|                 |       |       | $          | 9,705            |       |   |

 

**5.   Acquisitions**

*CreekPath Systems.*

On August 1, 2006, the Company acquired CreekPathSystems, a provider of IT storage management software and services that willhelp enable the Company to create an integrated product solution that allowscustomers to manage multiple aspects of their IT infrastructure. Thetransaction was valued at $10.6 million, which included cash consideration of$10.2 million and $357,000 of direct acquisition costs. The transaction wasaccounted for using the purchase method. Approximately $2.25 million of thecash paid in 

57

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**OPSWARE INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

the acquisition was placedin escrow as security for the satisfaction of indemnification claims, if any,by the Company under the merger agreement. All funds remaining in the escrowaccount following 18 months from the completion of the merger will bedistributed to CreekPath Systems stockholders. Under an earnout provision,additional contingent consideration of up to $5.0 million in cash may bepayable by the Company following the one-year anniversary of the closing.

The results of operations for CreekPath Systems wereincluded in the Company’s consolidated financial statements beginning on theeffective date of the acquisition, which was August 1, 2006.

Inaccordance with SFAS No. 141 “Business Combinations” (“SFAS 141”), theCompany allocated the purchase price of the acquisition to the liabilities andtangible and intangible assets acquired based on their estimated fair values.The excess purchase price over those fair values was recorded as goodwill. Thefair value assigned to intangible assets acquired was determined by managementbased on several factors, including independent valuations and estimates andassumptions by the Company. A summary of the total purchase price is as follows(in thousands):

| Cash consideration               |   | $   | 10,200 |   |
|----------------------------------|--------|-----|--------|--------|
| Direct costs of  the acquisition |   | 357 |   |
| Total purchase price             |   | $   | 10,557 |   |

 

Thetotal purchase price has been allocated as follows (in thousands):

| Cash                            |   | $      | 146    |   |
|---------------------------------|--------|--------|--------|--------|
| Other current  assets           |   | 38     |   |
| Property and  equipment, net    |   | 14     |   |
| Amortizable intangible  assets: |   |   |   |
| Developed Technology            |   | 5,590  |   |
| Customer Relationships          |   | 180    |   |
| Goodwill                        |   | 5,715  |   |
| Accounts payable                |   | (106   | )      |
| Other accrued  liabilities      |   | (137   | )      |
| Restructuring  liabilities      |   | (362   | )      |
| Deferred revenue                |   | (521   | )      |
| Total purchase  price           |   | $      | 10,557 |   |

 

In accordance with EITF No. 95-3,“Recognition of Liabilities in Connection with a Purchase Business Combination,”the Company committed to a plan and recorded a liability of $362,000 consistingof employee severance and relocation costs. These liabilities were fully paidby January 31, 2007.

*Goodwill*

Goodwill represents theexcess of the purchase price over the estimated fair value of the underlyingnet tangible and intangible assets acquired.

58

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**OPSWARE INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

*Purchasedidentified intangible assets*

**Intangibleassets consist of the following (in thousands)**

| ** **                      | ** ** | **Year Ended**            | ** ** |
|---------------------------------|------------|--------------------------------|------------|
| ** **                      | ** ** | **January 31, 2007** | ** ** |
| Developed  technology           |       |                           | $          | 5,590 |   |   |
| Customer  relationships         |       |                           | 180        |   |   |
| Less: Accumulated  amortization |       |                           | (721       | ) |   |
| Intangible assets, net          |       |                           | $          | 5,049 |   |   |

 

Theaggregate estimated annual intangible amortization expense through July 31,2010 is as follows (in thousands):

| **Fiscal Year** | ** ** | ** ** | ** ** | **Amortization** | ** ** |
|----------------------|------------|------------|------------|------------------|------------|
| 2008                 |       |       | $          | 1,443            |       |   |
| 2009                 |       |       | 1,443      |             |       |
| 2010                 |       |       | 1,443      |             |       |
| 2011                 |       |       | 720        |             |       |
|                 |       |       | $          | 5,049            |       |   |

 

*Pro forma results*

The unaudited pro forma financial information belowpresents the combined results of operations for the Company and CreekPathSystems as if the acquisition had occurred as of the beginning of the eachperiod presented. CreekPath Systems’ operating results have been included inthe Company’s operating results since the date of acquisition, which was August 1,2006. The unaudited pro forma financial information for the year ended January 31,2007 was derived from the Company’s condensed consolidated statements ofoperations for the year ended January 31, 2007 and CreekPath Systems’unaudited statements of operations for the six months ended June 30, 2006.The unaudited pro forma financial information for the year ended January 31,2006 was derived from the Company’s condensed consolidated statements ofoperations for the year ended January 31, 2006 and CreekPath Systems’unaudited statements of operations for the year ended December 31, 2005.The unaudited pro forma basic and diluted net loss per share computations arebased upon the weighted-average outstanding common stock of the Company duringthe periods presented. The unaudited pro forma financial information is notintended to represent or be indicative of the consolidated results ofoperations or financial condition that the Company would have reported had theacquisition been completed as of the dates presented and should not be taken asrepresentative of the future consolidated results of operations.

Unauditedpro forma financial information is as follows (in thousands, except per shareamounts):

| ** **                            | ** ** | **January 31, 2007** | ** ** | **January 31, 2006** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| Net revenue                           |       |                           | $          | 102,547                        |       |   |   | $ | 67,125 |   |   |
| Net loss                              |       |                           | $          | (20,205                        | )          |   |   | $ | (25,226 | ) |   |
| Basic and diluted net  loss per share |       |                           | $          | (0.20                          | )          |   |   | $ | (0.26 | ) |   |

 

59

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**OPSWARE INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**6.    Commitments**

Rent expense, net ofsublease income, was $3.2 million, $2.7 million and $2.3 million for the yearsended January 31, 2007, 2006, and 2005, respectively. The Company leasesapproximately 75,000 square feet in Sunnyvale, California for its corporateheadquarters, under a lease expiring in 2010. The Company issued a letter ofcredit in connection with this lease, which requires the Company to holdapproximately $2.3 million of restricted cash with the issuer of the letter ofcredit of cash on deposit. Accordingly, this amount is included in restrictedcash, a long-term asset, on the accompanying consolidated balance sheets.

Futurepayments under all non-cancellable leases entered into as of January 31,2007 are as follows (in thousands):

| **Years ending January 31,** | ** ** | ** ** | ** ** | **Capital Lease** | ** ** | **Operating  Leases** | ** ** |
|---------------------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|
| 2008                                        |       |       | $          | 36                     |       |                  |       | $ | 2,683 |   |   |
| 2009                                        |       |       | 36         |                   |       |                  | 2,333      |   |   |
| 2010                                        |       |       | 35         |                   |       |                  | 2,315      |   |   |
| 2011                                        |       |       | —     |                   |       |                  | 1,444      |   |   |
| 2012                                        |       |       | —     |                   |       |                  | 726        |   |   |
| Thereafter                                  |       |       | —     |                   |       |                  | 3,536      |   |   |
| Total minimum  payments                     |       |       | $          | 107                    |       |                  |       | $ | 13,037 |   |   |
| Amount  representing interest               |       |       | (33        | )                      |       |                  |       |   |   |
| Present value of  minimum payments          |       |       | 74         |                   |       |                  |       |   |   |
| Less current  portion                       |       |       | (19        | )                      |       |                  |       |   |   |
| Long term portion                           |       |       | $          | 55                     |       |                  |       |   |   |   |

 

**7.    Restructuring Costs**

In August 2003, theCompany entered into an agreement to amend the facility lease of its corporateheadquarters, portions of which were idle. Pursuant to the agreement, theCompany renegotiated its lease payments and paid the lessor approximately $7.4million. This resulted in a reduction of its restructuring liability related tothe sale of its Managed Services Business of approximately $2.2 million and arecovery of approximately $145,000 resulting from the adjustment to the presentvalue of the remaining payments included in the original restructuring charge.The remainder of the payment was accounted for as prepaid rent and will beamortized to operating expense through May 2010, the end of the leaseterm.

