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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 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended June 30, 2005



OR



| ̈ | Transition Report Pursuant To Section 13 or 15(d) of The Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------

For 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 registered
|Common 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



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



Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ̈No  x



As of December 31, 2004, the aggregate market value of Registrants voting stock held by non-affiliates was approximately $669 million
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 July 31, 2005, the Registrant had outstanding 47,742,438 shares of Common Stock.



Certain sections of Registrants definitive Proxy Statement for the 2005
Annual Meeting of Stockholders to be held on November 18, 2005 are incorporated by reference in Part III of this Annual Report on Form 10-K to the extent stated herein.





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##### Table of Contents

NetIQ Corporation



INDEX TO ANNUAL
REPORT ON FORM 10-K

FOR YEAR ENDED JUNE 30, 2005



|         |  |                                                                                                              |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                              |  | Page
|PART I  
|         |  |                                                                                                             
|ITEM 1.  |  | BUSINESS                                                                                                     |  | 3   
|         |  |                                                                                                             
|ITEM 2.  |  | PROPERTIES                                                                                                   |  | 13  
|         |  |                                                                                                             
|ITEM 3.  |  | LEGAL PROCEEDINGS                                                                                            |  | 13  
|         |  |                                                                                                             
|ITEM 4.  |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                          |  | 13  
|        
|PART II 
|         |  |                                                                                                             
|ITEM 5.  |  | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |  | 14  
|         |  |                                                                                                             
|ITEM 6.  |  | SELECTED FINANCIAL DATA                                                                                      |  | 15  
|         |  |                                                                                                             
|ITEM 7.  |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        |  | 16  
|         |  |                                                                                                             
|ITEM 7A. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                   |  | 41  
|         |  |                                                                                                             
|ITEM 8.  |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                  |  | 42  
|         |  |                                                                                                             
|ITEM 9.  |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                         |  | 42  
|         |  |                                                                                                             
|ITEM 9A. |  | CONTROLS AND PROCEDURES                                                                                      |  | 42  
|        
|PART III
|         |  |                                                                                                             
|ITEM 10. |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                           |  | 45  
|         |  |                                                                                                             
|ITEM 11. |  | EXECUTIVE COMPENSATION                                                                                       |  | 45  
|         |  |                                                                                                             
|ITEM 12. |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS               |  | 45  
|         |  |                                                                                                             
|ITEM 13. |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                               |  | 45  
|         |  |                                                                                                             
|ITEM 14. |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                       |  | 45  
|        
|PART IV 
|         |  |                                                                                                             
|ITEM 15. |  | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                   |  | 46  
|         |  |                                                                                                             
|         |  | SIGNATURES                                                                                                   |  | 49  



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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, intentions, strategies, and expected
operating results and financial condition. Forward-looking statements also 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



We are a
leading provider of integrated systems and security management solutions.



Our systems and security management software solutions enable organizations to assure the performance, availability and security of the services delivered by their information technology (IT) infrastructures. While we
initially focused on developing and marketing software to manage applications running on the Microsoft Windows operating system, we have expanded our core business to include cross-platform systems and security management solutions covering four
product areasPerformance & Availability Management, Security Management, Configuration & Vulnerability Management, and Operational Change Control. We also develop and market software to test and manage voice over internet
protocol (VoIP) deployments as part of our Performance & Availability Management offerings.



We were founded and incorporated as a California corporation in June 1995 and reincorporated in Delaware and completed our initial public offering in July
1999. We acquired Mission Critical Software, Inc. in May 2000, WebTrends Corporation (WebTrends) in March 2001 and PentaSafe Security Technologies, Inc. as well as Marshal Software, Ltd., in December 2002. In September 2000 we entered into a
licensing agreement with Microsoft Corporation (Microsoft agreement) whereby we granted Microsoft a perpetual license to our Operations Manager product technology and source code for $175 million paid in quarterly installments through August 2003.
In April 2005 we divested our WebTrends business unit.



During
fiscal 2005, we publicly unveiled our Knowledge-Based Service Assurance product strategy (KBSA). The key elements of this strategy are the four product areas outlined above delivered across four IT disciplinesOperational Integrity, Service
Management, Policy Compliance, and Risk Management. Also central to our KBSA strategy is deep integration among the four product areas to enable cross-product analyses, the sharing of important technology components, and use of a common reporting
engine and user interface to deliver cross-product and cross-user-group value.



Achieving the KBSA product vision will require several years of intense product development. Accordingly, concurrent with the launch of our KBSA product strategy, we began directing our principal product investments
to key areas of that strategy and we are making efforts to exit or deemphasize business areas that do not support our KBSA strategy.



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As part of our efforts to better align our activities to our strategy we sold our WebTrends web analytics
business to WebTrends Inc. (formerly Spider Holding Inc.), an affiliate of Francisco Partners, L.P., a private equity investment firm. The transaction closed on April 30, 2005 and we received approximately $91.1 million in net gross proceeds,
resulting in a pretax net gain of approximately $65.5 million, which is reflected as a gain from sale of discontinued operations net of tax in our fiscal 2005 income statement. In addition, the employment of approximately 237 of our employees was
assumed by WebTrends Inc. as of April 30, 2005. Accordingly, the historical financial statements of NetIQ have been retroactively adjusted to account for WebTrends as discontinued operations in accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets.



We believe
the sale of WebTrends enhances our long-term strategic direction and provides us greater opportunity to increase shareholder value by accelerating innovation in our core business. We intend to continue to evaluate our options across remaining
non-core product areas within NetIQ as we focus on executing our KBSA product strategy.



In July 2005, we announced a plan of organizational restructuring to take place in fiscal 2006, consisting of headcount reductions and realignment and movement of operations. As part of the restructuring and
realignment, we entered into an agreement with a third party to provide us with software product development services and other professional services. These services will be rendered principally from a Global Operations Center located in Bangalore,
India, and we will own the work product intellectual property created under the agreement. These actions are intended to adjust our expenses to a level more consistent with our anticipated revenues and to better align our expenditures with our
strategy.



For additional information on these and other recent
developments see Managements Discussion and Analysis of Financial Condition and Results of Operations.Through a link on our web site, www.netiq.com, and free of charge, we provide access to our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and Proxy Statements as well as any amendments to each of the foregoing, as soon as reasonably practicable after the reports are electronically filed with or furnished to the Securities
and Exchange Commission.



Markets and Products



Todays organizations are highly dependent on computer systems to
conduct their operations. The typical IT environment is characterized by complex distributed information systems and networks that support multiple business-critical applications for financial reporting, human resources, enterprise resource
planning, supply chain management, customer relationship management and email, as well as other industry-specific applications. In addition to the internal networks that connect employees to these geographically dispersed computing services, the
Internet has become an essential medium for connecting businesses with customers, suppliers, investors and employees.



The critical nature and growing complexity of these systems have placed increasing pressure on systems managers, IT organizations and chief information
officers to ensure the performance, availability, security and compliance of their computer systems, all of which have become increasingly interdependent. Todays organizations also face expanding security threats to their IT systems as they
rely on IT Systems to conduct critical business operations; as they gather, store and utilize growing amounts of highly sensitive customer and operational data; and as electronic attacks on IT systems proliferate. Simultaneously, privacy
legislation, such as HIPAA, and internal control legislation, such as Sarbanes-Oxley, are increasing the need for organizations to deploy a range of IT security solutions. Organizations must keep their IT infrastructures secure and available 24
hours per day, 7 days per week, must be able to support widely distributed global organizations with varying technological and operating requirements, and must ensure compliance with regulatory and internal policy requirements. Failure to ensure
business-appropriate service levels can result in substantial costs, including loss of productivity and revenue.



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We offer the following products to ensure the performance, availability, security and compliance of our
customers IT systems and services:



Performance & Availability Management



Our performance & availability management software is designed to promptly identify and provide notification and an automated response to system problems such as application failures, system software crashes, hardware failures,
slow response times and insufficient resource capacity. Our software continually monitors the performance, responsiveness and availability of systems and applications, and evaluates the capabilities of network services. These functions enable
systems administrators to proactively respond to actual or threatened performance degradation, and to plan and budget for additions, upgrades and configuration changes in a highly automated and scalable fashion.



Windows, UNIX and Linux Management.    Many
organizations are faced with trying to manage a heterogeneous IT environment that includes, among others, Windows, UNIX and Linux operating systems. The growth and deployment of varied systems and applications in highly complex computing
environments have expanded and further complicated the challenges of managing the performance and availability of information technology systems. These challenges range from basic tasks, such as monitoring central processing unit utilization, memory
and disk-space availability, to complex tasks such as monitoring application response times, IT service levels and policy compliance. We offer the following products to assist our customers with these tasks:



| |  | AppManager Suite is a set of programs for managing, diagnosing, and analyzing the performance and availability of distributed Windows, UNIX, and Linux-based operating
systems, including monitoring of service level metrics. AppManager also supports server applications, including Exchange, SQL, Oracle, SAP R/3, Lotus Domino and BlackBerry, among others; as well as web servers such as IBM WebSphere and BEA WebLogic.
AppManager utilizes a centralized management console to define operating parameters and configurations through a central repository that operates in conjunction with agents that run on the servers and applications being managed.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Extended Management Pack (XMP) Modules for Microsoft Operations Manager (MOM) provide value-added management capabilities that enable MOM to manage Windows NT
applications and non-Microsoft platforms and applications.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



VoIP Management.    Increasingly, companies are migrating voice communications onto Internet protocol-based computer network infrastructures using a technology called Voice over
Internet Protocol or VoIP. Because network performance is essential to continuous and consistent availability of all critical services throughout the infrastructure, systems administrators continually monitor application performance and routinely
test the impact of new applications, such as VoIP, on the network to identify and correct potential performance problems prior to deployment of new systems and upgrades to existing systems. Pre-deployment tests of a network to predict performance
and assess readiness and post-deployment monitoring to maintain consistent performance are critical for a smooth VoIP implementation and high quality operations. We offer the following VoIP products:



| |  | Vivinet Assessor is a pre-deployment testing tool that enables the user to assess a networks readiness for a VoIP implementation. Vivinet Assessor utilizes
simulated VoIP traffic to assess network readiness and generates detailed reports to help pinpoint where network improvements may be required.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | AppManagerfor VoIPis a set of programs for real-time monitoring, management and reporting of the performance and availability of a users entire VoIP
environment. These programs enable the user to quickly diagnose problems with call quality, call system health and network performance, and to automate problem management and response from a single console. Vivinet Manager modules and connectors
also provide integration with many of the most common third-party VoIP tools and utilities.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Vivinet Diagnosticsis designed to quickly pinpoint call quality problems in VoIP networks and to analyze reasons for reduced call quality. Vivinet
Diagnostics software is designed to reduce the time needed to resolve
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | voice quality issues and to reduce the skills required for VoIP troubleshooting, in both pre- and post-deployment environments.
| | -------------------------------------------------------------------------------------------------------------------------------



In July 2003, we granted Ixia exclusive distribution rights in the United
States and Canada, through December 31, 2004, to our Chariot product line, which measured and predicted end-to-end performance of network applications. At the same time, we granted Ixia a perpetual license to the source code for the Chariot
products to develop and distribute derivative products. In addition to the license rights, Ixia was granted an option to purchase assets associated with our Chariot products. In January 2005, Ixia finalized its exercise of the option to purchase the
remaining assets and assume the liabilities associated with the Chariot product line. Under the terms of our agreement with Ixia, we received a net cash payment of $2.2 million in consideration for the transfer of those assets and assumption of
the liabilities. The transaction resulted in a gain of $2.9 million, which is reflected in other income for the period ended June 30, 2005.



Security Management



To meet todays information technology security challenges, we offer security management solutions with security event detection, as well as products
for content security. Our security management products include:



| |  | NetIQ Security Manager Suiteis a set of programs that reduces exposure time to security incidents and protects against downtime by providing real-time detection and
prevention of security breaches and policy violations. This product centralizes the monitoring of leading third-party security products in a unified security console that automates responses to security alerts, and reduces false positives and
superfluous alert data through multi-stage correlation of security events. Many of todays regulations require that organizations retain, archive and protect log data from systems, applications and network devices across their enterprise
architecture, and that the log data must be reviewed and analyzed on a periodic basis. NetIQ Security Manager enables organizations to implement log management to efficiently collect and consolidate events over time. These events can then be
analyzed to minimize vulnerabilities and prevent future breaches, to expedite forensic investigations into security incidents, and to show due and reasonable care in complying with regulatory requirements.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Configuration & Vulnerability Management



We provide configuration and vulnerability management solutions that
allow organizations to assess vulnerabilities, manage risk and assure compliance.



| |  | NetIQ Vulnerability Manager Suiteis a set of programs designed to quickly and efficiently identify vulnerabilities and policy non-compliance. It enables companies to
establish and maintain security configuration baselines across heterogeneous IT environments, discover and mitigate vulnerabilities, comply with regulatory acts, and pass security audits by enabling users to identify compromised, vulnerable or
non-compliant systems.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Security Solutions for iSeriesprovides industry-leading security products for IBM iSeries (AS/400) systems. These solutions include vulnerability assessment and
policy compliance reporting, granular auditing and real-time security monitoring, log consolidation and analysis of OS/400 security journals, and user profile and password management.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Operational Change Control



We provide operational change control solutions that allow organizations to
securely delegate administrative tasks, automate user account provisioning, implement end-user self-service, and enable auditing and policy enforcement. Our products for Windows administration include:



| |  | Security Administration Suite includes our Directory and Resource Administrator (DRA), Directory Security Administrator (DSA) and Group Policy
Administrator (GPA) products. DRA provides advanced delegation
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | and policy-based administration capabilities designed to reduce administrative workload and expense while enhancing security. DSA is an active directory
permissions management solution that features role-based security, auditing and advanced analysis. GPA provides a platform for planning, managing, troubleshooting and reporting on group policies.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Group Policy Guardianis designed to minimize the risks associated with Group Policy Object (GPO) change management and helps users protect their Windows
infrastructure from security exposures and service disruptions. Group Policy Guardian enables users to monitor, verify and track GPO changes in real-time while capturing the changes in an auditing database.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Secure Password Administrator enables enterprise-wide password management by providing password synchronization, self-service password reset and automated password
policy enforcement. In addition, this product automatically tracks and logs all password activity, enabling administrators to access, search and sort data for comprehensive auditing, improved service management and heightened security.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Migration Suite is a suite of configuration, consolidation, and migration tools that accelerate the transition to Windows 2000/2003 or Exchange 2000/2003 or between
platforms, while minimizing the impact on IT resources and end-users.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other Products



We provide other products to our customers that include:



| |  | Content Security Solutions include NetIQ MailMarshal and NetIQ WebMarshal. MailMarshal offers a fast, easy-to-use e-mail security solution that enforces an
organizations usage policies for e-mail and protects against spam and viruses. MailMarshal enables an organization to delete, quarantine or simply monitor and report on suspect mail messages and attachments, whether in-bound or out-bound,
based on organizational needs. Our WebMarshal product is a configurable employee Internet management solution that enables administrators to enforce an organizations policy for Internet use, thereby improving employee productivity,
facilitating better utilization of computing resources, and reducing legal and operational risk.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Sales and Distribution



Our products are sold through the following:



| |  | our direct sales force, which includes both enterprise field sales and inside (telesales) sales organizations;
|- |  | --------------------------------------------------------------------------------------------------------------



| |  | our reseller channel, which includes distributors, systems integrators, and value-added resellers; and
|- |  | ------------------------------------------------------------------------------------------------------



| |  | online from our web site.
|- |  | -------------------------



Our products are also co-marketed, or integrated and sold with, the offerings of certain strategic partners, which include original equipment
manufacturers, system integrators, and others.



Field and
Inside Sales.We market our software and services through our 14 domestic and 18 international field sales offices.



During fiscal 2005 our direct sales organization was re-organized to reflect a named account focus. We recently refined that approach to better
support our customers in the enterprise and mid-tier segments. These changes were put in place in early fiscal 2006. Our field coverage model includes Major Account Managers, and Account Managers. Major Account Managers support our largest
enterprise accounts worldwide. Account Managers support enterprise accounts that have not been designated as major accounts. Corporate Sales Representatives are inside sales personnel who principally support small to medium businesses. Under our
refined sales model Corporate Sales Representatives also are now teamed with Account Managers to support larger accounts. This alignment is intended to optimize the use of our sales resources across the enterprise and



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mid-tier market segments. Our field and inside sales representatives are supported by system engineers and product specialists who assist with pre-sales
activities.



Typically, our field 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 normally takes 30 to 180 days depending on the product, but this process can
be longer for larger customers or enterprise-wide opportunities. A majority of our sales are to existing customers who often purchase additional software and complementary NetIQ products as their environments become more complex, their needs change,
and as we introduce new product offerings.



Value Added
Resellers, System Integrators, Distributors and Original Equipment Manufacturers.    The NetIQ Authorized Reseller Program provides training, technical support and priority communications, and facilitates joint sales and
marketing activities with our channel partners. 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. As of June 30, 2005 we had
over 600 third-party channel partners who resold our products and provided services to our customers worldwide. Our top ten channel partners represented approximately 28%, 24% and 18% of our worldwide license revenue, in the aggregate, during fiscal
2005, 2004 and 2003, respectively.



International
Revenue.    International revenue represented 37%, 36%, and 25% of total revenue during fiscal 2005, 2004 and 2003, respectively. Total revenue includes domestic revenue from the Microsoft agreement of $5.0 million
and $60.0 million during fiscal 2004 and 2003, respectively. We did not receive any revenue from the Microsoft agreement during fiscal 2005. As we expanded our international sales efforts and as revenue from Microsoft decreased in accordance
with the Microsoft agreement, the percentage of our revenues derived from international sources increased. During fiscal 2005 a majority of our international business was conducted in U.S. dollars.



Pricing.    We typically license our software to
customers under non-exclusive, perpetual license agreements priced on a per-server or per-user basis. Original purchases of maintenance and renewal maintenance are priced at specified percentages of the related list prices or license fees as
specified in the contract. Training and consulting services generally are priced on a daily rate.



Marketing



Our
marketing programs are designed to inform customers about the capabilities and benefits of our products and services, to connect our sales force with prospective customers and to attract third parties who can serve as distributors and resellers of
our products and services. Our marketing efforts include participation in industry trade shows, technical conferences, technology seminars, preparation of competitive analyses, sales training, publication of technical and educational articles in
industry journals, targeted database-driven direct response communications, advertising, public relations, and analyst and press tours.



We often work with third parties to expand the market for our products. We have cooperative business relationships with developers of Windows and
UNIX-based systems, including Dell Computer Corporation, Hewlett-Packard Company, International Business Machines Corporation, Microsoft Corporation, Oracle Corporation, Sun Microsystems, Inc., and Unisys Corporation. We have similar relationships
with developers of applications and technologies, including Check Point Software Technologies Ltd., Cisco Systems, Inc., Research in Motion Limited, Trend Micro Inc., and VERITAS Software Corporation. As part of these relationships, we may cooperate
in our engineering efforts or develop joint marketing programs with these partners.



We have a range of relationships with systems integration and consulting organizations that may recommend or sell our products to their customers or where we cooperate in serving joint customers. Examples



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of these relationships include Accenture Ltd., Avanade Inc., Electronic Data Systems Corp., HP Services, IBM Global Services, Siemens AG and Wipro Ltd.



Customer Support and Services



Customers typically purchase software maintenance with each new product
license. Software maintenance generally includes software updates, telephone and e-mail support as well as customer self service on our web site. Customers are typically provided an option to renew their maintenance agreements on an annual basis.
Our technical support organization provides product support to our current customers and to prospective customers in connection with product sales. Our support offerings are two tiered and our premium level offering includes support availability 24
hours per day, 7 days per week.



Our professional services
group provides implementation and other services. Our training courses focus on enabling customers and partners to successfully implement, use and extend our products in their respective environments in a timely and cost-effective manner. End-user
training is provided on a regularly scheduled basis at our training facilities in Houston, Texas and Staines, United Kingdom and through our authorized training partners.



Research and Development



Our research and development organizations are responsible for the design, development and release of our products. These groups are organized into
product management, development, quality assurance, documentation and localization disciplines by major product family. 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 an information feedback loop with our customers designed to enable us to respond to and address their changing systems and security management requirements. We also purchase or
license third-party technology to shorten our time to market. The focus of our 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 technology and increasing customer demands. During fiscal 2005, 2004 and 2003 research and development costs were $50.6 million, $55.2 million and $55.8 million, respectively.



Competition



The markets for systems and security management solutions are intensely competitive, and we expect competition to continue
to increase in the future. While there are few substantial barriers to entry at the low end, we have seen and expect to see increasing consolidation in the software industry, including among our competitors, which could increase the resources
available to our competitors and the scope of their product offerings. Our competitors and potential competitors may have more name and brand recognition, develop more advanced technology, undertake more extensive sales and marketing campaigns,
adopt more aggressive pricing policies and sales terms, and be able to leverage more extensive financial, customer and partner resources.



Our principal competitors include:



| |  |  | providers of performance and availability management products, such as BMC Software, Inc., Computer Associates International, Inc., Hewlett-Packard Company, International Business
Machines Corporation and Microsoft Corporation;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | providers of security solutions, such as ArcSight, BindView Corporation, Computer Associates International, Inc., Configuresoft, Inc., International Business Machines Corporation,
Internet Security Systems, Inc., McAfee, Inc., netForensics Inc., and Symantec Corporation;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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| |  |  | providers of content security solutions, such as Clearswift Limited, Postini Corporation, SurfControl plc, Symantec Corporation, Trend Micro, Inc., Tumbleweed Communications Corp.,
and Websense, Inc.; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | customers internal information technology departments that develop or integrate systems management and security management solutions for their particular needs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



We also expect future product consolidation to
be an important competitive factor, and that competitors may bundle their products with products similar to ours, or incorporate functionality into existing products that could render certain of our products unmarketable or obsolete. For example,
Microsoft is a competitor of ours in certain markets and has a history of adding functionality to new versions of Windows in ways that may impair the success of formerly complementary products. Customer perception of this pattern could also
adversely affect or delay sales of our products.



