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UNITED
STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C.
20549





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Form 10-K





x

Annual Report Pursuant To Section 13 or 15(d)of The Securities Exchange Act of 1934For the fiscal year ended June 30, 2001 OR ̈

Transition Report Pursuant To Section 13 or 15(d) of The Securities Exchange Act of 1934For the transition period from
                     to  Commission File Number 000-26757





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NetIQ CORPORATION


(Exact name of Registrant as specified in its charter)





Delaware

77-0405505(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification
No.)3553 North First Street, San Jose, CA

95134(Address of principal executive offices)

(Zip Code)





(408) 856-3000


(Registrants telephone number, including area code)





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





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





Title of each class

Name of each exchange on which registeredCommon Stock, $0.001 par value per share

NASDAQ National Stock Market





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





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





As of September 20, 2001, the aggregate market value of Registrants voting stock held by non-affiliates was approximately $1,048,214,000 based upon the closing sales price of
the Common Stock as reported on the Nasdaq National Stock Market on such date. Shares of Common Stock held by officers, directors and holders of more than ten percent of the outstanding Common Stock have been excluded from this calculation because
such persons may be deemed to be affiliates. The determination of affiliate status is not necessarily a conclusive determination for other purposes.





As of September 20, 2001, the Registrant had outstanding 53,613,266 shares of Common Stock.





Certain sections of Registrants definitive Proxy Statement for the 2001 Annual Meeting of
Stockholders to be held on November 15, 2001, are incorporated by reference in Part III of this Annual Report on Form 10-K to the extent stated herein.





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NetIQ Corporation





INDEX TO ANNUAL REPORT ON FORM 10-K


FOR YEAR ENDED JUNE 30, 2001





PagePART IITEM 1.

BUSINESS


3ITEM 2.

PROPERTIES


10ITEM 3.

LEGAL PROCEEDINGS


10ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS


10PART IIITEM 5.

MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED      STOCKHOLDER MATTERS


11ITEM 6.

SELECTED FINANCIAL DATA


12ITEM 7.

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND      RESULTS OF OPERATIONS


13ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


29ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


29ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING      AND FINANCIAL DISCLOSURE


29PART IIIITEM 10.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT


30ITEM 11.

EXECUTIVE COMPENSATION


34ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND     MANAGEMENT


34ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS


34PART IVITEM 14.

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


35SIGNATURES


37










The statements contained in this Annual Report on Form 10-K that are not
purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding our expectations, hopes, intentions or strategies
regarding the future. Forward-looking statements include statements regarding events, conditions and financial trends that may affect our future plans of operations, business strategy, results of operations and financial position. All
forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Investors are cautioned that any forward-looking statements
are not guarantees of future performance and are subject to risks and uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors. These forward-looking
statements are made in reliance upon the safe harbor provision of The Private Securities Litigation Reform Act of 1995. Factors that could cause or contribute to such differences include, but are not limited to, those described in
Managements Discussion and Analysis of Financial Condition and Results of Operations, under the heading Factors That May Affect Future Operating Results and elsewhere in this Annual Report on Form 10-K.





PART I





ITEM 1.    
BUSINESS





Overview





NetIQ is a leading provider of eBusiness infrastructure management and intelligence solutions
for the components of an organizations eBusiness infrastructurefrom back-end servers, networks and directories to front-end web servers and applications. Our customers use our comprehensive line of solutions to manage the entire life
cycle and the significant components of their distributed, complex enterprise and eBusiness infrastructures. Specifically, these solutions cover Network Performance Management, Windows 2000 and Exchange 2000 Migration, File and Directory
Administration, System and Application Monitoring, Security Management, Web Analytics, and Visitor Relationship Management.





The Company was founded in June 1995 and completed its initial public offering in July 1999 with a follow-on offering in December 1999. We acquired
Mission Critical Software and Ganymede Software in May 2000 and WebTrends Corporation in March 2001. In September 2000 we entered into a licensing agreement with Microsoft Corporation for $175.0 million in license revenue that we expect to receive
over three years, ending August 2003. For additional information on these events and other recent developments seeManagements Discussion and Analysis of Financial Condition and Results of Operations.





Industry Background





The evolution of enterprise computing from centralized, mainframe-based computing to distributed, Internet-based computing has added substantial
complexity to the management of computer network infrastructures. Todays information technology environments are characterized by distributed information systems, applications and networks. Use of the Internet as a medium for connecting
businesses with customers, suppliers and employees adds significant complexities to these environments. In the increasingly competitive business world, effective use of corporate and Internet-based networks has become a necessity, particularly for
companies pursuing eBusiness strategies. For those companies, security, performance, and availability of their eBusiness infrastructures have become mission critical business imperatives.





Businesses are increasingly turning to the Windows NT and Windows 2000 operating systems as
leading platforms for deploying eBusiness infrastructure software applications. The growth of Windows has been driven by, among other things, businesses increasing reliance on e-mail, web servers, and applications.





Because businesses rely on Windows NT and Windows 2000-based systems and
applications to help compete in an eBusiness environment, these systems and applications require high performance and availability
standards, including around-the-clock uptime. However, the growth and deployment of systems and applications in highly complex computing environments have created a number of unique performance
and systems management challenges. These complex, distributed computing environments typically include multiple servers running multiple enterprise-wide applications, often from remote locations. These challenges range from basic tasks such as
monitoring central processing unit utilization, memory and disk-space availability, to tasks as complex as monitoring Internet traffic, email response times, and identifying specific database tasks creating bottlenecks for system performance.





The growing complexity of infrastructures has
placed increasing pressure on systems managers to maintain reliable operations. These infrastructures must be kept secure and available 24 hours per day, 7 days per week and must be able to support widely distributed global organizations. Failure to
ensure these service levels can result in heavy penalties, including a loss of productivity and corporate revenue. To keep these eBusiness infrastructures running smoothly, companies have employed large departments of skilled systems managers and
administrators. This approach has proven costly and ineffective, due to the scarcity and high cost of employing these very expensive and high-skilled staff. To improve management efficiency and effectiveness, businesses are increasingly using
systems management software solutions, specifically in the following four areas:





Systems Administration.    The primary function of systems administration software is to create and maintain the data that directs and secures network
operating systems. Because of the volume, complexity and importance of the data produced by the operating system, its proper management is critical. Other key roles of systems administration are to:





| |  |  | determine appropriate policies, including those that are designed to secure access to the network, data and applications, and to audit adherence to those policies. The
automated application of policies benefits corporate and Internet networks by ensuring consistency in policies and reducing the systems administrator hours needed to maintain the network, and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | consolidate and migrate systems data to optimize hardware utilization and to take advantage of new operating systems and platforms.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------




Operations and Security
Management.    The primary function of operations management software is to identify and provide notification of and/or automated response to problems as early as possible such as application failures, breaches in security,
system software crashes, hardware failures, and insufficient capacity. These activities are critical to the ongoing operation of corporate and Internet-based networks. For example, applications management provides mechanisms for the notification of
application performance problems such as email response time. Security operations management also provides mechanisms for notification and response to unauthorized access or policy violations. As eBusiness systems continue to expand in size and
sophistication, the potential for security breaches also increases. Security professionals need to proactively ensure that their servers and internal networks are protected.





Another role of operations management is to continually monitor the performance, responsiveness and availability of network
services so that systems administrators can plan and budget for frequently needed additions, upgrades and configuration changes.





Network Performance Management.    The primary function of network performance management software is to test and monitor
the performance of applications running on the network. This enables systems administrators to perform two critical functions:





| |  |  | test the impact of a new application on the network and identify potential network performance problems before the application is actually implemented, and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | continually monitor application performance providing an end-to-end user view of application performance across the network to ensure that user requirements and
service levels are being met.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Web Analytics and Visitor Relationship management.    Successful Internet and eBusiness strategies require an understanding of how visitors and customers
interact with the companys Internet site and how various
marketing campaigns translate into bottom line results. Managers need a means of forecasting, tracking and integrating historical visitor data with other corporate and market databases in order
to optimize their eCommerce revenue and eMarketing return on investment. This creates a growing opportunity for powerful applications that can correlate data from web sites with customer relationship management and enterprise resource planning
systems and provide comprehensive real-time analysis and reporting.





Companies hosting various types of transactions on their Internet and intranet sites depend on multiple systems running constantly, consistently and reliably. Having any of these
systems down for just a few minutes can result in frustrated users and lost revenue.





Industry Perspective





Several software companies have attempted to
provide system management software solutions. Their products fall into three general categories:





| |  |  | Utilities.    Point-level applications and utilities that focus on a specific systems management problem and attempt to amplify systems
administrator efforts. While these are often helpful in workgroup and small network situations, many of them have not been designed and tested to scale to larger eBusiness infrastructures. Evaluating and procuring point-level applications and
utilities one-by-one is a costly and time-consuming process. Many of these applications and utilities also require substantial systems administrator time to integrate with other systems management tools.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Cross-platform point suites.    Cross-platform point suites have broader applications than the point product applications or utilities
because they have been ported to run on multiple operating systems such as Unix, Windows NT, and IBM Multiple Virtual Storage (MVS). However, we believe that these cross-platform point suites typically provide a limited depth of functionality due to
the heavy resource requirements for porting software to multiple operating systems. In addition, these suites are often more difficult to implement and manage than point-level applications or utilities.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Frameworks.    Frameworks attempt to solve most systems management problems on most operating systems. Although they offer the promise of a
one-stop-shop for all enterprise systems management needs, they are complex, require a significant amount of knowledge and training to manage, and require a lengthy, often multi-year, implementation.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




We believe that products in these categories have
exhibited a variety of shortcomings in addressing eBusiness infrastructure management requirements. They have either proven to be too narrow in scope, limited in terms of functionality, overly difficult and costly to implement or some combination of
the above. We believe that companies increasingly want modular management solutions that solve immediate points of pain and integrate with other modules to provide end-to-end integrated functionality for systems administration, operations management
and network performance management. These solutions must be easy to use and capable of being rapidly deployed.





The NetIQ Solution





NetIQs
product family is designed to reduce the cost of our customers operations and increase the security, performance and availability of Windows-based eBusiness applications, directories, servers and networks. Our solutions also address the key
eBusiness management needs and the wide variety of Internet-based systems, including web servers, firewalls, proxy servers, media servers, email servers, and database systems. Designed to improve the reliability, performance and security of even the
most complex computing environments by simplifying and automating many key systems management functions, our products are based on an open and extensible architecture, can be deployed quickly, and are flexible and easy to use.





Our product family consists of three broad product groups:





| | Systems Test, Migration and Administration:    Our system test,
migration and administration solutions are used to evaluate the ability of a network to support new technologies and applications before they are
deployed, troubleshoot network issues to minimize downtime and increase productivity, automate and centralize the critical and detailed process steps of migration to Windows 2000 and Active
Directory, and centralize the management and administration of distributed networks to reduce administrative effort, costs and increase security and integrity.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | Operations and Security Management:    Our operations management
solutions monitor and report on the health, performance, and availability of Microsoft and non-Microsoft platforms and applications. Our security management solutions integrate with leading anti-virus and firewall vendors to provide intrusion
detection, vulnerability assessment, firewall analysis, and incident management analysis and reporting.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | eBusiness Intelligence:    The eBusiness intelligence solutions are
used to analyze website traffic and performance and provide advanced reporting of web activity. This information is used to improve website performance, marketing campaign analysis, and integrate visitor data with other organizational data sources.
We also offer these solutions as a hosted service.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




NetIQ adds to the completeness of its solutions with a professional training and a professional services organization and around-the-clock technical support.





Sales and Distribution





Our products are sold through our internal corporate sales force, through an enterprise field sales organization, through national distributors,
through numerous value-added resellers and online from our web site. Our products are also co-marketed or integrated and sold with the offerings of our strategic partners, which include Internet service providers, original equipment manufacturers,
system integrators, and others. Continued expansion of international distributors of our products is one of our corporate objectives.





Field and Inside Sales.    We market our software and services through our domestic field sales offices located in
Atlanta, GA; Austin, TX; Bedminster, NJ; Bloomington, MN; Marlboro, MA; Carlsbad, CA; Dallas, TX; Denver, CO; Fairfax, VA; Homewood, IL; Lombard, IL; New York, NY; Reston, VA; Washington, D.C.; and Westlake Village, CA. Our international field
offices are located in Antwerp, Belgium; Copenhagen, Denmark; Hong Kong; Madrid, Spain; Melbourne, Australia; Mexico City, Mexico; Milan, Italy; Munich, Germany; Paris, France; Sao Paulo, Brazil; Singapore; Staines, United Kingdom; Stockholm,
Sweden; Sydney, Australia; Tokyo, Japan; Toronto, Canada; and Vienna, Austria. Each of our field sales offices includes a territory manager and one or more systems engineers. The territory managers and system engineers concentrate on Fortune
1000-sized accounts that have at least 100 Windows servers deployed.





Typically, our sales process includes an initial sales presentation in person or over the phone, a product demonstration, a product evaluation period, a closing meeting and a
purchasing process. Our sales process typically takes 90 to 180 days, but this process can be longer for larger customers or enterprise-wide opportunities.





Our field sales organization is complemented by inside sales personnel who handle orders from customers who have fewer than 100
Windows servers deployed. Our inside sales personnel also handle sales lead qualification, help recruit regional channel partners, and distribute leads to the field sales organization or channel partners.





Value Added Resellers, System Integrators, Distributors and Original Equipment
Manufacturers.    We have implemented a channel partner program, our NetIQ Partner Network, that provides training, technical support, and priority communications, and facilitates joint sales and marketing activities. Our
channel sales representatives focus on managing the sales activities of our regional channel partners and the branch sales offices of our national reseller partners. Currently GE Access, Ingram Micro, Network Trade Corporation, and Tech Data are our
primary distributors of products to other resellers. As of June 30, 2001, we had more than 139 third party channel partners who purchase our products or provide services to our customers in North America. We have also established approximately 98
channel partners in Europe, Latin America and the Asia-Pacific region as of June 30, 2001, who perform marketing, sales and technical support functions in their country or
region. Each value added reseller may distribute our products directly to the customer or through other resellers. In addition, we have worked with Fujitsu and Hitachi to develop branded Japanese
versions of AppManager that each of these original equipment manufacturers markets, sells and supports.





International Sales.    International sales represented 26%, 23% and 17% of total revenue in fiscal 2001, 2000, and 1999 respectively. We anticipate that
as we expand our international sales efforts, the percentage of revenue derived from international sources will increase. Currently, a majority of our international business is conducted in U.S. dollars. However, as we expand our international
operations, we expect that our international business will increasingly be conducted in foreign currencies. Fluctuations in the value of foreign currencies relative to the U.S. dollar have caused, and we expect such fluctuation to increasingly
cause, currency transaction gains and losses. We cannot predict the effect of exchange rate fluctuations upon future quarterly and annual operating results, and we may experience currency losses in the future. To date, we have not adopted a formal
hedging program to protect us from risks associated with foreign currency fluctuations.





Our ability to sell our products in new markets and to increase our share of existing markets will be impaired if we fail to significantly expand our distribution channels. Our
sales strategy requires establishing multiple indirect marketing channels in the United States and internationally through value added resellers, systems integrators, distributors and original equipment manufacturers, and requires that we increase
the number of customers licensing our products through these channels. Moreover, our channel partners must market our products effectively and must be qualified to provide timely and cost-effective customer support and service. If they are unable to
do so, this could harm our ability to increase revenue. See Managements Discussion and Analysis of Financial Condition and Results of OperationsFactors That May Affect Future Operating Results.





Marketing





We have a number of marketing programs designed to inform customers about the capabilities and benefits of our products. Our marketing efforts
include participation in industry trade shows, technical conferences and technology seminars, preparation of competitive analyses, sales training, publication of technical and educational articles in industry journals, advertising, public relations,
and analyst and press tours.





We have relationships
with developers of Windows NT and Windows 2000-based systems and applications including Citrix, Compaq, Dell Computer, Hewlett-Packard, IBM (including its Lotus and Tivoli subsidiaries), Microsoft, Oracle, and Unisys. As part of these relationships,
we often develop joint marketing programs with these partners. We have a number of engineers and product managers working on site at Microsofts Redmond, Washington headquarters. Microsoft also contracts for engineering services to provide
support for Microsofts use of our products. Other examples of our product-based relationships include Compaq, whose service organization is a worldwide reseller of our AppManager product, and Unisys Corporation, who has agreed to bundle a
portion of AppManager and to resell our entire product line.





Customer Support





Initial product license fees are typically sold with one year of product
software maintenance and support. Thereafter, customers are entitled to receive software updates, maintenance releases and technical support for an annual maintenance fee. Our technical support organization provides ongoing technical support for our
customers and for prospective customers during a pre-sales evaluation period. We offer technical support services 24 hours a day, seven days a week via our Internet site, telephone, e-mail, and fax. Customers under our maintenance program are
notified of maintenance and enhancement releases via email.





We offer training courses for the implementation and administration of our products. Training is provided on a periodic basis in Houston, TX; Portland, OR; and San Jose, CA, at the
offices of NetIQ partners, and at customer sites.





Our professional services group provides product training, consulting and implementation services in order to assist customers in maximizing the benefits of our products. A
significant focus of our professional services
group is also to train and support NetIQ partners in how to provide NetIQ products-related services and support to customers.





Research and Development





Our research and development organization is responsible for the design, development and release of our products. This group is organized into
development, quality assurance, documentation, and localization disciplines. Members from each discipline form separate product teams that work closely with sales, marketing and customer support to better understand market needs and user
requirements. Additionally, we have a well-developed information feedback loop with our customers to respond to and address their changing system and systems management requirements. When appropriate, we also utilize third parties to expand the
capacity and technical expertise of our internal research and development team. On occasion, we have licensed third-party technology, which we believe shortens time to market without compromising our competitive position or product quality.





The focus of research and development efforts is to
bring new products and services as well as new versions of existing products to market quickly in order to keep pace with the rapid evolution of Internet technologies and increasing customer demands.





Competition





The market for eBusiness infrastructure management software is new, rapidly evolving and highly competitive, and we expect competition in this market to persist and intensify. New
products for this market are frequently introduced and existing products are continually enhanced. We may not be able to compete successfully against current and/or future competitors and such inability would materially and adversely affect our
business, future quarterly and annual operating results and financial condition. See the section entitled Managements Discussion and Analysis of Financial Condition and Results of OperationsFactors That May Affect Future
Operating Results regarding risks associated with competitive pressures.