In May 2004, theCompany amended its agreement with its subtenant with respect to the Company’sfacility located in Sunnyvale, California. Pursuant to the amendment, the termof the sublease was extended, resulting in additional probable future subleasepayments. As a result, the Company revised its estimates of the fair value(computed as the revised present value of the future net lease payments onvacated leased facilities) of its restructuring liability, resulting in areduction to the recorded restructuring liability of approximately $436,000. Inaddition, the Company recorded a recovery for excess facilities ofapproximately $313,000 during the fiscal year ended January 31, 2005 dueto sublease payments received. The Company also recorded a recovery due to thesettlement of a sublease agreement of approximately $190,000. The subleasepayments were not included in the calculation of the Company’s original restructuringcharge in August 2002 due to the uncertainty of the financial condition ofthe subtenant. The Company also recorded a recovery of approximately $146,000for property taxes, due to a change in estimate of future property tax paymentsas property values had decreased. Property taxes had been included in theoriginal restructuring calculation.

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**OPSWARE INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Asummary of the restructuring charges is outlined as follows (in millions):

| ** **                        | ** ** | **Facilities** | ** ** | **Disposal of  Property and  Equipment** | ** ** | **Total** | ** ** |
|-----------------------------------|------------|----------------|------------|----------------------------------------------------|------------|-----------|------------|
| Total Charge                      |       |           | $          | 12.1                                               |       |      |       | $ | 1.2 |   |   | $ | 13.3 |   |
| Noncash Charges                   |       |           | —     |                                               |       |      | (1.2       | ) |   | (1.2 | ) |
| Cash Payments                     |       |           | (3.2       | )                                                  |       |      | —     |   |   | (3.2 | ) |
| Balance at January 31, 2003  |       |           | 8.9        |                                               |       |      | —     |   |   | 8.9 |   |
| Adjustments                       |       |           | 1.1        |                                               |       |      | (0.1       | ) |   | 1.0 |   |
| Noncash Charges                   |       |           | —     |                                               |       |      | 0.1        |   |   | 0.1 |   |
| Cash Payments                     |       |           | (7.4       | )                                                  |       |      | —     |   |   | (7.4 | ) |
| Balance at January 31, 2004  |       |           | 2.6        |                                               |       |      | —     |   |   | 2.6 |   |
| Adjustments                       |       |           | (0.9       | )                                                  |       |      | —     |   |   | (0.9 | ) |
| Noncash Charges                   |       |           | 0.4        |                                               |       |      | —     |   |   | 0.4 |   |
| Cash Payments                     |       |           | (0.4       | )                                                  |       |      | —     |   |   | (0.4 | ) |
| Balance at January 31, 2005  |       |           | 1.7        |                                               |       |      | —     |   |   | 1.7 |   |
| Cash Payments                     |       |           | (0.2       | )                                                  |       |      | —     |   |   | (0.2 | ) |
| Balance at January 31, 2006  |       |           | $          | 1.5                                                |       |      |       | $ | — |   |   | $ | 1.5 |   |
| Adjustments                       |       |           | (0.1       | )                                                  |       |      | —     |   |   | (0.1 | ) |
| Cash Payments                     |       |           | (0.2       | )                                                  |       |      | —     |   |   | (0.2 | ) |
| Balance at  January 31, 2007 |       |           | $          | 1.2                                                |       |      |       | $ | — |   |   | $ | 1.2 |   |

 

Amounts related to the remaining accrual for excessfacilities will be paid over the respective lease terms through 2010.

**8.    Transactionswith EDS**

In August 2002, the Company sold its ManagedServices Business to EDS for a total purchase price of $63.5 million in cashand entered into a separate agreement with EDS pursuant to which the Companygranted EDS a license to use its software products. Under this licenseagreement, EDS agreed to pay the Company a minimum license and maintenance feeof $52.0 million in the aggregate over a term of three years.

In August 2004, EDS agreed to extend the term ofthe agreement through March 2008 and committed to pay additional licenseand maintenance fees of approximately $50.0 million over the term of theextended license. These payments are in addition to the initial $52.0 millioncommitment. Pursuant to this amendment, (a) EDS is required to pay $2.0million per month from August 15, 2004 through August 14, 2005 and$1.6 million per month thereafter through March 2008, (b) EDS’monthly payments are no longer dependent upon the number of devices beingmanaged by our software products, (c) EDS receives rights to license allfuture products released by the Company, when and if available for commercialrelease, for no additional fee, (d) the Company deposited funds into anescrow account that allowed EDS to periodically purchase certain third-partyequipment and software for EDS’ use in connection with the Company’s softwareproducts, and (e) dedicated Opsware support personnel will continue to beprovided to EDS for the duration of the extended term. Following the extendedterm, the agreement will automatically renew at a fee of $1.6 million per monthfor five successive one-year terms unless terminated six months in advance byEDS. Revenue under this arrangement will continue to be recognized ratably overthe term of the arrangement, but in no case earlier than when monthly paymentsbecome due over the extended term of the amended agreement.

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**9.   Stockholders’Equity**

*Preferred Stock*

The Company is authorizedto issue up to 15 million shares of undesignated preferred stock, none of whichhad been issued as of January 31, 2007.

*Common Stock*

On December 15, 2004,the Company completed the sale of 10 million shares of its common stockpursuant to a shelf registration statement at a price of $6.40 per share toinstitutional investors for net proceeds of $61.8 million.

*Stock Plan*

The Company’s 2000 Incentive Stock Plan (the “StockPlan”) provides for the grant of incentive stock options to the Company’semployees and non-qualified stock options and stock purchase rights to itsemployees, directors and consultants. A total of 12.5 million shares of theCompany’s common stock plus any unissued but reserved shares under the StockPlan as of the effective date of the initial public offering and any sharesreturned to such plans were initially reserved for issuance under the StockPlan. The shares may be authorized, but unissued, or reacquired common stock.

The number of shares reserved for issuance under theStock Plan provides for annual increases on the first day of the Company’sfiscal year beginning in 2003 by an amount equal to the lesser of: (i) 6%of the outstanding shares of the Company’s common stock, (ii) 9.0 millionshares or (iii) an amount determined by the Company’s Board of Directors(or a committee thereof). In 2007, 2006 and 2005, an additional 4.0 million,4.0 million and 3.8 million shares, respectively, were made available pursuantto the annual increase provisions.

The Director OptionProgram is part of the Stock Plan and provides for formulaic and periodicgrants of non-qualified stock options to the Company’s non-employee directors.

*2000 Employee StockPurchase Plan*

Under the 2000 Employee Stock Purchase Plan (the “PurchasePlan”) a total of 1.5 million shares of the Company’s common stock wereinitially made available for sale. In addition, the Purchase Plan provides forannual increases in the number of shares available for issuance under thePurchase Plan on the first day of the Company’s fiscal year beginning in 2003in an amount equal to the lesser of: (i) 5.0 million shares, (ii) 2%of the outstanding shares of the Company’s common stock on that date, or (iii) anamount determined by the Company’s Board of Directors. In each of 2007, 2006,and 2005, an additional 1.0 million shares were made available pursuant to theannual increase provisions. The Compensation and Organizational DevelopmentCommittee of the Board of Directors administers the Purchase Plan.