In addition,
our ability to sell our products depends, in part, on their compatibility with other third-party products, such as operating systems and messaging, Internet and database applications. Some third-party software developers may change their products so
that they compete with our products or are no longer compatible with our products. In particular, our business continues to be largely focused on the Microsoft Windows environment and Microsoft has typically provided to us pre-release notification
of feature enhancements to its products and necessary development tools and information. If Microsoft stops this practice, we may be unable to coordinate our product offerings with Microsoft or to otherwise capitalize on new Microsoft product
releases and feature enhancements.



Intellectual Property



Our success is heavily dependent on our ability to create proprietary
technology and to protect and enforce our intellectual property rights in that technology, as well as our ability to defend against adverse claims of third parties with respect to our technology and intellectual property. We rely primarily on a
combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our intellectual property rights in our products and services. These laws and procedures provide only limited
protection. We presently have 10 issued or allowed patents in the United States, 17 pending patent applications in the United States, and 6 pending patent applications in certain foreign jurisdictions. However, these patents may not provide
sufficiently broad protection or they may not be enforceable in actions against alleged infringers. In addition, despite precautions that we take, it may be possible for unauthorized third parties to copy or reverse engineer aspects of our current
or future products, to independently develop similar or superior technology, or to design around the patents we own. Policing unauthorized use and transfer of our software is difficult and software piracy currently is and can be expected to continue
to be a persistent problem. In licensing our products, other than in enterprise license transactions, we typically rely on shrinkwrap or clickwrap licenses that are not signed by licensees. Such licenses may be unenforceable,
in whole or in part, under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our intellectual property rights to as great an extent as do the laws of the United States. It may be necessary to enforce
our intellectual property rights through the process of litigation, arbitration or other adversarial proceedings. In addition, third parties may bring actions against us alleging intellectual property infringement, such as the lawsuit brought by BMC
against us and discussed under Legal Proceedings. Our participation in such proceedings could be costly and distracting to management, and there is no assurance that we would prevail.



Employees



As of June 30, 2005 we had 1,006 employees, 374 of whom were in sales and marketing, 296 in research and development,
166 in customer support and services, and 170 in general and administration. None of our employees are represented by a collective bargaining agreement. We have not experienced any work stoppages and consider our relations with our employees to be
good.



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##### Table of Contents

Executive Officers



The following table sets forth information regarding our executive officers as of June 30, 2005.



|                      |  |     |  |                                                                              
|--------------------- |  | --- |  | -----------------------------------------------------------------------------
|Name                  |  | Age |  | Position                                                                     
|                      |  |    
|Charles M. Boesenberg |  | 57  |  | Chairman of the Board of Directors and Chief Executive Officer               
|                      |  |    
|Marc B. Andrews       |  | 41  |  | Senior Vice President & General Manager, Worldwide Field Operations          
|                      |  |    
|Betsy E. Bayha        |  | 54  |  | Senior Vice President, General Counsel and Secretary                         
|                      |  |    
|Matthew J. Dircks     |  | 40  |  | Senior Vice President, Product Management                                    
|                      |  |    
|David J. Ehrlich      |  | 42  |  | Senior Vice President, Corporate Strategy and Development                    
|                      |  |    
|John L. Steigerwald   |  | 49  |  | Senior Vice President, Engineering                                           
|                      |  |    
|Olivier J. Thierry    |  | 49  |  | Senior Vice President, Marketing and Alliances                               
|                      |  |    
|Richard H. Van Hoesen |  | 50  |  | Senior Vice President, Finance and Administration and Chief Financial Officer



Charles M.
Boesenberg joined NetIQ as President and Chief Executive Officer in January 2002, was named Chairman of the Board of Directors in August 2002 and in April 2004 Mr. Boesenbergs title was changed to Chief Executive Officer and
Chairman of the Board of Directors. Prior to joining NetIQ, he was President of Post PC Ventures, a management and investment group from March 2000 to December 2001. From December 1998 to February 2000, Mr. Boesenberg served
as President and Chief Executive Officer of Integrated Systems, Inc., a provider of embedded systems software. Before joining Integrated Systems, Mr. Boesenberg was President and Chief Executive Officer of Magellan Corporation, which was the
surviving corporation of a merger between Magellan and Ashtech, Inc., a position that he assumed in January 1995 with Ashtech. Magellan specializes in satellite navigation and communication products. Mr. Boesenberg has held senior
executive positions with a number of technology companies including International Business Machines Corporation and Apple Computer, Inc. Mr. Boesenberg served as a member of the Board of Directors of Symantec Corporation, a provider of Internet
security technology, from June 1994 until September 12, 2002, but did not participate in Symantec Corporation board meetings after assuming his position with NetIQ. Mr. Boesenberg currently serves as a member of the Board of Directors of
Maxtor Corporation, a provider of hard disk drive storage products and solutions, where he serves on the Compensation Committee. Since December 2004, Mr. Boesenberg has served on the Board of Directors of Macromedia, Inc., a company that
develops software that helps create and deliver effective user experiences on the Internet, fixed media, and wireless and digital devices. Mr. Boesenberg previously served as a member of the Board of Directors of Epicor Software, a provider of
integrated enterprise software solutions for mid-market companies, from December 2000 until May 2003. Mr. Boesenberg holds a B.S. in mechanical engineering from the Rose Hulman Institute of Technology and a M.S. in business
administration from Boston University.



Marc B. Andrewswas named Senior Vice President and General Manager of Worldwide Field Operations in May 2005. From January 2004 until May 2005, Mr. Andrews served as Senior Vice President and General Manager of our Systems and Security Management business
unit and from July 2002 through January 2004 he served as our Vice President and as General Manager for NetIQ Ltd, our UK subsidiary. Prior to joining NetIQ, Mr. Andrews was employed by BMC Software Inc., where he served as Vice President of
Marketing for Europe, the Middle East and Africa from April 2001 through June 2002. Mr. Andrews also served as the Director of Strategic Business Unit Marketing at BMC for Europe, the Middle East and Africa from January 2000 through March 2001
and prior to that he served as the Regional Director of BMC in Dubai, United Arab Emirates from 1997 through 1999.



Betsy E. Bayha was appointed Senior Vice President, General Counsel and Secretary in May 2005. Ms. Bayha joined NetIQ as Vice President,
General Counsel and Secretary in November 2001. Prior to joining NetIQ, Ms. Bayha was in private practice representing high technology corporations for more than 20 years. Ms. Bayha was a partner at General Counsel Associates LLP, a
private law firm, from November 1994 through



11



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##### Table of Contents

October 2001. From December 1986 through October 1994, Ms. Bayha was a partner at Coudert Brothers LLP, a private law firm. Prior to
1986, Ms. Bayha held various positions with other private law firms. Ms. Bayha holds a J.D. from Harvard Law School, an M.A. in public administration from The Ohio State University and a B.A. in economics from Oakland University.



Matthew J. Dircks was appointed Senior Vice President
of Product Management in May 2005. Mr. Dircks joined NetIQ in November 2001, as Vice President, Product Management. Prior to joining NetIQ, Mr. Dircks served as General Manager for the Web Products Group from August 2001 to November 2001
and Director of WW Product Management from June 1999 to August 2001 at Citrix Systems. From June 1998 to June 1999, Mr. Dircks was Senior Director of Product Management at PowerCerv Software. He holds a Bachelor of Business Administration from
the University of Iowa.



David J Ehrlich was named
Senior Vice President, Corporate Strategy and Development in January 2004, after joining NetIQ as Vice President, Corporate Development in February 2003. Prior to joining NetIQ, Mr. Ehrlich was a consultant to the CEO and Board of Visual
Networks from January 2002 until January 2003, and held the position of Senior Vice President, Product Marketing, Strategy, and Business Development at Visual Networks from November 2000 to January 2002, and Vice President from September 1998 to
November 2000. Prior to joining Visual Networks, Mr. Ehrlich held various management positions at McKinsey & Company, Orbyx Global Trade Group, Inc., and Wells Fargo Bank. Mr. Ehrlich holds an M.B.A from Harvard University and a
B. A. and a M. S. in industrial engineering from Stanford University.



John L. Steigerwald was appointed Senior Vice President of Engineering in May 2005. Mr. Steigerwald joined NetIQ as Director of Development when we acquired Ganymede Software in April 2000. He was named Senior Director, Software
Engineering on April 1, 2003 and Vice President, Engineering on August 1, 2003 and continued in that role after the acquisition. Before joining Ganymede in 1997, Mr. Steigerwald worked at IBM for over 18 years serving in a variety of
management and executive positions in Finance, Development, Product Management and Marketing. Mr. Steigerwalds last position at IBM was Director of Product Line Management for Routers and LAN Switching in IBMs Networking Hardware
Division. He received a Bachelor of Science degree in Finance and a Master in Business Administration, each from the University of North Carolina at Chapel Hill.



Olivier J. Thierry was named Senior Vice President Marketing and Alliances in January 2004. Prior to being named to
his current position, Mr. Thierry served as Vice President of International Marketing for NetIQ from June 2001 until January of 2004. From February 1998 until June 2001 Mr. Thierry served as Vice President of Marketing and Product
Management for Mission Critical Software, Inc. and continued in that position after it was acquired by NetIQ in May, 2000. He received a Bachelor of Commerce degree with a joint major in both Marketing and Computers and Systems from McGill
University.



Richard H. Van Hoesenwas appointed Senior
Vice President, Finance and Administration and Chief Financial Officer in May 2005. Mr. Van Hoesen joined NetIQ in February 2003 as Vice President, Finance, was named Chief Accounting Officer in April 2004 and was appointed Senior Vice
President and Chief Financial Officer in September 2004. From February 2000 until January 2003 Mr. Van Hoesen was Vice President and CFO at privately-held XACCT Technologies, Inc., a network-mediation software company. Mr. Van Hoesen held
the position of Senior Vice President and General Manager from January 1999 through January 2000 of the Micro Focus business unit of Merant Inc. which was formed as a merger between Micro Focus PLC and Intersolv, Inc. From March 1998 until January
2000, Mr. Van Hoesen was Senior Vice President and Chief Financial Officer of Micro Focus PLC. Mr. Van Hoesen holds a B.S. in industrial engineering from Lehigh University and an M.B.A. from the Wharton School of the University of
Pennsylvania.



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##### Table of Contents

|ITEM 2. | PROPERTIES
|------- | ----------



Our corporate and administrative headquarters and certain research and development and sales and marketing personnel are located at the 85,000 square foot
facility that we own in San Jose, California.



We lease
properties in the following locations to house our additional research and development, sales and marketing, and general and administrative personnel:



|                                                |  |                       |  |                 
|----------------------------------------------- |  | --------------------- |  | ----------------
|Location                                        |  | Area leased(sq. feet) |  | Lease expiration
|Houston, Texas                                  |  | 115,333               |  | July 2014       
|Durham (Research Triangle Park), North Carolina |  | 18,178                |  | October 2011    
|Staines, United Kingdom                         |  | 11,000                |  | March 2008      
|Herndon, Virginia                               |  | 6,600                 |  | August 2009     
|Galway, Ireland                                 |  | 6,400                 |  | July 2007       
|Bellevue, Washington                            |  | 5,200                 |  | February 2010   
|Munich, Germany                                 |  | 4,582                 |  | June 2008       
|Tokyo, Japan                                    |  | 4,200                 |  | June 2008       
|New York City, New York(1)                      |  | 3,777                 |  | June 2010       
|Milan, Italy                                    |  | 2,476                 |  | March 2011      
|Sydney, Australia                               |  | 2,152                 |  | July 2007       

---

|(1) | Lease agreement effective as of June 30, 2005 and property not yet occupied.
|--- | ----------------------------------------------------------------------------



We also lease various other smaller properties
in the United States and foreign countries primarily for our sales and marketing personnel. A majority of these leases are for a period of less than one year. We believe that our properties are in good condition, adequately maintained and suitable
for the conduct of our business. Certain of our lease agreements provide options to extend the lease for additional specified periods. For additional information regarding our obligations under leases, see Note 15 to our Consolidated Financial
Statements.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------



In January 2003, BMC Software, Inc. (BMC) filed suit against us in the U.S. District Court for the Southern District of Texas (Court) for patent and
trademark infringement. In August 2003, the Court ordered the litigation stayed, pending arbitration. In September 2003, BMC submitted to the American Arbitration Association a statement of claim seeking a declaratory judgment that
BMCs claims are not subject to arbitration and alleging that it believes that at least AppManager and our former operations manager product, the underlying technology of which is licensed to Microsoft, infringe the BMC patent. In
October 2003, we submitted our initial answer, denying the claims of infringement asserted by BMC. In November 2003, we filed an amended answer and counterclaim in the arbitration proceeding alleging that BMC infringes a valid patent that
we own. BMC has denied the allegations in our counterclaim. In April 2005, BMC amended its statement of claim to assert that one or more of our products infringes an additional patent owned by BMC. We have denied the allegations in the amended
claim. Each party is seeking injunctive relief, compensatory and treble damages, interest, and attorneys fees with respect to its claims. Currently, discovery is in the very early stages.



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



Not applicable.



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##### Table of Contents

PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ------------------------------------------------------------------------------------------------------------



Our Common Stock is traded on the Nasdaq National Stock Market under the
trading symbol NTIQ. The following table presents the range of high and low closing prices for our common stock for the two years ended June 30, 2005:



|               |  |                     |       |      |   |       |  |     |       |  |   |      
|-------------- |  | ------------------- | ----- | ---- | - | ----- |  | --- | ----- |  | - | -----
|               |  | Year Ended June 30,
|               |  | 2005                |       | 2004
|               |  | High                |       | Low  |   | High  |  | Low
|Fourth Quarter |  | $                   | 11.34 |      | $ | 9.85  |  | $   | 14.81 |  | $ | 12.50
|Third Quarter  |  | $                   | 12.63 |      | $ | 10.84 |  | $   | 14.70 |  | $ | 12.57
|Second Quarter |  | $                   | 13.11 |      | $ | 10.85 |  | $   | 13.55 |  | $ | 10.97
|First Quarter  |  | $                   | 12.57 |      | $ | 8.47  |  | $   | 17.06 |  | $ | 10.63



The number of record
holders of the shares of our common stock was 1,015 as of July 31, 2005, which 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 8,000 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 our Board of
Directors may deem relevant.



On September 8, 2004, our
Board of Directors approved a plan to buy back up to $50 million in NetIQ common stock over 12 months. On May 5, 2005 the Board of Directors replaced this program with a new program to buy back up to $200 million in NetIQ common stock over 12
months. The specific timing and amount of repurchases will vary based on market conditions, securities law limitations, and other factors. The repurchases will be made using our cash resources. The repurchase program may be suspended or discontinued
at any time without prior notice. Common stock repurchases in the fourth quarter of fiscal year 2005 were as follows:



|                             |  |                                   |  |                                |       |                                                                                 |           |                                                                                                        |   |        
|---------------------------- |  | --------------------------------- |  | ------------------------------ | ----- | ------------------------------------------------------------------------------- | --------- | ------------------------------------------------------------------------------------------------------ | - | -------
|Period                       |  | (a) Totalnumber ofsharespurchased |  | (b) Averageprice paidper share |       | (c) Total numberof sharespurchased aspart of publiclyannounced plansor programs |           | (d) Approximate dollarvalue of shares thatmay yet be purchasedunder the plans orprograms (inthousands)
|April 1, 2005April 30, 2005 |  |                                  |  | $                              |      |                                                                                 |          |                                                                                                        | $ | 26,474 
|May 1, 2005May 31, 2005     |  | 3,805,680                         |  | $                              | 10.90 |                                                                                 | 3,805,680 |                                                                                                        | $ | 158,533
|June 1, 2005June 30, 2005   |  | 3,029,630                         |  | $                              | 11.00 |                                                                                 | 3,029,630 |                                                                                                        | $ | 125,199
|                             |  |                                   |  |                                |       |                                                                                 |           |                                                                                                        |   |        
|Total                        |  | 6,835,310                         |  |                                |       |                                                                                 | 6,835,310 |                                                                                                        |   |        
|                             |  |                                   |  |                                |       |                                                                                 |           |                                                                                                        |   |        



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##### Table of Contents

|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------



The following selected historical consolidated financial data for each of the five years in the period ended June 30, 2005 have been derived from our
audited financial statements and, as a result of the sale of our WebTrends web analytics business unit, reflect the classification of that business as discontinued operations, as required under accounting principles generally accepted in the United
States, as a result of the sale of this business. While such reclassifications result in changes to certain previously reported amounts, the total and per share amounts of net loss have not changed from the amounts previously reported in our annual
report on Form 10-K filed on September 10, 2004. The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with Managements Discussion and Analysis of
Financial Condition and Results of Operation and the consolidated financial statements and notes to those statements included in Items 7 and 8 of Part II of this Form 10-K.



|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|------------------------------------------------------------------------------------ |  | ------------------------------------- | ------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                                                     |  | Year Ended June 30,                   |        
|                                                                                     |  | 2005                                  |         |   | 2004 |   |          | 2003 |  |   | 2002     |   |  | 2001 |          
|                                                                                     |  | (In thousands, except per share data) |        
|Consolidated Statements of Operations Data:                                          |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Software license revenue                                                             |  | $                                     | 109,627 |   |      | $ | 123,474  |      |  | $ | 183,916  |   |  | $    | 175,321   |   |  | $ | 114,469   |  
|Service revenue                                                                      |  |                                       | 103,589 |   |      |   | 93,526   |      |  |   | 80,222   |   |  |      | 61,384    |   |  |   | 37,108    |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Total revenue                                                                        |  |                                       | 213,216 |   |      |   | 217,000  |      |  |   | 264,138  |   |  |      | 236,705   |   |  |   | 151,577   |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Cost of software license revenue                                                     |  |                                       | 4,935   |   |      |   | 9,265    |      |  |   | 10,090   |   |  |      | 3,439     |   |  |   | 1,809     |  
|Cost of service revenue                                                              |  |                                       | 26,475  |   |      |   | 22,490   |      |  |   | 19,274   |   |  |      | 16,300    |   |  |   | 8,061     |  
|Amortization and impairment of purchased technology                                  |  |                                       | 11,813  |   |      |   | 8,607    |      |  |   | 9,452    |   |  |      | 5,125     |   |  |   | 4,892     |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Total cost of revenue                                                                |  |                                       | 43,223  |   |      |   | 40,362   |      |  |   | 38,816   |   |  |      | 24,864    |   |  |   | 14,762    |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Gross profit                                                                         |  |                                       | 169,993 |   |      |   | 176,638  |      |  |   | 225,322  |   |  |      | 211,841   |   |  |   | 136,815   |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Operating expenses:                                                                  |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Sales, marketing and general and administrative                                      |  |                                       | 131,877 |   |      |   | 133,304  |      |  |   | 135,933  |   |  |      | 106,001   |   |  |   | 80,250    |  
|Research and development                                                             |  |                                       | 50,567  |   |      |   | 55,202   |      |  |   | 55,818   |   |  |      | 46,434    |   |  |   | 36,015    |  
|Impairment of goodwill                                                               |  |                                       |        |   |      |   | 134,255  |      |  |   | 316,037  |   |  |      |          |   |  |   |          |  
|Amortization of goodwill                                                             |  |                                       |        |   |      |   |         |      |  |   |         |   |  |      | 457,272   |   |  |   | 461,975   |  
|Amortization of other intangible assets                                              |  |                                       | 8,553   |   |      |   | 8,487    |      |  |   | 9,956    |   |  |      | 7,307     |   |  |   | 7,354     |  
|Restructuring charge                                                                 |  |                                       | 12      |   |      |   | 1,313    |      |  |   | 4,511    |   |  |      |          |   |  |   |          |  
|Write-off of acquired in-process research and development                            |  |                                       |        |   |      |   |         |      |  |   | 1,396    |   |  |      |          |   |  |   |          |  
|Employee stock-based compensation                                                    |  |                                       | 1,493   |   |      |   | 307      |      |  |   | 544      |   |  |      | 320       |   |  |   | 712       |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Total operating expenses                                                             |  |                                       | 192,502 |   |      |   | 332,868  |      |  |   | 524,195  |   |  |      | 617,334   |   |  |   | 586,306   |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Loss from continuing operations                                                      |  | $                                     | (10,505 | ) |      | $ | (159,175 | )    |  | $ | (299,912 | ) |  | $    | (416,424  | ) |  | $ | (442,314  | )
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Income (loss) from discontinued operations                                           |  | $                                     | 57,252  |   |      | $ | (32,205  | )    |  | $ | (29,491  | ) |  | $    | (314,064  | ) |  | $ | (81,519   | )
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Cumulative effect of change in accounting principle, net of income taxes             |  | $                                     |        |   |      | $ |         |      |  | $ | (579,338 | ) |  | $    |          |   |  | $ |          |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Net income (loss)                                                                    |  | $                                     | 46,747  |   |      | $ | (191,380 | )    |  | $ | (908,741 | ) |  | $    | (730,488  | ) |  | $ | (523,833  | )
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Basic and diluted earnings per share:                                                |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Continuing operation loss before cumulative effect of change in accounting principle |  | $                                     | (0.19   | ) |      | $ | (2.81    | )    |  | $ | (5.63    | ) |  | $    | (7.83     | ) |  | $ | (10.54    | )
|Discontinued operation income (loss)                                                 |  |                                       | 1.06    |   |      |   | (0.57    | )    |  |   | (0.55    | ) |  |      | (5.91     | ) |  |   | (1.94     | )
|Cumulative effect of change in accounting principle                                  |  |                                       |        |   |      |   |         |      |  |   | (10.88   | ) |  |      |          |   |  |   |          |  
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Net earnings (loss) per share                                                        |  | $                                     | 0.87    |   |      | $ | (3.37    | )    |  | $ | (17.07   | ) |  | $    | (13.74    | ) |  | $ | (12.48    | )
|                                                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Consolidated Cash Flow Data:                                                         |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Net cash provided by operating activities                                            |  | $                                     | 10,449  |   |      | $ | 30,991   |      |  | $ | 47,124   |   |  | $    | 99,263    |   |  | $ | 52,880    |  
|Net cash provided by (used in) investing activities                                  |  |                                       | 122,489 |   |      |   | (27,919  | )    |  |   | (48,086  | ) |  |      | (53,163   | ) |  |   | (181,456  | )
|Purchases of property and equipment                                                  |  |                                       | (8,033  | ) |      |   | (7,367   | )    |  |   | (15,291  | ) |  |      | (15,609   | ) |  |   | (42,595   | )
|Net cash provided by (used in) acquisitions, net                                     |  |                                       | (1,828  | ) |      |   | (7,713   | )    |  |   | (202,312 | ) |  |      |          |   |  |   | 6,768     |  
|Purchases of long-term investments                                                   |  |                                       |        |   |      |   | (3,000   | )    |  |   | (5,000   | ) |  |      | (2,800    | ) |  |   |          |  
|Net cash provided by (used in) financing activities                                  |  |                                       | (88,948 | ) |      |   | (21,630  | )    |  |   | 13,803   |   |  |      | (72,184   | ) |  |   | 30,454    |  
|                                                                                     | 
|                                                                                     |  | June 30,                              |        
|                                                                                     |  | 2005                                  |         |   | 2004 |   |          | 2003 |  |   | 2002     |   |  | 2001 |          
|                                                                                     |  | (In thousands)                        |        
|Consolidated Balance Sheet Data:                                                     |  |                                       |         |   |      |   |          |      |  |   |          |   |  |      |           |   |  |   |           |  
|Cash and cash equivalents                                                            |  | $                                     | 101,432 |   |      | $ | 57,841   |      |  | $ | 76,095   |   |  | $    | 64,032    |   |  | $ | 89,494    |  
|Short-term investments                                                               |  |                                       | 195,311 |   |      |   | 229,781  |      |  |   | 237,281  |   |  |      | 411,861   |   |  |   | 377,287   |  
|Working capital                                                                      |  |                                       | 246,227 |   |      |   | 227,405  |      |  |   | 264,462  |   |  |      | 430,416   |   |  |   | 423,951   |  
|Other intangible assets                                                              |  |                                       | 15,758  |   |      |   | 39,040   |      |  |   | 56,245   |   |  |      | 57,537    |   |  |   | 97,175    |  
|Goodwill                                                                             |  |                                       | 96,034  |   |      |   | 124,081  |      |  |   | 272,561  |   |  |      | 915,813   |   |  |   | 1,672,628 |  
|Total assets                                                                         |  |                                       | 486,455 |   |      |   | 543,902  |      |  |   | 753,770  |   |  |      | 1,548,643 |   |  |   | 2,322,529 |  
|Total stockholders equity                                                           |  |                                       | 400,635 |   |      |   | 441,500  |      |  |   | 655,207  |   |  |      | 1,461,460 |   |  |   | 2,249,892 |  