Existing Competition.    We currently face competition from a number of sources, including:





| |  |  | providers of network and systems management framework products such as IBM, Computer Associates International, Inc. and Hewlett-Packard,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------




| |  |  | providers of performance and availability management solutions such as BMC Software, Inc.,
| | - |  | ------------------------------------------------------------------------------------------




| |  |  | providers of administration products such as Quest Software, Inc. and BindView Corporation,
| | - |  | -------------------------------------------------------------------------------------------




| |  |  | customers internal information technology departments that develop or integrate system and application monitoring tools for their particular needs,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | providers of eBusiness intelligence solutions such as Accrue Software, Inc. and NetGenesis Corporation,
| | - |  | -------------------------------------------------------------------------------------------------------




| |  |  | traditional business intelligence vendors such as Hyperion Solutions Corporation, SAS Institute, Cognos Incorporated, and Business Objects SA who are attempting to
develop analytical offerings for eBusiness applications,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | providers of eBusiness security solutions such as Internet Security Systems, Inc., Network Associates Technology, Inc., and BindView Corporation,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | vendors of eBusiness applications (e.g., eCommerce applications and eCRM solutions), Internet servers, operating systems, and networking hardware. In particular,
Microsoft Corporation, Netscape, Sun Microsystems, Inc., Oracle Corporation and others bundle Internet management solutions with their Internet products, and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | web management service providers, such as consulting firms, web design firms, Internet audit firms, site management vendors, Internet service providers, and
independent software vendors.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------









Future
Competition.    We may face competition in the future from established companies who have not previously entered the market for eBusiness infrastructure management, as well as from emerging companies. Barriers to entry in the
software market are relatively low. Established companies may not only develop their own eBusiness infrastructure management and intelligence solutions, but they may also acquire or establish cooperative relationships with our current competitors,
including cooperative relationships between large, established companies and smaller private companies. These larger companies may be able to acquire the technology and expertise of smaller companies to penetrate our market quickly. It is possible
that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.





To date, Microsoft has not competed against us in the market for eBusiness infrastructure management software. In September 2000, we licensed a substantial portion of our
Operations Manager technology to Microsoft for $175.0 million, payable over three years, ending August 2003. Microsoft may use the technology broadly with respect to Windows 2000, but its use is limited with respect to Windows NT. We have also
agreed to provide limited engineering resources for a fee and to develop and market products that operate with the products that Microsoft plans to offer based on our technology. We anticipate significant benefits from the agreement, but it also
poses significant risk (see Managements Discussion and Analysis of Financial Condition and Results of OperationsFactors That May Affect Future Operating Results for details). We anticipate a loss of product revenue
from NetIQ Operations Manager, and to a lesser extent, from AppManager, which we expect will be offset by product revenue from other products including our XMP modules that integrate directly with Microsoft Operations Manager. While our strategy is
to deliver complementary monitoring solutions to the Microsoft version of Operations Manager, some customers may perceive Microsoft Operations Manager as overlapping with our complementary solutions, which may cause confusion and delay some product
revenue. Even if the functionality provided by Microsoft were more limited than that of our products, customers may elect to accept more limited functionality in lieu of purchasing third-party software.





In addition to Microsoft, other potential competitors may bundle their products or incorporate
eBusiness infrastructure management software into existing products including use for promotional purposes. Also, our ability to sell our products will depend, in part, on the compatibility of our products with other third party products. These
third party software developers may change their products so that they will no longer be compatible with our products. If our competitors were to bundle their products in this manner or make their products non-compatible with our products, this
could materially and adversely affect our ability to sell our products and could lead to price reductions for our products, which in turn could reduce our profit margins.





Intellectual Property





Our success to a limited extent is dependent upon proprietary technology. We rely primarily on a combination of patent, copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect our proprietary rights. These laws and procedures provide only limited protection. We have 10 US patents either granted or allowed and 24 patent applications pending. We also seek protection for our
intellectual property in other countries where we do business. Effective protection for our proprietary rights may not be available in every country in which we market our products or services.





We license technology from Summit Software that is used in our some of our operations and
security management products. We license technology from Poet Software that is incorporated in our End2End products. Our customers have the option to incorporate technology from either Knosys Software or Hyperion Software when they buy our eBusiness
intelligence products. Our eBusiness intelligence products also incorporate technology from Inxight Software. We also license technology from SurfControl that is incorporated in our some of our Operations and Security Management products.





We are not aware that any of our products infringe
any proprietary rights of third parties. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in
different industry segments overlaps. Any infringement claims, with or without merit, could be time consuming to defend, result in costly
litigation, and divert managements attention and resources or cause product delays. Such infringement claims could also require us to enter into royalty or licensing agreements that may not
be available on terms acceptable to us, if at all. See Managements Discussion and Analysis of Financial Condition and Results of OperationsFactors That May Affect Future Operating Results.





Employees





As of June 30, 2001, we had 1,091 regular employees, 331 of whom were engaged in research and development, 465 in sales and marketing, 165 in
customer support and 130 in finance and administration. None of our employees is represented by a collective bargaining agreement. We have not experienced any work stoppages and consider our relations with our employees to be good. For a discussion
of our need to attract and retain additional qualified personnel, see Managements Discussion and Analysis of Financial Condition and Results of OperationsFactors That May Affect Future Operating ResultsWe
will need to recruit and retain additional qualified personnel to successfully manage our business.





ITEM 2.    
PROPERTIES





Our principal
corporate and administrative offices and certain research and development and sales and marketing personnel are located at our 85,000 square foot headquarters facility in San Jose, California.





We lease approximately 90,500 square feet in Portland, Oregon, approximately 69,000 square feet
in Houston, Texas, approximately 32,000 square feet in Santa Clara, California, approximately 23,000 square feet in Research Triangle Park, North Carolina, and approximately 5,000 square feet in Bellevue, Washington. All of these facilities house
research and development, sales and marketing personnel.





We also lease approximately 11,000 square feet in Staines, United Kingdom, for our European sales headquarters, and other space for sales and marketing offices in various locations
domestically and internationally.





All of these
leased facilities are under an initial term of five years with various options to extend the term from two to three years.





Our current facilities, including the building acquired in August 2000, are expected to be adequate to meet our needs for the next 12 months. For
additional information regarding our obligations under leases, see Note 12 to the Consolidated Financial Statements.





ITEM 3.    
LEGAL PROCEEDINGS





We currently
have no material legal proceedings.





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





Not applicable.










PART II





ITEM 5.    
MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS





Our Common Stock has been traded on the Nasdaq National Stock Market since July 30, 1999 under the trading symbol NTIQ. Before that time, there was no market for our
common stock. The initial public offering price was $13.00 per share on July 29, 1999.





The following table presents the range of high and low closing prices for our common stock from the date our stock began trading on the Nasdaq National Stock Market through June
30, 2001.





Year Ended June 30,2001

2000High

Low

High

LowFourth Quarter

$   36.010

$14.750

$61.500

$31.563Third Quarter

$   81.125

$18.625

$78.000

$51.000Second Quarter

$109.375

$46.375

$59.000

$23.500First Quarter

$   67.938

$42.000

$33.750

$14.938





The
approximate number of holders of the shares of our common stock was 268 as of September 20, 2001. This number does not include stockholders whose shares are held in trust by other entities. The actual number of stockholders is greater than this
number of holders of record. Based on the number of annual reports requested by brokers, we estimate that we have approximately 17,000 beneficial owners of our common stock.





We have never declared or paid any cash dividends on shares of our common stock and do not expect to do so in the
foreseeable future. We anticipate that all future earnings, if any, generated from operations will be retained to develop and expand our business. Any future decision to pay cash dividends will depend on our growth, profitability, financial
condition and other factors the Board may deem relevant.





Recent Sales of Unregistered Securities





In November 1999, we issued 3,750 shares of
common stock to a third party, valued at the fair market value of $45.69 per share, in exchange for services rendered. The sale of these shares was deemed exempt from registration under the Securities Act, in reliance on Section 4(2) thereof, as
transactions not involving a public offering.





In
July 1999, we issued 3,833 shares of common stock to two third parties, valued at the deemed fair market value of $12.00 per share, in exchange for services rendered. The sale of these shares was deemed exempt from registration under the Securities
Act, in reliance on Section 4(2) thereof, as transactions not involving a public offering.





In June 1999, we issued 26,667 shares of common stock to a third party, valued at the deemed fair market value of $12.00 per share, in exchange for services rendered in connection
with development of a new product module. The sale of these shares was deemed exempt from registration under the Securities Act, in reliance on Section 4(2) thereof, as transactions not involving a public offering.





Between July 1, 1996, and June 30, 1999, we issued and sold 1,264,493 shares
of unregistered Common Stock upon the exercise of outstanding options under our 1995 Stock Option Plan. The consideration paid in exchange for such Common Stock varied based on the deemed fair market value of the options at the time of grant. The
sale of these shares was deemed to be exempt from registration under the Securities Act of 1933, as amended (the Securities Act), in reliance on Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions not involving a public
offering or transactions pursuant to compensatory benefit plans and contracts
relating to compensation as provided under Rule 701. Each recipient of such shares had adequate access, through his or her relationship with the Company, to information about the Company.





Use of Proceeds





Not applicable.





ITEM 6.    
SELECTED FINANCIAL DATA





The
following selected historical consolidated financial data should be read in conjunction with our Consolidated Financial Statements, and Managements Discussion and Analysis of Financial Condition and Results of Operations,
included elsewhere in this Annual Report on Form 10-K.





Year Ended June 30,2001

2000

1999

1998

1997(In thousands, except per share data)Consolidated Statements of Operations Data:Software license revenue

$    125,670


$       37,235


$18,433


$6,603


$    369Service revenue

41,267


10,685


3,136


467


19Total revenue

166,937


47,920


21,569


7,070


388Cost of software license revenue

2,114


800


755


235


9Cost of service revenue

10,213


2,217


1,260


407


46Total cost of revenue

12,327


3,017


2,015


642


55Gross profit

154,610


44,903


19,554


6,428


333Operating expenses:Sales and marketing


80,581


24,695


11,685


5,748


1,238Research and development

35,732


10,109


4,344


2,192


1,003General and administrative

13,140


4,761


3,347


1,611


479Stock-based compensation

2,001


696


1,928


250


10Write-off of acquired in-process research and
               development costs

2,663


10,693








Amortization of goodwill and intangibles

554,686


64,184








Restructuring charge

816











Total operating expenses

689,619


115,138


21,304


9,801


2,730Loss from operations

(535,009
)

(70,235
)

(1,750
)

(3,373
)

(2,397
)Other income, net

21,786


7,307


108


262


116Loss before income taxes

(513,223
)

(62,928
)

(1,642
)

(3,111
)

(2,281
)Income taxes

10,610


2,400








Net loss

$    (523,833
)

$      (65,328
)

$  (1,642
)

$(3,111
)

$(2,281
)Basic and diluted net loss per share (1)

$         (12.48
)

$            (3.59
)

$     (0.47
)

$   (1.34
)

$   (1.62
)Shares used to compute basic and diluted net loss per      share (1)

41,984


18,189


3,476


2,325


1,411Consolidated Balance Sheet Data:Cash and cash equivalents

$       89,494


$    187,610


$   9,634


$3,358


$7,748Short-term investments

377,287


145,916








Working capital

423,951


311,709


4,443


4,314


7,493Total assets

2,322,529


1,721,761


18,354


8,205


8,202Long-term obligations, net of current portion







205





Total stockholders equity

2,249,892


1,685,722


5,799


4,939


7,787


---

|(1) |  | See Note 11 to the Consolidated Financial Statements for the determination of shares used in computing basic and diluted net loss per share.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------









|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------




The statements contained in this Report on Form 10-K that are not purely historical are forward-looking statements within the meaning of the
Securities Act of 1933 and Section 21E of the Securities Act of 1934, including statements about our plans, objectives, expectations and intentions. Forward-looking statements include: statements regarding future products or product development;
statements regarding future research and development spending and our product development strategy; statements regarding the levels of international sales; statements regarding future expenditures; and statements regarding current or future
acquisitions. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. It is important to note that our actual
results could differ materially from those in such forward-looking statements. Some of the factors that could cause actual results to differ materially are set forth in Factors That May Affect Future Operating Results under
Managements Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in, or incorporated by reference into, this report.





Overview





NetIQ is a leading provider of eBusiness infrastructure management and intelligence solutions for the components of an organizations eBusiness infrastructure  from
back-end servers, networks and directories to front-end web servers and applications. Our customers use our comprehensive line of solutions to manage the entire life cycle and the significant components of their distributed, complex enterprise and
eBusiness infrastructures. Specifically, these solutions cover Network Performance Management, Windows 2000 and Exchange 2000 Migration, File and Directory Administration, System and Application Monitoring, Security Management, Web Analytics and
Visitor Relationship Management.





We derive the
large majority of our revenue from software licenses. We also derive revenue from sales of annual maintenance service agreements and, to a lesser extent, consulting and training services. Service revenue has increased in recent periods as license
revenue has increased and as the size of our installed base has grown. The pricing of our products is based on the number of systems and applications managed, although volume and enterprise pricing is also available. Our customers typically purchase
one year of product software maintenance with their initial license of our products. Thereafter, customers are entitled to receive software updates, maintenance releases and technical support for an annual maintenance fee equal to a fixed percentage
of the current list price of the licensed product.





We sell our products through both our direct sales force, which includes our field and inside sales personnel, as well as through indirect channels, such as distributors,
value-added resellers and original equipment manufacturers. Customers can also download and pay for our products from our website.





Generally, we sell perpetual licenses and recognize revenue in accordance with accounting principles generally accepted in the United States of
America, upon meeting each of the following criteria:





| |  |  | execution of a written purchase order, license agreement or contract;
| | - |  | ---------------------------------------------------------------------




| |  |  | delivery of software and authorization keys;
| | - |  | --------------------------------------------




| |  |  | the license fee is fixed and determinable;
| | - |  | ------------------------------------------




| |  |  | collectibility of the proceeds within six months is assessed as being probable; and
| | - |  | -----------------------------------------------------------------------------------




| |  |  | vendor-specific objective evidence exists to allocate the total fee to all elements of the arrangement.
| | - |  | -------------------------------------------------------------------------------------------------------




Vendor-specific objective evidence is based on the price generally charged when an element is
sold separately, or if not yet sold separately, is established by authorized management. All elements of each order are valued at the time of revenue recognition. In situations where vendor-specific objective evidence does not exist or the fee is
not fixed or determinable, revenue is recognized ratably over the life of the agreement. If installation
is essential to the functionality of the software, license and consulting revenue is recognized upon completion of the installation.





Sales made through distributors, resellers, and original equipment manufacturers are recognized
at the time these partners report to the Company that they have sold the software or, alternatively, when the Company drop-ships the product to the end user, and after all revenue recognition criteria have been met.





Service revenue includes maintenance revenue, which is deferred and
recognized ratably over the maintenance period, and revenue from consulting and training services, which is recognized as services are performed.





| | Restructuring Charge
| | --------------------




During the quarter ended June 30, 2001, we recorded a restructuring charge of $816,000 related to redundancies and a reduction in force, resulting
from the WebTrends merger and the resizing of our combined businesses. A total of 36 employees of NetIQ were terminated under this plan, of which 12 were in research and development and 24 were in sales and marketing. All employees were informed of
their terminations and terminated by June 30, 2001. During the quarter ended June 30, 2001, $530,000 was paid out as termination benefits and $286,000 remained as a liability. The remaining liability is expected to be paid out during the year ending
June 30, 2002.





| | Tender Offer
| | ------------




On May 7, 2001 the Company announced a voluntary stock option exchange program for its employees. Under the program, Company employees were given
the opportunity, if they so chose, to cancel outstanding stock options previously granted to them in exchange for an equal number of new options to be granted at a future date. The exchange was limited to employees who held options with an exercise
price equal to or greater than $50.00 per share and those options with exercise prices lower than $50.00 granted on or after December 7, 2000. The grant price of the new options will be equal to the highest of (i) the closing selling price per share
on the trading day immediately before the day of grant; (ii) the average of the high and low per share sales price on the day of grant; or (iii) the closing selling price on the day of grant. The new options will not be granted before December 10,
2001, which is six months and one day following the date on which the Company canceled the options accepted for exchange. A total of 1,364,957 options were tendered by employees under the program. The offer and the right to withdraw expired on June
7, 2001.





| | Acquisition of WebTrends Corporation
| | ------------------------------------




On March 30, 2001 the Company acquired all of the outstanding shares of WebTrends Corporation (WebTrends) for 12.8 million shares
of common stock valued at approximately $926 million, assumed 2.7 million employee stock options valued at approximately $133 million, of which $4.9 million was recorded as an increase in deferred stock-based compensation and will be amortized over
the remaining vesting period of the options, and incurred approximately $11 million of direct merger costs for a total purchase price of approximately $1.1 billion. WebTrends provided web analytics and eBusiness intelligence software.





The acquisition was accounted for as a purchase
and, accordingly, the results of operations from the date of acquisition have been included in the consolidated financial statements. In connection with the acquisition, intangible assets of $975.8 million were acquired, of which $2.7 million is
reflected as a one-time charge to operations for the write-off of acquired in-process research and development costs that had not reached technological feasibility and, in managements opinion, had no probable alternative future use. This
one-time charge is reflected in our consolidated statement of operations for twelve months ended June 30, 2001, within operating expenses. The remaining intangible assets of $973.1 million, comprised primarily of goodwill, are included in other
assets in the accompanying consolidated balance sheets and are being amortized over three years.





In addition to the NetIQ employees, we also terminated 49 employees of WebTrends and accrued $1.5 million related to the reduction in the workforce resulting from resizing the
combined businesses. The cost of
terminating the WebTrends employees was accounted for as part of the purchase price. Of the total, 9 were in research and development, 27 were in sales and marketing, and 13 in general and
administration. All employees to be terminated were informed of their terminations prior to June 30, 2001. Of the total 49 employees, 39 employees were terminated of which 9 were in research and development, 27 were in sales and marketing, and 3
were in general and administration, during the quarter ended June 30, 2001. During the quarter ended June 30, 2001, $414,000 was paid out as termination benefits and $1.1 million remained as a liability. The remaining liability is expected to be
paid out during the year ending June 30, 2002.





| | Licensing agreement with Microsoft Corporation
| | ----------------------------------------------




On September 25, 2000, we entered into a licensing agreement with Microsoft Corporation whereby Microsoft licensed our Operations
Manager product technology and source code for core operations management of Windows 2000 and Microsoft server applications. Microsoft agreed to pay us $175.0 million in license fees and up to $6.0 million in engineering co-development funds over a
three-year period. License revenue from the Microsoft agreement was $25.0 million in fiscal year 2001, and is anticipated to be $15.0 million, $20.0 million, $25.0 million, and $25.0 million in the four fiscal quarters of the fiscal year ending June
30, 2002. For a period of three years, Microsoft also agreed to spend $5.0 million per year and pay us an additional $5.0 million per year to market the joint solutions. In addition, we became the Premier Independent Software Vendor (ISV) for
Microsoft operations management solutions (the only vendor with such a designation) and became a Microsoft Global Technology Partner.





| | Acquisition of Software Realization, Inc.
| | -----------------------------------------




On July 17, 2000 the Company acquired all outstanding shares of Software Realization, Inc. (Software Realization) for cash of
$745,000 and assumed liabilities of $528,000, and incurred $150,000 of direct merger costs, for a total purchase price of $1.4 million. Software Realization provided training and consulting services to NetIQ partners and customers. The acquisition
was accounted for as a purchase and, accordingly, the results of operations from the date of acquisition have been included in the consolidated financial statements. In connection with the acquisition, goodwill of $919,000 was acquired which is
being amortized over three years.





| | Acquisition of Mission Critical Software, Inc.
| | ----------------------------------------------




On May 12, 2000 we acquired all of the outstanding shares of Mission Critical Software, Inc. (Mission Critical) for 18.8 million
shares of common stock valued at $1.3 billion, assumed 4.9 million options valued at $285.0 million and incurred $9.4 million of direct merger costs, for a total purchase price of $1.6 billion. Mission Critical was a provider of systems
administration and operations management software products for corporate and Internet-based Windows NT and Windows 2000 networks. The merger was accounted for using purchase accounting.