The Purchase Plan contains consecutive, overlapping 24-monthoffering periods. Each offering period includes four six-month purchaseperiods.

The price of common stockthat may be purchased under the Purchase Plan is 85% of the lower of the fairmarket value of the Company’s common stock (i) at the beginning of anoffering period or (ii) after a purchase period ends. If the fair marketvalue at the end of a purchase period is less than the fair market value at thebeginning of the offering period, participants will be withdrawn from thecurrent offering 

62

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

periodfollowing their purchase of shares on the purchase date and will be re-enrolledin the immediately following offering period. The Company had issued 3.6million shares under the Purchase Plan as of January 31, 2007. As of January 31,2007, the Company had 4.6 million shares reserved for future issuance under thePurchase Plan.

*Stock-BasedCompensation*

Under the Stock Plan, options or stock purchase rightsfor common stock may be granted to eligible participants, pursuant to actionsby the Board of Directors (or a committee thereof). Options granted are eitherincentive stock options or non-qualified stock options and are exercisablewithin the times or upon the events determined by the Board (or a committeethereof) as specified in each agreement. Options and stock purchase rights vestover a period of time as determined by the Board (or a committee thereof) andhave a maximum term of ten years. For new hire grants, options and stockpurchase rights generally vest with respect to 25% of the shares one year afterthe participant’s employment start date and the remainder ratably over thefollowing three years. For performance, promotional or other grants followingthe start of employment, options and stock purchase rights generally vestratably over four years.

Thefollowing table summarizes all stock option plan activity:

| ** **                                | ** ** | ** **            | ** ** | **Options and Stock Purchase Rights Outstanding** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Shares  Available** | ** ** | **Shares**                                                                 | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| Balance at  January 31, 2004         |       | 12,853,695            |       | 11,977,237                                                                 |       |   | 3.05 |   |   |   |   |   |   |   |   |
| Shares authorized                         |       | 3,261,468             |       | —                                                                     |       |   | — |   |   |   |   |   |   |   |   |
| Granted                                   |       | (4,718,025            | )          | 4,718,025                                                                  |       |   | 7.30 |   |   |   |   |   |   |   |   |
| Exercised                                 |       | —                |       | (1,902,734                                                                 | )          |   | 2.17 |   |   |   |   |   |   |   |   |
| Repurchases                               |       | 16,980                |       | —                                                                     |       |   | 0.80 |   |   |   |   |   |   |   |   |
| Cancellations                             |       | 922,791               |       | (922,791                                                                   | )          |   | 3.80 |   |   |   |   |   |   |   |   |
| Balance at  January 31, 2005         |       | 12,336,909            |       | 13,869,737                                                                 |       |   | 4.57 |   |   |   |   |   |   |   |   |
| Shares authorized                         |       | 3,810,157             |       | —                                                                     |       |   | — |   |   |   |   |   |   |   |   |
| Options assumed in  Rendition acquisition |       | —                |       | 137,089                                                                    |       |   | 1.29 |   |   |   |   |   |   |   |   |
| Granted                                   |       | (4,545,778            | )          | 4,545,778                                                                  |       |   | 5.42 |   |   |   |   |   |   |   |   |
| Exercised                                 |       | —                |       | (887,183                                                                   | )          |   | 1.33 |   |   |   |   |   |   |   |   |
| Restricted stock award                    |       | (400,000              | )          | —                                                                     |       |   | 0.001 |   |   |   |   |   |   |   |   |
| Cancellations                             |       | 729,323               |       | (748,110                                                                   | )          |   | 6.13 |   |   |   |   |   |   |   |   |
| Balance at  January 31, 2006         |       | 11,930,611            |       | 16,917,311                                                                 |       |   | $ | 4.88 |   |   |   |   |   |   |   |   |
| Shares authorized                         |       | 4,001,830             |       | —                                                                     |       |   | — |   |   |   |   |   |   |   |   |
| Granted                                   |       | (4,176,875            | )          | 4,176,875                                                                  |       |   | $ | 7.97 |   |   |   |   |   |   |   |   |
| Exercised                                 |       | —                |       | (1,454,555                                                                 | )          |   | $ | 3.28 |   |   |   |   |   |   |   |   |
| Forfeitures or  expirations               |       | 813,312               |       | (813,312                                                                   | )          |   | $ | 6.45 |   |   |   |   |   |   |   |   |
| Outstanding at  January 31, 2007     |       | 12,568,878            |       | 18,826,319                                                                 |       |   | $ | 5.62 |   |   |   | 7.14 |   |   | $ | 46,732,123 |   |
| Exercisable at January 31, 2007      |       |                  |       | 11,596,207                                                                 |       |   | $ | 4.75 |   |   |   | 6.24 |   |   | $ | 38,759,745 |   |

 

63

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

In December 2005, the Company issued awards of200,000 shares of restricted stock to each of two executive officers. Theexpense is being amortized equally to research and development and sales andmarketing over the four-year vesting period of the stock awards. The Companyrecognized approximately $638,000 and $328,000 of stock compensation expense inconnection with these awards during the fiscal years ended January 31,2007 and 2006, respectively.

In August 2003, the Company issued an award of105,000 shares of restricted stock to an executive officer. The expense wasamortized to sales and marketing over the three-year vesting period of thestock award. The Company recognized approximately $13,000, $93,000 and $246,000of stock compensation expense in the fiscal years ended January 31, 2007,2006 and 2005, respectively.

Thefollowing table summarizes significant ranges of outstanding and exercisableoptions at January 31, 2007:

| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | ** **                   | ** ** | ** **                   | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **               | ** ** | ** **                   | ** ** | **Weighted-Average**         | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Ranges of**       | ** ** | **Number**                   | ** ** | **Remaining**                | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | ** **                   | ** ** | **of Shares**           | ** ** | **Contractual Life** | ** ** | **Price** | ** ** | **of Shares** | ** ** | **Price** | ** ** |
| 0.26—1.85           |       | 2,576,666                    |       |                         | 5.61       |   |   |   | $ | 1.29 |   |   | 2,535,948 |   |   | $ | 1.29 |   |   |
| 1.86—3.68           |       | 2,866,067                    |       |                         | 4.86       |   |   |   | 3.28 |   |   | 2,844,651 |   |   | 3.28 |   |   |
| 3.81—5.13           |       | 2,138,269                    |       |                         | 8.02       |   |   |   | 4.91 |   |   | 977,057 |   |   | 4.87 |   |   |
| 5.15—6.00           |       | 2,806,023                    |       |                         | 7.00       |   |   |   | 5.76 |   |   | 1,840,682 |   |   | 5.79 |   |   |
| 6.01—7.79           |       | 3,265,609                    |       |                         | 8.06       |   |   |   | 7.12 |   |   | 1,447,870 |   |   | 7.20 |   |   |
| 7.81—8.19           |       | 2,566,384                    |       |                         | 8.66       |   |   |   | 7.95 |   |   | 743,381 |   |   | 7.98 |   |   |
| 8.22—18.00          |       | 2,607,301                    |       |                         | 7.95       |   |   |   | 8.72 |   |   | 1,206,618 |   |   | 8.87 |   |   |
|                     |       | 18,826,319                   |       |                         | 7.14       |   |   |   | $ | 5.62 |   |   | 11,596,207 |   |   | $ | 4.75 |   |   |
|                          |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

There were approximately300,000 unvested shares of common stock subject to repurchase as of January 31,2007. Common stock is subject to repurchase upon termination of the employmentof the holder of the stock if the underlying purchase right has not yet vested.Such shares are subject to repurchase at their original issuance prices.