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



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, intentions, strategies, and expected operating results and financial
condition. Forward-looking statements also 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 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 under the heading Factors That May
Affect Future Operating Results below and elsewhere in this Annual Report on Form 10-K.



Overview



The following
Managements discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto.



Our systems and security management software solutions enable organizations to assure the performance, availability and security of the services delivered
by their information technology (IT) infrastructures. While we initially focused on developing and marketing software to manage applications running on the Microsoft Windows operating system, we have expanded our core business to include
cross-platform systems and security management solutions covering four product areas  Performance & Availability Management, Security Management, Configuration & Vulnerability Management, and Operational Change Control. We
also develop and market software to test and manage voice over internet protocol (VoIP) deployments as part of our Performance & Availability Management offerings.



We entered into the Microsoft agreement in September 2000. Pursuant to this agreement we granted to Microsoft a
non-exclusive perpetual license to our Operations Manager product and technology in exchange for $175 million in license revenue, payable in scheduled installments over three years, plus payment of an additional $15 million in marketing funds over
three years. Microsoft has further developed that technology and now offers systems management functionality for some versions of its Windows operating systems and certain Microsoft applications under the product name Microsoft Operations Manager.
Following entry into the agreement with Microsoft, we began a broad diversification program to develop additional revenue streams from new products and to extend our principal Performance & Availability Management product, AppManager.



Since fiscal 2001, we have introduced UNIX and Linux support
for AppManager, and have increased our support of non-Microsoft applications. In addition, in a move that was intended to extend our business further beyond performance and availability management, we acquired WebTrends Corporation in March 2001,
adding software solutions for tracking, reporting and analyzing web site traffic and usage to our product portfolio. We also focused our expansion strategy on developing and acquiring security management products due to the anticipated convergence
of the systems and security management markets and our perception of customer needs.



From fiscal 2001 through fiscal 2003, our revenue benefited substantially from license fees from the Microsoft agreement; $25.0 million in fiscal 2001, $80.0 million in fiscal 2002, and $65.0 million in fiscal 2003.
The last payment of $5.0 million was received in the first quarter of fiscal 2004. All marketing funds received by us from Microsoft had been exhausted as of December 31, 2004.



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Our operating margin also benefited from license fees received under our Microsoft agreement as costs
related to this revenue stream were insignificant. During 2002 and 2003, as part of our expansion strategy we utilized the Microsoft revenue stream in part to fund both higher levels of investment in research and development and acquisitions. We
used existing technology to develop portions of our security management capabilities and in December 2002 we acquired PentaSafe Security Technologies, Inc. and Marshal Software, LTD., both of which added additional security products, intellectual
property and expertise. During the remainder of fiscal 2003 and in fiscal 2004 we integrated and further developed these products and technologies, releasing a focused set of security products in the fourth quarter of fiscal 2004. Through
development and acquisition of products and complementary technologies, we positioned NetIQ to benefit from both convergence of the systems and security management markets and growth in the broader security software market.



In connection with our acquisition of PentaSafe in December 2002 and the
resizing of the combined businesses, we adopted a plan to eliminate redundant positions in both the NetIQ and PentaSafe workforces and to vacate excess facilities. We terminated the employment of 55 employees of PentaSafe and accrued $1.7
million related to severance benefits, which we accounted for as part of the acquisition of PentaSafe. We also terminated the employment of 52 NetIQ employees and vacated certain of our leased facilities, resulting in a charge of $5.3 million,
reflected as a restructuring charge in the second quarter of fiscal 2003. In the fourth quarter of fiscal 2003, we announced a further reduction in force designed to lower operating costs and to better support the convergence of the systems
management and security management markets, by combining our systems and security management business units and streamlining our organizational structure. As a result, we terminated the employment of 108 employees, including four senior executives.
Total severance costs of $1.5 million relating to this reduction in force were recorded as sales and marketing, research and development and general and administrative expenses in fiscal 2003.



Prior to fiscal 2004, we focused on marketing our products principally to
system or network administrators, and customer purchase approval levels were generally below the level of the chief information officer. As we expanded our product offerings and focused on broader solutions, it became increasingly important to
develop broad-based relationships within our customers and to cultivate relationships at higher levels in our customers IT organizations. Beginning in July 2003 we refocused our sales strategy from territory-based to a named-account-based
approach to better align our sales and marketing strategy with our product offerings and roadmap. As a result of the reorganization and changing strategy of our sales organization and the soft spending environment for IT products generally, we had
high turnover of sales personnel and the productivity of our sales force did not meet our expectations during the second half of fiscal 2003 and through fiscal 2004. During fiscal 2004, we implemented expanded product, solution and process training
and subsequently experienced reduced turnover of sales personnel.



As a result of the decreasing revenue received under our Microsoft agreement, integration and restructuring costs related to our acquisitions and low sales force productivity, our operating margins were under heavy pressure during the 2003
and 2004 fiscal years. Moreover, because our growth strategy involved significant acquisitions, some of which were consummated during periods of elevated stock market prices, our financial results were subjected to revaluation charges and
impairments of goodwill. Upon our adoption, in July 2003, of Statement of Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets, we evaluated the fair value of goodwill and took a transitional impairment charge of
$579.3 million, characterized as the cumulative effect of a change in accounting principle. During fiscal 2003 and 2004 we incurred further impairment charges of $316.0 million and $134.3 million respectively. No impairment charges were incurred in
fiscal 2005, leaving a balance of $96.0 million in goodwill at June 30, 2005.



In October 2003 we announced a more sharply focused strategy for fiscal 2004 and identified five key priorities: (1) refine and narrow our focus to our major product lines in our systems and security management
business, (2) renew contact with and re-sell AppManager to our existing customers, (3) sell to our current AppManager customers our other major product lines, (4) revise our marketing and sales strategy for Windows Administration
products, and (5) improve sales force productivity and operating performance.



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We refocused our systems and security management development teams, sales force and partners around our
key product areas, issued major product releases and upgrades in each area and sold or licensed other products such as SQL tools, Chariot, and certain AppManager modules, which allowed us to focus resources on core products. We also acquired the
Group Policy Administrator and Group Policy Guardian products, now part of our Operational Change Control product line in March 2004. Due to our focused sales and marketing initiatives, we increased sales of maintenance renewals and new licenses of
AppManager, including licenses for our UNIX/Linux cross-platform products, resulting in year-over-year growth in AppManager revenues for the fourth quarter of fiscal 2004. In addition, as a result of this strategic focus, about half of our larger
transactions in the third and fourth quarters of fiscal 2004 also included other NetIQ products, typically security management products. For the fourth quarter of fiscal 2004, we also increased our year-over-year revenues for products that are now
within our Operational Change Control product line.



In June
2004, we restructured our business to improve our customer service levels and increase operational efficiency. We consolidated our security management development activities and our systems and security technical support operations in Houston,
Texas. To better align our internal information systems with our business units we also reorganized our IT department. In connection with this restructuring, we terminated the employment of 86 employees and vacated a facility in Portland, Oregon and
a facility in Auckland, New Zealand, resulting in a restructuring charge of $1.8 million. In the financial statements this charge is partially offset by a $504,000 recovery of the fiscal 2003 restructuring charge.



During fiscal 2005, we publicly unveiled our Knowledge-Based Service
Assurance product strategy (KBSA). The key elements to this strategy are four product areas: (1) Performance & Availability Management (including VoIP Management), (2) Security Management, (3) Configuration &
Vulnerability Management, and (4) Operational Change Control, each delivered across four IT disciplinesOperational Integrity, Service Management, Policy Compliance, and Risk Management. Also central to our KBSA strategy is deep
integration among the four product areas to enable cross-product analyses, the sharing of important technology components, and the use of a common reporting engine and user interface to deliver cross-product and cross-user-group value.



Achieving the KBSA product vision will require several years of intense
product development. As such, concurrent with the launch of our KBSA product strategy, we are directing our product investments to key areas of that strategy and are making efforts to exit or deemphasize business areas that do not support that
strategy.



Our determination to concentrate on our KBSA product
strategy resulted in the sale of our WebTrends web analytics business to WebTrends Inc. (formerly Spider Holding Inc.), an affiliate of Francisco Partners, L.P., a private equity investment firm. The transaction closed on April 30, 2005 and we
received approximately $91.1 million in net proceeds, resulting in a pretax net gain of approximately $65.5 million, which is reflected as a gain from sale of discontinued operations net of tax in the fiscal 2005 income statement. In addition, the
employment of approximately 237 of our employees was assumed by WebTrends Inc. as of April 30, 2005. Accordingly, the historical financial statements of NetIQ have been retroactively adjusted to account for WebTrends as discontinued operations
in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.



In January 2005, Ixia finalized its exercise of an option to purchase the remaining assets and assume the liabilities associated with the Chariot product
line. Under the terms of our agreement with Ixia, we received a net cash payment of $2.2 million in consideration for the transfer of those assets and assumption of the liabilities. The transaction resulted in a gain of $2.9 million, which
is reflected in other income for the year ended June 30, 2005. Over the course of the Ixia license, we received $18.9 million in license revenue.



In July 2005, we announced a plan of organizational restructuring to take place in fiscal 2006, consisting of headcount reductions and realignment and
movement of operations. As part of the restructuring and realignment, we entered into an agreement with a third party to provide us with software product development services and other professional services. These services will be rendered
principally from a Global Operations Center located



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in Bangalore, India, and we will own the work product created under the agreement. These actions are designed to adjust expenses to a level more consistent
with anticipated revenues.



We believe that the sale of
WebTrends and our organizational restructuring should enhance our long-term strategic direction and provides us greater opportunity to increase shareholder value by accelerating innovation in our core business. We intend to continue to evaluate our
options across remaining non-core product areas within NetIQ as we increase our focus on executing our KBSA product strategy.



We have taken action to align the compensation of our executive management team with the interests of our stockholders through the use of employee
equity-based compensation, including both stock options and restricted stock. Our chief executive officer has forgone all cash compensation, and instead has received equity-based compensation, since September 2003. These arrangements are more fully
detailed in our fiscal 2005 Proxy Statement.



Stock Repurchases



Our Board of Directors periodically has authorized plans
to repurchase shares of our outstanding common stock. A summary of the stock repurchase plans and the activity in each plan follows (in thousands except share amounts):



|                                     |  |                                         |  |                                        |  |                              
|------------------------------------ |  | --------------------------------------- |  | -------------------------------------- |  | -----------------------------
|                                     |  | May 2005 Program                        |  | September 2004 Program                 |  | October 2003 Program         
|Program size                         |  | Up to $200 million of outstanding stock |  | Up to $50 million of outstanding stock |  | Up to 5% of outstanding stock
|                                     |  |                                         | 
|Shares purchased as of June 30, 2005 |  | 6,835,310                               |  | 2,004,742                              |  | 2,850,000                    
|                                     |  |                                         | 
|Cash used as of June 30, 2005        |  | $74,801                                 |  | $ 23,526                               |  | $36,927                      
|                                     |  |                                         | 
|Amount remaining in program          |  | $125,199                                |  | Program replaced by May 2005 program   |  | Complete                     



Critical Accounting Policies and
Estimates



The accompanying discussion and analysis of our
financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. We believe there are several
accounting policies that are critical to understanding our consolidated financial statements, as these policies affect the reported amounts of revenue and expenses and involve managements judgment regarding significant estimates. The critical
accounting policies and estimates are described below.



Revenue Recognition



We primarily generate
revenue from licensing software and providing related services. We recognize revenue in accordance with accounting principles generally accepted in the United States of America, as set forth in American Institute of Certified Public Accountants
(AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, and AICPA SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, and Securities and Exchange Commission Staff
Accounting Bulletin No. 104, Revenue Recognition, and other related pronouncements. In accordance with these statements, we recognize revenue upon meeting each of the following criteria:



| |  | Existence of persuasive evidence of an arrangement. Persuasive evidence generally is a purchase order, license agreement or other contract.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | Delivery of product and authorization keys. Delivery has occurred when the customer is given online access to the software and the authorization keys needed to activate the software
are made available to the customer.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | Fee is fixed or determinable. A fee is deemed to be fixed or determinable when it is not subject to subsequent refund or adjustment.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  | Collection is deemed probable.
|- |  | ------------------------------



| |  | Vendor-specific objective evidence exists to allocate fees to the undelivered elements of the arrangement.
|- |  | ----------------------------------------------------------------------------------------------------------



We recognize software revenue using the residual method. Under the residual
method revenue is recognized if vendor-specific objective evidence of fair value (VSOE) exists for all of the undelivered elements in an arrangement and all other revenue recognition criteria are met. VSOE is based on the price generally charged
when the element is sold separately or, if not yet sold separately, is established by authorized management. In situations where vendor-specific objective evidence of fair value for an undelivered element does not exist, the entire amount of revenue
from the arrangement may either be recognized ratably over the term of the service or deferred and recognized when one of the following occur: 1) fair value can be established for all undelivered elements or 2) when all elements are delivered and
all other revenue recognition criteria are met.



Service
revenue includes maintenance revenue and revenue from consulting and training services.



We defer license revenue until all of the criteria noted above are met. We defer maintenance revenue and recognize it ratably over the maintenance term, typically one year. We defer consulting and training revenues
and recognize them as those services are performed.



We
generally recognize revenue from sales made through distributors, resellers, and original equipment manufacturers at the time these partners report that they have sold the software or, alternatively, when we drop-ship the product to the end-user, in
each case after all revenue recognition criteria have been met. We also maintain an allowance for potential sales returns.



When licenses and services are sold together, we recognize license fees upon shipment, provided that (1) the above criteria have been met,
(2) payment of the license fee is not dependent upon the performance of the services, and (3) the services do not provide significant customization of the software and are not essential to the functionality of the software for which a
license was sold. For arrangements that do not meet the above criteria, we defer revenue recognition until all of the criteria are met.



Use of Estimates



The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us 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 revenue and expenses during the reported
period. We base our estimates and judgments on historical experience and on various assumptions that we believe are reasonable under current circumstances. However, future events are subject to change and our best estimates and judgments may require
further adjustments; therefore actual results could differ from our current estimates. Significant estimates made in the accompanying financial statements are:



| |  | Allowance for Uncollectible AccountsWe provide an allowance for uncollectible accounts receivable based on our assessment of the collectibility of specific customer accounts
and an analysis of the remaining accounts receivable. Changes in the allowance are included as a component of general and administrative expense on the statement of operations and comprehensive loss. The allowance for uncollectible accounts was
$555,000 at June 30, 2005, $671,000 at June 30, 2004 and $1.1 million at June 30, 2003.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Allowance for Sales ReturnsWe provide an allowance for sales returns in the same period the related revenues are recorded. The estimates are based on
historical trends in product returns. Revenue is recognized net of the provision for sales returns. The allowance for sales returns was $581,000 at June 30, 2005, $863,000 at June 30, 2004 and $1.1 million at June 30, 2003. If
the historical data we use to calculate these
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | estimates do not properly reflect future returns, then a change in the sales return allowance would be made in the period such determination is made and
revenues in that period could be materially affected.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Other Intangible AssetsWe record intangible assets when we acquire companies. The cost of the acquisition is allocated to the assets and liabilities acquired, including
identifiable intangible assets, with the remaining amount being classified as goodwill. Certain identifiable intangible assets such as purchased technology and customer lists are amortized over time, while in-process research and development is
recorded as a charge on the date of acquisition and goodwill is capitalized, subject to periodic review for impairment. Accordingly, the allocation of the acquisition cost to identifiable intangible assets has a significant impact on our future
operating results. The allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets. Should conditions be different than managements
assessment, material write-downs of the fair value of intangible assets may be required. We periodically review the estimated remaining useful lives and capitalized value of our other intangible assets. A reduction in the estimate of remaining
useful life and capitalized value could result in accelerated amortization expense or a write-down in future periods. As such, any future write-downs of these assets would adversely affect our gross and operating margins.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | GoodwillWe periodically assess goodwill for impairment. Accordingly, goodwill recorded in business combinations may significantly affect our future operating results to the
extent impaired, but the magnitude and timing of any such impairment is uncertain. When we conduct our annual evaluation of goodwill, as of April 30, or in the interim if impairment indicators are identified with respect to goodwill, the fair
value of goodwill is re-assessed using valuation techniques that require significant management judgment. Should conditions be different than managements last assessment, significant write-downs of goodwill may be required. Goodwill as of
June 30, 2005 was $96.0 million. Any future write-downs of goodwill will adversely affect our operating margin.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Restructuring Liabilities and Facility ReservesWe regularly evaluate the utilization of our facilities and when future use of a specific facility is no longer required and no
longer occupied, we record a charge for the remaining costs, net of any sublease or other recoveries anticipated. In connection with significant acquisitions and from time to time in an effort to better respond to customer needs, to reduce operating
costs or to facilitate better collaboration between organizations, we also restructure our operating activities and organizations, eliminating redundancies in personnel and facilities. Establishing reserves for unoccupied facilities typically
involved greater judgment than for personnel as sublease rental income or other recoveries are more difficult to estimate than severance benefits or salary continuation payments. There was no restructuring liability or facility reserve as of
June 30, 2005.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Provision for Income TaxesThe provision for income taxes includes taxes currently payable and changes in deferred tax assets and liabilities. We record deferred tax assets and
liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We record a valuation allowance to reduce net deferred tax assets to amounts
that are more likely than not to be recognized. Deferred tax assets are the result of the tax benefit of disqualifying dispositions of stock options, temporary timing differences, tax credits and acquired net operating losses which will be credited
to equity or to tax expense, respectively, when realized. We have established a valuation allowance to fully reserve these deferred tax assets due to the uncertainty regarding their realization.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Results of Operations



Total Revenue.    Total revenue and year-over-year changes are as follows (in thousands, except percentages):



|                                                   |  |      |         |      |   |         |  |                   |         |  |              |    |  |     |   
|-------------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | ----------------- | ------- |  | ------------ | -- |  | --- | --
|                                                   |  |      |         |      |   |         |  | Percentage Change |        
|                                                   |  | 2005 |         | 2004 |   | 2003    |  | 2004 to 2005      |         |  | 2003 to 2004 |   
|Software license revenue                           |  | $    | 109,627 |      | $ | 118,474 |  | $                 | 123,916 |  | (7           | )% |  | (4  | )%
|Software license revenue under Microsoft agreement |  |      |        |      |   | 5,000   |  |                   | 60,000  |  | (100         | )% |  | (92 | )%
|                                                   |  |      |         |      |   |         |  |                   |         |  |              |    |  |     |   
|Total software license revenue                     |  |      | 109,627 |      |   | 123,474 |  |                   | 183,916 |  | (11          | )% |  | (33 | )%
|Service revenue                                    |  |      | 103,589 |      |   | 93,526  |  |                   | 80,222  |  | 11           | %  |  | 17  | % 
|                                                   |  |      |         |      |   |         |  |                   |         |  |              |    |  |     |   
|Total revenue                                      |  | $    | 213,216 |      | $ | 217,000 |  | $                 | 264,138 |  | (2           | )% |  | (18 | )%
|                                                   |  |      |         |      |   |         |  |                   |         |  |              |    |  |     |   



|                                                   |  |                                                             |   |  |                                                             |   |  |      |   |  |      |   |  |      |   |  |      |  
|-------------------------------------------------- |  | ----------------------------------------------------------- | - |  | ----------------------------------------------------------- | - |  | ---- | - |  | ---- | - |  | ---- | - |  | ---- | -
|                                                   |  | Revenue as % of Total RevenueInclusive of Microsoft Revenue |   |  | Revenue as % of Total RevenueExclusive of Microsoft Revenue |  
|                                                   |  | 2005                                                        |   |  | 2004                                                        |   |  | 2003 |   |  | 2005 |   |  | 2004 |   |  | 2003 |  
|Software license revenue                           |  | 51                                                          | % |  | 55                                                          | % |  | 47   | % |  | 51   | % |  | 56   | % |  | 61   | %
|Software license revenue under Microsoft agreement |  | 0                                                           | % |  | 2                                                           | % |  | 23   | % |  | N/A  |   |  | N/A  |   |  | N/A  |  
|                                                   |  |                                                             |   |  |                                                             |   |  |      |   |  |      |   |  |      |   |  |      |  
|Total software license revenue                     |  | 51                                                          | % |  | 57                                                          | % |  | 70   | % |  | 51   | % |  | 56   | % |  | 61   | %
|Service revenue                                    |  | 49                                                          | % |  | 43                                                          | % |  | 30   | % |  | 49   | % |  | 44   | % |  | 39   | %
|                                                   |  |                                                             |   |  |                                                             |   |  |      |   |  |      |   |  |      |   |  |      |  
|Total revenue                                      |  | 100                                                         | % |  | 100                                                         | % |  | 100  | % |  | 100  | % |  | 100  | % |  | 100  | %
|                                                   |  |                                                             |   |  |                                                             |   |  |      |   |  |      |   |  |      |   |  |      |  



Total revenue
decreased by $3.8 million or 2%, from fiscal 2004 to 2005 and decreased by $47.1 million or 18%, from fiscal 2003 to 2004.