In April 2000, prior to completing the merger with NetIQ, Mission Critical acquired all of the
outstanding capital stock of Ganymede Software Inc. (Ganymede). Ganymede was a developer of network and application performance management solutions. The merger was accounted for using purchase accounting.





| | Acquisition of Sirana Software, Inc.
| | ------------------------------------




On March 10, 2000 we acquired all outstanding shares of Sirana Software, Inc. for 27,000 shares of common stock and cash valued
at $2.5 million plus $57,000 of direct merger costs, for a total purchase price of $2.5 million. Sirana was a developer of web-based enterprise analysis and reporting solutions for Microsoft BackOffice. The merger was accounted for using purchase
accounting.





| | Other
| | -----




In September 1996, Compuware Corporation filed a complaint against the Company alleging misappropriation of trade secrets, copyright infringement,
unfair competition and other claims. Compuware asserted these claims after a number of prior Compuware employees founded the Company or later joined the Company as officers and employees. These claims were settled and the complaint dismissed in
March 1999.










Historical Results of Operations





The following table sets forth our historical results of operations expressed as a percentage
of total revenue for fiscal 2001, 2000, and 1999.





Percentage of Total Revenue Year Ended June 30,2001

2000

1999Consolidated Statements of Operations Data:Software license revenue

75
%

78
%

85
%Service revenue

25


22


15Total revenue

100


100


100Cost of software license revenue

1


2


4Cost of service revenue

6


4


6Total cost of revenue

7


6


10Gross profit

93


94


90Operating expenses:Sales and marketing


49


52


54Research and development

21


21


20General and administrative

8


10


16Stock-based compensation

1


1


9Write-off of acquired in-process research and
development costs

2


22


Amortization of goodwill and intangibles

332


134


Restructuring charge







Total operating expenses

413


240


99Loss from operations

(320
)

(146
)

(9
)Other income, net

13


15


1Loss before income taxes

(307
)

(131
)

(8
)Income taxes

7


5


Net loss

(314
)%

(136
)%

(8
)%Cost of software license revenue, as a percentage of software license revenue

2
%

2
%

4
%Cost of service revenue, as a percentage of service revenue

25
%

21
%

40
%





On March
30, 2001 we completed the acquisition of WebTrends Corporation. On July 17, 2000 we completed the acquisition of Software Realization, Inc. On May 12, 2000 we completed the acquisition of Mission Critical Software, Inc., including the business and
operations of Ganymede Software, Inc. On March 10, 2000 we completed the acquisition of Sirana Software, Inc. Results of these operations from the date of acquisition forward have been included in the consolidated financial statements. Accounting
practices for all acquired companies have been conformed to those of NetIQ.





Comparison of Fiscal Years
Ended June 30, 2001 and 2000





Revenue.    Our total revenue increased to $166.9 million in fiscal 2001 from $47.9 million in fiscal 2000, representing growth of 248%. During this same
period, our software license revenue increased to $125.7 million from $37.2 million, representing growth of 238%. The increase is due primarily to increases in the number of software licenses sold, reflecting increased acceptance of our products,
expansion of our field and inside sales organizations and our third-party channel partners, and the inclusion of a full year of operations for Mission Critical, Ganymede, and Sirana in fiscal 2001, acquired in fiscal 2000, and our acquisition of
WebTrends in March 2001. Service revenue increased to $41.3 million in fiscal 2001 from $10.7 million in fiscal 2000,
representing growth of 286%. The increase was due primarily to maintenance fees associated with new software licenses and renewals by our existing customers. Service revenue increased as a
percentage of total revenue due to the compounding effect of our base of installed licenses and due to a significant majority of our customers renewing their maintenance service agreements.





| | Cost of Revenue
| | ---------------




Cost of Software License Revenue.    Our cost of software license revenue includes the costs associated with software
packaging, documentation, such as user manuals and CDs, and production, as well as non-employee commissions and royalties. Cost of software license revenue was $2.1 million and $800,000 in fiscal 2001 and fiscal 2000, respectively, representing 2%
of related software license revenue in both years. The increase in dollar amount is due to the increase in license revenue.





Cost of Service Revenue.    Cost of service revenue consists primarily of personnel costs and expenses incurred in
providing telephonic and on-site maintenance and consulting services. Costs associated with training activities consist principally of labor and departmental expenses as well as training materials. Cost of service revenue was $10.2 million and $2.2
million in fiscal 2001 and fiscal 2000, respectively, representing 25% and 21% of related service revenue. The increase in dollar amount of cost of service revenue is primarily attributable to the growth in our installed customer base. Cost of
service revenue as a percent of service revenue increased due primarily to hiring additional personnel to support our growing customer base, particularly including WebTrends service organization starting in Q4 of fiscal 2001, which provides more
implementation services than NetIQ had prior to the merger. We expect service revenue to increase as our installed license base grows and, as a consequence, our cost of service revenue to increase in absolute dollars.





| | Operating Expenses
| | ------------------




Sales and Marketing.    Our sales and marketing expenses consist primarily of personnel costs, including salaries and
employee commissions, as well as expenses relating to travel, advertising, public relations, seminars, marketing programs, trade shows and lead generation activities. Sales and marketing expenses increased to $80.6 million in fiscal 2001 from $24.7
million in fiscal 2000. The increase in dollar amount was due primarily to the hiring of additional field sales, inside sales and marketing personnel, which increased to 465 people from 257 people at the end of each year, and expanding our sales
infrastructure and third-party channel partners, as well as higher commissions. Sales and marketing expenses represented 49% and 52% of total revenue for fiscal 2001 and fiscal 2000, respectively. The decline in sales and marketing expenses as
percentage of total revenue was principally the result of economies of scale resulting from the increased number of sales transactions, including follow-on sales to existing customers, as well as the allocation of marketing expenses over a
substantially increased revenue base. We expect to continue hiring additional sales and marketing personnel and to increase promotion, advertising and other marketing expenditures in the future Accordingly, we expect sales and marketing expenses
will increase in absolute dollars in future periods to support increases in our overall revenue.





Research and Development.    Our research and development expenses consist primarily of salaries and other personnel-related costs, as well as facilities
costs, consulting fees and depreciation. These expenses increased to $35.7 million in fiscal 2001 from $10.1 million in fiscal 2000, representing 21%, of total revenue in both fiscal years. This increase in dollar amount resulted principally from
increases in engineering and technical writing personnel, which increased to 331 people from 189 people at the end of each year. To date, all research and development costs have been expensed as incurred in accordance with Statement of Financial
Accounting Standards (SFAS) No. 86 as our software development process is essentially completed concurrent with the establishment of technological feasibility. We expect to continue to devote substantial resources to product development such that
research and development expenses will increase in absolute dollars in future periods.





General and Administrative.    Our general and administrative expenses consist primarily of personnel costs for finance and administration, information
systems and human resources, as well as directors and officers
insurance, professional services expenses such as legal and accounting, and provision for doubtful accounts. General and administrative expenses increased to $13.1 million in fiscal 2001 from
$4.8 million in fiscal 2000, representing 8% and 10% of total revenues, respectively. The increase in dollar amount was due primarily to increased staffing necessary to manage and support our growth. General and administrative personnel increased to
130 from 53 at the end of each fiscal year. The decrease in general and administrative expense as a percentage of total revenue was due primarily to the growth in total revenue. We believe that our general and administrative expenses will increase
in absolute dollars as we expand our administrative staff, add new financial and accounting software systems and increase professional fees to manage our growth. We allocate costs associated with facilities and information systems to all functional
groups.





Stock-Based
Compensation.    Deferred stock-based compensation represents the intrinsic value of options assumed in the acquisition of WebTrends and costs related to the grant of options at less than fair market value. The deferred
amount is being amortized over the vesting periods of the assumed and granted options, which is generally four years. Deferred stock-based compensation of $4.9 million was recorded during fiscal 2001 due to the assumption of the WebTrends options in
the acquisition. Due to employee attrition, $396,000 and $140,000 of deferred stock-based compensation was reversed during fiscal 2001 and 2000, respectively. During fiscal 2001 and fiscal 2000, we recognized stock-based compensation expense of $2.0
million and $696,000, respectively.





Write-off of
Acquired In-Process Research and Development Costs.    Related to our acquisition of WebTrends in fiscal 2001 and Mission Critical and Sirana in fiscal 2000 we wrote-off a total of $2.7 million in fiscal 2001 and $10.7
million in fiscal 2000 as charges to operations associated with the purchase of in-process technology that had yet not reached technological feasibility.





In connection with the acquisitions of WebTrends in March 2001, Mission Critical in May 2000, and Sirana in March 2000, acquired
technology included both existing technology and in-process research and development. The valuation of acquired technology was made by applying the income forecast method, which considers the present value of free cash flows by product lines. The
key elements of the acquired companies development process include: design of user interface, developing code, integration with existing products, technical documentation, and testing. A project is considered to be technologically feasible
when a prototype is available for beta or general release. At the date of acquisition, additional research and development effort was anticipated prior to the release of the products under development. Value was allocated to in-process research and
development based on the discounted cash flow expected to be generated and considering the core technology resident in the in-process products, the acquired companies past experience with typical product life cycles, and expected demand from
the acquired companies customers for new products. Acquired in-process technologies were charged to operations, as the technologies did not have alternative future uses as of the date of the acquisition.





Amortization of Goodwill and Intangibles.    During fiscal 2001 and
fiscal 2000, we amortized $554.7 million and $64.2 million of the goodwill and intangibles recognized in the acquisitions of WebTrends, Mission Critical, Sirana, and Software Realization. We expect to amortize approximately $794.0 million of
goodwill and intangibles during fiscal 2002.





In
June 2001, the FASB issued SFAS No. 141,Business Combinations, and SFAS No 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of
a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with
indefinite lives will not be amortized, but will rather be tested at least annually for impairment. We will adopt SFAS No. 142 for our fiscal year beginning July 1, 2002. Upon adoption of SFAS 142, we will stop the amortization of goodwill with an
expected net carrying value of approximately $920 million at the date of adoption that resulted from business combinations completed prior to the adoption of SFAS No. 141. We will evaluate goodwill under the SFAS No. 142
transitional impairment test and have not yet determined whether or not there is an impairment loss. Any transitional impairment loss will be recognized as a change in accounting principle.





Restructuring
Charge.    During the quarter ended June 30, 2001, we recorded a restructuring charge of $816,000 related to redundancies and a reduction in force, resulting from the WebTrends merger and the resizing of the combined
businesses. A total of 36 employees have been terminated under this plan, of which 12 were in research and development and 24 were in sales and marketing. All employees terminated were terminated before June 30, 2001. During the quarter ended June
30, 2001, $530,000 was paid out as termination benefits and $286,000 remained as a liability. The remaining liability is expected to be paid out during the year ending June 30, 2002.





Other Income, Net.    Other income, net, represents interest income
earned on our cash and cash equivalent balances, short-term investments, interest expense, and foreign currency transaction gains and losses. For fiscal 2001 and fiscal 2000, other income, net, was $21.8 million and $7.3 million, respectively. The
increase in other income, net is due primarily to the increase in total cash and cash equivalents and short-term investment balances in fiscal 2001 from cash generated by operations and funds obtained in the acquisition of WebTrends in fiscal 2001
and Mission Critical in fiscal 2000.





Income
Taxes.    We recorded income tax expense of $10.6 million and $2.4 million in fiscal 2001 and fiscal 2000, respectively, mainly due to the non-deductibility of the write-off of acquired in-process research and development
costs and goodwill amortization, for income tax purposes. The tax benefit associated with dispositions from employee stock plans reduced federal and certain state income taxes currently payable to zero in fiscal 2001 and 2000.





Comparison of Fiscal Years Ended June 30, 2000 and 1999





Revenue.    Our total revenue increased to $47.9 million in fiscal
2000 from $21.6 million in fiscal 1999, representing growth of 122%. During this same period, our software license revenue increased to $37.2 million from $18.4 million, representing growth of 102%. The increase is due primarily to increases in the
number of software licenses sold, reflecting increased acceptance of our AppManager products, expansion of our field and inside sales organizations and our third-party channel partners, and effects of the merger with Mission Critical,
Ganymede and Sirana. Service revenue increased to $10.7 million in fiscal 2000 from $3.1 million in fiscal 1999, representing growth of 241%. The increase was due primarily to the compounding effect of our base of installed licenses and due to a
significant majority of our customers renewing their maintenance service agreements.





| | Cost of Revenue
| | ---------------




Cost of Software License Revenue.    Our cost of software license revenue includes the costs associated with software
packaging, documentation, such as user manuals and CDs, and production, as well as non-employee commissions and royalties. Cost of software license revenue was $800,000 and $755,000 in fiscal 2000 and fiscal 1999, respectively, representing 2% and
4% of related software license revenue. The percentage decrease is due to economies of scale and lowering of royalty expense, as our new products incorporate a lesser amount of third-party technologies.





Cost of Service Revenue.    Cost of service revenue consists
primarily of personnel costs and expenses incurred in providing telephonic and on-site maintenance and consulting services. Costs associated with training activities consist principally of labor and departmental expenses as well as training
materials. Cost of service revenue was $2.2 million and $1.3 million in fiscal 2000 and fiscal 1999, respectively, representing 21% and 40% of related service revenue. The increase in dollar amount of cost of service revenue is primarily
attributable to the growth in our installed customer base. Cost of service revenue as a percent of service revenue declined due primarily to economies of scale achieved as our revenue and installed base have grown.













| | Operating Expenses
| | ------------------




Sales and Marketing.    Our sales and marketing expenses consist primarily of personnel costs, including salaries and
employee commissions, as well as expenses relating to travel, advertising, public relations, seminars, marketing programs, trade shows and lead generation activities. Sales and marketing expenses increased to $24.7 million in fiscal 2000 from $11.7
million in fiscal 1999. The increase in dollar amount was due primarily to the hiring of additional field sales, inside sales and marketing personnel, which increased to 257 people from 66 people at the end of each year, and expanding our sales
infrastructure and third-party channel partners, as well as higher commissions. Sales and marketing expenses represented 52% and 54% of total revenue for fiscal 2000 and fiscal 1999, respectively. The decline in sales and marketing expenses as a
percentage of total revenue was principally the result of economies of scale resulting from the increased number of sales transactions, including follow-on sales to existing customers, as well as the allocation of marketing expenses over a
substantially increased revenue base.





Research
and Development.    Our research and development expenses consist primarily of salaries and other personnel-related costs, as well as facilities costs, consulting fees and depreciation. These expenses increased to $10.1
million, or 21% of total revenue, in fiscal 2000, from $4.3 million, or 20%, of total revenue in fiscal 1999. This increase in dollar amount resulted principally from increases in engineering and technical writing personnel, which increased to 189
people from 43 people at the end of each year, together with the establishment of a new facility in Bellevue, Washington, and the inclusion of the Mission Critical, Ganymede and Sirana facilities in Houston, Texas, Raleigh, North Carolina, and
Bellevue, Washington. To date, all research and development costs have been expensed as incurred in accordance with Statement of Financial Accounting Standards (SFAS) No. 86 as our current software development process is essentially completed
concurrent with the establishment of technological feasibility.





General and Administrative.    Our general and administrative expenses consist primarily of personnel costs for finance and administration, information
systems and human resources, as well as directors and officers insurance, professional services expenses such as legal and accounting, and provision for doubtful accounts. The decrease in general and administrative expense as a percentage of total
revenue in fiscal 2000 was due primarily to the growth in total revenue. General and administrative expenses increased to $4.8 million in fiscal 2000 from $3.3 million in fiscal 1999, representing 10% and 16% of total revenues, respectively. The
increase in dollar amount was due primarily to increased staffing necessary to manage and support our growth. General and administrative personnel increased to 53 people at June 30, 2000, from 14 people at June 30, 1999. Legal expenses have been a
significant cost in 1999, amounting to $966,000. Higher legal costs were principally due to litigation with Compuware, where a settlement was reached in January 1999 final documentation entered into and claims subsequently dismissed in March 1999.
During fiscal 1999 we recorded $364,000 of expenses associated with the settlement of litigation with Compuware related to the exercise of warrants in connection with our initial public offering of our common stock on July 29, 1999.





Stock-Based
Compensation.    Deferred stock-based compensation represents the costs related to grant of options at less than fair market value. The deferred amount is being amortized over the vesting periods of the options, which is
generally four years. No deferred stock-based compensation was recorded during fiscal 2000. However, due to employee attrition, $140,000 of deferred stock-based compensation was reversed during fiscal 2000. During fiscal 1999, we recorded deferred
stock-based compensation of $3.0 million, relating to stock option grants to employees and non-employees. These amounts are being amortized over the vesting periods of the granted options, which is generally four years for employees. During fiscal
2000 and fiscal 1999, we recognized stock-based compensation expense of $696,000 and $1.9 million, respectively. At June 30, 2000, total deferred stock-based compensation was $1.3 million.





Write-off of Acquired In-Process Research and Development
Costs.    Related to our acquisition of Mission Critical and Sirana we wrote-off a total of $10.7 million in fiscal 2000 as a charge to operations associated with the purchase of in-process technology that had not yet reached
technological feasibility.





In the above
acquisitions, acquired technology included both existing technology and in-process research and development. The valuation of acquired technology was made by applying the income forecast method,
which considers the present value of cash flows by product lines. The key elements of the acquired companies development process include: design of user interface, developing code,
integration with existing products, technical documentation, and testing. A project is considered to be technologically feasible when a prototype is available for beta or general release. At the date of acquisition, additional research and
development effort was anticipated prior to the release of the products under development. Value was allocated to in-process research and development based on a discounted cash flow expected to be generated and considering the core technology
resident in the in-process products, the acquired companies past experience with typical product life cycles, and expected demand from the acquired companies customers for new products. Acquired in-process technologies were charged to
operations, as the technologies did not have alternative future uses as of the date of the acquisition.





Amortization of Goodwill and Intangibles.    During fiscal 2000 we amortized $64.2 million of the goodwill and intangibles recorded in the merger with
Mission Critical and acquisition of Sirana.





Other Income, Net.    Other income, net, represents interest income earned on our cash and cash equivalent balances, short-term investments and interest
expense on our equipment loans and loan subordinated to our bank line of credit. For fiscal 2000 and fiscal 1999, other income, net, was $7.3 million and $108,000, respectively. The increase in interest income, net is primarily due to increased cash
and cash equivalents and short-term investment balances in fiscal 2000 from the proceeds of our public offerings and from cash obtained in the merger with Mission Critical.





Income Taxes.    We recorded income tax expense of $2.4 million for fiscal 2000 mainly due to the
non-deductibility of the write-off of acquired in-process research and development costs and goodwill amortization, for income tax purposes. We incurred net operating losses in fiscal 1999, and consequently paid no federal, state or foreign income
taxes.





Effects of Recent Accounting Pronouncements





In June 1998, FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, which defines derivatives, requires that all derivatives be carried at fair value, and provides for hedge accounting when certain conditions are met. The Company adopted SFAS No. 133 effective July 1 2000. Adoption of this statement
did not have a material impact on our financial position or results of operations.