*Restricted StockAwards*

As discussed above, the Company has issued restrictedstock awards to three executive officers. A portion of the common stock issubject to repurchase at the original issuance price upon the termination ofthe officer’s employment if the underlying common stock has not yet vested asof termination. These awards have a vesting period of three or four years.

Thefollowing table summarizes the Company’s unvested restricted stock activity forthe year ended January 31, 2007:

| ** **                                          | ** ** | **Number  of Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------|------------|
| Unvested  restricted stock at January 31, 2006 |       | 419,686                    |       |                                        | $          | 0.001                                                    |       |   |   | $ | 6.98 |   |   |
| Vested                                              |       | (119,686                   | )          |                                        | $          | 0.001                                                    |       |   |   | $ | 6.79 |   |   |
| Unvested restricted  stock at January 31, 2007 |       | 300,000                    |       |                                        | $          | 0.001                                                    |       |   |   | $ | 7.03 |   |   |

 

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

As of January 31,2007, $1.8 million of total unrecognized compensation cost related to unvestedrestricted stock is expected to be recognized over a weighted-average period of3 years.

**10.   SegmentInformation**

SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,”establishes standards for reporting information about operating segments in theCompany’s financial statements. Operating segments are defined as components ofan enterprise about which separate financial information is available that isevaluated regularly by the chief operating decision maker (CODM), or decisionmaking group, in deciding how to allocate resources and in assessingperformance. The Company’s CODM regularly reviews information about revenues bygeographic region for purposes of making operating decisions and assessingfinancial performance. The Company’s CODM is the Chief Executive Officer of theCompany. During the periods ended January 31, 2007, 2006, and 2005, theCompany had only one operating segment. The Company is organized into threegeographic regions:  North and South America (Americas), Europe, MiddleEast and Africa (EMEA) and Asia Pacific (APAC). Net revenue by customers’geographic location is as follows (in thousands):

| ** **                          | ** ** | **Year Ended January 31,** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues  generated in the Americas |       | $                                         | 88,548     |   | $ | 54,371 |   | $ | 33,173 |   |
| Revenues  generated in EMEA         |       | 11,560                                    |       | 2,924 |   | 378 |   |
| Revenues  generated in APAC         |       | 1,618                                     |       | 3,782 |   | 4,241 |   |
| Revenues as reported(1)             |       | $                                         | 101,726    |   | $ | 61,077 |   | $ | 37,792 |   |

----

(1)          For the years endedJanuary 31, 2007 and 2006, EDS accounted for 21% and 35% of the Company’snet revenues, respectively. For the year ended January 31, 2005, EDS andanother customer accounted for 54% and 11% of the Company’s net revenues,respectively.

Long-livedassets by geographic location were as follows (in thousands):

| ** ** | ** ** | **Year Ended  January 31,** | ** ** |
|------------|------------|---------------------------------------|------------|
| ** ** | ** ** | **2007**                              | ** ** | **2006** | ** ** |
| Americas   |       | $                                     | 5,708      |   | $ | 3,885 |   |
| EMEA       |       | 150                                   |       | 57 |   |
| APAC       |       | 40                                    |       | 2 |   |
| Total      |       | $                                     | 5,898      |   | $ | 3,944 |   |

 

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**11.   IncomeTaxes**

Theprovision for income taxes consists of the following (in thousands):

| ** **                            | ** ** | **January 31,** | ** ** |
|---------------------------------------|------------|----------------------|------------|
| ** **                            | ** ** | **2007**             | ** ** | **2006** | ** ** | **2005** | ** ** |
| Current:                              |       |                 |       |   |   |   |   |
| Federal                               |       | —               |       | — |   | — |   |
| State                                 |       | —               |       | $ | 64 |   | $ | 32 |   |
| Foreign                               |       | 218                  |       | 129 |   | 356 |   |
|                                  |       | $                    | 218        |   | $ | 193 |   | $ | 388 |   |
| Deferred:                             |       |                 |       |   |   |   |   |
| Federal                               |       | —               |       | — |   | — |   |
| State                                 |       | —               |       | — |   | — |   |
| Foreign                               |       | —               |       | — |   | — |   |
| Provision  (benefit) for income taxes |       | $                    | 218        |   | $ | 193 |   | $ | 388 |   |

 

TheCompany’s provision for income taxes differs from the amount computed byapplying the federal statutory rate to income before taxes as follows (inthousands):

| ** **                            | ** ** | **January 31,** | ** ** |
|---------------------------------------|------------|----------------------|------------|
| ** **                            | ** ** | **2007**             | ** ** | **2006** | ** ** | **2005** | ** ** |
| Federal statutory  rate               |       | $                    | (5,388     | ) | $ | (4,819 | ) | $ | (1,639 | ) |
| Unbenefited net  operating losses     |       | 5,388                |       | 4,819 |   | 1,639 |   |
| State taxes                           |       | —               |       | 64 |   | 32 |   |
| Foreign taxes                         |       | 218                  |       | 129 |   | 356 |   |
| Provision (benefit) for  income taxes |       | $                    | 218        |   | $ | 193 |   | $ | 388 |   |

 

Foreign pretax income was insignificant for the yearsended January 31, 2007, 2006, and 2005.

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

Deferredincome taxes reflect the net tax effects of net operating losses and tax creditcarryovers and temporary differences between the carrying amounts of assets andliabilities for financial reporting purposes and the amounts used for incometax purposes. Significant components of the Company’s deferred tax assets areas follows (in thousands):

| ** **                           | ** ** | **Year Ended January 31,** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **2007**                                  | ** ** | **2006** | ** ** |
| Deferred tax  assets                 |       |                                      |       |   |   |
| Net operating loss carry-forwards    |       | $                                         | 136,332    |   | $ | 136,800 |   |
| Deferred revenue                     |       | 542                                       |       | 736 |   |
| Non-deductible reserves and accruals |       | 9,747                                     |       | 2,668 |   |
| Other                                |       | 5,450                                     |       | 4,612 |   |
| Total deferred tax assets            |       | 152,071                                   |       | 144,816 |   |
| Valuation allowance                  |       | (148,189                                  | )          | (141,771 | ) |
| Deferred tax  liability:             |       |                                      |       |   |   |
| Purchased intangibles                |       | (3,882                                    | )          | (3,045 | ) |
| Net deferred tax  assets             |       | $                                         | —     |   | $ | — |   |

 

Realization of deferred tax assets is dependent uponfuture earnings, if any, the timing and amount of which are uncertain.Accordingly, the net deferred tax assets have been fully offset by a valuationallowance. The valuation allowance increased by approximately $3.7 million,$15.1 million, and $15.5 million during the years ended January 31, 2007,2006, and 2005, respectively.

As of January 31, 2007, the Company had netoperating loss carry-forwards for federal income tax purposes of approximately$362.9 million, which expire in the years 2007 through 2027, and federalresearch and development tax credits of approximately $2.2 million, whichexpire in the years 2020 through 2027. In addition, the Company had state netoperating loss carry-forwards of approximately $215.5 million, which expire inthe years 2007 through 2017, and state research and development credits ofapproximately $2.3 million, which do not expire.

Utilization of the Company’snet operating loss and tax credit carry-forwards may be subject to asubstantial annual limitation due to the ownership change limitations providedby the Internal Revenue Code and similar state provisions. Such an annuallimitation may result in the expiration of the net operating loss and taxcredit carry-forwards before utilization.