Software License Revenue.    Total software license revenue decreased by $13.8 million or 11% from fiscal 2004 to 2005
primarily as a result of decrease in revenue under the Microsoft agreement of $5.0 million, a decrease in Ixia revenue of $4.2 million, and a decrease in orders due to lower sales productivity. The decrease in license revenue from 2004 to 2005
together with improved maintenance revenue and other service revenue resulted in a decline of license revenue as a percentage of total revenue.



Total software license revenue decreased by $60.4 million or 33% from fiscal 2003 to 2004, primarily due to a $55.0 million decrease in revenue under
the Microsoft agreement during fiscal 2004. Software license revenue, excluding revenue from the Microsoft agreement, decreased $5.4 million or 4% from fiscal 2003 to 2004. This decrease was primarily a result of low productivity of the sales
organization, changing product positioning regarding some of our security management products, lack of integration of our security management products and the challenging economic environment. The decrease in license revenue from 2003 to 2004
together with improved maintenance revenue and other service revenue resulted in a decline of license revenue as a percentage of total revenue.



Service Revenue.    Service revenue consists of revenue from the sale of maintenance service agreements, consulting services
and training services. Maintenance revenue represented 92%, 92% and 91% of total service revenue in fiscal 2003, 2004 and 2005, respectively. Service revenue increased by $10.1 million and $13.3 million, or 11% and 17%, from fiscal 2004 to
2005 and from fiscal 2003 to 2004, respectively. The increase was primarily due to additional maintenance fees associated with new software licenses and increased renewals by our existing customers. Service revenue increased in absolute terms due to
the compounding effectof our broader base of installed licenses and a significant majority of our customers renewing their maintenance service agreements. We expect our service revenue to continue to grow as a percentage of total revenue in
fiscal 2006 as our installed base increases, and existing customers renew maintenance contracts.



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Total Cost of Revenue.    Total cost of revenue and year-over-year changes are
as follows (in thousands, except percentages):



|                                     |  |      |        |   |      |   |        |      |  |   |        |  
|------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                     |  | 2005 |        |   | 2004 |   |        | 2003 | 
|Cost of software license revenue     |  | $    | 4,935  |   |      | $ | 9,265  |      |  | $ | 10,090 |  
|As percentage of license revenue     |  |      | 5      | % |      |   | 8      | %    |  |   | 5      | %
|                                     |  |      |       
|Cost of service revenue              |  | $    | 26,475 |   |      | $ | 22,490 |      |  | $ | 19,274 |  
|As percentage of service revenue     |  |      | 26     | % |      |   | 24     | %    |  |   | 24     | %
|                                     |  |      |       
|Amortization of purchased technology |  | $    | 11,813 |   |      | $ | 8,607  |      |  | $ | 8,654  |  
|Impairment of purchased technology   |  | $    |       |   |      | $ |       |      |  | $ | 798    |  
|Total cost of revenue                |  | $    | 43,223 |   |      | $ | 40,362 |      |  | $ | 38,816 |  
|                                     |  |      |        |   |      |   |        |      |  |   |        |  
|As percentage of total revenue       |  |      | 20     | % |      |   | 19     | %    |  |   | 15     | %



Total cost of revenue
increased by $2.9 million or 7% from fiscal 2004 to 2005 and by $1.5 million or 4%, from fiscal 2003 to 2004.



Cost of Software License Revenue.    Cost of software license revenue includes royalties paid to third parties, personnel costs
and costs associated with software packaging, documentation such as user manuals and CDs, and production, as well as shipping. Cost of software license revenue as a percentage of related license revenue decreased from 8% during fiscal 2004 to 5%
during fiscal 2005. The percentage decrease was primarily due to a decrease in royalty expense as result of our acquisition, in March 2004, of certain technology previously subject to quarterly royalty payments. Such costs were previously included
in the cost of software and from the purchase date forward the amortization of the purchase price has been recorded as amortization of purchased technology. In addition we recognized cost savings during fiscal 2005 associated with the implementation
of our electronic software delivery, which significantly reduced the cost for packaging and delivery. Cost of software license revenue as a percentage of related license revenue increased from 5% during fiscal 2003 to 8% during fiscal 2004. The
percentage increase primarily is due to a decrease in license revenue over which to spread fixed costs associated with the cost of software license revenue. Cost of software license revenue decreased by $4.3 million and $825,000 from fiscal 2004 to
2005 and from fiscal 2003 to fiscal 2004 respectively, due to a net decrease in royalty expense as a result of our acquisition of technology that was previously subject to a royalty agreement.



Cost of Service Revenue.    Cost of service
revenue consists primarily of personnel costs and expenses incurred in providing telephonic support, on-site consulting services and training services. Cost of service revenue as a percentage of related service revenue remained constant at 24%
during fiscal 2003 and 2004 and increased to 26% during fiscal 2005.



The decrease in the services gross margin in fiscal 2005 compared to fiscal 2004 is primarily attributable to the increase in the number of consulting service employees as we focus on selling more consulting to better enable our customers
to take advantage of new features and functionality of our products.



We expect service revenue to increase in absolute dollars as our installed license base grows and, as a consequence, our cost of service revenue to increase in absolute dollars. We plan to continue to focus on selling additional services in
fiscal 2006 to better enable our customers to take advantage of the new features and functionality of our products.



Amortization and Impairment of Purchased Technology.Purchased technology consists of developed software capitalized in our
acquisitions or purchased separately and is amortized using the straight-line method over the estimated useful life of the software, generally three years. Amortization remained relatively constant during fiscal 2003 and fiscal 2004 at $8.7
million and $8.6 million and increased to $11.8 million during fiscal 2005. The increase in fiscal 2005 primarily relates to our acquisition, in March 2004, of certain technology



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previously subject to quarterly royalty payments. Such costs were previously included in the cost of software and from the purchase date forward the
amortization of the purchase price has been recorded as amortization of purchased technology. This increase in amortization is offset in both fiscal 2004 and fiscal 2005 by amounts capitalized in prior acquisitions becoming fully amortized. We
expect to amortize approximately $8.2 million of purchased technology during fiscal 2006, absent further acquisitions, impairments or divestitures.



Operating Expenses



Sales and Marketing.    Our sales and marketing expenses consist primarily of personnel costs, including salaries and employee
commissions, and expenses relating to travel, advertising, public relations, seminars, marketing programs, trade shows, lead generation activities and proportionately allocated facilities and information technology costs, net of payments from
Microsoft for product promotions.



Sales and marketing expenses
and year-over-year changes are as follows (in thousands, except percentages and headcount):



|                                     |  |      |         |    |      |   |         |      |  |   |         |  
|------------------------------------ |  | ---- | ------- | -- | ---- | - | ------- | ---- |  | - | ------- | -
|                                     |  | 2005 |         |    | 2004 |   |         | 2003 | 
|Sales and marketing expenses         |  | $    | 102,561 |    |      | $ | 106,400 |      |  | $ | 111,913 |  
|Percentage change from previous year |  |      | (4      | )% |      |   | (5      | )%   |  |   |         |  
|As a percentage of total revenue     |  |      | 48      | %  |      |   | 49      | %    |  |   | 42      | %
|Headcount at June 30                 |  |      | 374     |    |      |   | 436     |      |  |   | 402     |  



Sales and marketing
expenses decreased by $3.8 million or 4%, from fiscal 2004 to 2005. The decrease in absolute dollars in fiscal 2005 compared to fiscal 2004 is principally a result of lower headcount and the payment of lower incentive compensation amounts.
Sales and marketing expense decreased by $5.5 million or 5%, from fiscal 2003 to 2004. The decrease in absolute dollars resulted principally from our lower revenue during fiscal 2004, resulting in the payment of lower commissions and bonuses,
combined with our implementation of cost savings measures. Sales and marketing as a percentage of revenue decreased to 48% in fiscal 2005 from 49% in fiscal 2004, while it had increased from 42% in fiscal 2003. The increase in the percentages was
principally the result of the reduction of revenue from Microsoft in each fiscal year, which revenue did not require significant sales or marketing expenditures. During fiscal 2006, we expect sales and marketing expenses to increase, but to remain
at about the same percentage of total revenue as in fiscal 2005.



Research and Development.    Our research and development expenses consist primarily of salaries and other personnel-related costs, consulting fees, depreciation and proportionately allocated facilities and
information technology costs. To date, we have expensed all research and development costs as incurred in accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to Be Sold,
Leased or Otherwise Marketed, as technological feasibility is established at the time our software development process is completed.



Research and development expenses and year-over-year changes are as follows (in thousands, except percentages and headcount):



|                                     |  |      |        |    |      |   |        |      |  |   |        |  
|------------------------------------ |  | ---- | ------ | -- | ---- | - | ------ | ---- |  | - | ------ | -
|                                     |  | 2005 |        |    | 2004 |   |        | 2003 | 
|Research and development             |  | $    | 50,567 |    |      | $ | 55,202 |      |  | $ | 55,818 |  
|Percentage change from previous year |  |      | (8     | )% |      |   | (1     | )%   |  |   |        |  
|As a percentage of total revenue     |  |      | 24     | %  |      |   | 25     | %    |  |   | 21     | %
|Headcount at June 30                 |  |      | 296    |    |      |   | 326    |      |  |   | 349    |  



Research and
development expenses decreased by $4.6 million or 8% from fiscal 2004 to 2005. This decrease in absolute dollars resulted principally from lower overall headcount. Research and development expenses also decreased by $616,000 or 1% from
fiscal 2003 to 2004. This decrease in absolute dollars resulted



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principally from lower overall headcount and payment of lower bonuses partially offset by the effect of annual base salary increases that took place in
November 2003. Our strategy since signing the license agreement with Microsoft in September 2000 was to increase spending in research and development through fiscal 2003. As a result, we have brought to market a number of new products. During
fiscal 2006, we expect research and development expenses to decrease as we focus efforts on consolidating our research and development efforts in our Raleigh and Houston offices, cease engineering operations in our San Jose location, and commence
operations under our agreement with a third party to provide us with software product development services and other professional services principally from the third partys Global Operations Center in Bangalore, India. We expect most of these
activities to be concluded by the end of our second fiscal quarter and for the cost savings to begin to be realized in the third fiscal quarter. The consolidation of research and development and the outsourcing of routine engineering in fiscal 2006
is expected to allow us to focus a greater number of individuals on new product areas within our KBSA strategy.



General and Administrative.    Our general and administrative expenses consist primarily of personnel costs for finance and
administration, as well as directors and officers insurance, directors fees, professional services expenses, such as legal and accounting fees, and proportionately allocated facilities and information technology costs.



General and administrative expense and year-over-year changes are as
follows (in thousands, except percentages and headcount):



|                                       |  |      |        |   |      |   |        |      |  |   |        |  
|-------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                       |  | 2005 |        |   | 2004 |   |        | 2003 | 
|General and administrative             |  | $    | 29,316 |   |      | $ | 26,904 |      |  | $ | 24,020 |  
|Percentage increase from previous year |  |      | 9      | % |      |   | 12     | %    |  |   |        |  
|As a percentage of total revenue       |  |      | 14     | % |      |   | 12     | %    |  |   | 9      | %
|Headcount at June 30                   |  |      | 170    |   |      |   | 180    |      |  |   | 182    |  



General and
administrative expenses increased by $2.4 million and $2.9 million, or 9% and 12%, from fiscal 2004 to 2005 and from fiscal 2003 to 2004, respectively. The increase in fiscal 2005 is primarily due to an increase in payments for
outside services, primarily associated with our Sarbanes-Oxley Section 404 (SOX) compliance activities, increased legal fees related to dispute resolution matters and increased salaries and related payroll taxes,. The increase in fiscal 2004 is
primarily due to an increase in legal expense, additional costs associated with SOX compliance, increased premiums associated with directors and officers insurance, increased fees paid to board members and an overall increase in other professional
fees required to manage and support our business. During fiscal 2006, we expect our general and administrative expenses to decrease when compared to fiscal 2005 as a result of reduced compliance expenses.



Employee Stock-Based Compensation.    Deferred
employee stock-based compensation represents the intrinsic value of unvested options assumed in acquisitions and the charges associated with the grant of restricted stock and options at less than fair market value. The deferred amount is being
amortized over the vesting periods of the restricted stock grants and the assumed and granted options, generally one to four years. During fiscal 2005, 2004 and 2003, we recognized employee stock-based compensation expense of $1.5 million,
$307,000 and $544,000, respectively. The increase in fiscal 2005 is due to restricted stock grants made during fiscal 2005. The decrease in fiscal 2004 and 2003 is due to the decrease in amortization of deferred employee stock based compensation
related to the assumption of options, which has decreased over time in accordance with the vesting periods. In fiscal 2006 we will begin to reflect the expense for stock options in our income statement in accordance with SFAS 123(R), Share-Based
Payments. Management has not yet determined the impact that SFAS 123(R) will have on its financial position and results of operations, but expects that the impact will be material.



Amortization of Other Intangible Assets.    Amortization of other intangible assets includes
amortization of capitalized values relating to customer contracts, customer lists, patents, and trade name intangibles from our



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acquisitions. Other intangible assets are amortized using the straight-line method over their estimated useful lives, generally three years. Amortization
remained relatively constant at $8.6 million in fiscal 2005 compared to $8.5 million in fiscal 2004 and decreased from $10.0 million during fiscal 2003. The decrease in the amortization during fiscal 2004 resulted from the full
amortization of amounts capitalized in previous acquisitions, partially offset by intangible assets capitalized in connection with an acquisition in March of 2004. During fiscal 2006, we expect to amortize approximately $3.8 million of
other intangible assets, absent further acquisitions or divestitures.



Impairment and Amortization of Goodwill.    We adopted SFAS No. 142, Goodwill and Other Intangible Assets, on July 1, 2002 and accordingly stopped amortizing goodwill on that date. Upon adoption
of SFAS No. 142, we recorded a one-time, non-cash transitional impairment charge of $579.3 million to reduce the carrying value of our goodwill from previous acquisitions. The charge is reflected as the cumulative effect of a change in
accounting principle in the accompanying consolidated statements of operations. There was no income tax effect resulting from the change in accounting principle.



We conducted our first annual review for impairment of goodwill as of April 30, 2003 and recorded a non-cash charge of
$316 million. The impairment charge is attributable to our revised forecast for operating profits and cash flows.



Revenue for the three months ended September 30, 2003 was significantly lower than we anticipated. Because a significant portion of our revenues
historically has been generated during the last month of each fiscal quarter, the actual drop-off in revenue compared with plan was not evident until the end of the quarter. Accordingly, as of September 30, 2003 we reduced our forecasted future
operating profits and cash flows. This significant change in estimated future results required us to perform an interim review of goodwill for impairment, as prescribed by SFAS No. 142. This resulted in a further non-cash impairment charge of
$134.3 million during the three months ended September 30, 2003. We completed our annual test of impairment as of April 30, 2004 and April 30, 2005 and noted no further impairment.



Write-off of Acquired In-Process Research and Development
Costs.    During fiscal 2003 we expensed $1.4 million for in-process research and development costs related to acquisitions. This value was established by applying the income approach, which considers the present
value of the projected free cash flows expected to be generated by the products. This cost was charged to operations at the date of the acquisition as the uncompleted development projects had not reached technological feasibility and did not have
alternative future uses at those dates. No such charges were recorded during fiscal 2004 and 2005.



Restructuring Charge.    During fiscal 2004, we recorded a net restructuring charge of $1.3 million related to an effort to
enhance our customers experience with NetIQ products and services, to create a more efficient business structure and to better enable collaboration between key functions. During fiscal 2003, we recorded a restructuring charge of
$4.5 million related to a plan to terminate employment of 52 employees and vacate certain of our facilities that will no longer be used due to resizing the combined business after the acquisition of PentaSafe. No such charge was recorded during
fiscal 2005. The gross $1.8 million charge in fiscal 2004 was offset by a recovery of $504,000 related to the expected recovery of personnel and facility reserves pertaining to the fiscal 2003 restructuring charge.



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Other Income.



Total other income (expense) is as follows (in thousands):



|                                     |  |      |        |      |   |        |      |  |   |        |  
|------------------------------------ |  | ---- | ------ | ---- | - | ------ | ---- |  | - | ------ | -
|                                     |  | 2005 |        | 2004 |   |        | 2003 | 
|Interest income                      |  | $    | 6,028  |      | $ | 5,013  |      |  | $ | 10,764 |  
|Foreign exchange gains (losses)      |  |      | 375    |      |   | (396   | )    |  |   | 1,406  |  
|Impairment of long-term investment   |  |      |       |      |   | (4,100 | )    |  |   | (1,438 | )
|Gain on sale of technology           |  |      | 2,893  |      |   |       |      |  |   |       |  
|Gain on sale of long term investment |  |      | 4,100  |      |   |       |      |  |   |       |  
|Other income (expense)               |  |      | 205    |      |   | 148    |      |  |   | 19     |  
|                                     |  |      |        |      |   |        |      |  |   |        |  
|Total                                |  | $    | 13,601 |      | $ | 665    |      |  | $ | 10,751 |  
|                                     |  |      |        |      |   |        |      |  |   |        |  



For fiscal 2005,
2004 and 2003, total other income, net was $13.6 million, $665,000 and $10.8 million, respectively. The increase in interest income in fiscal 2005 is primarily the result of higher interest income earned on our cash and cash equivalents and
short-term investments, due to an increase in the yield on new investments as earlier investments mature, as well as higher cash and investment balances. The decrease in interest income in fiscal 2004 compared to fiscal 2003 is primarily the result
of lower interest income earned on our cash and cash equivalents and short-term investments, due to a decrease in the yield on new investments as earlier investments mature, as well as lower cash and investment balances due to the use of cash.
Foreign exchange gains and losses have fluctuated as a result of changes in foreign exchange rates affecting the remeasurement of U.S. dollar denominated monetary accounts held in foreign subsidiaries with local functional currencies, particularly
euro. In fiscal 2005 we recorded other income of $2.9 million related to Ixias exercise of its option to purchase our remaining assets associated with the Chariot products. In addition, we recorded a gain of $4.1 million when a company in
which we held a long-term investment was acquired. Impairments of long-term investments in fiscal 2004 included a charge of $4.1 million from a write down of an investment and in fiscal 2003 a charge of $1.4 million resulting from a
write down of an investment in an affiliate, based on managements assessments that the declines in value were other than temporary.



Income Taxes.    We recorded income tax expense of $1.6 million, $3.6 million, and $11.8 million in fiscal 2005, 2004, and
2003, respectively. The higher income tax expense in fiscal 2004 as compared to fiscal 2005 is primarily due to an increase in foreign taxes payable. The higher income tax expense in fiscal 2003 as compared 2004 and 2005 is primarily due to the
non-deductibility of goodwill impairment for income tax purposes. The tax benefit associated with employee stock options reduced federal (other than federal alternative minimum tax) and certain state income taxes payable to zero, in fiscal 2005,
2004 and 2003.



Recent Accounting Pronouncements



In December 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123(R), Share-Based Payment (SFAS 123(R)). This statement replaces SFAS No. 123, Accounting for Stock-Based Compensationand supersedes APB No. 25, Accounting for Stock Issued to Employees.
SFAS 123(R) requires companies to apply a fair-value-based measurement method in accounting for shared-based payment transactions with employees and to record compensation cost for all stock awards granted after the required effective date and
to awards modified, repurchased, or cancelled after that date. In addition, the Company is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at
the date of adoption. SFAS 123(R) will be effective for years beginning after June 15, 2005, which is our fiscal year 2006. Management has not yet determined the impact that SFAS 123(R) will have on its financial position and results
of operations, but expects that the impact will be material.