In March 2000, the FASB issued FASB Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB Opinion
No. 25. FIN 44 clarifies certain elements of APB Opinion No. 25. Among other issues, this interpretation clarifies: the definition of employee for purposes of applying APB Opinion No. 25, the criteria for determining whether a plan qualifies as
non-compensatory, the accounting consequences of various modifications to the terms of a previously fixed stock option award, and the accounting for an exchange of stock compensation in a business combination. This interpretation is effective for us
in fiscal 2001. Adoption of this interpretation did not have a material impact on our financial position or results of operations.





In June 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS No 142, Goodwill and Other Intangible Assets. SFAS No. 141
requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that
intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. We will adopt SFAS No. 142 for the fiscal year
beginning July 1, 2002. Upon adoption of SFAS 142, we will stop the amortization of goodwill with an expected net carrying value of approximately $920 million at the date of adoption and annual amortization of approximately $753 million that
resulted from business combinations completed prior to the adoption of SFAS No. 141. We will evaluate goodwill under the SFAS No. 142 transitional impairment test and have not yet determined whether or not there is an impairment loss. Any
transitional impairment loss will be recognized as a change in accounting principle.










Liquidity and Capital Resources





As of June 30, 2001, we had $89.5 million in cash and cash equivalents and $377.3 million in
short-term investments.





Our operating activities
resulted in net cash inflows of $52.8 million, $4.0 million, and $2.0 million in fiscal 2001, 2000, and 1999, respectively. Sources of cash during these periods were principally from increases in deferred revenue and accrued compensation. Uses of
cash in these periods were principally increases in accounts receivable and other liabilities, and net losses in all three years offset by depreciation and amortization, write-off of acquired research and development costs, tax benefit from
disqualifying dispositions, and stock-based compensation.





Our investing activities resulted in net cash outflows (inflows) of $181.4 million, ($35.8) million, and $1.4 million in fiscal years 2001, 2000, and 1999, respectively. Uses of
cash were principally net purchases of short-term investments of $144.5 million and $45.1 million in fiscal years 2001 and 2000, respectively. Additional uses of cash were for purchases of property and equipment of $42.5 million, $2.2 million, and
$1.4 million in fiscal years 2001, 2000, and 1999, respectively, including the purchase in August 2000 of an 85,000 square foot facility for our corporate offices in San Jose, California for a total purchase price of $28.2 million. Sources of cash
were principally cash received in the acquisitions of WebTrends and Software Realization in fiscal 2001 of $6.8 million and cash received in the acquisition of Mission Critical and Sirana Software in fiscal 2000 of $83.2 million.





Financing activities resulted in net cash inflows of $30.5 million,
$138.2 million, and $5.6 million, in fiscal 2001, 2000, and 1999, respectively. Sources of cash during these periods were principally from the sale of common stock in our public offerings and exercises of stock options. Sources of cash in fiscal
1999 also included $5.4 million from the proceeds of the $5.0 million loan from Compuware and borrowings on our bank credit facility. Uses of cash were principally for the repayment of the loan to Compuware and our bank to retire short-term and
long-term debt of $2.1 million in fiscal 2000.





Deferred revenue consists principally of the unrecognized portion of revenue received under maintenance service agreements. These amounts are recognized ratably over the term of
the service agreement. Deferred revenue was $33.1 million at June 30, 2001.





As of June 30, 2001, we do not have any significant commitments outstanding other than under operating leases. See Note 12 to the Consolidated Financial Statements for additional
information regarding our obligations.





We believe
that the net proceeds from our public offerings, together with our cash balances and cash flows generated by operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for the next 12 months.
Thereafter, we may require additional funds to support our working capital requirements, or for other purposes, and may seek to raise such additional funds through public or private equity financings or from other sources, however, we may not be
able to obtain adequate or favorable financing at that time.





From time to time, in the ordinary course of business, we may evaluate potential acquisitions of businesses, products or technologies. A portion of our cash may be used to acquire
or invest in complementary businesses or products or to obtain the right to use complementary technologies. We have no current plans, agreements or commitments, and are not currently engaged in any negotiations with respect to any such transaction.





Factors That May Affect Future Operating Results





The following risk factors and other information included in this report should be carefully
considered, although the risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business
operations. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.





We may not be able to sustain the revenue growth rates we have previously experienced.





Although our revenues have grown rapidly in recent years, we may not
continue to experience this rate of revenue growth. If our revenue does not increase at or above the rate financial or industry analysts expect, the trading price of our common stock may decline.





In the second half of fiscal 2001, revenue decreased as a result of our sales cycle lengthening
due to a general slowdown in the US economy. Further, the recent terrorist attacks on the United States may cause increased instability in the global economic environment, potentially causing a worldwide recession.





Increasing competition could also impact our revenue growth. Additionally,
it will be more difficult to maintain high growth rates in revenue as the base of our revenue expands. Our efforts to expand our software product suites, sales and marketing activities, direct and indirect distribution channels and maintenance and
support functions and to pursue strategic relationships or acquisitions may not succeed or may prove more expensive that we currently anticipate. As a result, we cannot predict our future operating results with any degree of certainty and our
operating results may vary significantly from quarter to quarter.





We have a history of losses and may
experience losses in the future.





Since our
inception, we have incurred significant net losses, although in recent quarters we have achieved profitability, excluding amortization of stock-based compensation, goodwill and intangible assets. It is expected that we will continue to incur
significant sales and marketing, product development and administrative expenses. Currently, under accounting principles generally accepted in the United States of America, we amortize all intangible assets, including goodwill, from acquisitions
occurring prior to July 1, 2001 over the useful lives of such assets. However, beginning July 1, 2002 certain intangible assets, including goodwill, will be maintained on the balance sheet rather than being amortized, although they may eventually be
written down to the extent they are deemed to be impaired. To the extent that we amortize goodwill and other intangible assets created in our acquisitions, we are unlikely to generate net income until the goodwill and other intangible assets are
fully amortized or amortization is discontinued.





Unanticipated fluctuations in our operating results may
make it difficult to predict our future performance and may result in volatility in the market price of our common stock.





We may experience significant fluctuations in our operating results. We believe that quarter-to-quarter financial comparisons are not necessarily
meaningful indicators of our future operating results and should not be relied on as an indication of future performance. If our quarterly operating results fail to meet the expectations of analysts, the trading price of our common stock could be
negatively affected. Our quarterly operating results have varied substantially in the past and may vary substantially in the future due to a number of factors described elsewhere in this report, including many that are beyond our control.





We face several risks in connection with our license, development and marketing agreement with Microsoft.





In September 2000, we licensed a substantial
portion of our Operations Manager technology to Microsoft for $175.0 million, payable over three years. Microsoft may use the technology broadly with respect to Windows 2000, but its use is limited with respect to Windows NT. We have also agreed to
provide limited engineering resources for a fee and to develop and market products that operate with the products that Microsoft plans to offer based on our technology. We anticipate significant benefits from the agreement, but it also poses
significant risks, including:





| |  |  | Potential loss of revenue from existing Operations Manager and AppManager products until we establish revenue from products that operate with Microsofts new
products. The faster the rate of customer
adoption of Windows 2000, the greater the potential loss of revenue from operations management products. Faster adoption of Windows 2000 may increase our opportunity for additional revenue from
licenses of our migration tools and new products that operate with those Microsoft plans to offer. However, this additional revenue may not be sufficient to offset the loss of revenue from our Operations Manager and AppManager products;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Difficulties associated with coordinating some of our new product offerings with future releases of products from Microsoft;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------




| |  |  | The difficulty of creating new products that support and operate efficiently with Microsofts new products, in particular Microsoft Operations Manager;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | The difficulty of creating new products that operate with operating systems other than Windows NT or Windows 2000 (Windows NT/2000);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Customer acceptance of new product offerings;
| | - |  | ---------------------------------------------




| |  |  | Potential competition from Microsoft and other systems management providers for any new products that we may create; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------




| |  |  | Potential reduction of revenue or linearity of revenue from month to month as customers evaluate the resulting product strategies of Microsoft, other systems
management companies and ours.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




We may not realize the benefits we expect from the license agreement, which could have a material adverse effect on our business, financial condition and operating results.
Furthermore, if Microsoft partners with one our competitors for operations management products we may be disadvantaged in our efforts to develop new products compatible with Windows 2000 and future operating systems.





We will continue to depend on our marketing, product development and sales relationship with Microsoft, and if this relationship
suffers, our customers would likely purchase other vendors systems management software products.





We believe that our success in penetrating target markets for our systems management products depends part on our ability to maintain strong strategic marketing, product
development and sales relationships with Microsoft. Our relationship with Microsoft will be important to validate our technology, facilitate broad market acceptance of our products and enhance our sales, marketing and distribution capabilities.





We currently rely heavily on our relationship with
Microsoft and we attempt to coordinate our systems management product offerings with the future releases of Microsofts operating systems. It is possible that Microsoft may not notify us of feature enhancements to its products prior to new
releases of its operating systems in the future. In that case, we may not be able to introduce products on a timely basis that capitalize on new operating system releases and feature enhancements.





We may not be able to develop acceptable new products, services or enhancements to our existing products at the rate required by our rapidly changing
market.





Our future success depends upon our
ability to address the rapidly changing needs of our customers by developing and introducing high quality products, product enhancements, and services on a timely basis and by keeping pace with technological developments and emerging industry
standards. The market for some of our products is in the early stage of development and is rapidly evolving. As is common in such new and rapidly evolving industries, demand and market acceptance for recently introduced products are subject to high
levels of uncertainty and risk. Furthermore, new products can quickly render obsolete products that were only recently in high demand.





New products and services may present additional and unanticipated risks.





As we introduce new products and services such as hosted services on-line we may encounter risks not present in our current business. We must
anticipate and manage these risks, which may include new regulations,
competition, technological requirements and our own ability to deliver or maintain reliable services to our customers or partners. Failure to do so may result in unrecovered costs, loss of market
share or adverse publicity.





Our failure to integrate WebTrends effectively could have a material adverse
effect on our business, financial condition and operating results and could result in loss of key personnel.





We have made significant progress in integrating the management teams, strategies, culture, operations, technology, and products of the two companies. However, the breadth and the
complexity of the combined organization are much greater. As a result, we must develop new techniques to effectively manage multiple geographic locations, develop new products that utilize the assets and resources of both companies, and continue to
develop uniform standards, controls, procedures, policies, and information systems to realize the anticipated benefits from the acquisition. We must effectively manage post-acquisition risks that may lead to the potential disruption of our ongoing
business, our relationships with employees and customers, and distraction of our management.





These risks are particularly challenging because we have completed other sizable acquisitions in the last two years. If we do not succeed in addressing these risks or any other
problems encountered in connection with the merger, our operating results and financial condition would be adversely affected.





The acquisition of WebTrends could adversely affect combined financial results.





We believe that the acquisition of WebTrends will have an ongoing positive effect on earnings per share before taking into account the write-off of
acquired in-process research and development costs, and amortization of stock-based compensation, goodwill and intangible assets. However, the dilution associated with the shares issued in the acquisition could reduce earnings per share if the
potential benefits of the acquisition are not realized.





We may acquire technologies or companies in the
future, which could cause disruption of our business or other risks.





We regularly consider acquiring technologies or companies or investments in complementary companies, products or technologies. Such acquisitions entail many risks, any of which
could materially harm our business.





New competitors could emerge and this could impair our ability to grow
our business and sell our products.





We believe
the principal factors that will draw end-users to eBusiness infrastructure management and intelligence solutions products include: breadth of product offering and depth of product functionality; scalability; product quality and performance,
conformance to industry standards, competitive price and customer support. To be competitive, we must respond promptly and effectively to the challenges of technological change, evolving standards and our competitors innovations by continuing
to enhance our products and sales channels.





We may
face competition in the future from established companies who have not previously entered the market for eBusiness infrastructure management and intelligence solutions as well as from emerging companies. Many of our anticipated competitors have
greater financial, technical, marketing, professional services and other resources than ours. Established companies may not only develop their own eBusiness infrastructure management and intelligence solutions but they may also acquire or establish
cooperative relationships with our competitors. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. If those future competitors are successful, we are likely to lose market
share and our revenue would likely decline.





Competition could also create bundling or compatibility issues and adversely affect our ability to sell our products. Potential competitors may bundle their products or incorporate
eBusiness infrastructure management
and intelligence solutions into existing products, including for promotional purposes. In addition, our ability to sell our products will depend, in part, on the compatibility of our products
with other third party products, such as operating systems and messaging, Internet and database applications. Some of these third party software developers may change their products so that they will no longer be compatible with our products. If our
competitors bundle their products in this manner or third party software developers make their products incompatible with our products, this could materially and adversely affect our ability to sell our products, which could lead to price reductions
for our products and reduction of our profit margins.





If the markets for eBusiness infrastructure management
and intelligence solutions do not continue to develop as we anticipate, our ability to grow our business and sell our products will be adversely affected.





Historically the majority of our products have been designed to support Windows NT/2000-based systems and applications and it is
anticipated that many of our products will be dependent on the Windows market for the foreseeable future. If the market for Windows 2000 does not develop or develops more slowly than we currently anticipate, this would materially and adversely
affect our ability to grow our business, sell our products, and maintain profitability. In addition, users of previous versions of Windows NT may decide to migrate to an operating system other than Windows 2000 due to improved functionality of some
other vendors operating system. Windows 2000 and related products from Microsoft may address more of the needs of its customers for systems administration and operations management, in which case our customers would not need to purchase our
products to perform those functions. Although the market for Windows NT/2000-based systems has grown rapidly in recent periods, this growth may not continue at the same rate, or at all. If there is broader acceptance of other existing or new
operating systems that provide enhanced capabilities or offer similar functionality to Windows NT/2000 at a lower cost, our business would likely suffer.





The market for eBusiness infrastructure management and intelligence solutions software may not develop or may grow more slowly
than we anticipate, and this could materially and adversely affect our ability to grow our business, sell our products, and maintain profitability on an operating basis. The rate of acceptance of our products is dependent on the increasing
complexity of businesses operating environments as businesses deploy additional servers and applications. Many companies have been addressing their eBusiness infrastructure management and intelligence needs internally and only recently have
become aware of the benefits of third-party solutions. Our future financial performance will depend in large part on the continued growth in the number of businesses adopting third-party applications management software products and their deployment
of these products on an enterprise-wide basis.





The lengthy sales cycle for our products makes our revenues
susceptible to fluctuations.





The delay or
failure to complete sales, particularly large enterprise-wide sales, in a quarter or fiscal year would reduce our quarterly and annual revenue. We have traditionally focused on sales of our products to workgroups and divisions of a customer,
resulting in a sales cycle ranging between 90 and 180 days. The sales cycle associated with the purchase of our products is subject to a number of significant risks over which we have little or no control, including customers budgetary
constraints and internal acceptance procedures, installation requirements, and the introduction or announcement of new products by our company, competitors or Microsoft. In recent quarters we have experienced increased financial and purchasing
review cycles from many of our customers as a result of the economic slowdown.





We offer a broader range of products after the acquisition of WebTrends that may require increased selling effort for the customers entire enterprise than has historically
been required. The sales cycle for these enterprise-wide sales typically can be significantly longer than the sales cycle for smaller-sized departmental sales. Enterprise-wide sales of the combined companys products require an extensive sales
effort throughout a customers organization because decisions to license and deploy this type of software generally involve the evaluation of the software by many people in various functional and geographic areas, each of whom may have specific
and conflicting requirements. This evaluation process often requires significant efforts to educate information technology decision-makers about the benefits of our products. In addition, enterprise-wide deployments could also erode per-user license
fees even though average sales prices might increase.










Our success depends on continued use and expansion of the Internet and
Internet-based systems.





Many of our eBusiness
infrastructure management and intelligence solutions are targeted for Internet-based systems. The rapid growth of the Internet is a recent phenomenon. The growth of our revenue is dependent on the continued use of the Internet for communication and
commerce. Additionally, the Internet infrastructure must continue to evolve to handle increased levels of Internet activity, security, reliability, cost, ease of use, accessibility and quality of service. Potential federal, state and foreign
regulation in the areas of privacy and content, as well as potential taxation of Internet use, could hamper Internet growth. Similarly, Internet users may become more concerned about Internet privacy and security. To the extent that government
regulation or user concern hampers the growth of the Internet, our business could be negatively affected.





The market price of our common stock, like that of other technology stocks, has been and may continue to be volatile.





The market price of our common stock has been highly volatile and we expect that our stock price will continue to fluctuate. The value of an
investment in NetIQ could decline due to the impact of any of the following factors upon the market price of our common stock: growth rate expectations for the Internet sector generally; variations in our actual and anticipated operating results;
changes in our earnings estimates by analysts; and our failure to meet analysts performance expectations.





The stock markets have in general, and with respect to technology companies in particular, recently experienced stock price and volume volatility. The stock markets may continue to
experience volatility that may adversely affect the market price of our common stock. Stock prices for many companies in the technology and emerging growth sector have experienced wide fluctuations that have often been unrelated to the operating
performance of such companies. Fluctuations such as these may adversely affect the market price of our common stock.





We will need to recruit and retain additional qualified personnel to successfully manage our business.





Our future success will depend in large part on our ability to attract and retain experienced sales, research and development, marketing, technical support and management
personnel. New employees will likely require substantial training in the use of the combined companys products, which in turn will require significant resources and management attention. If we do not attract and retain such personnel, this
could materially and adversely affect our ability to grow our business.





Moreover, the complexity of distributed computing systems requires highly trained customer service and technical support personnel to assist customers with deployment of our
products. The labor market for these personnel is very competitive due to the limited number of people available with the necessary technical skills. We have experienced difficulty in recruiting qualified personnel, particularly technical and sales
personnel. There is a risk that even if we invest significant resources in attempting to attract, train and retain these qualified personnel, we will not be successful in our efforts.





To achieve our business objectives, we may recruit and employ skilled technical professionals
from other countries to work in the United States. Limitations imposed by federal immigration laws and the availability of visas could materially and adversely affect our ability to attract necessary qualified personnel. This may have a negative
effect on our business and future operating results.





Our executive officers and other key personnel are
critical to our business and they may not remain with us in the future, which could hurt our ability to grow our business.





Our success will depend to a significant extent on the continued services of our executive officers and other key employees, including key sales,
consulting, technical and marketing personnel. If we lose the services of one or more of our executives or key employees, including if one or more of our executives or key employees
decided to join a competitor or otherwise compete directly or indirectly with us, this could harm our business and could affect our ability to successfully implement our business objectives. Glen
Boyd and Eli Shapira, co-founders of WebTrends, resigned in August 2001 and September 2001, respectively.





Errors in our products could result in significant costs to us and could impair our ability to sell our products.





Because our software products are complex, they may contain errors, or bugs, that could be detected at any point in a products
life cycle. These errors could materially and adversely affect our reputation, result in significant costs to us and impair our ability to sell our products in the future. The costs we may incur in correcting any product errors may be substantial
and could decrease our profit margins. While we expect to continually test our products for errors and work with customers through our customer support services organization to identify and correct bugs, errors in our products may be found in the
future. Testing for errors is complicated in part because it is difficult to simulate the highly complex computing environments in which our customers use these products as well as because of the increased functionality of our product offerings.
Detection of any significant errors may result in, among other things, loss of, or delay in, market acceptance and sales of our products, diversion of development resources, injury to our reputation, increased service and warranty costs or exposure
to product liability litigation. Moreover, because our products will support operating systems and applications, any software errors or bugs in the operating server software or the systems and applications that our products operate with may result
in errors in the performance of our software.