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**12.   NetLoss Per Share**

TheCompany follows the provisions of Statement of Financial Accounting Standards No. 128,“Earnings Per Share” (“SFAS 128”). Basic and diluted net loss per share iscomputed using the weighted-average number of common shares outstanding duringthe period less shares subject to repurchase. Shares subject to repurchase arenot included in the computation of basic consolidated net loss per share untilthe time-based vesting restrictions have lapsed and are not included in thecomputation of diluted net loss per share because their effect would beanti-dilutive. Diluted net loss per share excludes potential common sharesoutstanding as their effect is anti-dilutive, and also excludes unvested sharesas their effect is also anti-dilutive. The following table presents thecalculation of basic and diluted net loss per share (in thousands, except pershare amounts):

| ** **                                           | ** ** | **Year Ended January 31,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Numerator:                                           |       |                                      |       |   |   |   |   |
| Net loss                                             |       | $                                         | (16,069    | ) | $ | (14,751 | ) | $ | (7,246 | ) |
| Denominator:                                         |       |                                      |       |   |   |   |   |
| Weighted-average common shares outstanding           |       | 100,585                                   |       | 98,629 |   | 85,404 |   |
| Less: weighted-average shares subject to repurchase  |       | (435                                      | )          | (514 | ) | (671 | ) |
| Shares used in  basic and diluted net loss per share |       | 100,150                                   |       | 98,115 |   | 84,733 |   |
| Basic and diluted  net loss per share                |       | $                                         | (0.16      | ) | $ | (0.15 | ) | $ | (0.09 | ) |

 

For the years ended January 31,2007, 2006, and 2005, the Company excluded 2.3 million, 7.3 million, and 12.8million shares of common stock and common stock equivalents, respectively, inthe computation of diluted net loss per share. The Company has excluded theimpact of all shares of common stock subject to repurchase, and stock optionsfrom the calculation of historical diluted consolidated net loss per commonshare because all such securities are anti-dilutive for these periods.

**13.   Guaranteesand Indemnifications**

The Company from time to time in the ordinary courseof its business enters into contractual arrangements with third parties underwhich the Company has agreed to defend, indemnify and hold the third partyharmless from and against certain losses. These arrangements may limit the timewithin which an indemnification claim can be made, the type of the claim andthe total amount that the Company can be required to pay in connection with theindemnification obligation. For example, the Company has entered into certainreal estate leases that require it to indemnify property owners against certainenvironmental claims. However, the Company only engages in the development,marketing and distribution of software, and has never been subject to anyenvironmental related claim. The Company is also responsible for certain costsof restoring leased premises to their original condition. In addition, theCompany has entered into indemnification agreements with its directors andofficers, and the Company’s bylaws contain indemnification obligations in favorof the Company’s directors, officers and agents.

It is not possible todetermine or reasonably estimate the maximum potential amount of futurepayments under any of these indemnification obligations due to the varyingterms of such obligations, the lack of any history of prior indemnificationclaims and the unique facts and circumstances involved in each particularcontractual arrangement and in each potential future claim for indemnification.The Company has not had any claims for indemnification under any of thesearrangements, nor has it had a history of 

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

indemnifyingthird parties. The Company believes that the likelihood of theseindemnifications is remote. As a result, the Company has not recorded aliability under these arrangements.

**14.   Settlements**

In May 2004, theCompany and Qwest entered into a settlement of the arbitration of Qwest’s claimthat the Company breached the amended and restated ethernet collocationinternet access service agreement, amended and restated reseller agreement andconfidentiality agreement that the Company entered into with Qwest in fiscal2002. Prior to this settlement, the Company accrued a liability related to itsManaged Services Business in the amount of $6.8 million in connection withQwest’s claim. As a result of the settlement, the Company reversedapproximately $4.3 million of previously accrued data center facility costs andrecognized the gain as a component of the sale of assets and liabilities fromthe Managed Services Business in the consolidated statements of operations infiscal 2005. However, the Company did not reverse as a gain the component ofthe accrual for potential future settlement of any claims either party may haveunder the guaranteed term agreement between the parties, up to an aggregatemaximum of $300,000, because it was reasonably possible certain claims underthat agreement could be made against the Company. As no claims were made withinthe specified time period, the Company reversed the $300,000 liability andrecognized the gain as a component of the sale of assets and liabilities fromthe Managed Services Business in the consolidated statements of operations infiscal 2007.

**15.   LegalProceedings**

The Company is notcurrently involved in any material legal proceedings. In the future, theCompany may bring, or be subject to, legal proceedings. Any litigation, even ifsuccessful for the Company, could result in substantial costs and divertmanagement’s attention and other resources away from the operation of itsbusiness.

**16.   SubsequentEvent**

In March 2007, theCompany entered into a definitive agreement for the acquisition of iConcludeCo. (“iConclude”), a company engaged in the development of IT processautomation solutions located in Bellevue, Washington. The Company agreed toacquire all of iConclude’s outstanding capital stock in exchange forapproximately $30 million in cash and approximately 3.39 million shares of theCompany’s common stock, subject to certain adjustments. In addition, iConclude’sremaining cash at closing, after certain adjustments, will be distributed toits stockholders in the form of a dividend, which is expected to beapproximately $7 million. A portion of the cash consideration paid to iConcludestockholders, will be deposited in escrow at closing for 12 months as securityagainst breaches of representations, warranties and covenants and otherindemnification obligations by iConclude pursuant to the merger agreement.Completion of this transaction is subject to customary closing conditions.

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**OPSWARE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**17.   QuarterlyResults (Unaudited)**

Thetable below sets forth selected supplementary unaudited financial data for eachquarter of the last two years (in thousands, except per share amounts):

| ** **                                                                   | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                                                   | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| **Year ended January 31,  2007**                                        | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Net revenues                                                                 |       | $           | 21,996     |        | $          | 25,134      |       | $           | 25,041     |   | $ | 29,555 |   |
| Cost of revenues                                                             |       | 5,489       |       | 5,456       |       | 5,902       |       | 5,574       |       |
| Loss from  operations                                                        |       | (6,726      | )          | (5,078      | )          | (5,872      | )          | (3,154      | )          |
| Gain on sale of  assets and liabilities related to Managed Services Business |       | —      |       | —      |       | —      |       | 329         |       |
| Net loss                                                                     |       | (5,798      | )          | (3,767      | )          | (4,794      | )          | (1,710      | )          |
| Basic and diluted  net loss per share                                        |       | $           | (0.06      | )           | $          | (0.04       | )          | $           | (0.05      | ) | $ | (0.02 | ) |
| **Year  ended January 31, 2006**                                        | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Net revenues                                                                 |       | $           | 12,615     |        | $          | 14,123      |       | $           | 15,747     |   | $ | 18,592 |   |
| Cost of revenues                                                             |       | 3,019       |       | 3,480       |       | 3,534       |       | 4,188       |       |
| Restructuring  costs(recoveries), net                                        |       | (18         | )          | —      |       | —      |       | —      |       |
| Amortization of  deferred stock compensation                                 |       | 415         |       | 324         |       | 267         |       | 276         |       |
| Loss from  operations                                                        |       | (5,740      | )          | (4,589      | )          | (3,225      | )          | (4,101      | )          |
| Loss on sale of  assets and liabilities related to Managed Services Business |       | (33         | )          | (11         | )          | (12         | )          | (13         | )          |
| Net loss                                                                     |       | (5,129      | )          | (3,924      | )          | (2,380      | )          | (3,318      | )          |
| Basic and diluted net  loss per share                                        |       | $           | (0.05      | )           | $          | (0.04       | )          | $           | (0.02      | ) | $ | (0.03 | ) |

 

Basic and diluted net loss per share are computedindependently for each of the quarters presented. Therefore, the sum of thequarters may not be equal to the full year net loss per share amounts.