In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154). SFAS 154 replaces APBO No. 20 (APBO 20) and SFAS No. 3, Reporting Accounting Changes in Interim Financial
Statements, and applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. APBO 20 previously required that most



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voluntary changes in accounting principle be recognized by including in net income of the period of change a cumulative effect of changing to the new
accounting principle whereas SFAS 154 requires retrospective application to prior periods financial statements of a voluntary change in accounting principle, unless it is impracticable. SFAS 154 enhances the consistency of financial
information between periods. SFAS 154 will be effective for years beginning after December 15, 2005, which is our fiscal year 2007. We do not expect that the adoption of SFAS 154 will have a material impact on our results of operations or
financial position.



Liquidity and Capital Resources



As of June 30, 2005, we had $101.4 million in cash and cash equivalents
and $195.3 million in short-term investments, for a total of $296.7 million compared to a total of $287.6 million as of June 30, 2004, an increase of $9.1 million. The primary reasons for the increase during fiscal 2005 were cash
generated from investing activities of $122.5 million which included $91.1 million in net proceeds from the sale of WebTrends and cash generated from operating activities of $10.4 million. The increases were partially offset by cash used in the
repurchase of shares of our common stock pursuant to our stock repurchase program of approximately $98.3 million, net of $9.4 million in proceeds from the sale of common stock and the exercise of a warrant.



Cash flows from operations have been positive in each year presented even
though we have sustained net losses from continuing operations of $10.5 million, $159.2 million and $300.0 million in fiscal 2005, 2004 and 2003, respectively. These losses have been largely the result of non-cash charges relating to depreciation
and amortization and impairments of goodwill and long-term investments. Depreciation and amortization related to physical assets such as our headquarters building, leasehold improvements in leased facilities and computer and other equipment and
amortization of purchased technology and other intangible assets in each of the three fiscal years presented.



Upon the adoption of SFAS 142 effective July 1, 2003, we ceased amortization of goodwill and recorded a transitional impairment of $579.3 million
reflected as the cumulative effect of a change in accounting principle. In fiscal 2003 and 2004, we recorded additional impairments of goodwill of $316.0 million and $134.3 million, respectively, as we re-evaluated our business prospects and future
cash flows. Goodwill remaining on our balance sheet at June 30, 2005 was $96.0 million.



Our investing activities resulted in net cash inflow of $122.5 million in fiscal 2005 and net cash outflows of $27.9 million and $48.1 million in fiscal 2004 and 2003, respectively. The principal
source of cash during fiscal 2005 was $91.1 million in net proceeds for the sale of the WebTrends business unit. Principal uses of cash during fiscal 2005, 2004 and 2003, were acquisitions of property and equipment of $8.0 million,
$7.4 million and $15.3 million, respectively. The principal uses of cash during fiscal 2004 were the acquisition of product and technology previously licensed and the acquisition of a small business for a combined amount of $23.1
million. The larger amounts spent in fiscal 2003 included purchases related to major new programs for sales force automation and enterprise resource planning. Cash outflows also included purchases of short-term investments of $110.2 million,
$203.8 million and $183.0 million in fiscal 2005, 2004 and 2003, respectively, and purchases of long-term investments of $3.0 million and $5.0 million during fiscal 2004 and 2003, respectively. The principal sources of cash
from investing activities during fiscal 2005, 2004 and 2003 were proceeds from the sales and maturities of short-term investments of $144.4 million, $209.5 million and $357.3 million, respectively.



Our financing activities resulted in net cash outflows of $88.9 million
and $21.6 million during fiscal 2005 and 2004, respectively, and a net cash inflow of $13.8 million in fiscal 2003. During 2005 and 2004, we used cash of $98.3 million and $36.9 million to repurchase our common stock in open
market transactions, in block purchases or in privately negotiated transactions. In September 2004 our Board of Directors approved the repurchase of up to an additional $50.0 million of our common stock in open market transactions during the
succeeding 12 months. On May 3, 2005, our Board of Directors approved a program, which replaced the September 2004 approved plan, to repurchase up to $200 million of our outstanding common stock in open market transactions, in block purchases
or in privately negotiated transactions. Sources of cash from financing activities during these periods were principally from proceeds from the sale of common stock under our stock option and employee stock purchase plans.



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A summary of the stock repurchase plans and the activity in each plan follows (in thousands except share
amounts):



|                                     |  |                                         |  |                                        |  |                              
|------------------------------------ |  | --------------------------------------- |  | -------------------------------------- |  | -----------------------------
|                                     |  | May 2005 Program                        |  | September 2004 Program                 |  | October 2003 Program         
|Program size                         |  | Up to $200 million of outstanding stock |  | Up to $50 million of outstanding stock |  | Up to 5% of outstanding stock
|                                     |  |                                         | 
|Shares purchased as of June 30, 2005 |  | 6,835,310                               |  | 2,004,742                              |  | 2,850,000                    
|                                     |  |                                         | 
|Cash used as of June 30, 2005        |  | $74,801                                 |  | $23,526                                |  | $36,927                      
|                                     |  |                                         | 
|Amount remaining in program          |  | $125,199                                |  | Program replaced by May 2005 program   |  | Complete                     



As of June 30,
2005, we had no significant debt.



Long-term Obligations and Commitments



The following summarizes our contractual obligations and
commitments as of June 30, 2005 and the effect such obligations and commitments are expected to have on our liquidity and cash flows in future periods (in thousands, including lease payments accrued as part of our restructuring liability,
facility reserve, and goodwill):



|                                            |  |                        |        |                 |   |          |  |          |       |              |   |       |  |   |      
|------------------------------------------- |  | ---------------------- | ------ | --------------- | - | -------- |  | -------- | ----- | ------------ | - | ----- |  | - | -----
|                                            |  | Payments Due by Period
|                                            |  | Total                  |        | Less Than1 Year |   | 1-3Years |  | 4-5Years |       | After5 Years
|Operating leases                            |  | $                      | 28,448 |                 | $ | 4,751    |  | $        | 8,296 |              | $ | 5,930 |  | $ | 9,471
|Future minimum royalty payments             |  |                        | 1,453  |                 |   | 753      |  |          | 700   |              |   |      |  |   |     
|Purchase Obligations                        |  |                        | 440    |                 |   |         |  |          |      |              |   |      |  |   |     
|Total long-term obligations and commitments |  | $                      | 30,341 |                 | $ | 5,504    |  | $        | 8,996 |              | $ | 5,930 |  | $ | 9,471
|                                            |  |                        |        |                 |   |          |  |          |       |              |   |       |  |   |      



Also, see Note 15
to the Consolidated Financial Statements for additional information regarding our long-term obligations.



We believe that our cash and cash equivalent balances, short-term investments, and cash flows generated by operations will be sufficient to satisfy our
anticipated cash needs for working capital and capital expenditures for at least 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. In addition, we may use cash to repurchase additional shares under Board
authorized share repurchase programs.



Employee Stock Options and other
Equity Incentives



Our stock option program is a
broad-based, long-term retention program that is intended to attract and retain talented employees and align stockholder and employee interests. Since June 2005, we have incorporated the use of restricted stock and restricted stock units as part of
that broad-based retention program. We consider our option program critical to our operation and productivity and most of our employees participate in our option program. During fiscal 2005, 83% of the options granted were granted to employees
other than our six mostly highly compensated executive officers and most highly compensated employee, and 75% of the awards of rights



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to restricted stock and restricted stock units were made to employees other than our six most highly compensated executive officers and highly compensated
employee. Options granted under the plans expire no later than 10 years from the grant date and generally vest within 4 years. Since August 2002, employee options granted were for a term of not more than seven years. We also have an employee stock
purchase plan under which employees are entitled to purchase a limited number of shares at 85% of fair market value. The Compensation Committee of our Board of Directors administers these plans.



See Note 12 to the Consolidated Financial Statements for additional
information regarding our stock option plans.



We have assumed
other option plans in connection with our acquisitions. Generally, these options were granted under terms similar to the terms of our stock option plans at prices adjusted to reflect the relative exchange ratios in the acquisition.



Plans approved by stockholders.    The NetIQ
Corporation 1995 Stock Plan (1995 Stock Plan) provides for annual increases in the number of shares available for issuance on the first day of each fiscal year equal to the lowest of (i) 2,600,000 shares, (ii) 5% of the outstanding shares
of common stock on the first day of the fiscal year, or (iii) a number of shares as authorized by the Board of Directors. At June 30, 2005, the number of shares available for grant was 3,132,929. No increase was authorized for fiscal 2006.
The 1995 Stock Plan expires on November 1, 2005.



The
NetIQ Corporation 1999 Employee Stock Purchase Plan (Purchase Plan) provides for annual increases in the number of shares available for issuance under the stock purchase plan on the first day of each fiscal year equal to the lowest of
(i) 800,000 shares, (ii) 2% of the outstanding shares of common stock on the first day of the fiscal year, or (iii) a number of shares as authorized by the Board of Directors. At June 30, 2005, the number of shares available for
issuance was 2,334,523. No increase was authorized for fiscal 2006.



Plans not approved by stockholders.    On January 25, 2002 our Board of Directors approved and adopted the 2002 Stock Plan (2002 Plan), and reserved 1,500,000 shares for issuance thereunder. At June 30,
2005 the number of shares of common stock subject to outstanding options under the 2002 Plan is 925,753, and the number of shares of common stock that may be granted under the 2002 Plan is 519,283. The 2002 Plan may be used for non-statutory grants
only and no options may be granted to executive officers or directors. These options may be granted at not less than 85% of fair market value, but are generally issued at fair market value.



As a result of our acquisition of WebTrends Corporation (WebTrends) on
March 30, 2001, we assumed the outstanding options granted by WebTrends under its option plan and assumed that plan as the NetIQ Amended and Restated 1998 Stock Incentive Compensation Plan (1998 Stock Plan). On December 17, 2001 the Board
of Directors approved and adopted the NetIQ Corporation Approved UK Sub Plan (UK Sub Plan) under the 1998 Stock Plan and reserved 500,000 shares for issuance thereunder. On October 21, 2003, the Board of Directors approved the reduction of the
number of shares reserved for issuance under the UK Sub Plan from 500,000 shares to 250,000 shares. The UK Sub Plan was approved by the United Kingdom Inland Revenue in February 2002 and we have used the shares available under the UK sub plan only
for the purpose of granting options to our employees in the United Kingdom. At June 30, 2005 the number of shares of common stock subject to outstanding options under the 1998 Stock Plan is 1,831,129, and the number of shares of common stock
that may be granted under the 1998 Stock Plan is 481,000, of which 152,226 shares are covered by the UK Sub Plan.



As a result of our acquisition of Mission Critical Software, Inc. (Mission Critical) on May 12, 2000, we assumed the outstanding options granted by
Mission Critical under the Mission Critical 1997 Stock Plan (Mission Critical Plan). At June 30, 2005 the number of shares of common stock subject to outstanding options under the Mission Critical Plan is 262,957, and no additional shares of
common stock can be granted under the Mission Critical Plan. As a result of our acquisition of PentaSafe Security Technologies, Inc. (PentaSafe) on December 9, 2002, we assumed the outstanding options granted by PentaSafe under the PentaSafe,
Inc. Third



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Amended and Restated 1998 Stock Purchase and Option Plan (PentaSafe Plan). At June 30, 2005 the number of shares of common stock subject to outstanding
options under the PentaSafe Plan is 1,001,446 and no additional shares of common stock can be granted under the PentaSafe Plan



On June 27, 2005, our Board of Directors awarded restricted stock purchase rights, under the Companys 1995 Stock Plan, or restricted stock
units, under the Companys 1998 Stock Plan, covering a total of 1,461,836 shares, to substantially all of the Companys active employees (approximately 950 employees). The program did not include employees resident in certain countries
outside the United States where the cost of regulatory compliance (given the number of employees in that jurisdiction or the regulatory scheme) were deemed excessive for the benefits conferred. Restricted stock purchase rights covering a total of
270,000 restricted shares were granted to executive officers, exclusive of the Companys Chief Executive Officer, who did not participate in this program. These awards vest over an approximately 2 year period.



The following table summarizes common stock subject to future issuance under
the Companys equity compensation plans as of June 30, 2005:



|                                      |  |                                                         |  |                               |       |                                                                            |           |    
|------------------------------------- |  | ------------------------------------------------------- |  | ----------------------------- | ----- | -------------------------------------------------------------------------- | --------- | ---
|                                      |  | Stock to be issuedupon exerciseof outstandingoptions(1) |  | Weighted-averageexerciseprice |       | Stock remainingavailable for futureissuance under equitycompensation plans |          
|Plans approved by stockholders(2)     |  | 11,087,639                                              |  | $                             | 17.13 |                                                                            | 3,132,929 | (3)
|Plans not approved by stockholders(4) |  | 3,071,045                                               |  | $                             | 17.96 |                                                                            | 1,000,283 |    
|                                      |  |                                                         |  |                               |       |                                                                            |           |    
|Total                                 |  | 14,158,684                                              |  |                               |       |                                                                            | 4,133,212 |    
|                                      |  |                                                         |  |                               |       |                                                                            |           |    

---

|(1) | Does not include an aggregate of 1,001,446 shares of common stock to be issued upon exercise
of options assumed under the PentaSafe Plan.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes the 1995 Plan and the Purchase Plan.
|--- | ---------------------------------------------

|(3) | Does not include 2,334,523 shares of common stock reserved for issuance pursuant to the
Purchase Plan.
|--- | ------------------------------------------------------------------------------------------------------

|(4) | Includes the 2002 Plan, the 1998 Stock Plan, including the UK Sub Plan and the Mission
Critical Plan.
|--- | -----------------------------------------------------------------------------------------------------



A Summary of stock option
activity under the Plans is as follows:



|                                                      |  |                             |        |  |                     |                                |  |   |      
|----------------------------------------------------- |  | --------------------------- | ------ |  | ------------------- | ------------------------------ |  | - | -----
|                                                      |  | Shares Availablefor Options |        |  | Options Outstanding
|                                                      |  |                             | Shares |  |                     | Weighted-AverageExercise Price
|Outstanding, June 30, 2003                            |  | 5,709,798                   |        |  | 12,614,884          |                                |  | $ | 21.26
|Grantedoptions                                       |  | (6,774,998                  | )      |  | 6,774,998           |                                |  | $ | 13.69
|Exercisedoptions                                     |  |                            |        |  | (888,285            | )                              |  | $ | 9.98 
|Cancelledoptions                                     |  | 3,259,892                   |        |  | (3,259,892          | )                              |  | $ | 19.85
|Expiredoptions                                       |  | (854,912                    | )      |  |                    |                                |  |   |     
|Additional shares reserved                            |  | 2,600,000                   |        |  |                    |                                |  |   |     
|                                                      |  |                             |        |  |                     |                                |  |   |      
|Outstanding, June 30, 2004                            |  | 3,939,780                   |        |  | 15,241,705          |                                |  | $ | 18.86
|Grantedoptions                                       |  | (4,194,806                  | )      |  | 4,194,806           |                                |  | $ | 9.67 
|Grantedrestricted stock and restricted stock units   |  | (1,744,721                  | )      |  |                    |                                |  |   |     
|Exercisedoptions                                     |  |                            |        |  | (467,604            | )                              |  | $ | 7.31 
|Cancelledoptions                                     |  | 3,808,777                   |        |  | (3,808,777          | )                              |  | $ | 17.54
|Cancelledrestricted stock and restricted stock units |  | 32,885                      |        |  |                    |                                |  |   |     
|Expiredoptions                                       |  | (308,703                    | )      |  |                    |                                |  |   |     
|Additional shares reserved                            |  | 2,600,000                   |        |  |                    |                                |  |   |     
|                                                      |  |                             |        |  |                     |                                |  |   |      
|Outstanding, June 30, 2005                            |  | 4,133,212                   |        |  | 15,160,130          |                                |  | $ | 17.00
|                                                      |  |                             |        |  |                     |                                |  |   |      



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Factors That May Affect Future Results



In addition to the other information contained in this Annual Report on Form 10-K, the following risk factors should be
carefully considered. 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 less significant also may impair our business operations. The
occurrence of any of the following risks could materially and adversely affect our business, financial condition and operating results.



Success in our markets requires rapid innovation and response to market changes, and we may be unable to remain competitive.



The markets for our systems and security management software solutions are
characterized by rapid technological innovation, with frequent product introductions and enhancements. To maintain our competitive position, we must continue to develop new products and services, and to enhance the features, functionality and
performance of our existing products and services. The development of new products and services, and the enhancement of existing products and services, require significant investment and planning, and entail significant risk of technical failure. If
we are unable to successfully and timely innovate in response to the offerings of our competitors and the requirements of our customers, our products and services may become obsolete, our ability to compete may be impaired, and our operating results
may suffer.



We expect to face increasing competition in
the future, which could result in loss of market share, decreased prices, reduced gross margins and diminished profits.



The markets for our systems and security management software solutions are intensely competitive, and we expect competition to continue to increase in the
future. There are few substantial barriers to entry at the low end to prevent new entrants to those markets. Moreover, many of our competitors and potential competitors have substantially greater financial and other resources than we have or may
enjoy other competitive advantages. As a consequence, these competitors may have greater name and brand recognition, develop more advanced technology, deliver more compelling solutions, bring solutions to market more rapidly, undertake more
extensive sales and marketing campaigns, adopt more aggressive pricing policies and sales terms, and be able to leverage more extensive financial, customer and partner resources.



Our principal competitors include:



| |  | providers of network and systems management products, such as BMC Software, Inc., Computer Associates International, Inc., Hewlett-Packard Company, International Business Machines
Corporation and Microsoft Corporation;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | providers of security management solutions, such as ArcSight Inc., BindView Corporation, Computer Associates International, Inc., Configuresoft, Inc., International Business
Machines Corporation, Internet Security Systems, Inc., McAfee, Inc., netForensics Inc., and Symantec Corporation;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  | providers of content security solutions, such as Clearswift Limited, Postini Corporation, SurfControl plc, Symantec Corporation, Trend Micro, Inc., Tumbleweed Communications Corp.,
and Websense, Inc.;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | customers internal information technology departments that develop or integrate systems management and security management solutions for their particular needs.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



Due to the competitive nature of our markets, we
have experienced increasing pressure on product and service pricing, and we may be required to continue to lower our prices to remain competitive. Our failure to effectively compete with our competitors, on the basis of price, technology, available
solution sets or otherwise, could lead to our inability to achieve anticipated revenue and adversely affect our operating results.



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The trend towards consolidation in the software industry could impede our ability to compete
effectively.



The software industry has experienced
increasing consolidation, as software firms seek to offer broader arrays of products and product functionality, to integrate hardware and software solutions, and to achieve greater economies of scale. The firms resulting from these consolidations
may have greater resources, more compelling product offerings and greater pricing flexibility than our existing competitors, making it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs,
technology, and available solution sets. In addition, the industry trend towards consolidation may impact customers perceptions of the viability of smaller or even medium sized software firms and consequently customers willingness to
purchase from such firms.



The trend towards product
integration and bundling could impede our ability to compete effectively.



We have seen increasing integration and bundling of software products in the systems and security market into solution sets or bundles, and expect integration and bundling to be an important competitive factor in the
future. We anticipate that competitors may bundle their products with products similar to ours, or incorporate functionality into their existing products that could render certain of our products unmarketable or obsolete. Microsoft is a competitor
for certain of our products and has an established business practice of adding functionality to new versions of Windows in ways that can impair the success of formerly complementary products. For instance, if Microsoft were to incorporate Microsoft
Operations Manager with its Windows operating system, the demand for our AppManager product could be affected. Customer perception of this pattern could also adversely affect or delay sales of our products. If we are unable to sufficiently
differentiate our products from the integrated or bundled products of our competitors, such as by price or enhanced functionality or performance, we may see a decrease in demand for those products.



We expect our quarterly revenue and operating results to fluctuate for
a number of reasons, and it is difficult to predict our future revenue and operating results.



Our revenue and operating results have varied in the past and are likely to vary significantly from period to period in the future. These fluctuations are
due to a number of factors, many of which are outside of our control, including:



| |  | general economic conditions and the discretionary nature of our customers purchasing practices, IT budgets and budget cycles;
|- |  | ------------------------------------------------------------------------------------------------------------------------------



| |  | the timing of new product introductions or enhancements by us, our competitors and our platform vendors, which may result in purchase deferrals by our customers in anticipation of
new products;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | competitive conditions in our industry, including new products, product announcements and programs offered by our competitors;
|- |  | ------------------------------------------------------------------------------------------------------------------------------



| |  | changes in our pricing policies or those of our competitors;
|- |  | ------------------------------------------------------------



| |  | our ability to introduce new products and enhancements and the timing of their release;
|- |  | ---------------------------------------------------------------------------------------



| |  | our ability to complete specific sales transactions in a given quarter or fiscal year;
|- |  | --------------------------------------------------------------------------------------



| |  | changes in the mix of products or services sold in a quarter;
|- |  | -------------------------------------------------------------



| |  | fluctuation in the number and size of orders in a quarter;
|- |  | ----------------------------------------------------------



| |  | unanticipated operating expense; and
|- |  | ------------------------------------



| |  | our ability to recognize revenues from the fees we charge to our customers.
|- |  | ---------------------------------------------------------------------------



We base our operating expenses on our expectations regarding future revenue. However, a significant portion of our revenue historically has been generated
during the last month of each fiscal quarter, with a substantial portion of sales occurring in the last week and on the last day of the fiscal quarter. Since we may not



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learn of shortfalls in anticipated revenue until late in a particular quarter, we may be unable to proportionately reduce operating expenses for that
quarter. As a consequence, our operating results may fail to meet the expectations of our investors or securities analysts, and the market price of our stock could decline.



Our license bookings historically have been seasonal, with the second and fourth quarter of our fiscal year typically having
the largest volume in new license bookings. We believe that this seasonality results from the budgeting, procurement and work cycles of our customers, and from the structure of our direct sales incentive and compensation program. We expect this
seasonality to continue in the future.