Our ability to secure, protect and expand our network and data
centers is increasingly important to our current and future business.





We rely on our network and data center infrastructure for internal communications, communications with customers and partners, direct sales of our software products, sales lead
generation and direct provision of fee-based services. We must protect our network infrastructure and equipment against damage from human error, physical or electronic security breaches, power loss and other facility failures, fire, earthquake,
flood, telecommunications failure, sabotage, vandalism and similar events. Despite precautions, a natural disaster or other unanticipated problems could result in interruptions in our service or significant damage. In addition, failure of any of our
telecommunications providers to provide consistent data communications capacity could result in interruptions in our services and thus in our ability to provide service to our customers. Additionally, we must continue to expand and adapt our network
to satisfy our internal and customer requirements. We are dependent on certain telecommunications providers for our backbone capacity and it may be difficult to quickly increase this capacity in light of the lead times in the industry.





If we fail to protect our intellectual property rights, competitors may be able to use our technology or
trademarks and this could weaken our competitive position, reduce our revenue and increase costs.





Our success is heavily dependent on proprietary technology. We expect to rely primarily on a combination of patent, copyright and trademark laws, trade secrets, confidentiality
procedures and contractual provisions to protect our proprietary rights and prevent competitors from using our technology in their products. These laws and procedures provide only limited protection. We have a number of patents but they may not
provide sufficiently broad protection or they may not be enforceable in actions against alleged infringers. Our ability to sell our products and prevent competitors from misappropriating our proprietary technologies, trademarks and trade names is
dependent on protecting intellectual property. Despite precautions that we take, it may be possible for unauthorized third parties to copy aspects of our current or future products or to obtain and use information that we regard as proprietary. In
particular, we may provide our licensees with access to proprietary information underlying our licensed applications. Additionally, our competitors may independently develop similar or superior technology or design around the patents we own.
Policing unauthorized use of software is difficult and some foreign laws do not protect proprietary rights to the same extent as United States laws. Legal standards relating to the validity, enforceability and scope of protection of intellectual
property rights in Internet-related industries are uncertain and still evolving. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the
proprietary rights of
others. Such litigation would be costly and distracting to management, and there is no assurance such litigation would be successful.





Third parties could assert that our products infringe their intellectual property rights. Such claims could injure our reputation and adversely affect
our ability to sell our products.





Third parties
may claim that our current or future products infringe their proprietary rights, and these claims, whether they have merit or not, could harm our business by increasing our costs or reducing our revenue. We previously litigated a claim with
Compuware alleging that we had infringed a third partys intellectual property rights. In 1999, WebTrends was involved in an intellectual property dispute with WebSideStory, Inc. Although these claims have been settled, any future claims could
affect our relationships with existing customers and may prevent future customers from licensing our products. The intensely competitive nature of our industry and the importance of technology to our competitors businesses may contribute to
the likelihood of being subject to third party claims of this nature. Any such claims, with or without merit, could be time consuming, result in potentially significant litigation costs, including costs related to any damages we may owe resulting
from such litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or license agreements may not be available on acceptable terms or at all. Such claims could also force us either to stop
selling, incorporating or using products or services that incorporate the challenged intellectual property or to redesign those products or services that incorporate such technology. We expect that software developers will increasingly be subject to
infringement claims as the number of products and competitors in the software industry grows and the functionality of products in different industry segments overlaps.





ITEM 7A.    
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





We do not use derivative financial instruments in our investment portfolio and have no foreign exchange contracts. Our financial instruments consist of cash and cash equivalents,
short-term investments, trade accounts, and accounts payable. We consider investments in highly liquid debt instruments purchased with a remaining maturity of three months or less to be cash equivalents. Our exposure to market risk for changes in
interest rates relates primarily to our short-term investments; thus, fluctuations in interest rates would not have a material impact on the fair value of these securities.





Principally our business is transacted in United States dollars. In fiscal 2001, 7% of our invoices were in currencies other
than the United States dollar. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to local currency denominated revenue and operating expenses in Australia, Belgium,
Canada, Denmark, France, Germany, Italy, Japan, Singapore, Spain, Sweden, Switzerland, and the United Kingdom. We believe that a natural hedge exists in some local currencies, as local currency denominated revenue will substantially offset the local
currency denominated operating expenses. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis. However, as of June 30, 2001, we had no hedging contracts outstanding.





At June 30, 2001 we had $89.5 million in cash and cash equivalents, and
$377.3 million in short-term investments. Based on our cash, cash equivalents and short-term investments at June 30, 2001, a hypothetical 10% increase/decrease in interest rates would increase/decrease our annual interest income and cash flows by
approximately $2.3 million.





ITEM 8.    
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





The financial statements and supplementary financial information required to be filed under this Item are presented in Item 14 and the Schedule of Valuation and Qualifying Accounts
which follows Item 14.





ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE





Not applicable.







PART III





ITEM 10.    
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT





The following table sets forth information regarding the executive officers and directors as of June 30, 2001.





Name

Age

PositionChing-Fa Hwang


52


President, Chief Executive Officer and DirectorJames A. Barth


58


Senior Vice President, Finance, Chief Financial Officer and  SecretaryGlenn S. Winokur


42


Chief Operating OfficerThomas P. Bernhardt


48


Senior Vice President, Chief Technology Officer and DirectorW.Glen Boyd*


34


Chief Information OfficerFlint J. Brenton


45


Senior Vice President, EngineeringHer-Daw Che**


52


Senior Vice President, UNIX TechnologyThomas R. Kemp


35


Senior Vice President, ProductsMark P. Marron***


40


Senior Vice President, Worldwide SalesDaniel J. Meub


48


Senior Vice President, eServicesRichard J. Pleczko


43


Senior Vice President, MarketingMark E. Reed****


50


Senior Vice President, Business DevelopmentElijahu Shapira*****


35


Chief Strategy Officer and DirectorAlan W. Kaufman (1)(2)(3)


63


DirectorMichael J. Maples (1)


58


DirectorScott D. Sandell (2)


36


DirectorYing-Hon Wong (1)(2)(3)


43


Director


---

|*     |  | Resigned as of August 31, 2001                                        
|----- |  | ----------------------------------------------------------------------
|**    |  | Resigned effective October 31, 2001                                   
|***   |  | Joined on August 27, 2001                                             
|****  |  | Resigned as of August 15, 2001                                        
|***** |  | Resigned effective September 30, 2001, but will continue as a director
|(1)   |  | Member of Audit Committee.                                            
|(2)   |  | Member of Compensation Committee.                                     
|(3)   |  | Member of Nominating Committee.                                       




Ching-Fa Hwang co-founded NetIQ in June 1995 and has served as its President and Chief Executive Officer and as a director since its
inception. From June 1995 to March 1999, Mr. Hwang also served as our Chief Financial Officer. From September 1994 to June 1995, Mr. Hwang served as the Vice President of Research at Compuware, a developer of information systems software. From
August 1993 to September 1994, Mr. Hwang served as the Vice President of Technical Services and General Manager at the EcoSystems Business Group of Compuware. In May 1991, Mr. Hwang co-founded EcoSystems Software, a client/server management software
provider, and served as its Vice President of Engineering from its inception until its sale to Compuware in August 1993. Mr. Hwang holds a B.S. in electrical engineering from National Taiwan University and a M.S. in computer science from the
University of Utah.





James A. Barth has
served as NetIQs Chief Financial Officer and Secretary since March 1999. November 2000, Mr. Barth was named Senior Vice President, Finance and Administration and prior to that he served as Vice President, Finance. From November 1997 until
March 1999, Mr. Barth served as the Vice President, Chief Financial Officer and Secretary of Interlink Computer Sciences, a developer of enterprise networking software designed for the IBM mainframe platform. From October 1994 to August 1997, Mr.
Barth served as Executive Vice President, Chief Financial Officer and Secretary of MagiNet, a provider of interactive entertainment and information systems for hotels. From March 1994 to October 1994, he served as Vice President and Chief Financial
Officer at ACC Microelectronics, a semiconductor company. From 1982 to March 1994, Mr. Barth







served as Vice President, Chief Financial Officer and Secretary at Rational Software, a developer of software engineering tools. Mr. Barth holds a B.S. in business administration from the
University of California at Los Angeles and is a certified public accountant.





Glenn S. Winokur was named Chief Operating Officer of NetIQ in July 2001. Prior to that he served as NetIQs Senior Vice President, Worldwide Sales since November 2000
and as Vice President, Worldwide Sales since October 1999. Prior to his promotion to Vice President, Worldwide Sales, Mr. Winokur served as NetIQs Vice President, Sales since May 1997 and from May 1996 to April 1997, Mr. Winokur served as
NetIQs Director of Sales. From March 1994 to May 1996, Mr. Winokur served as Regional Sales Manager at Compuware. Mr. Winokur has a B.S. in business administration and marketing from the University of Illinois.





Thomas P. Bernhardt has served as Senior Vice President, Chief
Technology Officer and as a director since November 2000. He served as NetIQs Chief Technology Officer and as a director from May 2000, when Mission Critical became a wholly owned subsidiary of NetIQ, to November 2000. Mr. Bernhardt is a
founder of Mission Critical and served as a director there since July 1996. Mr. Bernhardt was a consultant to Mission Critical from September 1996 to January 1997, when he joined Mission Critical on a full time basis as Chief Technology Officer.
From February 1998 to May 1998, he also served as Mission Criticals interim President and Chief Executive Officer. From January 1989 to December 1996, Mr. Bernhardt was a consultant with RCG International, an information technology consulting
services company. Mr. Bernhardt holds a B.S. in experimental psychology from the University of Notre Dame.





W. Glen Boyd served as Chief Information Officer of NetIQ after WebTrends Corporation was acquired in March 2001, until his resignation as of August 31, 2001. Mr. Boyd
co-founded WebTrends Corporation, serving at various times as Chief Technology Officer, President, Vice President and Secretary and as a director from September 1993. Prior to WebTrends, from October 1990 to January 1993, Mr. Boyd was a Section
Manager for the AntiVirus Commute and PCTools product lines at Central Point Software (now a division of Symantec).





Flint J. Brenton was named Senior Vice President of Engineering of NetIQ in November 2000. From August 1999 to October 2000, Mr. Brenton served as Vice President of
Worldwide eCommerce at Compaq Computer Corporation. From 1996 to 1999, Mr. Brenton served as Director of Product Development at BMC Software. From 1995 to 1996, Mr. Brenton served as General Manager at I-NET, Inc. From 1984 to 1994, Mr. Brenton held
various executive and manager positions with IBM. Mr. Brenton holds a B.S. in accounting from Mount Union College and a Masters in business and public management from Rice University.





Her-Daw Che co-founded NetIQ and has served as NetIQs Senior Vice President, Unix
Technology from November 2000 and prior to that as Vice President, Engineering, and as a director since November 1995. From September 1993 to July 1995, Mr. Che served as the Director of Engineering of the EcoSystems Business Group at Compuware. Mr.
Che co-founded EcoSystems and served as its Director of Engineering from its inception until its sale to Compuware. Mr. Che holds a B.S. in electrical engineering from National Taiwan University and an M.S. in computer science and a Ph.D. in
computer science from the University of Pennsylvania.





Thomas R. Kemp was named Senior Vice President of Products in November 2000 and has served as NetIQs Vice President of Products since May 2000. Mr. Kemp served as our
Vice President Marketing from May 1997 until May 2000. From January 1996 to April 1997, Mr. Kemp served as our Director of Products. From April 1995 to November 1995, he served as a Director of Product Management at Compuware and from August 1993 to
March 1995, he served as a Manager of Systems Engineers at Compuware. From July 1992 to July 1993, Mr. Kemp served as a Manager of System Engineers at EcoSystems until its sale to Compuware. Prior to July 1992, Mr. Kemp held various consulting and
marketing positions at Oracle Corporation, a database management company. Mr. Kemp holds a B.S. in computer science and history from the University of Michigan.





Mark P. Marron joined NetIQ in August 2001 as Senior Vice President, Worldwide Sales. Prior to joining NetIQ, from 1999 to
August 2001, Mr. Marron served as General Manager Worldwide Channel Sales for Computer Associates International Inc. From 1997 to 1999, he served as Senior Vice President of Channel Sales and
Operations for Europe, Middle East and Africa; from 1993 to 1997 he served as Senior Vice President of Channel Sales for U.S., and from 1991 to 1993, he served as Vice President of Telesales at
Computer Associates International, Inc. From 1989 to 1991 he served as District Sales Manager/Account Manager at On Line Software International, and from 1988 to 1989, he was National Account Manager at Information Sciences, Inc. Mr. Marron holds a
B.S. in computer science from Montclair State University.





Daniel J. Meub has served as Senior Vice President, eServices of NetIQ after WebTrends Corporation was acquired in March 2001. At WebTrends, he served as Chief Operating
Officer from February 2000 to March 2001, Senior Vice President of Marketing and Sales from April 1999 to February 2000, and Vice President of Marketing from December 1998 to April 1999. From December 1996 to October 1998, Mr. Meub served as the
President and Chief Executive Officer of Adaptive Solutions Inc., a supplier of forms processing software and imaging solutions for the health care and governmental markets, which filed a voluntary petition under Chapter 7 of the United States
Bankruptcy Code due to insolvency. From January 1995 to November 1996, Mr. Meub served as the Executive Vice President of Marketing and Product Development of Now Software Inc., a supplier of time management and utility software. Mr. Meub has served
in a variety of sales and marketing roles since 1976. Mr. Meub holds a B.A. from Stanford University and an M.B.A. from Northwestern University.





Richard J. Pleczkow as named Senior Vice President of Marketing in November 2000 and served as NetIQs Vice President of Marketing after
Mission Critical was acquired in May 2000. Prior to the merger in May 2000, he served as Mission Criticals Vice President of Marketing and Product Management beginning December 1998. From May 1998 to December 1998, Mr. Pleczko served as Senior
Vice President of World Wide Marketing at PLATINUM Technology, a software company. From April 1985 until May 1998, Mr. Pleczko served in various managerial positions with Learmonth & Burchett, the most recent of which was Senior Vice President,
Marketing and Product Development.





Mark E.
Reed served as Senior Vice President, Business Development of NetIQ after WebTrends was acquired in March 2001, until his resignation as of August 15, 2001. In September 2000, Mr. Reed joined WebTrends as Senior Vice President of Corporate
Development. In 1997 Mr. Reed founded High Ground Partners LLC, a leading high tech consulting firm. During this time, Mr. Reed served in executive positions, including Chief Executive Officer, of several technology companies. From May 1993 to
September 1997, he served as Senior Vice President of Sales, Marketing and Services at In Focus Systems, and as President and Chief Executive Officer of Genigraphics, a wholly owned subsidiary of In Focus Systems. Mr. Reed holds a B.S. from the
University of Phoenix.





Elijahu Shapira has
served as Chief Strategy Officer and as a director of NetIQ after WebTrends Corporation was acquired in March 2001. Mr. Shapira resigned from his position as CSO effective September 30, 2001. Mr. Shapira co-founded WebTrends Corporation and served
as its Chief Executive Officer since December 1997 and as a director since September 1993. From September 1994 to November 1995 and from November 1996 to December 1998, he served as WebTrends Vice President and Secretary. Before founding
WebTrends, Mr. Shapira was the product development manager for the anti-virus product line at Central Point Software. Prior to Central Point, he served as the Vice President of Business Development for Carmel Software Engineering, a network security
and encryption products company.





Alan W.
Kaufman has been a director of NetIQ since August 1997. Since August 1997, Mr. Kaufman has served as a director of QueryObject Systems, which develops and markets proprietary business intelligence software, he served as their Chairman of the
Board from May 1998 to October 1999, and he served as their President and Chief Executive Officer from October 1997 to December 1998. From December 1996 to October 1997, Mr. Kaufman was an independent consultant. From April 1986 to December 1996,
Mr. Kaufman held various positions at Cheyenne Software, most recently as Executive Vice President of Worldwide Sales. Mr Kaufman is also a director of Global Telecommunications Solutions, a provider of prepaid phone cards, and was the founding
President of the New York Software Industry Association. Mr. Kaufman holds a B.S. electrical engineering from Tufts University.










Michael J. Maples
is a director of NetIQ, having previously served as a director of Mission Critical beginning April 1999. Mr. Maples manages private investments. From April 1988 to July 1995, Mr. Maples held various management positions at Microsoft Corporation, the
most recent of which was Executive Vice President of the Worldwide Products Group and a member of the office of the president. Prior to that, he served as a Director of Software Strategy for IBM. He also serves as a director of J.D. Edwards &
Company, an enterprise software company. Mr. Maples is also a member of the Board of Visitors for the Engineering School at the University of Oklahoma and the College of Engineering Foundation Advisory Council at the University of Texas at Austin.
Mr. Maples holds a B.S. degree in electrical engineering from the University of Oklahoma and an M.B.A. degree from Oklahoma City University.





Scott D. Sandell is a director of NetIQ, having previously served as a director of Mission Critical beginning September 1996. Mr. Sandell is
a partner of New Enterprise Associates, a venture capital firm, and has served in other capacities at such firm since January 1996. Prior to joining New Enterprise Associates, Mr. Sandell was the President of Yankee Pacific Company, a marketing and
business strategy-consulting firm, from March 1994 to December 1995. He is also a member of the boards of directors of several privately held companies. Mr. Sandell holds a B.S. degree in Engineering Sciences from Dartmouth College and an M.B.A.
degree from the Stanford Graduate School of Business.





Ying-Hon Wong co-founded NetIQ in June 1995 and has served as a director since its inception. Since January 1991, Mr. Wong has been a General Partner of Wongfratris
Investment Company, a venture investment firm. Mr. Wong holds a B.S. in electrical engineering and industrial engineering from Northwestern University and an M.B.A. from the Wharton School of Business at the University of Pennsylvania.





Agreements with Certain Executive Officers and Directors





NetIQ entered into employment agreements with Elijahu Shapira, former Chairman and Chief
Executive Officer of WebTrends, and W. Glen Boyd, former President and Chief Technical Officer of WebTrends, on January 16, 2001 that provided for certain benefits and the terms of their employment with NetIQ following the merger. As a result of his
resignation and pursuant to his employment agreement, Mr. Boyd is precluded from selling his NetIQ shares until March 30, 2002, the first anniversary of the merger. Mr. Shapira has entered into a revised agreement with NetIQ pursuant to which he may
continue selling up to 250,000 of his NetIQ shares each quarter until March 30, 2002, so long as he remains a director of NetIQ.





Classified Board





Our certificate of incorporation and bylaws provide for a board of directors of nine members consisting of three classes of directors, each serving staggered three-year terms. As a
result, a portion of our board of directors is elected each year. Directors are elected for three-year terms. We currently have seven directors. Alan W. Kaufman, Scott Sandell, and Elijahu Shapira have been designated Class I directors who term
expires at the 2002 annual meeting of stockholders; Michael J. Maples and Ying-Hon Wong have been designated Class II directors whose term expires at the 2003 annual meeting of stockholders; and Ching-Fa Hwang and Thomas P. Bernhardt have been
designated as Class III directors whose term expires at the 2001 annual meeting of stockholders.