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 

None. 

**ITEM 9A.**        CONTROLSAND PROCEDURES 

*ConclusionsRegarding Disclosure Controls and Procedures.**  *Disclosure controls and proceduresare controls and other procedures designed to ensure that information requiredto be disclosed in our reports filed under the Securities Exchange Act of 1934is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms and that such information isaccumulated and communicated to our management, including our chief executiveofficer and chief financial officer, as appropriate to allow timely decisionsregarding required disclosure. 

Under the supervision and with the participation of ourmanagement, including our chief executive officer and chief financial officer,we conducted an evaluation of the effectiveness of the design and operation ofour disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934). Based on thisevaluation, our chief executive officer and chief financial officer, as of January 31,2007, concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934) are effective toprovide reasonable assurance that the objectives for which they are designedwill be achieved. 

*Management’sReport on Internal Control Over Financial Reporting.**  *Our management is responsible forestablishing and maintaining adequate internal control over financial reportingto provide reasonable assurance regarding the reliability of our financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. Internal control overfinancial reporting includes those policies and procedures that (i) pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the company’s assets that could have a material effect on the financialstatements. 

Management assessed our internal control overfinancial reporting as of January 31, 2007, the end of our fiscal year.Management based its assessment on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission. Management’s assessment included an evaluation of such elements asthe design and operating effectiveness of key financial reporting controls,process documentation, accounting policies, and our overall controlenvironment. 

Based on its assessment, management has concluded thatour internal control over financial reporting was effective as of the end ofthe fiscal year to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalreporting purposes in accordance with U.S. generally accepted accountingprinciples. We reviewed the results of management’s assessment with the AuditCommittee of our Board of Directors. 

Our independent registered public accounting firm,Ernst & Young LLP, audited management’s assessment and independentlyassessed the effectiveness of the company’s internal control over financialreporting. Ernst & Young LLP has issued an attestation report onmanagement’s assessment, which is included at the end of Part II, Item 8of this Form 10-K. 

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*Changesin Internal Control Over Financial Reporting.**  *There were no changes in ourinternal control over the financial reporting during the period covered by thisreport that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting. 

*Limitation onEffectiveness of Controls.**  *It should be noted that any system of controls,however well designed and operated, can provide only reasonable, and notabsolute, assurance that the objectives of the system are met. The design ofany control system is based, in part, upon the benefits of the control systemrelative to its costs. Control systems can be circumvented by the individualacts of some persons, by collusion of two or more people, or by managementoverride of the control. In addition, over time, controls may become inadequatebecause of changes in conditions, or the degree of compliance with the policiesor procedures may deteriorate. Because of these and other inherent limitationsof control systems, there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions, regardless ofhow remote. 

**ITEM 9B.**       OTHERINFORMATION 

Not applicable.

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**PART III**

Wehave omitted certain information from this Annual Report on Form 10-K thatis required by Part III. We intend to file a definitive proxy statementwith the Securities and Exchange Commission relating to our annual meeting ofstockholders no later than 120 days after the end of the fiscal year covered bythis Annual Report on Form 10-K, and such information is incorporated byreference as indicated below. 

**ITEM 10.**         DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 

The information required by this item concerning ourdirectors and executives officers is incorporated by reference to the sectionscaptioned *“Election of Directors”*and*“Section 16(a) BeneficialOwnership Reporting Compliance”* contained in our definitive ProxyStatement for the 2007 Annual Meeting of Stockholders, or the Proxy Statement,to be filed with the Securities and Exchange Commission within 120 days ofthe end of our fiscal year pursuant to Instruction G(3) of Form 10-K.Certain information required by this item concerning executive officers is setforth in Part I of this Annual Report on Form 10-K in *“Business—Executive Officers.”*

The information required by this item concerning ouraudit committee, our audit committee financial expert, procedures by whichstockholders may recommend nominees to the board of directors, and our code ofethics is incorporated by reference to the section captioned *“Corporate Governance Principles and Board Matters”*inthe Proxy Statement. 

Theinformation concerning compliance with Section 16(a) of theSecurities Exchange Act of 1934 required by this item is incorporated byreference to the section in our Proxy Statement entitled “*Section 16(a) BeneficialOwnership Reporting Compliance*.”

**ITEM 11.**         EXECUTIVECOMPENSATION 

The information requiredby this Item is incorporated by reference to information set forth in the ProxyStatement. 

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS 

The information requiredby this Item is incorporated by reference to information set forth in the ProxyStatement under the headings “Principal Stockholders and Stock Ownership byManagement” and “Equity Compensation Plan Information.” 

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information required by this Item with respect todirector independence is incorporated by reference to information set forth inthe Proxy Statement.

Theinformation concerning certain relationships and related transactions requiredby the Item is incorporated by reference to the section in our Proxy Statemententitled “Certain Transactions.”

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES 

The information required by this Item is incorporatedby reference to our proxy statement under the heading “Principal AccountantFees and Services.”

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES 

**(a)   1.           Consolidated Financial Statements.**

See Index toConsolidated Financial Statements at Item 8 on page 40 of this AnnualReport on Form 10-K. 

**         2.           Financial Statement Schedules.**

Schedules have beenomitted because they are not applicable or are not required or the informationrequired to be set forth therein is included in the Consolidated FinancialStatements or notes thereto. 

**         3.           Exhibits.**

Thefollowing exhibits are filed as part of, or incorporated by reference into,this Report on Form 10-K: 

|               | ** **      | ** **  | ** ** | **Incorporated By   Reference**                                                                                                                                                        | ** ** | ** **        | ** ** |
|---------------|-----------------|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| Exhibit   No. | ** **      | **Exhibit** | ** ** | **Form**                                                                                                                                                                               | ** ** | **File No.** | ** ** | **Filing   Date** | ** ** | **Exhibit   No.** | ** ** | **Filed   Herewith** | ** ** |
|          |   2.1 |        |       | Asset Purchase Agreement between the Registrant and Electronic Data  Systems Corporation, dated June 14, 2002                                                                     |       | DEF14A            |       | 000-32377 |   | 7-10-02 |   | Annex A |   |   |   |   |   |
|          |   2.2 |        |       | Agreement and Plan of Reorganization between  Registrant, TES Acquisition Corp. and Tangram Enterprise  Solutions, Inc., dated December 4, 2003                              |       | S-4               |       | 333-111418 |   | 12-19-03 |   | Annex A |   |   |   |   |   |
|          |   2.3 |        |       | Amendment to Agreement and Plan of Reorganization  between Registrant, TES Acquisition Corp. and Tangram Enterprise  Solutions, Inc., dated February 20, 2004                |       | 8-K               |       | 000-32377 |   | 3-8-04 |   | 2.2 |   |   |   |   |   |
|          |   2.2 |        |       | Agreement and Plan of Reorganization between  Registrant, Rendition Networks, Inc., RN1 Acquisition Corp., RN2  Acquisition LLC and Cameron Myhrvold, dated December 1, 2004 |       | 8-K               |       | 000-32377 |   | 2-3-05 |   | 2.01 |   |   |   |   |   |
|          |   3.1 |        |       | Amended and Restated Certificate of Incorporation of  the Registrant.                                                                                                                  |       | S-1/A             |       | 333-46606 |   | 2-16-01 |   | 3.2 |   |   |   |   |   |
|          |   3.2 |        |       | Certificate of Amendment of the Amended and Restated  Certificate of Incorporation of the Registrant.                                                                                  |       | DEF14A            |       | 000-32377 |   | 7-10-02 |   | Annex B |   |   |   |   |   |
|          |   3.3 |        |       | Bylaws of the  Registrant.                                                                                                                                                             |       | 10-K              |       | 000-32377 |   | 5-1-02 |   | 3.2 |   |   |   |   |   |
|          | 10.1+           |        |       | Registrant’s 1999  Stock Plan.                                                                                                                                                    |       | S-1/A             |       | 333-46606 |   | 3-2-01 |   | 10.1 |   |   |   |   |   |
|          | 10.2+           |        |       | Registrant’s 2000 Stock Plan.                                                                                                                                                     |       | S-1/A             |       | 333-46606 |   | 3-2-01 |   | 10.2 |   |   |   |   |   |
|          | 10.3+           |        |       | Registrant’s Amended and Restated 2000 Incentive  Stock Plan.                                                                                                                     |       | 10-K              |       | 000-32377 |   | 5-3-01 |   | 10.3 |   |   |   |   |   |
|          | 10.4+           |        |       | Registrant’s Employee Stock Purchase Plan.                                                                                                                                        |       | 10-K              |       | 000-32377 |   | 5-3-01 |   | 10.4 |   |   |   |   |   |