Given the above
factors, we believe that sequential revenue comparisons are not necessarily meaningful, and should not be relied upon as indicative of our future performance.



If we are unable to sufficiently align our expenses with revenue we will be unable to achieve an acceptable operating profit.



Since our inception, we have incurred significant net losses from
continuing operations. During fiscal 2005, 2004 and 2003, we reported net losses from continuing operations of $10.5 million, $159.2 million and $299.9 million, respectively. These losses principally resulted from impairment of
goodwill, amortization of purchased technology and other intangible assets, and other acquisition related charges.



We expect to incur a net loss in fiscal 2006. To the extent our operating expenses exceed our expectations or we do not accurately forecast our
operating results, our earnings may be harmed, which may in turn adversely affect our stock price.



We continue to adopt a number of measures to better align our expenses with anticipated revenue, including various reductions in headcount, closure of
facilities and reorganization of our business, including the divestiture of the Web analytics business, to better address our strategic business initiative. In addition, we have taken steps to improve the efficiency of our sales force. However,
while these measures have contributed to improved operating profitability during certain recent periods, we have not been wholly successful in achieving an operating profit commensurate with that of many of our peers, and we continue to focus on
reduction of our operating expenses, as well as seeking to grow revenue. The organizational and operational changes that we believe are necessary to achieve an acceptable operating profit may disrupt our business or negatively impact customer
service and satisfaction, and consequently our ability to grow our revenue. Such changes also may not result in the intended operational improvements and cost reductions, and may adversely affect our business, results of operations and financial
condition.



Our recent restructuring activities may
adversely impact our future performance.



We continue
to adopt a number of measures to better align our expenses with anticipated revenue, including various reductions in headcount, closure of facilities and reorganization of our business to better address our strategic business initiative. Such
changes may not result in the intended operational improvements and cost reductions, and may adversely affect our business, results of operations and financial condition.



We commenced realignment of our North American sales force during the fourth quarter of fiscal 2005 and such efforts will
continue into the first quarter of fiscal 2006, which could impact our ability to make anticipated sales during the first quarter of fiscal 2006 and thereafter. In addition, we recently announced that we would be reducing our workforce by 15 percent
(from the level at March 31, 2005) during fiscal 2006, and we commenced the transfer of selected business operations from San Jose, California to Houston, Texas. We also commenced the transition of certain of our software development activities
from San Jose, California to a global operations center run by a third-party provider in Bangalore, India. These types of changes can cause material disruption to our business operations, including reduced employee morale and difficulties in
retaining and attracting highly skilled personnel. Affected employees may take retaliatory action against us, such as by misappropriating or damaging our property. While we may seek to relocate certain key personnel, not all such employees may be



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wiling to relocate, which could result in our losing the knowledge held by such employees. Political uncertainty in India could interfere with our
development efforts and we may not be able to adequately protect our intellectual property rights in that region due to piracy, misappropriation or weaker legal protection for intellectual property. We may have difficulty managing our remote
development activities, resulting in diminished quality of certain products or our failure to meet anticipated product release dates.



Changes in financial accounting standards or practices, including those that require us to recognize employee stock options as a compensation
expense, could substantially and adversely our financial results.



The accounting rules applicable to our business have undergone significant changes in recent years, and future changes in accounting regulations and related interpretations and policies, particularly those related to
expensing of employee stock options, could cause us to account for our business in ways that may adversely affect our financial results and investor perception of those results. As permitted by SFAS No. 123, Accounting for Stock-Based
Compensation, during fiscal 2005 we applied Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for our employee stockbased compensation. Under
APB No. 25, no compensation expense is recognized for options granted to employees where the exercise price equals the market price of the underlying stock on the date of grant. On December 16, 2004, the Financial Accounting Standards
Board (FASB) issued Statement No. 123 (R), Share-Based Payment. Statement No. 123(R) requires that, commencing with fiscal 2006, we recognize compensation expense in an amount equal to the fair value of share-based payments, such as
stock options and restricted stock, granted to employees. This is expected to have a material impact on our consolidated results of operations.



We expect that our implementation of the change proposed by FASB Statement No.123(R) will result in a reduction of our operating income or an increase in
our operating losses as a result of these non-cash expenses. In such an event, investor perception of our results of operations may be adversely affected and our stock price may fall.



We may not be successful in executing our product strategies and our customers may not accept our product strategies.



Our Knowledge-Based Service Assurance strategy
requires us to develop new product capabilities, to integrate our new and existing products with each other, and to develop new common components that will be used by multiple products. We may not be successful in developing these new capabilities
within the timeframe required for market acceptance. We may also overestimate the aggregate demand for these new capabilities and over-invest in their development. Competitors may market products with these capabilities prior to us, and we may
encounter technical difficulties with developing these capabilities as envisioned. Moreover, customers may not accept our newly introduced products and may be reluctant to purchase products from us if they do not accept our overall product strategy
and vision. Our business and operating results could materially suffer unless we are able to respond quickly and effectively to these developments.



In order to focus our resources behind our Knowledge-Based Service Assurance strategy, we have reduced emphasis on those products that do not fall solidly
within this strategy and may sell or license the rights to those products or discontinue manufacturing them. Our customers may not accept these product decisions and may not want to license additional products from us. Any decision to limit
investment in or dispose of or otherwise exit businesses may result in the recording of special charges, such as technology related write-offs, workforce reduction costs, charges relating to consolidation of excess facilities, or claims from third
parties who were resellers or users of discontinued products. Our estimates with respect to the useful life or ultimate recoverability of our carrying basis of assets, including purchased intangible assets, could change as a result of such
assessments and decisions.



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Our investments in products and companies, including through internal development and acquisition,
present many risks, and we may not realize the financial and strategic goals that were contemplated at the time of the investment.



We have made substantial investments in developing and acquiring new products, services and technologies, and have made investments in and acquisitions of
other companies. We intend to continue to make investments in products, services and technologies, and may in the future acquire or make investments in companies we perceive to be complementary or to have synergies with our business. The risks we
may encounter in connection with such investments include:



| |  | the investment may not further our business strategy, we may pay more than the investment proves to be worth, the technology may not be feasible or may fail to be popular with
customers, or economic conditions may change, any of which may diminish the value of the investment to us;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we may fail to anticipate new technological developments, customer requirements or industry standards, or may be unable to develop or purchase new products, services and
technologies that adequately address these developments, requirements or standards in a timely manner;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we may have difficulty integrating the investment with our business, marketing and sales strategies;
|- |  | ----------------------------------------------------------------------------------------------------



| |  | we may have difficulty integrating acquired technologies, operations or personnel into our existing business and product lines; and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  | our ongoing business may be disrupted by transition or integration issues arising from the investment.
|- |  | ------------------------------------------------------------------------------------------------------



Our failure to realize the anticipated benefits or synergies of our investments may adversely affect our operating results,
consolidated financial position, cash flows and stock price. Our earnings may be adversely affected by amortization of purchased technology and other intangible assets, other acquisition or investment related charges, and impairment charges
associated with goodwill. In addition, we may be required to record charges for impairment if a product or technology is later discontinued, if we pay more than an investment is worth, or if an investment subsequently declines in value. In the past
we have taken significant impairment charges as a consequence of revised forecasts for future operating profits and cash flows from our investments and the decline in our market capitalization. We will be required to record additional charges if in
future periods we discontinue additional products, or determine that our remaining goodwill has become further impaired or that our investments have further declined in value.



The consideration paid in connection with an investment or acquisition also affects our immediate operating results and
financial condition. To the extent we issue shares of stock or other rights to purchase stock, such as options, the stock holdings of existing stockholders will be diluted and earnings per share may decrease. To the extent we pay cash for future
investments or acquisitions, our cash reserves will be commensurately reduced.



The development and enhancement of many of our products requires early access to third party technology.



Our ability to sell our products depends, in part, on the compatibility of our products with other third-party products, such as operating systems and
messaging, Internet and database applications, which may require that we have access to third party technology to develop and test our products and new versions of our products. Some of these third-party software developers may change their products
so that they are no longer compatible with our products. In particular, our business continues to be largely focused on the Microsoft Windows environment and Microsoft has typically provided to us pre-release notification of feature enhancements to
its products and necessary development tools and information. If Microsoft stops this practice, we may be unable to coordinate our product offerings with Microsoft or to otherwise capitalize on new Microsoft product releases and feature
enhancements.



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We incorporate software licensed from third parties into some of our products and any significant
interruption in the availability of these third-party software products or defects in these products could reduce the demand for, or prevent the sale or use of, our products.



Certain of our software products contain components developed and maintained by commercial third-party software vendors or
available through the open source software community. We also expect that we may incorporate software from commercial third-party vendors and open source software in our future products. Software obtained from commercial third-party
vendors is typically made available for a specific term, with no guaranty of renewal. Our business would be disrupted if this software, or functional equivalents of this software, were either no longer available to us or no longer offered to us on
commercially reasonable terms. In either case, we would be required to either redesign our software to function with alternate third-party software or open source software, or develop these components ourselves, which would result in increased costs
and could result in delays in our software shipments. Alternatively, we might be forced to limit the features available in our current or future software offerings, which could adversely affect our ability to sell our products and services.



Our business requires the creation of technology and the
effective protection and enforcement of our intellectual property rights in that technology.



Our success is heavily dependent on our ability to create proprietary technology and to protect and enforce our intellectual property rights in that
technology, as well as our ability to defend against adverse claims of third parties with respect to our technology and intellectual property. We rely on a combination of patents, copyrights and trademarks, service marks, trade secrets,
confidentiality procedures and contractual provisions (including confidentiality and licensing restrictions) to protect our intellectual property rights in our products and services. These laws and procedures provide only limited protection, and may
not provide sufficiently broad protection or be enforceable in actions against alleged infringers. In particular, the laws of some foreign countries do not protect our intellectual property rights to as great an extent as do the laws of the United
States, and some of our license provisions may be unenforceable under the laws of certain jurisdictions. In addition, despite precautions that we take, it may be possible for unauthorized third parties to copy or reverse engineer aspects of our
current or future products or to independently develop similar or superior technology or design around the patents we own.



It occasionally is necessary to enforce or defend our intellectual property rights through the process of litigation, arbitration or other adversarial
proceedings. Such proceedings can be costly and potentially distracting to management, and even if successful, can adversely affect our operating results.



Sales of our products may be adversely affected by software piracy.



Policing unauthorized use and transfer of our software is difficult. Although we are unable to quantify the extent of piracy
of our software products, certain of our products have been subject to software piracy and our exposure to software piracy is expected to increase as we expand our international operations and obtain certain engineering services through our
relationship with a third party providing such services from Bangalore, India.



Third parties could assert that our products infringe their intellectual property rights.



Third parties may claim that our current or future products infringe their intellectual property rights, and these claims, even if without merit, could
harm our business by increasing our costs, reducing our revenue or by creating customer concern or confusion that results in reduced sales. This is particularly true in the patent area, as an increasing number of U.S. patents covering computer
software have been issued during the past few years. Patent owners may claim that one or more of our products infringes a patent held by the claimant. For example, in January 2003, one of our competitors, BMC Software, Inc., initiated a lawsuit
alleging that one or more of our products infringed a BMC patent. These claims now have been submitted to arbitration. Although we believe these claims to be without merit, the costs of defense have been significant. The intensely competitive nature
of our industry and the importance of technology to our competitors businesses may enhance the likelihood of being subject to third-party claims of this nature. Any such claims, even if without merit, could be time consuming, result in
potentially significant litigation costs or damages, cause product shipment delays and



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require us to enter into royalty or licensing agreements. Royalty or license agreements may not be available on commercially favorable terms or at all. The
judgments or awards entered with respect to such claims could require 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, the functionality of products in different industry
segments overlaps, and the number of issued software patents increases.



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 that could be detected at any point in a products life cycle. Moreover, the
complexity of our products, and the associated risk of errors, may increase as we pursue our Knowledge-Based Service Assurance strategy, as this strategy involves integrating our various complex independent products with each other into even more
complex solutions. These software errors could materially and adversely affect our business reputation, result in significant costs to us, and impair our ability to sell our products in the future. The costs incurred 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. Because it is difficult to simulate the highly complex computing environments in which our customers use our products and because of the increasing functionality of our product offerings, testing may be complicated and fail
to identify all errors. Moreover, because our products support and interoperate with third-party operating systems and applications, any errors or bugs in that software may result in problems with the performance of our products and may require
cooperation from the third-party to resolve.



Detection of
significant errors may result in, among other things, lost or delayed market acceptance and sales of our products, diversion of development resources, injury to our reputation, and increased service and warranty costs. Errors in our software also
may result in expensive and time-consuming litigation, and the potential award of substantial damages. While our software license agreements typically contain provisions designed to limit our liability for damages resulting from errors in our
software, there is no assurance that such provisions will be effective in limiting our liability. We presently carry errors and omissions insurance against such claims, but there is no assurance that such insurance coverage will be adequate to cover
any losses as a result of errors or will be available in the future on commercially reasonable terms.



Our international sales and operations subject us to additional risks that can adversely affect our operating results.



We derive a substantial and increasing amount of our revenues from customers
outside the United States and are continuing to expand our international operations. We have support and administrative services operations in Galway, Ireland, Tokyo, Japan and Staines, United Kingdom, and sales and support offices in a number of
other foreign locations. Our international operations subject us to a variety of risks, including:



| |  | the overlap of different tax regimes;
|- |  | -------------------------------------



| |  | the difficulty of managing and staffing foreign offices;
|- |  | --------------------------------------------------------



| |  | differing regulatory and legal requirements and employment schemes, including with respect to separation and redundancies, and our ability to identify and timely comply with such
requirements and schemes;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | longer payment cycles and difficulties in collecting accounts receivable;
|- |  | -------------------------------------------------------------------------



| |  | fluctuations in currency exchange rates and difficulties in transferring funds from certain countries;
|- |  | ------------------------------------------------------------------------------------------------------



| |  | the need to localize and internationalize our products and licensing programs;
|- |  | ------------------------------------------------------------------------------



| |  | significant reliance on our distributors and other resellers who do not offer our products exclusively;
|- |  | -------------------------------------------------------------------------------------------------------



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| |  | import and export licensing requirements, including export controls on encryption technology;
|- |  | ---------------------------------------------------------------------------------------------



| |  | political and economic instability in some countries, including terrorism and wars;
|- |  | -----------------------------------------------------------------------------------



| |  | seasonal reductions in business activity during the summer months in Europe and certain other regions;
|- |  | ------------------------------------------------------------------------------------------------------



| |  | laws restricting the use and transfer of personally identifiable information about our customers, employees and other individuals;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  | reduced protection for intellectual property rights in some countries; and
|- |  | --------------------------------------------------------------------------



| |  | increased travel and infrastructure costs associated with multiple international locations.
|- |  | -------------------------------------------------------------------------------------------



Any of these risks could harm our international operations and reduce our international sales, adversely affecting our
operating results.



Our stock buyback program will reduce
our available cash resources.



During fiscal 2005, we
repurchased and retired 8.8 million shares of our common stock pursuant to stock buyback programs approved by our Board of Directors. We have continued this program in fiscal 2006, and the Board has authorized the Company to spend up to $200
million on such repurchases under the current repurchase program. While we deem this a prudent expenditure, such repurchases serve to reduce our available cash and may limit our ability to make other investments.



Our financial results may be positively or negatively impacted by
foreign currency fluctuations.



To date, a substantial
portion of our sales have been denominated in U.S. dollars, and we have not used risk management techniques or hedged the risks associated with fluctuations in foreign currency exchange rates. During fiscal 2005 we recorded a gain of
approximately $375,000 consisting primarily of foreign exchange gains and losses on U.S. dollars and other foreign currency receivables held in subsidiaries with local functional currencies. In the future, if we continue not to engage in hedging
transactions, our results of operations could be subject to further fluctuations resulting in losses or gains from fluctuations in foreign currency exchange rates to the extent our sales are denominated in foreign currencies and the dollar
fluctuates in value relative to such currencies.



We are
increasingly relying on indirect distribution channels to generate revenue.



To further increase our revenues, we have increasingly relied on indirect distribution channels as a means of growing product sales, including with respect to international sales. These relationships, both
domestically and internationally, are typically non-exclusive and can be terminated upon short notice. This strategy presents a number of risks and uncertainties including:



| |  | the ability of resellers or integrators to cease marketing or integrating our products with little or no notice;
|- |  | ----------------------------------------------------------------------------------------------------------------



| |  | the ability of our resellers or integrators to market or use competitive products or services from third parties and to promote such third-party products or services in preference
to ours;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the effectiveness of our resellers and integrators in marketing our products;
|- |  | -----------------------------------------------------------------------------



| |  | the difficulty in attracting and replacing high quality resellers and integrators;
|- |  | ----------------------------------------------------------------------------------



| |  | the potential of conflicts between our direct and indirect sales channels resulting in lost sales and customer confusion or dissatisfaction;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  | financial difficulties that resellers or integrators may experience (and which may lead to payment problems); and
|- |  | -----------------------------------------------------------------------------------------------------------------



| |  | risk associated with accurately reporting revenue arising from these indirect distribution channels.
|- |  | ----------------------------------------------------------------------------------------------------



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We face challenges in the retention of key management, technical and sales personnel.



We depend on certain key management, technical and
sales personnel and on our ability to attract and retain highly qualified personnel. Given recent competitive pressures, we anticipate that it may become more difficult to retain key personnel. In addition, our ability to attract and retain
personnel may be made more difficult by anticipated changes in the accounting treatment of stock-based compensation, which may limit our ability to use broad-based stock option grants as a means to attract and retain qualified personnel. The
volatility or lack of improvement in our stock price may also affect our ability to attract and retain key personnel, who may expect to realize value from our stock options. In addition, our cash incentive plan is based upon company performance and
failure to achieve our established targets may limit the amount or eliminate the payment of cash incentive compensation and further impact our ability to retain key personnel.



Our success will depend to a significant extent on our ability to retain the services of our key personnel. We do not have
employment contracts for a defined term with our employees, including our key personnel. If we lose the services of one or more of our key personnel, including if one or more of our key employees decided to join a competitor or otherwise compete
directly or indirectly with us, our business and ability to successfully implement our business objectives could be negatively affected.



We continue to make substantial changes in our information systems, which could disrupt our business and adversely affect our operating results.



We are continuously engaged in the process of
improving our information systems, including modifying and refining our customer relationship management system and enterprise resource planning system to better meet our needs and to provide the enhanced reporting required by increased competitive
pressures and regulatory requirements. Disruption caused by the migration, or the failure, poor performance or errors of any of our systems could impact our ability to sell and deliver our products or could result in our inability to maintain our
internal controls to the standards required by applicable law, any of which could in turn materially and adversely impact our business, including our ability to meet our revenue and expense targets. Moreover, notwithstanding our investment in
maintenance and upgrades, our enterprise systems may not fully meet our needs in the future. If we determine to replace them, we may write off the remaining value of the associated assets.



Natural disasters and targeted attacks on our networks and data centers
may disrupt our business.



We rely on our network and
data center infrastructure for internal communications, communications with customers and partners, direct sales of our software products and sales lead generation. That infrastructure and our other facilities are vulnerable to damage from human
error, physical or electronic security breaches, power loss and other utility failures, fire, earthquake, flood, sabotage, vandalism and similar events. In addition, continued attempts to exploit security vulnerabilities in infrastructure products
pose a threat to the stability of our IT infrastructure. Despite precautions, a natural disaster or other incident could result in interruptions in our service or significant damage, and affect our provision of services and fulfillment of product
orders, our ability to process product orders and invoices, and our ability otherwise timely conduct our business operations.



Changes in our market may affect our operating results by changing the manner in which we are required to account for sales.



There have been various changes in the enterprise software market that may
affect the manner in which we do business. We currently sell most of our software licenses on a perpetual basis, which enables us to recognize the majority of revenue received in connection with the sale promptly upon consummation of the
sale. However, certain software vendors are moving towards a subscription-based model in which periodic fees are charged for use of the software. If customers increasingly demand that we sell licenses to our software on a subscription basis, or
otherwise charge a periodic fee for its use, it will delay our recognition of revenue for those sales and will decrease the revenue attributable to such sales during the reporting period in which the sale is made (although the associated deferred
revenue generally will be recognized in subsequent periods). If substantial portions of our license sales are converted to a subscription basis, this could materially affect our revenue during the initial quarters in which the change is implemented.



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The price of our stock may fluctuate significantly, which may result in losses for investors.



Our stock price has been volatile and we expect that
it will continue to fluctuate in the future. The value of an investment in our stock could decline due to the impact of a number of factors upon our stock price, many of which are outside of our control and are unrelated to our actual operating
results. These factors include:



| |  | changes in the market valuations of technology and software companies;
|- |  | ----------------------------------------------------------------------



| |  | changes in general economic conditions;
|- |  | ---------------------------------------



| |  | the effects of war and terrorist attacks;
|- |  | -----------------------------------------



| |  | actual or anticipated variations in our operating results and revenues;
|- |  | -----------------------------------------------------------------------



| |  | announcements of new products, investments or developments by us or our competitors;
|- |  | ------------------------------------------------------------------------------------



| |  | industry and product consolidation;
|- |  | -----------------------------------



| |  | changes by securities analysts of their estimates of our earnings or valuation; and
|- |  | -----------------------------------------------------------------------------------



| |  | the failure of our performance to meet the expectations of securities analysts.
|- |  | -------------------------------------------------------------------------------



We have various mechanisms in place that may discourage takeover attempts.