Executive officers are appointed by the board of directors on an annual basis and serve until their successors have been duly elected and qualified. There are no family
relationships among any of our directors, officers or key employees.





Audit Committee





Our audit committee reviews our internal accounting procedures and
consults with and reviews the services provided by our independent auditors.










Compensation Committee Interlocks and Insider Participation





Our Compensation Committee is responsible for
determining salaries, incentives and other forms of compensation for our directors, officers and other employees and administering various incentive compensation and benefit plans. Ching-Fa Hwang, our President and Chief Executive Officer, and a
member of our board of directors, participates in all discussions and decisions regarding salaries and incentive compensation for all of our employees and consultants, except that he is excluded from discussions regarding his own salary and
incentive compensation. No interlocking relationship exists between any member of our compensation committee and any member of any other companys board of directors or compensation committee.





ITEM 11.    
EXECUTIVE COMPENSATION





The
information required by this item is incorporated by reference to the section captioned Executive Compensation contained in the Proxy Statement to be filed in connection with our 2001 Annual Meeting of Stockholders.





ITEM 12.    
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT





The information required by this item is incorporated by reference to the sections captioned Security Ownership of Certain Beneficial Owners and Management and
Record Date and Shares Outstanding contained in the Proxy Statement to be filed in connection with our 2001 Annual Meeting of Stockholders.





ITEM 13.    
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS





The information required by this item is incorporated by reference to the sections captioned Compensation Committee Interlocks and Insider Participation and
Certain Transactions contained in the Proxy Statement to be filed in connection with our 2001 Annual Meeting of Stockholders.







PART IV





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





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





| | 1.  Financial Statements. The following financial statements of the Company
and the Report of Deloitte & Touche LLP, Independent Auditors, are included in this Report on the pages indicated:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




PageIndependent Auditors Report


38Consolidated Balance Sheets as of June 30, 2001 and 2000


39Consolidated Statements of Operations and Comprehensive Loss     for the
Years ended June 30, 2001, 2000. and 1999


40Consolidated Statements of Stockholders Equity     for the Years ended
June 30, 2001, 2000, and 1999


41Consolidated Statements of Cash Flows for the Years ended     June 30, 2001,
2000, and 1999


42Notes to Consolidated Financial Statements


43





| | 2.  Financial Statement Schedules. The following financial statement schedule
of the Company for the years ended June 30, 2001, 2000, and 1999 is filed as part of this report on Form 10-K and should be read
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

in conjunction with the financial statements.





Schedule

Title

PageII


Valuation and Qualifying Accounts


62





| | Schedules not listed above have been omitted because they are not applicable, not required, or
the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| | 3.  Exhibits.
| | -------------




Exhibit Number

Description3(a)

Restated Certificate of Incorporation of NetIQ (incorporated by reference to the exhibit of the same name filed with NetIQs Registration Statement
on Form S-4, declared effectiveFebruary 23, 2001)3(c)

Restated Bylaws of NetIQ (incorporated by reference to the exhibit of the same name filed with NetIQs Registration Statement on Form S-4, declared
effective February 23, 2001)4(a)

Specimen Common Stock Certificate (incorporated by reference to the exhibit 4.1 of NetIQs Registration Statement on Form S-1, declared effective
July 29, 1999)4(b)

Registration Rights Agreement, dated May 14, 1997 by and among NetIQ and certain NetIQ stockholders identified therein (incorporated by reference to the
exhibit 4.2 of NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.1

Form of Indemnification Agreement between NetIQ and each of its directors and executive officers (incorporated by reference to the exhibit of the same
number filed with NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.2

Form of Change of Control Severance Agreements between NetIQ and each of its executive officers (incorporated by reference to the exhibit of the same
number filed with NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.3A

Amended and Restated 1995 Stock Plan (incorporated by reference to the exhibit of the samenumber filed with NetIQs Registration Statement on Form
S-1, declared effective July 29, 1999)







Exhibit Number

Description10.3B

Form of Stock Option Agreement under the Amended and Restated Stock Plan (incorporated by reference to the exhibit of the same number filed with
NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.3C

Form of Director Option Agreement under the 1995 Amended and Restated Stock Plan (incorporated by reference to the exhibit of the same number filed with
NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.4A

1999 Employee Stock Purchase Plan (incorporated by reference to the exhibit of the same number filed with NetIQs Registration Statement on Form
S-1, declared effective July 29, 1999)10.4B

Form of Subscription Agreement under the 1999 Employee Stock Purchase Plan (incorporated by reference to the exhibit of the same number filed with
NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.6*

Software Distribution Agreement, dated June 23, 1998, between NetIQ and Tech Data Product Management, Inc. (incorporated by reference to the exhibit of
the same number filed with NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.7

Agreement of Sublease, dated July 31, 1998, between NetIQ and AMP Incorporated (incorporated by reference to the exhibit of the same number filed with
NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.8

Confidential Settlement Agreement, dated March 10, 1999, by and between Compuware Corporation, NetIQ Corporation, and the individuals named therein
(incorporated by reference to the exhibit of the same number filed with NetIQs Registration Statement on Form S-1, declared effective July 29, 1999)10.9

Purchase and Sale Agreement, dated July 24, 2000, between NetIQ and TMG North First Associates, L.P. (incorporated by reference to the exhibit of the
same number filed with NetIQs Quarterly Report on Form 10-Q, filed November 14, 2000)10.10*

License, Development and Marketing Agreement, dated September 25, 2000, between NetIQ and Microsoft Corporation (incorporated by reference to the
exhibit of the same number filed with NetIQs Quarterly Report on Form 10-Q, filed November 14, 2000)10.11

Employment Agreement, dated January 16, 2001, as amended on September 24, 2001 by and between NetIQ and Elijahu Shapira21

Subsidiaries of the Registrant23

Independent Auditors Consent24

Power of Attorney (See page 37)*

Subject to Confidential Treatment

Previously filed





(b)  Reports on Form 8-K: Not applicable.





| | (i) On April 10, 2001, we filed a current report on Form 8-K relating to the press release for
the completion of the merger with WebTrends Corporation.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------




| | (ii) On April 11, 2001, we filed a current report on Form 8-K/A relating to the press release
for the completion of the merger with WebTrends Corporation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------






SIGNATURES





Pursuant to the
requirements of the Securities Act, NetIQ Corporation has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Jose, State of California, on the 26th day of
September, 2001.





| | NE | TIQ CORPORATION
| | -- | ---------------




| | JAMES A. BARTH
| | --------------

| | By | :
| | -- | -

| | James A. Barth,
| | ---------------

| | Chief Financial Officer
| | -----------------------




KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James A. Barth his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he might or could do in person, and hereby ratifies and confirms all that said attorney-in-fact and agent, or his substitute or substitutes, or any of them, shall do or cause to be done by virtue hereof.





Name

Title

DateCHING-FA HWANG (Ching-Fa Hwang)

President, Chief Executive     Officer and
Director     (Principal Executive Officer)

September 26, 2001JAMES A. BARTH (James A. Barth)

Senior Vice President, Finance Chief      Financial Officer, and
Secretary     (Principal Financial and Accounting     Officer)

September 26, 2001THOMAS P. BERNHARDT (Thomas P. Bernhardt)

Senior Vice President, Chief      Technology Officer and Director

September 26, 2001ELIJAHU SHAPIRA (Elijahu Shapira)

Director

September 26, 2001ALAN W. KAUFMAN (Alan W. Kaufman)

Director

September 26, 2001MICHAEL J. MAPLES (Michael J. Maples)

Director

September 26, 2001SCOTT D. SANDELL (Scott D. Sandell)

Director

September 26, 2001YING-HON WONG (Ying-Hon Wong)

Director

September 26, 2001










INDEPENDENT AUDITORS REPORT





To the Board of Directors and Stockholders of NetIQ Corporation:





We have audited the accompanying consolidated balance sheets of NetIQ Corporation and
subsidiaries (the Company) as of June 30, 2001 and 2000, and the related consolidated statements of operations and comprehensive loss, stockholders equity and cash flows for each of the three years in the period ended June 30, 2001. These
financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.





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





In our
opinion, such consolidated financial statements present fairly, in all material respects, the financial position of NetIQ Corporation and subsidiaries as of June 30, 2001 and 2000, and the results of their operations and their cash flows for each of
the three years in the period ended June 30, 2001 in conformity with accounting principles generally accepted in the United States of America.





Deloitte & Touche LLP


San Jose, California


July 23, 2001







NetIQ CORPORATION





CONSOLIDATED BALANCE SHEETS


June 30, 2001 and 2000


(In thousands, except share and per share amounts)





2001

2000ASSETSCurrent assets:Cash and cash equivalents
$
89,494


$
187,610Short-term investments

377,287



145,916Accounts receivable, net of allowance for uncollectible accounts and sales 
               returns of $4,045 and $1,550 in 2001 and 2000

27,116



10,744Prepaid expenses and other

2,691



3,478Total current assets

496,588



347,748Property and equipment, net

54,731



7,181Goodwill and other intangibles, net of accumulated amortization of $618,870 and       $64,184 in 2001 and 2000

1,769,803



1,365,891Other assets

1,407



941Total assets
$
2,322,529


$
1,721,761LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
$
5,451


$
2,044Accrued compensation and related benefits

14,704



5,023Other liabilities

19,389



11,285Deferred revenue

33,093



17,687Total current liabilities

72,637



36,039Commitments and contingencies (Note 12)Stockholders equity:Convertible preferred stock$0.001; 5,000,000 shares authorized, no shares
                issued and outstanding





Common stock$0.001; 250,000,000 shares authorized, 53,284,629 issued 
               and outstanding in 2001; 100,000,000 shares authorized, 37,533,359 issued 
               and outstanding in 2000

2,849,211



1,760,396Deferred stock-based compensation

(3,782
)


(1,286
)Accumulated deficit

(597,104
)


(73,271
)Accumulated other comprehensive income (loss)

1,567



(117
)Total stockholders
equity

2,249,892



1,685,722Total
liabilities and stockholders equity
$
2,322,529


$
1,721,761





See notes to consolidated financial statements.










NetIQ CORPORATION





CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS


Years Ended June 30, 2001, 2000 and 1999


(In thousands, except per share amounts)





2001

2000

1999Software license revenue

$125,670


$   37,235


$18,433Service revenue

41,267


10,685


3,136Total revenue

166,937


47,920


21,569Cost of software license revenue

2,114


800


755Cost of service revenue

10,213


2,217


1,260Total cost of revenue

12,327


3,017


2,015Gross profit

154,610


44,903


19,554Operating expenses:Sales and marketing


80,581


24,695


11,685Research and development

35,732


10,109


4,344General and administrative

13,140


4,761


3,347Stock-based compensation (*)

2,001


696


1,928Write-off of acquired in-process research and
development costs

2,663


10,693


Amortization of goodwill and intangibles

554,686


64,184


Restructuring charge

816





Total operating expenses

689,619


115,138


21,304Loss from operations

(535,009
)

(70,235
)

(1,750
)Other income (expenses):Interest income

22,274


7,440


219Interest expense

(40
)

(40
)

(111
)Other expenses

(448
)

(93
)

Total other income

21,786


7,307


108Loss before income taxes

(513,223
)

(62,928
)

(1,642
)Income taxes

10,610


2,400


Net loss

(523,833
)

(65,328
)

(1,642
)Other comprehensive income (expenses), net of income taxes:Foreign currency translation adjustments

(6
)

2


Unrealized gain (loss) on short-term
investments

1,690


(119
)

Comprehensive loss

$(522,149
)

$  (65,445
)

$  (1,642
)Basic and diluted net loss per share

$     (12.48
)

$        (3.59
)

$     (0.47
)Shares used to compute basic and diluted net loss per share

41,984


18,189


3,476(*)Stock-based compensation:Sales and marketing

$          668


$         326


$       395Research and
development

624


167


302General and
administrative

709


203


1,231Total

$      2,001


$         696


$   1,928





See notes to consolidated financial statements.







NetIQ CORPORATION





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY


Years Ended June 30, 2001, 2000, and 1999


(In thousands, except share amounts)





Convertible Preferred Stock

Common Stock

Note Receivable From Stockholder

Deferred Stock-based Compensation

Accumulated Deficit

Accumulated Other Comprehensive Income (loss)

TotalShares

Amount

Shares

AmountBalances, June 30, 1998

7,399,977


$10,955


3,217,833


$       1,302



$    (6
)



$(1,011
)



$    (6,301
)



$    



$       4,939Exercise of stock options







929,325


254






















254Repurchase of common stock







(58,331
)

(3
)


6


















3Issuance of stock







26,667


320






















320Deferred stock-based compensation










3,036








(3,036
)












Amortization of deferred stock-based compensation



















1,925













1,925Net loss
























(1,642
)







(1,642
)Balances, June 30, 1999

7,399,977


10,955


4,115,494


4,909








(2,122
)



(7,943
)







5,799Conversion of preferred stock to common stock

(7,399,977
)

(10,955
)

7,399,977


10,955






















Exercise of stock options







1,434,574


3,426






















3,426Issuances of stock under Employee Stock Purchase Plan







103,870


1,187






















1,187Issuances of stock in public offerings, net of expenses of
        $10,243







5,337,000


135,555






















135,555Exercise of warrant







280,025


3,640






















3,640Issuances of stock and options in business combinations, net







18,862,419


1,599,644






















1,599,644Tax benefit of employee stock transactions










1,003






















1,003Options isssued in lieu of compensation










145






















145Deferred stock-based compensation










(140
)







140













Amortization of deferred stock-based compensation



















696













696Gain from stockholder transaction










72






















72Foreign currency translation adjustments





























2



2Unrealized loss on short-term investments





























(119
)


(119
)Net loss
























(65,328
)







(65,328
)Balances, June 30, 2000







37,533,359


1,760,396








(1,286
)



(73,271
)



(117
)


1,685,722Exercise of stock options







2,538,963


24,768






















24,768Issuances of stock under Employee Stock Purchase Plan







362,473


5,686






















5,686Issuances of stock and options in business combinations, net







12,849,834


1,058,706








(4,893
)












1,053,813Stock isssued in lieu of compensation










51






















51Deferred stock-based compensation










(396
)







396













Amortization of deferred stock-based compensation



















2,001













2,001Foreign currency translation adjustments





























(6
)


(6
)Unrealized gain on short-term investments





























1,690



1,690Net loss
























(523,833
)







(523,833
)Balances, June 30, 2001




$      


53,284,629


$2,849,211



$




$(3,782
)



$(597,104
)



$1,567



$2,249,892





See notes to consolidated financial statements.







NETIQ CORPORATION





CONSOLIDATED STATEMENTS OF CASH FLOWS


Years Ended June 30, 2001, 2000, and 1999


(In thousands)





2001

2000

1999Cash flows from operating activities:Net loss

$   (523,833
)

$     (65,328
)

$(1,642
)Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization

560,875


65,527


406Write-off of acquired research and development costs

2,663


10,693


Tax benefit from disqualifying dispositions

9,620


1,003


Amortization of stock-based compensation

2,001


696


1,928Stock issued in lieu of compensation

51


145


320Loss on sale of investments and property and equipment

415





11Changes in:Accounts receivable

(4,509
)

284


(2,340
)Prepaid expenses and other

2,631


(1,783
)

(597
)Accounts payable

(1,675
)

387


(209
)Accrued compensation and related
benefits

6,207


2,195


291Other liabilities

(7,577
)

(13,065
)

1,464Deferred revenue

6,011


3,282


2,394Net cash provided by
operating activities

52,880


4,036


2,026Cash flows from investing activities:Purchases of property and equipment

(42,595
)

(2,243
)

(1,366
)Proceeds from sales of property and equipment

31





11Cash received in acquisitions, net of payments

6,768


83,207


Purchases of short-term investments

(397,566
)

(63,054
)

Proceeds from sale of short-term investments

62,588





Proceeds from maturities of short-term investments

190,510


18,000


Other

(1,192
)

(98
)

2Net cash (used in)
provided by investing activities

(181,456
)

35,812


(1,353
)Cash flows from financing activities:Proceeds from borrowings on debt







5,433Repayments on short-term borrowings




(1,724
)

(84
)Repayments on long-term borrowings




(349
)

Proceeds from gain on stockholder transaction




72


Proceeds from sale of common stock

30,454


140,168


254Net cash provided by
financing activities

30,454


138,167


5,603Effect of exchange rate changes on cash

6


(39
)

Net increase (decrease) in cash and cash equivalents

(98,116
)

177,976


6,276Cash and cash equivalents, beginning of year

187,610


9,634


3,358Cash and cash equivalents, end of year

$     89,494


$    187,610


$9,634Noncash investing and financing activities:Issuance of common stock and options in business combinations

$1,058,706


$1,549,644


$    Conversion of preferred stock to common stock

$          


$     10,955


$    Cancellation of borrowings for warrants exercised

$          


$       3,276


$    Receipt of common stock for stockholders note receivable

$          


$          


$       (6
)Supplemental disclosure of cashflow information-cash paid for:Interest

$            40


$          131


$     20Income taxes

$          677


$          167


$     37





See notes to consolidated financial statements.







NETIQ CORPORATION





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Years Ended June 30, 2001, 2000, and 1999





1.    Organization and Summary of Significant Accounting Policies





OrganizationNetIQ Corporation (the Company) was established in
June 1995 to develop, market and support eBusiness infrastructure management and intelligence solutions-from back-end servers, networks and directories to front-end Web servers and applications. The Company markets its products through its field and
inside sales organization and reseller channel partners, which are focused on customers primarily located in the United States, Europe and Asia.





Basis of PresentationThe consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are
wholly owned. All intercompany accounts and transactions have been eliminated in consolidation.





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





Cash EquivalentsThe Company considers all highly liquid debt instruments purchased with a remaining maturity of three months or less to be cash equivalents. At June
30, 2001 cash equivalents include $9 million of market auction preferred stock.





Short-term InvestmentsShort-term investments consist of highly liquid debt instruments purchased with remaining maturities of greater than three months. Short-term
investments are classified as available-for-sale securities and are stated at market value with unrealized gains and losses included as a separate component of stockholders equity in accumulated other comprehensive income, net of income taxes.





Property and EquipmentProperty and
equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives, generally three to five years.





Software Development CostsCosts for the development of new software products and substantial enhancements to existing software products
are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized in accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Computer Software To Be Sold,
Leased or Otherwise Marketed. The costs to develop such software have not been capitalized as the Company believes its current software development process is essentially completed concurrent with the establishment of technological feasibility.





Revenue RecognitionStatement of
Position 97-2, Software Revenue Recognition (SOP 97-2), was issued in October 1997 by the American Institute of Certified Public Accountants (AICPA) and was amended by Statement of Position 98-4 (SOP 98-4). The Company believes its current
revenue recognition policies and practices are consistent with SOP 97-2 and SOP 98-4. Additionally, the AICPA issued SOP 98-9 in December 1998, which provides certain amendments to SOP 97-2.