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|        | 10.5  |   |   | Amended and Restated 1998 Stock Option Plan of  Rendition Networks, Inc.                                                                          |   | S-8    |   | 000-32377 |   | 3-3-05   |   | 99.01            |   |   |   |   |   |
|--------|-------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|-----------|--------|----------|--------|------------------|--------|--------|--------|--------|--------|
|   | 10.6+ |   |   | Registrant’s Form of Stock Option Agreement  under the Amended and Restated 2000 Incentive Stock Plan                                        |   | 10-Q   |   | 000-32377 |   | 12-12-05 |   | 10.1   |   |   |   |   |   |
|   | 10.7+ |   |   | Registrant’s Form of Restricted Stock Agreement  under the Amended and Restated 2000 Incentive Stock Plan                                    |   | 10-Q   |   | 000-32377 |   | 12-12-05 |   | 10.2   |   |   |   |   |   |
|   | 10.8+ |   |   | Form of Directors and Officers’ Indemnification  Agreement.                                                                                  |   | S-1/A  |   | 333-46606 |   | 10-31-00 |   | 10.5   |   |   |   |   |   |
|   | 10.9  |   |   | Investor Rights Agreement, dated June 23, 2000,  by and among the Registrant and the parties who are signatories thereto.                         |   | S-1    |   | 333-46606 |   | 9-26-00  |   | 10.6   |   |   |   |   |   |
|   | 10.10 |   |   | Lease Agreement between the Registrant and Sequoia  Del Rey, dated January 31, 2000.                                                              |   | S-1    |   | 333-46606 |   | 9-26-00  |   | 10.13            |   |   |   |   |   |
|   | 10.11 |   |   | Lease between the Registrant and Maude Avenue Land  Corporation, dated October 17, 2000.                                                          |   | S-1/A  |   | 333-46606 |   | 12-5-00  |   | 10.14            |   |   |   |   |   |
|   | 10.12 |   |   | First Amendment to Lease Agreement                                                                                                                     |   | 10-Q   |   | 000-32377 |   | 12-12-03 |   | 10.1   |   |   |   |   |   |
|   | 10.13 |   |   | Second Amendment to Lease Agreement                                                                                                                    |   | 10-Q   |   | 000-32377 |   | 9-12-03  |   | 10.1   |   |   |   |   |   |
|   | 10.14 |   |   | License Agreement between the Registrant and  Electronics Data Systems Corporation, dated June 14, 2002                                           |   | S-3    |   | 333-91064 |   | 6-24-02  |   | 10.1   |   |   |   |   |   |
|   | 10.15 |   |   | Amendment to EDS License and Maintenance Agreement,  effective August 15, 2004                                                                    |   | 10-Q   |   | 000-32377 |   | 9-9-04   |   | 10.1   |   |   |   |   |   |
|   | 21.1  |   |   | Subsidiaries of the Registrant                                                                                                                         |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 23.1  |   |   | Consent of Independent Registered Public Accounting  Firm                                                                                              |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 24.1  |   |   | Power of Attorney (See page 77)                                                                                                                   |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 31.1  |   |   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |   |   |   |      |   |     |   |             |   |   | X      |   |   |

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|        | 31.2 |   |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.          |   |   |   |   |   |   |   |   |   |   | X |   |   |
|--------|------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|--------|--------|
|   | 32.1 |   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.* |   |   |   |   |   |   |   |   |   |   | X |   |   |
|   | 32.2 |   |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.* |   |   |   |   |   |   |   |   |   |   | X |   |   |

----

+                Managementcontract, compensatory plan or arrangement. 

*                    Ascontemplated by SEC Release No. 33-8212, these exhibits are furnished withthis Annual Report on Form 10-K and are not deemed filed with theSecurities and Exchange Commission and are not incorporated by reference in anyfiling of Opsware Inc. under the Securities Act of 1933 or the Securities Actof 1934, whether made before or after the date hereof and irrespective of anygeneral incorporation language in any such filings. 

**         (b)         Exhibits.**

See Item 15(a)(3) above.

**         (c)         Financial Statements and Schedules.**

See Item 15(a)(2) above.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|        | OPSWARE INC. |
|--------|--------------|
|   | By:          | /s/ BENJAMIN A. HOROWITZ |
|   | ** **   | **Benjamin  A. Horowitz** |
|   | ** **   | **President,  Chief Executive Officer and Director** |
|   | Date:        | April 13, 2007 |

 

**POWER OF ATTORNEY**

KNOW ALL MEN BY THESE PRESENTS, that each person whosesignature appears below constitutes and appoints Benjamin A. Horowitz andJordan J. Breslow, and each of them, his or her true and lawfulattorneys-in-fact and agents, each with full power of substitution andresubstitution, for him or her and in his or her name, place and stead, in anyand all capacities, to sign any and all amendments, to this report on Form 10-Kand to file the same, with exhibits thereto and other documents in connectiontherewith, with the Securities and Exchange Commission, granting unto saidattorneys-in-fact and agents, and each of them, full power and authority to doand perform each and every act and thing requisite and necessary to be done, asfully to all intents and purposes as he might or could do in person, herebyratifying and confirming all that each of said attorneys-in-fact and agents ortheir substitute or substitutes may lawfully do or cause to be done by virtuehereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed by the following persons on behalf of the registrant on April 13,2007 in the capacities indicated:
|                            | **Signature** | ** **                                       | ** ** | ** ** | **Title** | ** ** |
|----------------------------|---------------|--------------------------------------------------|------------|------------|-----------|------------|
| /s/ BENJAMIN A. HOROWITZ   |          | President, Chief  Executive Officer and Director |
| **Benjamin A. Horowitz**   |          | *(Principal Executive Officer)*                  |
| /s/  DAVID F. CONTE        |          | Chief Financial  Officer                         |
| **David F. Conte**         |          | *(Principal Financial and  Accounting Officer)*  |
| /s/  MARC L. ANDREESSEN    |          | Chairman of the  Board of Directors              |
| **Marc L. Andreessen**     |          |                                             |
| /s/ WILLIAM V. CAMPBELL    |          | Director                                         |
| **William V. Campbell**    |          |                                             |
| /s/  MIKE J. HOMER         |          | Director                                         |
| **Mike J. Homer**          |          |                                             |
| /s/  SIMON M. LORNE        |          | Director                                         |
| **Simon M. Lorne**         |          |                                             |
| /s/  MICHAEL S. OVITZ      |          | Director                                         |
| **Michael S. Ovitz**       |          |                                             |
| /s/ MICHELANGELO A. VOLPI  |          | Director                                         |
| **Michelangelo  A. Volpi** |          |                                             |