Certain provisions of our certificate of incorporation and bylaws and
certain provisions of Delaware law could delay or make difficult a change in control that a stockholder may consider favorable. Our certificate of incorporation allows our Board of Directors to designate and issue one or more series of preferred
stock that may have rights preferences and privileges superior to our common stock without any action by our stockholders. Our bylaws limit the ability of a stockholder to call a special meeting. Although we intend to seek stockholder approval to
eliminate our classified Board of Directors at the fiscal 2005 annual stockholders meeting, our Board of Directors presently has staggered, three-year terms, which may lengthen the time required to gain control of our Board. In addition,
certain of our officers are parties to a Change of Control Agreement or other agreements with us that provide for the acceleration of stock option and restricted stock vesting and the payment of certain compensation in the event such officers
employment is terminated within a specified period after a change of control. In addition, our 1995 and 2002 Stock Plans provide for acceleration of the vesting of employee stock-based compensation in the event an employees employment is
terminated within a specified period after a change of control. Any of these provisions could dissuade a potential acquirer from seeking to acquire control of NetIQ, which in turn could result in our stockholders not being able to participate in
premiums that may otherwise have been offered in a potential acquisition.



|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.



Our business is transacted principally in U.S. dollars. During the fiscal
year ended June 30, 2005, 18% of the total amount of our invoices was in currencies other than the U.S. 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, Ireland, 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 offsets some of 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, 2005, we had no hedging contracts outstanding.



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At June 30, 2005 we had $101.4 million in cash and cash equivalents and $195.3 million in
short-term investments. Based on our cash, cash equivalents and short-term investments at June 30, 2005 a 10% change in interest rates would change our annual interest income and cash flows by approximately $705,000.



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------



The financial statements and supplementary financial information required to be filed under this Item and the Schedule of Valuation and Qualifying
Accounts are presented in Item 15.



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



Not applicable.



ITEM 9A.CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



Under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), we conducted an evaluation of our disclosure controls and procedures, as such term is defined
under Rules 13a-15(e) or 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of
the period covered by this annual report.



Managements
Annual Report on Internal Control Over Financial Reporting



Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934, as amended). Our management, including
our CEO and CFO, conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2005. In making our evaluation, we used the framework set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal ControlIntegrated Framework.



Based on our evaluation, under the framework set forth by the COSO in Internal ControlIntegrated Framework, our management concluded that, as of June 30, 2005, our internal control over financial
reporting was effective. Our managements assessment of the effectiveness of our internal control over financial reporting as of June 30, 2005 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as
stated in their report which is included herein.



Our
management, including our CEO and CFO, acknowledge that because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



Changes in Internal Control Over Financial Reporting



There were no changes in our internal control over financial reporting identified in connection with the evaluation required
by paragraph (d) of the Exchange Act Rules 13a-15 or 15d-15 that occurred during the quarter ended June 30, 2005 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Stockholders of

NetIQ Corporation

San Jose, California



We have audited
managements assessment, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting, that NetIQ Corporation and subsidiaries (the Company) maintained effective internal control over
financial reporting as of June 30, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Companys management is responsible
for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion
on the effectiveness of the Companys internal control over financial reporting based on our audit.



We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial
reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.



A companys
internal control over financial reporting is a process designed by, or under the supervision of, the companys principal executive and principal financial officers, or persons performing similar functions, and effected by the companys
board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions
of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the companys assets that could have a material effect on the financial statements.



Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override
of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are
subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



In our opinion, managements assessment that the Company maintained effective internal control over financial reporting
as of June 30, 2005, is fairly stated, in all material respects, based on the criteria established in Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in
our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2005, based on the criteria established in Internal ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission.



We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheet and the related consolidated statement of operations and comprehensive
loss, stockholders equity, cash flows and the financial statement schedule of the



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##### Table of Contents

Company as of and for the year ended June 30, 2005 and our report dated September 12, 2005, expressed an unqualified opinion on those financial
statements and the financial statement schedule and includes explanatory paragraphs related to the adoption of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets and the retroactive adjustment of
NetIQ Corporations consolidated financial statements to account for the sale of the WebTrends web analytics business as discontinued operations for all periods presented in accordance with Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long Lived Assets.



/s/ Deloitte & Touche LLP



San
Jose, California

September 12, 2005



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##### Table of Contents

PART III



|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- | --------------------------------------------------



For information with respect to our executive officers, see the section captioned Executive Officers at the end of Part I of this report. All
other information required by this item is incorporated by reference to the sections captioned Election of Directors and Section 16(a) Beneficial Ownership Reporting Compliance contained in the Proxy Statement to be filed in
connection with our 2005 Annual Meeting of Stockholders.



|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 2005 Annual Meeting of Stockholders.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



The information required by this item is incorporated by reference to the section captioned Beneficial Ownership of
Company Stock contained in the Proxy Statement to be filed in connection with our 2005 Annual Meeting of Stockholders.



See the information contained under the heading Employee Stock Options within Item 7 of this Form 10-K regarding common stock subject to
future issuance under the Companys equity compensation plans and warrant agreements as of June 30, 2005.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- | ----------------------------------------------



The information required by this item is incorporated by reference to the section captioned Certain Relationships and Related Transactions
contained in the Proxy Statement to be filed in connection with our 2005 Annual Meeting of Stockholders.



|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------



The information required by this item is incorporated by reference to the section captioned Audit and Related Fees contained in the Proxy
Statement to be filed in connection with our 2005 Annual Meeting of Stockholders.



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##### Table of Contents

PART IV



|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|-------- | ------------------------------------------



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 Registered Public Accounting Firm, are included in this Report on the pages indicated:



|                                                                                                               |  |     
|-------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                               |  | Page
|Report of Independent Registered Public Accounting Firm                                                        |  | 50  
|Consolidated Balance Sheets as of June 30, 2005 and 2004                                                       |  | 51  
|Consolidated Statements of Operations and Comprehensive Loss for the Years ended June 30, 2005, 2004, and 2003 |  | 52  
|Consolidated Statements of Stockholders Equity for the Years ended June 30, 2005, 2004, and 2003              |  | 53  
|Consolidated Statements of Cash Flows for the Years ended June 30, 2005, 2004, and 2003                        |  | 54  
|Notes to Consolidated Financial Statements                                                                     |  | 55  



2. Financial
Statement Schedules.    The following financial statement schedule of the Company for the years ended June 30, 2005, 2004 and 2003, is filed as part of this report on Form 10-K and should be read in conjunction with the
financial statements.



|         |  |                                   |  |     
|-------- |  | --------------------------------- |  | ----
|Schedule |  | Title                             |  | Page
|         |  |                                  
|II       |  | Valuation and Qualifying Accounts |  | 80  



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.



|              |  |                                                                                                                                                                                                                                                      
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                          
|              | 
|3(a)+         |  | Restated Certificate of Incorporation of NetIQ (incorporated by reference to the exhibit 3(a) filed with NetIQs Registration Statement on Form S-4, declared effective February 23,
2001)                                                           
|              | 
|3(b)+         |  | Restated Bylaws of NetIQ (incorporated by reference to the exhibit 3(ii) filed with NetIQs Quarterly Report on Form 10-Q filed February, 13, 2004)                                                                                                  
|              | 
|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 10.1 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Amended                                                                                                                                              
|              | 
|10.3A+        |  | Amended and Restated 1995 Stock Plan                                                                                                                                                                                                                 
|              | 
|10.3B+        |  | Form of Stock Option Agreement under the Amended and Restated Stock Plan (incorporated by reference to the exhibit 10.3B filed with NetIQs Registration Statement on Form S-1, declared
effective July 29, 1999)                                    



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##### Table of Contents

|              |  |                                                                                                                                                                                                                                                          
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                              
|              | 
|10.3C+        |  | Form of Director Option Agreement under the 1995 Amended and Restated Stock Plan (incorporated by reference to the exhibit 10.3C 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 10.4A 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 10.4B filed with NetIQs Registration Statement on Form S-1, declared
effective July 29, 1999)                                      
|              | 
|10.5A+        |  | 2002 Stock Plan (incorporated by reference to the same exhibit 10.5 filed with NetIQs Initial employee benefits plan statement on Form S-8, filed January 30, 2002)                                                                                     
|              | 
|10.5B+        |  | Form of 2002 Option Agreement                                                                                                                                                                                                                            
|              | 
|10.6*+        |  | License, Development and Marketing Agreement, dated September 25, 2000 between NetIQ and Microsoft Corporation (incorporated by reference to the exhibit 10.10 filed with NetIQs
Quarterly Report on Form 10-Q, filed November 14, 2000)                
|              | 
|10.7+         |  | Employment Agreement, dated January 25, 2002 by and between NetIQ and Charles M. Boesenberg (incorporated by reference to the exhibit 10.12 filed with NetIQs Quarterly Report on Form
10-Q, filed February 12, 2002)                                   
|              | 
|10.8+         |  | Action by Unanimous Written Consent of the Compensation Committee of NetIQ, effective as of January 25, 2002 (incorporated by reference to the exhibit 10.13 filed with NetIQs Quarterly
Report on Form 10-Q, filed February 12, 2002)                  
|              | 
|10.9+         |  | Common Stock Warrant Agreement, dated March 31, 2002 by and between NetIQ and Heidrick & Struggles, Inc. (incorporated by reference to the exhibit 10.16 filed with NetIQs Quarterly
Report on Form 10-Q, filed May 14, 2002)                           
|              | 
|10.10A+       |  | Amended and Restated 1998 Stock Incentive Compensation Plan (incorporated by reference to the exhibit 10.17 filed with NetIQs Quarterly Report on Form 10-Q, filed May 14,
2002)                                                                        
|              | 
|10.10B+       |  | Form of Amended and Restated 1998 Stock Option Agreement                                                                                                                                                                                                 
|              | 
|10.11A+       |  | The Approved UK Sub-Plan of the NetIQ Amended and Restated 1998 Stock Incentive Compensation Plan (incorporated by reference to the exhibit 10.18 filed with NetIQs Quarterly Report on
Form 10-Q, filed May 14, 2002)                                  
|              | 
|10.11B+       |  | Form of the stock option agreement under the Approved UK Sub-Plan of the NetIQ Amended and Restated 1998 Stock Incentive Compensation Plan                                                                                                               
|              | 
|10.12+        |  | Agreement of Sublease, dated April 30, 2002 between NetIQ and Compaq Computer Corporation                                                                                                                                                                
|              | 
|10.13A+       |  | PentaSafe, Inc. Third Amended and Restated 1998 Stock and Option Plan (incorporated herein by reference to the Companys Registration Statement on Form S-8 (File No.
101821))                                                                           
|              | 
|10.13B+       |  | Form of the PentaSafe, Inc. Third Amended and Restated 1998 Option Agreement                                                                                                                                                                             
|              | 
|10.14+        |  | Waiver Agreement to Employment Agreement and Certain Option Agreements by and between NetIQ and Charles M. Boesenberg                                                                                                                                    
|              | 
|10.15+        |  | Restricted Stock Purchase Agreement by and between NetIQ and Charles M. Boesenberg                                                                                                                                                                       
|              | 
|10.16         |  | NetIQ Corporation Management Incentive Plan for Fiscal 2005 (incorporated by reference to the exhibit 10.1 filed with NetIQs Report on Form 8-K, filed October 22, 2004)                                                                                
|              | 
|10.17         |  | Asset Purchase Agreement, dated as of March 26, 2005, between NetIQ Corporation, NetIQ Ireland Limited, NetIQ Limited and Spider Holding Inc. (incorporated by reference to the exhibit 10.1
filed with NetIQs Report on Form 8-K, filed March 29, 2005)



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##### Table of Contents

|              |  |                                                                                                                                                                
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                    
|              | 
|10.18         |  | Marc Andrews terms and conditions regarding relocation (incorporated by reference to the exhibit 10.1 filed with NetIQs Report on Form 8-K, filed May 6, 2005)
|              | 
|10.19         |  | Form of Restricted Stock Purchase Agreement (incorporated by reference to the exhibit 99.1 filed with NetIQs Report on Form 8-K, filed June 27, 2005)         
|              | 
|21            |  | Subsidiaries of the Registrant                                                                                                                                 
|              | 
|23            |  | Consent of Independent Registered Public Accounting Firm                                                                                                       
|              | 
|24            |  | Power of Attorney (see page 49)                                                                                                                                
|              | 
|31.1          |  | Certification of Chief Executive Officer Pursuant to Section 302(a) of The Sarbanes-Oxley Act of 2002                                                          
|              | 
|31.2          |  | Certification of Chief Financial Officer Pursuant to Section 302(a) of The Sarbanes-Oxley Act of 2002                                                          
|              | 
|32            |  | Certification Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002                                                                                        

---

|* | Subject to Confidential Treatment
|- | ---------------------------------

|+ | Previously filed
|- | ----------------



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SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, 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 13thday of September, 2005.



By:

/S/    RICHARD H. VAN
HOESENRichard H. Van Hoesen Senior Vice President and Chief Financial Officer




KNOW ALL PERSONS
BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard H. Van Hoesen 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                                                                                        |  | Date              
|                                                    |  |                                                                                             
|/S/    CHARLES M.
BOESENBERG(Charles M.
Boesenberg) |  | Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    RICHARD H. VAN
HOESEN(Richard H. Van
Hoesen) |  | Senior Vice President and Chief Financial Officer (Principal Financial Officer)              |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    KENNETH W. LONG
III(Kenneth W. Long III)     |  | Vice President, Chief Accounting Officer and Corporate Controller                            |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    DAVID J.
BARRAM(David J.
Barram)             |  | Director                                                                                     |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    ALAN W.
KAUFMAN(Alan W.
Kaufman)             |  | Director                                                                                     |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    MICHAEL E.
LEHMAN(Michael E.
Lehman)         |  | Director                                                                                     |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    MAUREEN F.
MCNICHOLS(Maureen F.
McNichols)   |  | Director                                                                                     |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    MICHAEL J.
ROSE(Michael J.
Rose)             |  | Director                                                                                     |  | September 13, 2005
|                                                    |  |                                                                                             
|/S/    ELIJAHU
SHAPIRA(Elijahu
Shapira)             |  | Director                                                                                     |  | September 13, 2005



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors and Stockholders of

NetIQ Corporation

San Jose, California



We have audited the
accompanying consolidated balance sheets of NetIQ Corporation and subsidiaries (the Company) as of June 30, 2005 and June 30, 2004, 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, 2005. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15. These financial statements and
financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.



We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our 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 the Company as of June 30, 2005 and June 30, 2004, and the results of its operations
and its cash flows for each of the three years in the period ended June 30, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, 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 herein.



We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
effectiveness of the Companys internal control over financial reporting as of June 30, 2005, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated September 12, 2005 expressed an unqualified opinion on managements assessment of the effectiveness of the Companys internal control over financial reporting and an unqualified opinion on the
effectiveness of the Companys internal control over financial reporting.



As discussed in Note 2, the consolidated financial statements give retroactive effect to the classification of the WebTrends web analytics business as discontinued operations for all periods presented in accordance
with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long Lived Assets.



As discussed in Note 4 to the consolidated financial statements, in 2003 the Company changed its method of accounting for goodwill and other intangible
assets to conform to Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.



/s/ Deloitte & Touche LLP



San Jose, California

September 12, 2005



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##### Table of Contents

NetIQ CORPORATION



CONSOLIDATED
BALANCE SHEETS

June 30, 2005 and 2004

(In thousands, except share and per share amounts)



|                                                                                                                                         |  |      |            |   |      |   |            |  
|---------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                                                                                                                         |  | 2005 |            |   | 2004 |  
|ASSETS                                                                                                                                   |  |      |            |   |      |   |            |  
|Current assets:                                                                                                                          |  |      |            |   |      |   |            |  
|Cash and cash equivalents                                                                                                                |  | $    | 101,432    |   |      | $ | 57,841     |  
|Short-term investments                                                                                                                   |  |      | 195,311    |   |      |   | 229,781    |  
|Accounts receivable, net of allowance for uncollectible accounts and sales returns of $1,136 in 2005 and $1,534 in 2004                  |  |      | 25,989     |   |      |   | 31,081     |  
|Prepaid expenses and other                                                                                                               |  |      | 6,694      |   |      |   | 5,269      |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Total current assets                                                                                                                     |  |      | 329,426    |   |      |   | 323,972    |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Property and equipment, net                                                                                                              |  |      | 40,594     |   |      |   | 49,706     |  
|Other intangible assets, net                                                                                                             |  |      | 15,758     |   |      |   | 39,040     |  
|Long-term investments                                                                                                                    |  |      | 3,714      |   |      |   | 4,614      |  
|Other assets                                                                                                                             |  |      | 929        |   |      |   | 2,489      |  
|Goodwill                                                                                                                                 |  |      | 96,034     |   |      |   | 124,081    |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Total assets                                                                                                                             |  | $    | 486,455    |   |      | $ | 543,902    |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                     |  |      |            |   |      |   |            |  
|Current liabilities:                                                                                                                     |  |      |            |   |      |   |            |  
|Accounts payable                                                                                                                         |  | $    | 9,939      |   |      | $ | 8,278      |  
|Accrued compensation and related benefits                                                                                                |  |      | 10,034     |   |      |   | 14,374     |  
|Other liabilities                                                                                                                        |  |      | 12,523     |   |      |   | 11,812     |  
|Restructuring liability, current portion                                                                                                 |  |      |           |   |      |   | 929        |  
|Deferred revenue, current portion                                                                                                        |  |      | 50,703     |   |      |   | 61,174     |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Total current liabilities                                                                                                                |  |      | 83,199     |   |      |   | 96,567     |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Deferred revenue, net of current portion                                                                                                 |  |      | 2,621      |   |      |   | 5,442      |  
|Restructuring liability, net of current portion                                                                                          |  |      |           |   |      |   | 393        |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Total liabilities                                                                                                                        |  |      | 85,820     |   |      |   | 102,402    |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Commitments and contingencies (Note 15)                                                                                                  |  |      |            |   |      |   |            |  
|                                                                                                                                         |  |     
|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, 49,102,557 issued and outstanding in 2005; 55,216,057 issued and outstanding in
2004 |  |      | 2,835,822  |   |      |   | 2,905,610  |  
|Deferred employee stock-based compensation                                                                                               |  |      | (17,594    | ) |      |   | (313       | )
|Accumulated deficit                                                                                                                      |  |      | (2,416,078 | ) |      |   | (2,462,825 | )
|Accumulated other comprehensive loss                                                                                                     |  |      | (1,515     | ) |      |   | (972       | )
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Total stockholders equity                                                                                                               |  |      | 400,635    |   |      |   | 441,500    |  
|                                                                                                                                         |  |      |            |   |      |   |            |  
|Total liabilities and stockholders equity                                                                                               |  | $    | 486,455    |   |      | $ | 543,902    |  
|                                                                                                                                         |  |      |            |   |      |   |            |  



See Notes to
Consolidated Financial Statements.



51



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##### Table of Contents

NetIQ CORPORATION



CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

Years Ended June 30, 2005, 2004, and 2003

(In thousands, except per share amounts)



|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|-------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                 |  | 2005 |         |   | 2004 |   |          | 2003 | 
|Software license revenue                                                         |  | $    | 109,627 |   |      | $ | 123,474  |      |  | $ | 183,916  |  
|Service revenue                                                                  |  |      | 103,589 |   |      |   | 93,526   |      |  |   | 80,222   |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Total revenue                                                                    |  |      | 213,216 |   |      |   | 217,000  |      |  |   | 264,138  |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Cost of software license revenue                                                 |  |      | 4,935   |   |      |   | 9,265    |      |  |   | 10,090   |  
|Cost of service revenue                                                          |  |      | 26,475  |   |      |   | 22,490   |      |  |   | 19,274   |  
|Amortization and impairment of purchased technology                              |  |      | 11,813  |   |      |   | 8,607    |      |  |   | 9,452    |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Total cost of revenue                                                            |  |      | 43,223  |   |      |   | 40,362   |      |  |   | 38,816   |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Gross profit                                                                     |  |      | 169,993 |   |      |   | 176,638  |      |  |   | 225,322  |  
|Operating expenses:                                                              |  |      |         |   |      |   |          |      |  |   |          |  
|Sales and marketing                                                              |  |      | 102,561 |   |      |   | 106,400  |      |  |   | 111,913  |  
|Research and development                                                         |  |      | 50,567  |   |      |   | 55,202   |      |  |   | 55,818   |  
|General and administrative                                                       |  |      | 29,316  |   |      |   | 26,904   |      |  |   | 24,020   |  
|Impairment of goodwill                                                           |  |      |        |   |      |   | 134,255  |      |  |   | 316,037  |  
|Amortization of other intangible assets                                          |  |      | 8,553   |   |      |   | 8,487    |      |  |   | 9,956    |  
|Restructuring charge                                                             |  |      | 12      |   |      |   | 1,313    |      |  |   | 4,511    |  
|Write-off of acquired in-process research and development                        |  |      |        |   |      |   |         |      |  |   | 1,396    |  
|Employee stock-based compensation (*)                                            |  |      | 1,493   |   |      |   | 307      |      |  |   | 544      |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Total operating expenses                                                         |  |      | 192,502 |   |      |   | 332,868  |      |  |   | 524,195  |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Loss from operations                                                             |  |      | (22,509 | ) |      |   | (156,230 | )    |  |   | (298,873 | )
|Other income (expenses):                                                         |  |      |         |   |      |   |          |      |  |   |          |  
|Interest income                                                                  |  |      | 6,028   |   |      |   | 5,013    |      |  |   | 10,764   |  
|Interest expense                                                                 |  |      | (26     | ) |      |   | (48      | )    |  |   | (40      | )
|Gain on sale of long-term investment                                             |  |      | 4,100   |   |      |   |         |      |  |   |         |  
|Gain on sale of technology, net                                                  |  |      | 2,893   |   |      |   |         |      |  |   |         |  
|Impairment of long-term investment                                               |  |      |        |   |      |   | (4,100   | )    |  |   | (1,438   | )
|Other income (expenses), net                                                     |  |      | 606     |   |      |   | (200     | )    |  |   | 1,465    |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Total other income                                                               |  |      | 13,601  |   |      |   | 665      |      |  |   | 10,751   |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Loss before income taxes and cumulative effect of change in accounting principle |  |      | (8,908  | ) |      |   | (155,565 | )    |  |   | (288,122 | )
|Income taxes                                                                     |  |      | 1,597   |   |      |   | 3,610    |      |  |   | 11,790   |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Loss from continuing operations                                                  |  |      | (10,505 | ) |      |   | (159,175 | )    |  |   | (299,912 | )
|Discontinued operations, net of tax:                                             |  |      |         |   |      |   |          |      |  |   |          |  
|Income (loss) from discontinued operations                                       |  |      | 418     |   |      |   | (32,205  | )    |  |   | (29,491  | )
|Gain on sale of discontinued operations, net                                     |  |      | 56,834  |   |      |   |         |      |  |   |         |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Income (loss) from discontinued operations                                       |  |      | 57,252  |   |      |   | (32,205  | )    |  |   | (29,491  | )
|Income (loss) before cumulative effect of change in accounting principle         |  |      | 46,747  |   |      |   | (191,380 | )    |  |   | (329,403 | )
|Cumulative effect of change in accounting principle, net of income taxes         |  |      |        |   |      |   |         |      |  |   | (579,338 | )
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Net income (loss)                                                                |  |      | 46,747  |   |      |   | (191,380 | )    |  |   | (908,741 | )
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Other comprehensive income (expenses), net of income taxes:                      |  |      |         |   |      |   |          |      |  |   |          |  
|Foreign currency translation adjustments                                         |  |      | (266    | ) |      |   | (421     | )    |  |   | (763     | )
|Unrealized loss on short-term investments                                        |  |      | (277    | ) |      |   | (594     | )    |  |   | (819     | )
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Comprehensive income (loss)                                                      |  | $    | 46,204  |   |      | $ | (192,395 | )    |  | $ | (910,323 | )
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Basic and diluted earnings (loss) per share                                      |  |      |         |   |      |   |          |      |  |   |          |  
|Continuing operations                                                            |  | $    | (0.19   | ) |      | $ | (2.81    | )    |  | $ | (5.63    | )
|Discontinued operations                                                          |  |      | 1.06    |   |      |   | (0.57    | )    |  |   | (0.55    | )
|Cumulative effect of change in accounting principle                              |  |      |        |   |      |   |         |      |  |   | (10.88   | )
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Net earnings (loss) per share                                                    |  | $    | 0.87    |   |      | $ | (3.37    | )    |  | $ | (17.07   | )
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Shares used to compute basic and diluted earnings (loss) per share               |  |      | 54,019  |   |      |   | 56,729   |      |  |   | 53,253   |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|(*) Employee stock-based compensation:                                           |  |      |         |   |      |   |          |      |  |   |          |  
|Sales and marketing                                                              |  | $    | 83      |   |      | $ | 31       |      |  | $ | 234      |  
|Research and development                                                         |  |      | 166     |   |      |   | 179      |      |  |   | 232      |  
|General and administrative                                                       |  |      | 1,244   |   |      |   | 97       |      |  |   | 78       |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  
|Total                                                                            |  | $    | 1,493   |   |      | $ | 307      |      |  | $ | 544      |  
|                                                                                 |  |      |         |   |      |   |          |      |  |   |          |  



See Notes to
Consolidated Financial Statements.