Software license revenue is recognized upon meeting all of the following criteria: execution of
a written purchase order, license agreement or contract; delivery of software and authorization keys; the license fee is fixed and determinable; collectibility of the proceeds within six months is assessed as being probable; and vendor-specific
objective evidence exists to allocate the total fee to all elements of the arrangement. Vendor-specific objective evidence is based on the price generally charged when an element is sold separately, or if not
yet sold separately, is established by authorized management. All elements of each order are valued at the time of revenue recognition. In situations where vendor-specific objective evidence does
not exist or the fee is not fixed or determinable, revenue is recognized ratably over the life of the agreement. If installation is essential to the functionality of the software, license and consulting revenue is recognized upon completion of the
installation.





Sales made through distributors,
resellers, and original equipment manufacturers are recognized at the time these partners report to the Company that they have sold the software or, alternatively, when the Company drop-ships the product to the end user, and after all revenue
recognition criteria have been met.





Service revenue
includes maintenance revenue, which is deferred and recognized ratably over the maintenance period, and revenue from consulting and training services, which is recognized as services are performed.





Income TaxesDeferred tax assets and liabilities are recorded for the expected
future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. A valuation allowance is recorded to reduce net deferred tax assets to amounts that are more likely than
not to be recognized.





Stock-based
CompensationThe Company accounts for its employees stock option plan in accordance with provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.





Net Loss Per ShareBasic net loss per share excludes dilution and is computed by
dividing net loss by the weighted average number of common shares outstanding, less shares subject to repurchase by the Company. Diluted net loss per share was the same as basic net loss per share for all periods presented since the effect of any
potentially dilutive securities is excluded, as they are antidilutive due to the Companys net loss.





Foreign Currency TransactionsThe functional currencies of the Companys foreign subsidiaries are the local currencies. Accordingly, assets and liabilities of the
foreign subsidiaries are translated to U.S. dollars at the exchange rates in effect as of the balance sheet date and results of operations for each subsidiary are translated using average rates in effect for the period presented. Translation
adjustments are included in stockholders equity as accumulated other comprehensive income and as part of our comprehensive loss.





Concentration of Credit RiskFinancial instruments, which potentially subject the Company to concentrations of credit risk, consist
primarily of cash and cash equivalents, short-term investments, and trade receivables. Cash equivalents consist primarily of money market funds and market auction preferred stock. Short-term investments consist primarily of commercial paper,
corporate notes and bonds, US government, municipalities and foreign debt issues, and are regularly monitored by management. The Company sells its products to companies in diverse industries and generally does not require its customers to provide
collateral to support accounts receivable. To reduce credit risk, management performs ongoing credit evaluations of its customers financial condition. The Company maintains allowances for potential credit losses.





Certain Significant Risks and UncertaintiesThe Company operates
in the software industry, and accordingly, can be affected by a variety of factors. For example, management of the Company believes that changes in any of the following areas could have significant negative effect on the Companys future
financial position, results of operations and cash flows; merger integration efforts; demand for performance and availability management software solutions, including new product introductions by competitors; development of distribution channels;
demand for Windows NT and Windows 2000 based systems and applications; ability to
implement and expand operational customer support and financial control systems to manage rapid growth, both domestically and internationally; the hiring, training and retention of key employees;
the Companys relationship with Microsoft; fundamental changes in technology underlying software products; litigation or other claims against the Company.





Recently Issued Accounting StandardsIn June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, which defines derivatives, requires that all derivatives be carried at fair value, and provides for hedge accounting when certain
conditions are met. The Company adopted SFAS No. 133 effective July 1, 2000. Adoption of this statement did not have a material impact on our financial position or results of operations.





In March 2000, the FASB issued FASB Interpretation No. 44 (FIN 44), Accounting for Certain
Transactions Involving Stock Compensationan Interpretation of APB Opinion No. 25. FIN 44 clarifies certain elements of APB Opinion No. 25. Among other issues, this interpretation clarifies: the definition of employee for purposes of
applying APB Opinion No. 25, the criteria for determining whether a plan qualifies as non- compensatory, the accounting consequences of various modifications to the terms of a previously fixed stock option award, and the accounting for an exchange
of stock compensation in a business combination. This interpretation is effective for the Company in fiscal 2001. Adoption of this interpretation did not have material impact on our financial position or results of operations.





In June 2001, the FASB issued SFAS No. 141, Business
Combinations and SFAS No 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill
and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be
tested at least annually for impairment. The Company will adopt SFAS No. 142 for its fiscal year beginning July 1, 2002. Upon adoption of SFAS 142, the Company will stop the amortization of goodwill with an expected net carrying value of
approximately $920 million at the date of adoption and annual amortization of approximately $753 million that resulted from business combinations completed prior to the adoption of SFAS No. 141. The Company will evaluate goodwill under the SFAS No.
142 transitional impairment test and has not yet determined whether or not there is an impairment loss Any transitional impairment loss will be recognized as a change in accounting principle.





ReclassificationsCertain amounts previously reported have been reclassified to
conform to the current year presentation.





2.    Business Combination





| | Fiscal 2001 acquisitions:
| | -------------------------




Acquisition of WebTrends Corporation:





On March 30, 2001 the Company acquired all outstanding shares of WebTrends Corporation (WebTrends) for approximately 12.8 million shares of common
stock valued at approximately $926 million, assumed approximately 2.7 million employee stock options valued at approximately $133 million, of which approximately $4.9 million was recorded as an increase in deferred stock-based compensation and will
be amortized over the
remaining vesting period of the options, and incurred approximately $11 million of direct merger costs, for a total purchase price of approximately $1.1 billion. WebTrends provided web analytics
and eBusiness intelligence software.





The
acquisition was accounted for as a purchase and, accordingly, the results of operations of WebTrends from the date of acquisition have been included in the Companys consolidated financial statements. In connection with the acquisition,
intangible assets of approximately $975.8 million were acquired, of which approximately $2.7 million is reflected as a one-time charge to operations for the write-off of acquired in process research and development costs that had not reached
technological feasibility and, in managements opinion, had no probable alternative future use, and is reflected in the Companys consolidated statement of operations for the year ended June 30, 2001, within operating expenses. The
remaining intangible assets of approximately $973.1 million, comprised primarily of goodwill, are included in other assets in the accompanying consolidated balance sheets and are being amortized over three years.





In the merger the Company terminated 49 employees of WebTrends and accrued
$1.5 million related to the reduction in the workforce resulting from resizing the combined businesses. The cost of terminating the employees was accounted for as part of the purchase price. Of the total, 9 were in research and development, 27 were
in sales and marketing, and 13 in general and administration. All employees to be terminated were informed of their terminations prior to June 30, 2001. During the quarter ended June 30, 2001, 39 employees were terminated of which 9 were in research
and development, 27 were in sales and marketing, and 3 were in general and administration. During the quarter ended June 30, 2001, $414,000 was paid out as termination benefits and $1.1 million remained as a liability. The remaining liability is
expected to be paid out during the year ending June 30, 2002.





Net assets that were acquired as a result of the acquisition were as follows (in thousands):





Current assets

$    104,652Property and equipment, net

11,168Intangible assets, including in-process research and development costs

975,803Liabilities assumed

(21,899
)Net assets acquired


$1,069,724





Acquisition
of Software Realization, Inc.:





On July 17, 2000 the
Company acquired all outstanding shares of Software Realization, Inc. (Software Realization) for cash of $745,000, assumed liabilities of approximately $528,000, and incurred approximately $150,000 of direct merger costs, for a total purchase price
of approximately $1.4 million. Software Realization provided training and consulting services to NetIQ partners and customers.





The acquisition was accounted for as a purchase and, accordingly, the results of operations of Software Realization from the date of acquisition
have been included in the Companys consolidated financial statements. In connection with the acquisition, goodwill of approximately $919,000 was acquired which is being amortized over three years.














Net assets
that were acquired as a result of the acquisition were as follows (in thousands):





Current assets

$    442Property and equipment, net

62Intangible assets

1,447Liabilities assumed

(528
)Net assets acquired


$1,423





| | Fiscal 2000 acquisitions:
| | -------------------------




Acquisition of Mission Critical Software, Inc.:





On May 12, 2000 the Company acquired all outstanding shares of Mission Critical Software, Inc. (Mission Critical) for approximately 18.8 million
shares of common stock valued at approximately $1.3 billion, assumed approximately 4.9 million options valued at approximately $285.0 million and incurred approximately $9.4 million of direct merger costs, for a total purchase price of approximately
$1.6 billion. Mission Critical provided systems administration and operations management software products for corporate and Internet-based Windows NT and Windows 2000 networks.





The acquisition was accounted for as a purchase and, accordingly, the results of operations of
Mission Critical from the date of acquisition have been included in the Companys consolidated financial statements. In connection with the acquisition, intangible assets of approximately $1.4 billion were acquired, of which approximately $10.0
million is reflected as a one-time charge to operations for the write-off of acquired in-process research and development costs that had not reached technological feasibility and, in managements opinion, had no probable alternative future use,
and is reflected in the Companys consolidated statement of operations for the year ended June 30, 2000, within operating expenses. The remaining intangible assets of approximately $1.4 billion, comprised primarily of goodwill, are included in
other assets in the accompanying consolidated balance sheets and are being amortized over three years.





Net assets that were acquired as a result of the acquisition were as follows (in thousands):





Current assets

$    191,232Property and equipment, net

4,822Intangible assets, including in-process research and development costs

1,438,158Liabilities assumed

(36,619
)Net assets acquired


$1,597,593





On March
10, 2000 Mission Critical acquired all outstanding shares of Ganymede Software, Inc. (Ganymede) for 2,750,000 shares of common stock of Mission Critical valued at $171.2 million and incurred approximately $4.2 million of direct merger costs, for a
total purchase price of approximately $175.4 million. Ganymede is a developer of network and application performance management solutions.





Acquisition of Sirana Software, Inc.:





On March 10, 2000 the Company acquired all outstanding shares of Sirana Software, Inc. (Sirana) for approximately 27,000 shares of common stock and
cash valued at approximately $2.5 million and incurred
approximately $57,000 of direct merger costs, for a total purchase price of approximately $2.5 million. Sirana is a developer of web-based enterprise analysis and reporting solutions for
Microsoft BackOffice.





The acquisition was accounted
for as a purchase and, accordingly, the results of operations of Sirana from the date of acquisition have been included in the Companys consolidated financial statements. In connection with the acquisition, intangible assets of approximately
$2.7 million were acquired, of which $706,000 is reflected as a one-time charge to operations for the write-off of acquired in-process research and development costs that had not reached technological feasibility and, in managements opinion,
had no probable alternative future use, and is reflected in the Companys consolidated statement of operations for twelve months ended June 30, 2000, within operating expenses. The remaining intangible assets of approximately $1.9 million,
comprised primarily of goodwill, are being amortized over three years.





In connection with the acquisition, net assets acquired were as follows (in thousands):





Current assets
$
25Property and equipment, net

52Intangible assets, including in-process research and development costs

2,507Liabilities assumed

(279
)Net assets acquired
$
2,305





The
following unaudited pro forma information shows the results of operations for the year ended June 30, 2001 and 2000, as if the above acquisitions of WebTrends, Software Realization, Mission Critical, Ganymede and Sirana had occurred at the beginning
of the earliest period presented and at the purchase price established at the time of acquisition (in thousands, except per share amounts):





Year Ended June 30,2001


2000Total revenue
$ 221,683


$ 132,753Net loss
$(758,308
)

$(777,930
)Basic net loss per share
$    (14.70
)

$    (16.44
)





The pro
forma results for the year ended June 30, 2001 and 2000 exclude the $2.7 million and $10.7 million charge for the write-off of acquired in-process research and development costs, respectively, as they are a non-recurring charge. The pro forma
results for the twelve months ended June 30, 2001 and 2000 include amortization of intangible assets as if the acquisitions were consummated on July 1, 1999.





The pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results
that would have occurred if the acquisition had been consummated at the beginning of the earliest period presented, nor is it necessarily indicative of future operating results.





In the above acquisitions, acquired technology included both existing technology and in-process
research and development. The valuation of acquired technology was made by applying the income forecast method, which considers the present value of cash flows by product lines. The key elements of the acquired companies development process
include: design of user interface, developing code, integration with existing products, technical documentation, and testing. A project is considered to be technologically feasible when a prototype is available for beta or general release. At the
date of acquisition, additional research and development effort was
anticipated prior to the release of the products under development. Value was allocated to in-process research and development based on a discounted cash flow expected to be generated and
considering the core technology resident in the in-process products, the acquired companies past experience with typical product life cycles, and expected demand from the acquired companies customers for new products. Acquired in-process
technologies were charged to operations, as the technologies did not have alternative future uses as of the date of the acquisition.





3.    Short-term Investments





Short-term investments at June 30 consist of (in thousands):





2001Amortized  Cost

Gross  Unrealized  Holding  Gains

Gross  Unrealized  Holding  Losses

Fair ValueCorporate notes and bonds

$199,010


$1,499



$ 



$200,509U.S. Government and municipalities

90,639


692







91,331Foreign debt issues

32,740


341







33,081Commercial paper

51,332


30







51,362Other debt securities

1,003


1







1,004Short-term investments

$374,724


$2,563



$ 



$377,2872000Amortized  Cost

Gross  Unrealized  Holding  Gains

Gross  Unrealized  Holding  Losses

Fair ValueCorporate notes and bonds

$  88,485


$    



$  (59
)


$  88,426U.S. Government and municipalities

20,214






(55
)


20,159Foreign debt issues

8,633






(23
)


8,610Other debt securities

28,734






(13
)


28,721Short-term investments

$146,066


$    



$(150
)


$145,916





At June 30,
2001, short-term investments with amortized cost $225.5 million and fair value of $226.8 million have maturities of less than one year. At June 30, 2001, short-term investments with amortized cost $149.2 million and fair value of $150.5 million have
maturities of one to five years.





Any gains and
losses on sales of securities are computed on a specific identification basis. During the year ended June 30, 2001 gross realized loss on sale of investments was $355,000. There were no gains during the year ended June 30, 2001. There were no gains
or losses during the years ended June 30, 2000 and 1999.














4.    Property and Equipment





Property and equipment at June 30 consist of
(in thousands):





2001

2000Land and building

$32,495


$     Computer equipment and software

21,067


6,775Furniture and fixtures

3,846


1,108Leasehold improvements

2,524


720Construction in progress

2,650


34362,582


8,946Less accumulated depreciation

(7,851
)

(1,765
)Property and equipment, net

$54,731


$7,181





In August
2000, the Company purchased a building for its corporate offices in San Jose, California for approximately $28.2 million. Approximately $4.5 million has been spent on improvements during fiscal 2001.





5.    Settlement of Litigation





In September 1996, Compuware Corporation filed a complaint against the Company alleging misappropriation of trade secrets, copyright infringement,
unfair competition and other claims. Compuware asserted these claims after a number of prior Compuware employees founded the Company or later joined the Company as officers and employees. A settlement of these claims was reached in January 1999 and
final documentation was entered into and the claims dismissed in March 1999. As part of the settlement in March 1999, Compuware loaned the Company $5.0 million with interest at 6% per year. Additionally, as part of the settlement in March 1999,
Compuware was issued a warrant to purchase 280,025 shares of common stock at 90% of the per share sale price of shares sold to investors in the Companys initial public offering. Compuware exercised the warrant in full upon the closing of the
initial public offering, paying $11.70 per share and sold all of their shares in the follow-on public offering in December 1999. Pursuant to the completion of the initial public offering we paid approximately $1.8 million to satisfy the note and
interest obligation, and the remaining $3.3 million was cancelled in connection with the exercise of the warrant. The value of such warrant, approximately $364,000 based on the initial public offering price of $13.00 per share, was charged to
operating results in June 1999.





6.    Other Liabilities





Other liabilities at June 30 consist of (in thousands):





2001

2000Accrued merger costs

$   5,088

$   3,942Accrued sales and marketing costs

5,108

1,909Other

9,193

5,434Other liabilities

$19,389

$11,285














7.    Stockholders Equity





At June 30, 2001 and 2000 there was no
convertible preferred stock outstanding. At June 30, 1999, convertible preferred stock consisted of:





Shares  Designated

Shares  Outstanding

Price  Per  Share

Amount (Net  of Issuance  Costs)

Aggregate  Liquidation  PreferenceSeries A

4,666,656

4,666,656

$0.60

$   2,786,304

$   2,800,000Series B

2,733,321

2,733,321

$3.00

8,169,049

8,200,0007,399,977

7,399,977



$10,955,353

$11,000,000





Significant
terms of the 1999 convertible preferred stock were as follows:





| |  |  | Each share was convertible, at the option of the holder, into one share of common stock (subject to adjustments for events of dilution). Shares of Series A and B would
be automatically converted into common stock upon the closing of a public offering yielding proceeds in excess of $7,500,000 and at a price of not less than $2.40 and $6.00 per share, respectively, or upon approval (by vote or written consent) of at
least 662/3% of the then outstanding shares of Series A or at least a majority of the then outstanding shares of Series
B.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Each share had the same voting rights as the number of shares of common stock into which it was convertible.
| | - |  | ------------------------------------------------------------------------------------------------------------




| |  |  | In the event of liquidation, dissolution or winding up of the Company, the preferred shareholders of Series A and Series B would receive an amount equal to $0.60 and
$3.00 per share, respectively, plus an amount equal to all declared but unpaid dividends on each share. Any remaining assets would be distributed among the holders of Series A and Series B preferred stock and common stock, pro rata, based on the
number of shares of common stock held by each shareholder on an as-converted basis. In total, the holders of Series A and Series B preferred stock would not be entitled to receive more than $1.50 and $7.50 per share, respectively.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Holders of preferred stock were
entitled to annual noncumulative dividends of $0.06 and $0.24 per share for Series A and Series B, respectively, when and if declared by the Board of Directors, prior to any dividends declared on common stock. No such dividends have been declared.





See Note 8 concerning the conversion of preferred
stock into common stock during fiscal 2000.





Effective July 27, 1999, the stockholders approved a two-for-three reverse stock split of its common and preferred stock outstanding as of July 27, 1999. All share and per share
information, in the accompanying financial statements, have been adjusted to retroactively give effect to the stock split for all periods presented.





Restricted StockDuring fiscal 1998, the Company issued 53,333 shares of common stock at a total price of $80,000, to an officer of the
Company. The shares are subject to repurchase by the Company at the original purchase price per share upon termination of employment prior to vesting of such shares. The restricted shares vest over four years in accordance with the terms of the
original stock purchase agreement. No restricted shares were issued during fiscal 2001, 2000, and 1999. The exercise price of $1.50 was less than the deemed fair value of the shares issued. Accordingly, the Company recorded $138,000 as deferred
compensation during fiscal 1998 and amortized $29,500, $34,500, and $74,000 to expense during fiscal 2001, 2000, and 1999, respectively. At June 30, 2001, no shares were subject to repurchase.














In the
acquisition of Ganymede, Mission Critical issued 655,971 shares of common stock to certain of the selling shareholders of Ganymede. The shares are subject to repurchase by the Company at the quotient of (i) $0.01 and (ii) the exchange ratio as
defined in the original stock purchase agreement upon termination of employment prior to vesting of such shares. The restricted shares vest over three years in accordance with the terms of the original stock purchase agreement. At June 30, 2001,
411,643 shares of stock were subject to repurchase.