 

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**Exhibit Index**

|               | ** **      | ** **  | ** ** | **Incorporated By   Reference**                                                                                                                                                        | ** ** | ** **        | ** ** |
|---------------|-----------------|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| Exhibit   No. | ** **      | **Exhibit** | ** ** | **Form**                                                                                                                                                                               | ** ** | **File No.** | ** ** | **Filing   Date** | ** ** | **Exhibit   No.** | ** ** | **Filed   Herewith** | ** ** |
|          |   2.1 |        |       | Asset Purchase Agreement between the Registrant and Electronic Data  Systems Corporation, dated June 14, 2002                                                                     |       | DEF14A            |       | 000-32377 |   | 7-10-02 |   | Annex A |   |   |   |   |   |
|          |   2.2 |        |       | Agreement and Plan of Reorganization between  Registrant, TES Acquisition Corp. and Tangram Enterprise  Solutions, Inc., dated December 4, 2003                              |       | S-4               |       | 333-111418 |   | 12-19-03 |   | Annex A |   |   |   |   |   |
|          |   2.3 |        |       | Amendment to Agreement and Plan of Reorganization  between Registrant, TES Acquisition Corp. and Tangram Enterprise  Solutions, Inc., dated February 20, 2004                |       | 8-K               |       | 000-32377 |   | 3-8-04 |   | 2.2 |   |   |   |   |   |
|          |   2.2 |        |       | Agreement and Plan of Reorganization between  Registrant, Rendition Networks, Inc., RN1 Acquisition Corp., RN2  Acquisition LLC and Cameron Myhrvold, dated December 1, 2004 |       | 8-K               |       | 000-32377 |   | 2-3-05 |   | 2.01 |   |   |   |   |   |
|          |   3.1 |        |       | Amended and Restated Certificate of Incorporation of  the Registrant.                                                                                                                  |       | S-1/A             |       | 333-46606 |   | 2-16-01 |   | 3.2 |   |   |   |   |   |
|          |   3.2 |        |       | Certificate of Amendment of the Amended and Restated  Certificate of Incorporation of the Registrant.                                                                                  |       | DEF14A            |       | 000-32377 |   | 7-10-02 |   | Annex B |   |   |   |   |   |
|          |   3.3 |        |       | Bylaws of the  Registrant.                                                                                                                                                             |       | 10-K              |       | 000-32377 |   | 5-1-02 |   | 3.2 |   |   |   |   |   |
|          | 10.1+           |        |       | Registrant’s 1999  Stock Plan.                                                                                                                                                    |       | S-1/A             |       | 333-46606 |   | 3-2-01 |   | 10.1 |   |   |   |   |   |
|          | 10.2+           |        |       | Registrant’s 2000 Stock Plan.                                                                                                                                                     |       | S-1/A             |       | 333-46606 |   | 3-2-01 |   | 10.2 |   |   |   |   |   |
|          | 10.3+           |        |       | Registrant’s Amended and Restated 2000 Incentive  Stock Plan.                                                                                                                     |       | 10-K              |       | 000-32377 |   | 5-3-01 |   | 10.3 |   |   |   |   |   |
|          | 10.4+           |        |       | Registrant’s Employee Stock Purchase Plan.                                                                                                                                        |       | 10-K              |       | 000-32377 |   | 5-3-01 |   | 10.4 |   |   |   |   |   |
|          | 10.5            |        |       | Amended and Restated 1998 Stock Option Plan of  Rendition Networks, Inc.                                                                                                          |       | S-8               |       | 000-32377 |   | 3-3-05 |   | 99.01 |   |   |   |   |   |
|          | 10.6+           |        |       | Registrant’s Form of Stock Option Agreement  under the Amended and Restated 2000 Incentive Stock Plan                                                                        |       | 10-Q              |       | 000-32377 |   | 12-12-05 |   | 10.1   |   |   |   |   |   |
|          | 10.7+           |        |       | Registrant’s Form of Restricted Stock Agreement  under the Amended and Restated 2000 Incentive Stock Plan                                                                    |       | 10-Q              |       | 000-32377 |   | 12-12-05 |   | 10.2   |   |   |   |   |   |
|          | 10.8+           |        |       | Form of Directors and Officers’ Indemnification  Agreement.                                                                                                                  |       | S-1/A             |       | 333-46606 |   | 10-31-00 |   | 10.5   |   |   |   |   |   |

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|        | 10.9  |   |   | Investor Rights Agreement, dated June 23, 2000,  by and among the Registrant and the parties who are signatories thereto.                                  |   | S-1    |   | 333-46606 |   | 9-26-00  |   | 10.6   |   |   |   |   |   |
|--------|-------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|-----------|--------|----------|--------|------------------|--------|--------|--------|--------|--------|
|   | 10.10 |   |   | Lease Agreement between the Registrant and Sequoia  Del Rey, dated January 31, 2000.                                                                       |   | S-1    |   | 333-46606 |   | 9-26-00  |   | 10.13            |   |   |   |   |   |
|   | 10.11 |   |   | Lease between the Registrant and Maude Avenue Land  Corporation, dated October 17, 2000.                                                                   |   | S-1/A  |   | 333-46606 |   | 12-5-00  |   | 10.14            |   |   |   |   |   |
|   | 10.12 |   |   | First Amendment to Lease Agreement                                                                                                                              |   | 10-Q   |   | 000-32377 |   | 12-12-03 |   | 10.1   |   |   |   |   |   |
|   | 10.13 |   |   | Second Amendment to Lease Agreement                                                                                                                             |   | 10-Q   |   | 000-32377 |   | 9-12-03  |   | 10.1   |   |   |   |   |   |
|   | 10.14 |   |   | License Agreement between the Registrant and  Electronics Data Systems Corporation, dated June 14, 2002                                                    |   | S-3    |   | 333-91064 |   | 6-24-02  |   | 10.1   |   |   |   |   |   |
|   | 10.15 |   |   | Amendment to EDS License and Maintenance Agreement,  effective August 15, 2004                                                                             |   | 10-Q   |   | 000-32377 |   | 9-9-04   |   | 10.1   |   |   |   |   |   |
|   | 21.1  |   |   | Subsidiaries of the Registrant                                                                                                                                  |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 23.1  |   |   | Consent of Independent Registered Public Accounting  Firm                                                                                                       |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 24.1  |   |   | Power of Attorney (See page 77)                                                                                                                            |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 31.1  |   |   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.          |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 31.2  |   |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.          |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 32.1  |   |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.* |   |   |   |      |   |     |   |             |   |   | X      |   |   |
|   | 32.2  |   |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.* |   |   |   |      |   |     |   |             |   |   | X      |   |   |

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+                Managementcontract, compensatory plan or arrangement. 

79

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*                    Ascontemplated by SEC Release No. 33-8212, these exhibits are furnished withthis Annual Report on Form 10-K and are not deemed filed with theSecurities and Exchange Commission and are not incorporated by reference in anyfiling of Opsware Inc. under the Securities Act of 1933 or the Securities Actof 1934, whether made before or after the date hereof and irrespective of anygeneral incorporation language in any such filings. 

80

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