Stock-Based CompensationIn connection with options granted to purchase common stock, the Company recorded deferred stock-based compensation of $3,036,000 in fiscal
1999. Such amounts represent, for employee stock options, the difference between the exercise price and the fair value of the Companys common stock at the date of grant, and, for non-employee options, the deemed fair value of the option at the
date of vesting. The deferred charges for employee options are being amortized to expense through fiscal 2003; all deferred charges for non-employees were fully amortized as of June 30, 1999.





In connection with the acquisition of WebTrends Corporation and the assumptions of the
outstanding options the Company recorded deferred stock-based compensation of $4.9 million. Stock options assumed in the acquisition are accounted for in accordance with the provisions of FIN 44, Accounting for Certain Transactions Involving
Stock Compensationan Interpretation of APB Opinion No. 25 and the deferred stock based compensation will be amortized over the vesting period of the options through March 2005.





Stock-based compensation expense of $2,001,000, $696,000, and $1,928,000 was recognized during
fiscal 2001, 2000, and 1999, respectively.





Options granted to non-employeesThe Company has granted options to non-employees for consulting and legal services performed. The vesting period for these options has
ranged from immediate vesting to vesting over 4 years and the option exercise period has ranged from 6 months to 10 years. Stock options issued to non-employees are accounted for in accordance with the provisions of SFAS No. 123, Accounting for
Stock-Based Compensation and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued To Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services.





During fiscal 2000, options to purchase 3,833 shares were granted at an
exercise price of $12.00 and options to purchase 3,750 shares were granted at an exercise price of $45.69, to non-employees. In connection with these options, the Company recorded compensation expense of $145,000. The fair value of stock options
issued to non-employees was calculated using the Black-Scholes pricing model with the following assumptions: a risk free interest rate of 6%, expected volatility of 75% and actual length of the option. All non-employee options were fully vested and
deferred stock-based compensation was fully amortized as of June 30, 2000.





During fiscal 1999, options to purchase 20,333 shares were granted at an exercise price of $0.13, options to purchase 108,333 shares were granted at an exercise price of $0.67 and
options to purchase 58,333 shares were granted at an exercise price of $9.00, to non-employees. In connection with these options, the Company recorded deferred stock-based compensation of $1,041,000 and amortized $1,194,000 as an expense during
fiscal 1999.





The fair value of stock options issued
to non-employees during fiscal 1999 was calculated using the Black-Scholes pricing model with the following assumptions: a risk free interest rate of 6%, expected volatility of 50% and actual length of the option.














Common
Shares Reserved for IssuanceAt June 30, 2001, the Company had reserved shares of common stock for issuance as follows.





Issuance under stock option plan

12,118,323Issuance under Employee Stock Purchase Plan

1,407,442Total

13,525,765





Stock
Option PlanUnder the Companys 1995 Stock Plan (the Plan) 9,875,000 shares are reserved for issuance to employees, consultants and directors. Incentive stock options are granted at fair market value at the date of grant; nonstatutory
options and stock sales may be offered at not less than 85% of fair market value. Generally, options become exercisable over four years and expire ten years after the date of grant.





A summary of stock option activity under the Plan is as follows:





Shares

Exercise PriceOutstanding, June 30, 1998 (631,723 shares exercisable at $0.13)

2,236,295



$   0.20Granted (weighted-average fair value of $3.15)

1,299,216



6.03Exercised

(929,325
)


0.27Canceled

(57,165
)


0.30Outstanding, June 30, 1999 (732,371 shares exercisable at $1.25)

2,549,021



3.13Granted and assumed (weighted-average fair value of $50.91)

6,487,785



24.88Exercised

(1,434,574
)


2.43Canceled

(296,082
)


13.13Outstanding, June 30, 2000 (1,551,530 shares exercisable at $6.19)

7,306,150



22.17Granted and assumed (weighted average fair value of $36.37)

6,594,714



42.78Exercised

(2,538,963
)


9.75Canceled

(2,157,099
)


57.07Outstanding, June 30, 2001

9,204,802



$32.18





At June 30,
2001, 2,913,521 shares were available under the Plan for future grant. On July 16, 2001 the Board of Directors increased the number of shares available for grant under the Plan by 2,600,000.





The following table summarizes information concerning options outstanding as of June 30, 2001:





Options outstanding

Options VestedRange ofExercise Prices

Number of Options Outstanding

Weighted-Average Remaining Contractual life (Years)

Weighted Average Exercise Price

Vested atJune 30,2001

Weighted Average Exercise Price$    0.06$    2.66


1,049,296



6.91



$   1.12


630,727


$   0.94$    2.66$  13.28


1,015,381



7.77



9.58


459,229


8.99$  13.54$  19.66


1,196,326



9.41



18.30


84,316


16.50$  22.58$  27.60


1,054,681



9.82



26.30


8,986


25.24$  27.81$  40.63


2,139,805



8.80



35.50


764,287


35.19$  40.64$  62.00


1,987,760



8.85



53.85


527,110


54.85$  62.63$111.65


761,553



9.21



69.22


70,014


72.70$    0.06$111.65


9,204,802



8.71



$32.18


2,544,669


$26.42














Tender
OfferOn May 7, 2001 the Company announced a voluntary stock option exchange program for its employees. Under the program, only Company employees were given the opportunity, if they so chose, to cancel outstanding stock options previously
granted to them in exchange for an equal number of new options to be granted at a future date. The exchange was limited to employees who held options with an exercise price equal to or greater than $50.00 per share and those options with exercise
prices lower than $50.00 granted on or after December 7, 2000. The grant price of the new options will be equal to the highest of (i) the closing selling price per share on the trading day immediately before the day of grant; (ii) the average of the
high and low per share sales price on the day of grant; or (iii) the closing selling price on the day of grant. The new option will not be granted before December 10, 2001, which is six months and one day following the date when the Company canceled
the options accepted for exchange. A total of 1,364,957 options were tendered by employees under the program. The offer and the right to withdraw expired on June 7, 2001.





The officers of the Company were not eligible to participate in this program. The exchange program has been organized to comply
with FIN 44 Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB Opinion No. 25 and is not expected to result in any additional compensation charges or variable plan accounting.





Employee Stock Purchase PlanUnder the Companys 1999
Employee Stock Purchase Plan (the Purchase Plan) eligible employees are permitted to have up to 15% of salary withholdings to purchase shares of common stock at a price equal to 85% of the lower of the market value of the stock at the beginning or
end of the defined purchase period, subject to an annual limitation. The initial purchase period commenced on July 29, 1999, the effective date of the initial public offering of the Companys common stock. During fiscal 2001 and 2000, 362,473
and 103,870 shares of common stock were issued under the Purchase Plan at a weighted-average price of $15.69 and $11.43, respectively. On July 16, 2001 the Board of Directors increased the number of shares available for grant under the Purchase Plan
by 600,000.





SFAS 123, Accounting for Stock-Based
Compensation, requires the disclosure of pro forma net income or loss had the Company adopted the fair value method since the Companys inception. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the
use of the Black-Scholes options pricing model, even though such model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Companys stock
option awards. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.





The weighted-average fair values of the Companys stock-based awards to employees in
fiscal 2001 and 2000 are based on the single option valuation approach, forfeitures are recognized as they occur and assuming no dividends will be declared. The weighted-average fair value of the Companys stock-based awards to employees prior
to fiscal 2000 was estimated using the minimum value method and assuming no dividends will be declared. In addition, the weighted-average fair value calculations were based on the following assumptions:





Year ended June 30,2001

2000

1999Estimated life (in years)

4.00


4.00


4.00Risk-free interest rate

5.0
%

6.3
%

6.0
%Volatility

85
%

75
%
















For pro
forma purposes, the estimated fair value of the Companys stock-based awards to employees is amortized using the straight-line method over the options vesting period. The Companys pro forma results are as follows (in thousands,
except per share amounts):





Year Ended June 30,2001

2000

1999Net loss:Asreported

$(523,833
)

$(65,328
)

$(1,642
)Proforma

(553,882
)

(73,644
)

(2,936
)Basic and diluted net loss per share:Asreported

$       (12.48
)

$       (3.59
)

$   (0.47
)Proforma

(13.19
)

(4.05
)

(0.84
)





8.    Public Offerings





In July 1999, the Company sold 3,000,000 shares of common stock in an
underwritten public offering and in August 1999 sold an additional 450,000 shares through the exercise of the underwriters over-allotment option for net proceeds of approximately $40.4 million at an exercise price of $13.00 per share.
Simultaneously with the closing of the public offering, all 7,399,977 shares of the Companys preferred stock were converted to common stock on a share for share basis.





In December 1999, the Company sold 1,500,000 shares of common stock in an underwritten offering and in January 2000 sold an
additional 387,000 shares through the exercise of the underwriters over-allotment option for net proceeds of approximately $95.1 million at an exercise price of $53.50 per share.





9.    Income Taxes





Tax expense consists of the following (in thousands):





Year Ending June 30,2001

2000Currently payable:Federal

$   9,125

$1,490State

1,382

780Foreign

103

130Total

$10,610

$2,400














Deferred
income tax assets at June 30 consist of (in thousands):





2001

2000Deferred tax assets:Net operating loss carryforwards

$56,785


$25,542Research and development and alternative
minimum tax credits

2,991


1,191Accruals deductible in different periods

4,970


1,26464,746


27,997Deferred tax liability:Purchased intangibles

(40,813
)

(13,975
)Other

(1,183
)

Net deferred tax assets

22,750


14,022Valuation allowance

(22,750
)

(14,022
)Total

$        


$        





Deferred
income taxes reflect the tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as net operating loss and tax credit
carryforwards. A valuation allowance has been established to fully reserve these deferred tax assets due to the uncertainty regarding their realizability due to the expectation of future stock options exercises.





The valuation allowance increased by $8.7 million, $10.9 million, and
$651,000, in fiscal 2001, 2000, and 1999, respectively. As of June 30, 2001, all of the valuation allowance is attributable to the tax benefit of disqualifying dispositions of stock options and will be credited to equity when realized.





The Companys effective tax rate differs from
the expected benefit at the federal statutory rate as follows (in thousands):





Year Ended June 30,2001

2000

1999Federal statutory tax benefit

$(179,628
)

$(22,025
)

$(565
)State tax expense (benefit)

898


507


(73
)Amortization of goodwill

187,520


21,884


Stock-based compensation expense

700





225Write-off of acquired in-process research and development costs

932


3,743


Tax-exempt interest income

(261
)




Valuation allowance




(3,142
)

651Other

449


1,433


(238
)$   10,610


$   2,400


$ 





At June 30,
2001, the Company had net operating loss (NOL) carryforwards of approximately $146 million for federal, and $79 million for state income tax purposes. The federal NOL carryforwards expire
through 2021 and the state NOL carryforwards expire through 2006. In addition, at June 30, 2001, the Company had $1.9 million of research and development tax credit carryforwards for federal and
$1.1 million for state income tax purposes. The extent to which the loss carryforwards can be used to offset future taxable income may be limited, depending on the extent of ownership changes within any three-year period as provided in the Tax
Reform Act of 1986 and the California Conformity Act of 1987. Additionally, loss carryforwards generated in fiscal 1997 are required to be amortized over six years, as the Company elected to change its tax fiscal year end to June 30.





10.    Restructuring Charge





During the quarter ended June 30, 2001, the Company recorded a restructuring charge of $816,000
related to redundancies at NetIQ resulting from the WebTrends merger and the resizing of the combined businesses. The entire restructuring charge was related to the reduction in the workforce resulting from resizing the combined businesses. A total
of 36 employees have been terminated under this plan, of which 12 were in research and development and 24 were in sales and marketing. All employees to be terminated were informed of their terminations and terminated by June 30, 2001. During the
quarter ended June 30, 2001, $530,000 was paid out as termination benefits and $286,000 remained as a liability. The remaining liability is expected to be paid out during the year ending June 30, 2002.





11.    Net Loss Per Share





The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per share (in thousands, except
per share amounts):





Year ended June 30,2001

2000

1999Net loss (numerator), basic and diluted

$(523,833
)

$(65,328
)

$(1,642
)Shares (denominator):Weighed average common shares outstanding

42,548


18,299


3,654Weighed average common shares outstanding
subject to                repurchase

(564
)

(110
)

(178
)Shares used in computation, basic and diluted

41,984


18,189


3,476Net loss per share, basic and diluted

$     (12.48
)

$     (3.59
)

$   (0.47
)





For the
above-mentioned periods, the Company had securities outstanding which could potentially dilute basic earnings per share in the future, but were excluded in the computation of diluted net loss per share in the periods presented, as their effect would
have been antidilutive. Such outstanding securities consist of the following (in thousands):





Year Ended June 30,2001

2000

1999Shares of common stock subject to repurchase

412

669

27Outstanding options



7,306

2,549Convertible preferred stock





7,400Warrants





280Total

412

7,975

10,256














12.    Commitments and Contingencies





Operating LeasesThe Company leases
certain facilities under noncancelable operating leases which expire through fiscal 2005, and certain equipment under operating leases. Under the terms of the facility leases, the Company is responsible for its proportionate share of maintenance,
property tax and insurance expenses. One of the agreements provides an option to extend the lease for two years and a second option to extend for an additional 28 months, another agreement provides an option to extend the lease for three years.
Future minimum annual lease commitments are as follows: 2002, $5,327,000; 2003, $4,924,000; 2004, $3,995,000; 2005, $2,566,000; 2006, $1,709,000.





Rent expense under operating leases was approximately $4,343,000, $1,210,000, and $888,000, for fiscal 2001, 2000, and 1999, respectively.





Royalty AgreementUnder multiple
agreements the Company has non-exclusive worldwide licenses to certain third-party technologies. The Company is required to pay specified royalties based on a percentage of revenue from products incorporating the technologies. Total royalty expense
under the agreements was $1,007,000, $404,000, and $262,000, for fiscal 2001, 2000, and 1999, respectively.





The Company may be a potential defendant in lawsuits and claims arising in the ordinary course of business. While the outcomes of such claims, lawsuits, or other proceedings cannot
be predicted with certainty, management expects that such liability, to the extent not provided by insurance or otherwise, will not have a material adverse effect on the financial condition or results of operations of the Company.





13.    Employee Benefit Plan





The Company sponsors a 401(k) Savings and Retirement Plan (the Plan) for all eligible employees
who meet certain eligibility requirements. Participants may contribute, on a pre-tax basis, between 1% and 20% of their annual compensation, but not to exceed a maximum contribution amount pursuant to Section 401(k) of the Internal Revenue Code. The
Company was not required to contribute to the Plan as of June 30, 2001 and has not contributed for any of the periods presented. Effective July 1, 2001 the Board of Directors authorized a matching contribution whereby the Company will match 50% of
the first 6% of each employees contributions up to a maximum of $3,500. Employer matching contributions will vest ratably over five years.





14.    Major Customers





No single customer accounted for greater than 10% of accounts receivable at June 30, 2001 and 2000. Microsoft Corporation accounted for 18% of total revenue during fiscal 2001. No
single customer accounted for greater than 10% of total revenue during fiscal 2000 and 1999.














15.    Segment and Geographical Information





As defined in SFAS No. 131, Disclosures
About Segments of an Enterprise and Related Information, the Company operates in one reportable segment: the design, development, marketing, support and sales of performance and availability management software for the Microsoft Windows NT and
Windows 2000 environment. No individual foreign country accounted for greater than 10% of total revenue or long-lived assets in any of the periods presented. The following table summarizes total net revenue and long-lived assets attributed to
foreign locations (in thousands).





Year Ended June 30,2001

2000

1999Total revenue:United States

$ 123,691

$ 36,950

$ 17,999Foreign


43,246

10,970

3,570Total revenue*

$ 166,937

$ 47,920

$ 21,569Long-lived assets (excluding goodwill and other intangible assets):United States

$   55,006

$   7,732

$   1,445Foreign


1,132

390

116Total long-lived assets

$   56,138

$   8,122

$   1,561


---

|* |  | Revenue is attributed to countries based on location of customer invoiced.
|- |  | --------------------------------------------------------------------------













16.    Quarterly Results (Unaudited)





A summary of quarterly financial information
for each of the last two fiscal years is as follows. The Company believes that the following information reflects all normal recurring adjustments necessary for a fair presentation of the information for the periods presented. The operating results
for any quarter are not necessarily indicative of results for any future period.





Year Ended June 30, 2001First Quarter

Second Quarter

Third Quarter

Fourth Quarter(In thousands, except per share data)Total revenue

$     30,529


$    39,653


$    38,131


$    58,624Gross profit

28,838


37,170


35,356


53,246Net loss

(111,784
)

(109,316
)

(115,978
)

(186,756
)Basic and diluted net loss per share*

$        (3.00
)

$       (2.83
)

$       (2.95
)

$       (3.55
)Shares used to compute basic and diluted net loss      per share

37,286


38,596


39,360


52,670Year Ended June 30, 2000First Quarter

Second Quarter

Third Quarter

Fourth Quarter(In thousands, except per share data)Total revenue

$       7,586


$       9,122


$    10,900


$    20,313Gross profit

7,011


8,552


10,149


19,191Net income (loss)

472


1,433


2,154


(69,389
)Basic net income (loss) per share*

$         0.04


$         0.09


$         0.12


$       (2.49
)Shares used to compute basic net loss per share

11,696


15,709


17,544


27,914Diluted net income (loss) per share*

$         0.03


$         0.08


$         0.11


$       (2.49
)Shares used to compute diluted net loss per share

15,785


17,556


19,259


27,914


---

|* |  | The sum of quarterly per share amounts may not equal per share amounts reported for the year due to changes in the number of weighted-average shares
outstanding and the effects of rounding in individual periods.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------






INDEPENDENT AUDITORS REPORT





To the Board of Directors and Stockholders of NetIQ Corporation:





We have audited the consolidated financial statements of NetIQ Corporation and subsidiaries (the Company) as of June 30, 2001 and 2000, and for each
of the three years in the period ended June 30, 2001 and have issued our report thereon dated July 23, 2001 (included elsewhere in this Annual Report on Form 10-K). Our audits also included the financial statement schedule of the Company, listed in
Item 14(a)(2). The financial statement schedule is the responsibility of the Companys management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.





Deloitte & Touche LLP


San Jose, California


July 23, 2001







SCHEDULE II





VALUATION AND QUALIFYING ACCOUNTS


(In thousands)





Balance at  beginning  of period

Charged  to cost  and  expenses

Other*

Deductions

Balance at end of periodYear ended June 30, 1999Allowance for doubtful accounts

$
307


$
343


$


$




$
650Allowance for sales returns

$
50


$
200


$


$




$
250Year ended June 30, 2000Allowance for doubtful accounts

$
650


$



$
402

$




$
1,052Allowance for sales returns

$
250


$
169


$
79

$




$
498Year ended June 30, 2001Allowance for doubtful accounts

$
1,052


$
562


$
1,500

$
(458
)


$
2,656Allowance for sales returns

$
498


$
819


$
450

$
(378
)


$
1,389


---

|* |  | Reserve assigned in acquisitions.
|- |  | ---------------------------------