52



---

##### Table of Contents

NetIQ CORPORATION



CONSOLIDATED
STATEMENTS OF STOCKHOLDERS EQUITY

Years Ended June 30, 2005, 2004, and 2003

(In thousands, except share and per share amounts)



|                                                             |  |              |   |  |                                           |           |   |                     |   |         |                                              |  |   |                |   |  |       |        |   |  |            |   |  |   |         |   |  |   |           |  
|------------------------------------------------------------ |  | ------------ | - |  | ----------------------------------------- | --------- | - | ------------------- | - | ------- | -------------------------------------------- |  | - | -------------- | - |  | ----- | ------ | - |  | ---------- | - |  | - | ------- | - |  | - | --------- | -
|                                                             |  | Common Stock |   |  | DeferredEmployee Stock-based Compensation |           |   | Accumulated Deficit |   |         | AccumulatedOther Comprehensive Income (loss) |  |   | Treasury Stock |   |  |       |       
|                                                             |  | Shares       |   |  | Amount                                    |           |   |                     |   |         | Shares                                       |  |   | Amount         |   |  | Total |       
|Balances, June 30, 2002                                      |  | 54,588,258   |   |  | $                                         | 2,876,462 |   |                     | $ | (395    | )                                            |  | $ | (1,327,592     | ) |  | $     | 1,625  |   |  | 4,003,550  |   |  | $ | (88,640 | ) |  | $ | 1,461,460 |  
|Exercise of stock options                                    |  | 1,174,385    |   |  |                                           | 6,405     |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 6,405     |  
|Issuances of stock under Employee Stock Purchase Plan        |  | 609,274      |   |  |                                           | 7,356     |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 7,356     |  
|Exercise of warrant                                          |  | 3,837        |   |  |                                           | 43        |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 43        |  
|Deferred employee stock-based compensation                   |  |             |   |  |                                           | (550      | ) |                     |   | 550     |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   |          |  
|Amortization of deferred stock-based compensation            |  |             |   |  |                                           |          |   |                     |   | 796     |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 796       |  
|Issuances of stock and options in business combinations, net |  | 165,154      |   |  |                                           | 37,754    |   |                     |   | (1,812  | )                                            |  |   | (35,112        | ) |  |       |       |   |  | (4,003,550 | ) |  |   | 88,640  |   |  |   | 89,470    |  
|Foreign currency translation adjustments                     |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   |               |   |  |       | (763   | ) |  |           |   |  |   |        |   |  |   | (763      | )
|Unrealized loss on short-term investments                    |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   |               |   |  |       | (819   | ) |  |           |   |  |   |        |   |  |   | (819      | )
|Net loss                                                     |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   | (908,741       | ) |  |       |       |   |  |           |   |  |   |        |   |  |   | (908,741  | )
|                                                             |  |              |   |  |                                           |           |   |                     |   |         |                                              |  |   |                |   |  |       |        |   |  |            |   |  |   |         |   |  |   |           |  
|Balances, June 30, 2003                                      |  | 56,540,908   |   |  |                                           | 2,927,470 |   |                     |   | (861    | )                                            |  |   | (2,271,445     | ) |  |       | 43     |   |  |           |   |  |   |        |   |  |   | 655,207   |  
|Exercise of stock options                                    |  | 888,285      |   |  |                                           | 8,868     |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 8,868     |  
|Issuances of stock under Employee Stock Purchase Plan        |  | 630,468      |   |  |                                           | 6,429     |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 6,429     |  
|Exercise of warrant                                          |  | 6,396        |   |  |                                           |          |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   |          |  
|Repurchase of common stock                                   |  | (2,850,000   | ) |  |                                           | (36,927   | ) |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | (36,927   | )
|Deferred employee stock-based compensation                   |  |             |   |  |                                           | (230      | ) |                     |   | 230     |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   |          |  
|Amortization of deferred stock-based compensation            |  |             |   |  |                                           |          |   |                     |   | 318     |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 318       |  
|Foreign currency translation adjustments                     |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   |               |   |  |       | (421   | ) |  |           |   |  |   |        |   |  |   | (421      | )
|Unrealized loss on short-term investments                    |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   |               |   |  |       | (594   | ) |  |           |   |  |   |        |   |  |   | (594      | )
|Net loss                                                     |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   | (191,380       | ) |  |       |       |   |  |           |   |  |   |        |   |  |   | (191,380  | )
|                                                             |  |              |   |  |                                           |           |   |                     |   |         |                                              |  |   |                |   |  |       |        |   |  |            |   |  |   |         |   |  |   |           |  
|Balances, June 30, 2004                                      |  | 55,216,057   |   |  |                                           | 2,905,610 |   |                     |   | (313    | )                                            |  |   | (2,462,825     | ) |  |       | (972   | ) |  |           |   |  |   |        |   |  |   | 441,500   |  
|Exercise of stock options                                    |  | 467,604      |   |  |                                           | 3,419     |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 3,419     |  
|Issuances of stock under Employee Stock Purchase Plan        |  | 611,247      |   |  |                                           | 5,960     |   |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 5,960     |  
|Repurchase of common stock                                   |  | (8,840,052   | ) |  |                                           | (98,326   | ) |                     |   |        |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | (98,326   | )
|Deferred employee stock-based compensation                   |  | 1,647,701    |   |  |                                           | 19,159    |   |                     |   | (18,779 | )                                            |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 380       |  
|Amortization of deferred stock-based compensation            |  |             |   |  |                                           |          |   |                     |   | 1,498   |                                              |  |   |               |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 1,498     |  
|Foreign currency translation adjustments                     |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   |               |   |  |       | (266   | ) |  |           |   |  |   |        |   |  |   | (266      | )
|Unrealized loss on short-term investments                    |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   |               |   |  |       | (277   | ) |  |           |   |  |   |        |   |  |   | (277      | )
|Net income                                                   |  |             |   |  |                                           |          |   |                     |   |        |                                              |  |   | 46,747         |   |  |       |       |   |  |           |   |  |   |        |   |  |   | 46,747    |  
|                                                             |  |              |   |  |                                           |           |   |                     |   |         |                                              |  |   |                |   |  |       |        |   |  |            |   |  |   |         |   |  |   |           |  
|Balances, June 30, 2005                                      |  | 49,102,557   |   |  | $                                         | 2,835,822 |   |                     | $ | (17,594 | )                                            |  | $ | (2,416,078     | ) |  | $     | (1,515 | ) |  |           |   |  | $ |        |   |  | $ | 400,635   |  
|                                                             |  |              |   |  |                                           |           |   |                     |   |         |                                              |  |   |                |   |  |       |        |   |  |            |   |  |   |         |   |  |   |           |  



See Notes to
Consolidated Financial Statements.



53



---

##### Table of Contents

NetIQ CORPORATION



CONSOLIDATED
STATEMENTS OF CASH FLOWS

Years Ended June 30, 2005, 2004, and 2003

(In thousands)



|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|---------------------------------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                         |  | 2005 |          |   | 2004 |   |          | 2003 | 
|Cash flows from operating activities:                                                    |  |      |          |   |      |   |          |      |  |   |          |  
|Net income (loss)                                                                        |  | $    | 46,747   |   |      | $ | (191,380 | )    |  | $ | (908,741 | )
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |      |          |   |      |   |          |      |  |   |          |  
|Gain from discontinued operations                                                        |  |      | (65,517  | ) |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                            |  |      | 33,350   |   |      |   | 51,279   |      |  |   | 58,250   |  
|Amortization of employee stock-based compensation                                        |  |      | 1,879    |   |      |   | 318      |      |  |   | 796      |  
|Loss on sale of investments and property and equipment                                   |  |      | 194      |   |      |   | 145      |      |  |   | 824      |  
|Impairment of goodwill                                                                   |  |      |         |   |      |   | 150,842  |      |  |   | 330,484  |  
|Gain on sale of long-term investment                                                     |  |      | (4,100   | ) |      |   |         |      |  |   |         |  
|Gain on sale of technology                                                               |  |      | (2,893   | ) |      |   |         |      |  |   |         |  
|Impairment of long-term investment                                                       |  |      |         |   |      |   | 4,100    |      |  |   |         |  
|Equity interest in loss of unconsolidated investee                                       |  |      |         |   |      |   |         |      |  |   | 500      |  
|Impairment of long-term investment in affiliate                                          |  |      |         |   |      |   |         |      |  |   | 1,438    |  
|Write-off of acquired in-process research and development costs                          |  |      |         |   |      |   | 773      |      |  |   | 1,396    |  
|Cumulative effect of change in accounting principle                                      |  |      |         |   |      |   |         |      |  |   | 579,338  |  
|Tax benefit from disqualifying dispositions of stock options                             |  |      |         |   |      |   |         |      |  |   | 181      |  
|Changes in:                                                                              |  |      |          |   |      |   |          |      |  |   |          |  
|Accounts receivable                                                                      |  |      | 449      |   |      |   | 10,720   |      |  |   | 3,491    |  
|Prepaid expenses and other                                                               |  |      | (678     | ) |      |   | 1,417    |      |  |   | (1,394   | )
|Accounts payable                                                                         |  |      | 3,085    |   |      |   | 823      |      |  |   | (245     | )
|Accrued compensation and related benefits                                                |  |      | (3,128   | ) |      |   | (2,632   | )    |  |   | (5,785   | )
|Other liabilities                                                                        |  |      | 1,962    |   |      |   | (974     | )    |  |   | (15,311  | )
|Restructuring liability                                                                  |  |      | (659     | ) |      |   | (1,513   | )    |  |   | 2,834    |  
|Deferred revenue                                                                         |  |      | (242     | ) |      |   | 7,073    |      |  |   | (932     | )
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash provided by operating activities                                                |  |      | 10,449   |   |      |   | 30,991   |      |  |   | 47,124   |  
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Cash flows from investing activities:                                                    |  |      |          |   |      |   |          |      |  |   |          |  
|Purchases of property and equipment                                                      |  |      | (8,033   | ) |      |   | (7,367   | )    |  |   | (15,291  | )
|Proceeds from sales of property and equipment                                            |  |      | 46       |   |      |   | 36       |      |  |   | 20       |  
|Cash used in acquisitions, net                                                           |  |      | (1,828   | ) |      |   | (7,713   | )    |  |   | (202,312 | )
|Purchases of short-term investments                                                      |  |      | (110,163 | ) |      |   | (203,771 | )    |  |   | (182,967 | )
|Proceeds from sale of long-term investments                                              |  |      | 5,000    |   |      |   |         |      |  |   |         |  
|Proceeds from sale of short-term investments                                             |  |      | 4,912    |   |      |   | 26,952   |      |  |   | 132,742  |  
|Proceeds from maturities of short-term investments                                       |  |      | 139,447  |   |      |   | 182,574  |      |  |   | 224,521  |  
|Proceeds from sales of technology, net                                                   |  |      | 2,209    |   |      |   |         |      |  |   |         |  
|Purchase of technology                                                                   |  |      | (300     | ) |      |   | (15,402  | )    |  |   |         |  
|Sale of discontinued operations, net                                                     |  |      | 91,061   |   |      |   |         |      |  |   |         |  
|Purchases of long-term investments                                                       |  |      |         |   |      |   | (3,000   | )    |  |   | (5,000   | )
|Other                                                                                    |  |      | 138      |   |      |   | (228     | )    |  |   | 201      |  
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) investing activities                                      |  |      | 122,489  |   |      |   | (27,919  | )    |  |   | (48,086  | )
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Cash flows from financing activities:                                                    |  |      |          |   |      |   |          |      |  |   |          |  
|Proceeds from sale of common stock and exercise of warrant                               |  |      | 9,379    |   |      |   | 15,297   |      |  |   | 13,803   |  
|Repurchase of common stock                                                               |  |      | (98,327  | ) |      |   | (36,927  | )    |  |   |         |  
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) financing activities                                      |  |      | (88,948  | ) |      |   | (21,630  | )    |  |   | 13,803   |  
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Effect of exchange rate changes on cash                                                  |  |      | (399     | ) |      |   | 304      |      |  |   | (778     | )
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Net increase (decrease) in cash and cash equivalents                                     |  |      | 43,591   |   |      |   | (18,254  | )    |  |   | 12,063   |  
|Cash and cash equivalents, beginning of year                                             |  |      | 57,841   |   |      |   | 76,095   |      |  |   | 64,032   |  
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Cash and cash equivalents, end of year                                                   |  | $    | 101,432  |   |      | $ | 57,841   |      |  | $ | 76,095   |  
|                                                                                         |  |      |          |   |      |   |          |      |  |   |          |  
|Noncash investing activities:                                                            |  |      |          |   |      |   |          |      |  |   |          |  
|Issuance of common stock and options in business combinations                            |  | $    |         |   |      | $ |         |      |  | $ | 37,754   |  
|Issuance of treasury stock in business combination                                       |  | $    |         |   |      | $ |         |      |  | $ | 53,528   |  
|                                                                                         |  |      |         
|Supplemental disclosure of cashflow information-cash paid for:                           |  |      |          |   |      |   |          |      |  |   |          |  
|Interest                                                                                 |  | $    | 107      |   |      | $ | 31       |      |  | $ | 40       |  
|Income taxes                                                                             |  | $    | 2,928    |   |      | $ | 647      |      |  | $ | 2,451    |  



See Notes to
Consolidated Financial Statements.



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NetIQ CORPORATION



NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

Years Ended June 30, 2005, 2004, and 2003



1.    Organization and Summary of Significant Accounting Policies



OrganizationNetIQ Corporation (Company),
established in June 1995, develops, markets and supports systems and security management solutions. The Company markets its products through its field and inside sales organization and reseller channel partners. The terms we,
our and us throughout these Notes to the Consolidated Financial Statements refer to NetIQ Corporation.



Basis of PresentationThe consolidated financial statements include the accounts of the Company and our 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 requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reported periods. Significant estimates include allowance for uncollectible accounts receivable, allowance for sales returns, net realizable value of other intangible assets and goodwill, facility reserves,
restructuring liabilities, and recoverability of deferred income tax assets and liabilities. Actual results could differ from those estimates.



Cash EquivalentsWe consider all highly liquid debt instruments and time deposits with a remaining maturity of three months or less at the
time of purchase to be cash equivalents.



Allowance for
Doubtful AccountsThe allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts and an assessment of international, political and economic risk as well as the aging of the accounts
receivable.



Short-term InvestmentsShort-term
investments consist of highly liquid debt instruments with remaining maturities of greater than three months at the time of purchase. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and
because such marketable securities represent the investment of cash that is available for current operations. All 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 fifteen years for the building, three to five years for computer equipment and software, five years for furniture and fixtures, and the shorter of five years or life of the related lease for leasehold improvements.



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 we believe our current software development process
is essentially completed concurrent with the establishment of technological feasibility.



Other Intangible AssetsOther intangible assets consist of purchased technology, acquired customer lists and contracts, trade names and trademarks, patents, and publishing rights and are amortized using
the straight-line method over the estimated useful lives, generally three years.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



GoodwillGoodwill represents the excess of acquisition costs over the fair value of net
assets acquired. Through June 30, 2002 goodwill was amortized on a straight-line method over three years. On July 1, 2002 we adopted SFAS No. 142, Goodwill and Other Intangible Assets, and discontinued the amortization of
goodwill (see Notes 4 and 9). We perform our annual test of impairment of goodwill as of April 30.



Long-Term InvestmentsLong-term investments consist of equity investments in privately held companies, accounted for under the cost method, as
we do not have the ability to exert significant influence.



Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary. If the cost of an investment exceeds its fair value, among other factors, general market conditions, the duration and extent to
which the fair value is less than cost, as well as our intent and ability to hold such investment are considered in assessing whether the decline is other-than-temporary. We also consider specific adverse conditions related to the financial health
of and business outlook for the investee, including industry and sector performance, changes in technology and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge
is recorded and a new cost basis in the investment is established.



Long Lived AssetsWe review the carrying value of our long-term assets on a periodic basis. The recoverability of property and equipment and other intangible assets is assessed based on current projections of future revenue and
cash flows. In addition to the annual test of impairment of goodwill, management assesses potential impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit
below its carrying amount.



Revenue RecognitionWe
primarily generate revenue from licensing software and providing related services. We recognize revenue in accordance with accounting principles generally accepted in the United States of America, as set forth in American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, and AICPA SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, and Securities and Exchange
Commission Staff Accounting Bulletin No. 104, Revenue Recognition, and other related pronouncements. In accordance with these statements, we recognize revenue upon meeting each of the following criteria:



| |  | Existence of persuasive evidence of an arrangement. Persuasive evidence generally is a purchase order, license agreement or other contract.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | Delivery of product and authorization keys. Delivery has occurred when the customer is given online access to the software and the authorization keys needed to activate the software
are made available to the customer.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Fee is fixed or determinable. A fee is deemed to be fixed or determinable when it is not subject to subsequent refund or adjustment.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  | Collection is deemed probable.
|- |  | ------------------------------



| |  | Vendor-specific objective evidence exists to allocate fees to the undelivered elements of the arrangement.
|- |  | ----------------------------------------------------------------------------------------------------------



We recognize software revenue using the residual method. Under the residual
method revenue is recognized if vendor-specific objective evidence of fair value (VSOE) exists for all of the undelivered elements in an arrangement and all other revenue recognition criteria are met. VSOE is based on the price generally charged
when the element is sold separately or, if not yet sold separately, is established by authorized management. In situations where vendor-specific objective evidence of fair value for an undelivered element does not exist, the entire amount of revenue
from the arrangement may either be recognized ratably over the term of the service or



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



deferred and recognized when one of the following occur: 1) fair value can be established for all undelivered elements or 2) when all elements are delivered
and all other revenue recognition criteria are met.



Service
revenue includes maintenance revenue and revenue from consulting and training services.



We defer license revenue until all of the criteria noted above are met. We defer maintenance revenue and recognize it ratably over the maintenance term, typically one year. We defer consulting and training revenues
and recognize them as those services are performed.



We
generally recognize revenue from sales made through distributors, resellers, and original equipment manufacturers at the time these partners report that they have sold the software or, alternatively, when we drop- ship the product to the end-user,
in each case after all revenue recognition criteria have been met. We also maintain an allowance for potential sales returns.



When licenses and services are sold together, we recognize license fees upon shipment, provided that (1) the above criteria have been met,
(2) payment of the license fee is not dependent upon the performance of the services, and (3) the services do not provide significant customization of the software and are not essential to the functionality of the software for which a
license was sold. For arrangements that do not meet the above criteria, we defer revenue recognition until all of the criteria are met.



Stock-based CompensationWe account for employee stock option plans in accordance with provisions of Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees. Unvested options assumed in acquisitions are accounted for in accordance with the provisions of Financial Accounting Standards Board Interpretation No. 44 (FIN 44),
Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB Opinion No. 25, and the related deferred employee stock-based compensation is amortized ratably over the vesting periods.



SFAS No. 123, Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure, requires the disclosure of pro forma earnings as though we had adopted the SFAS No. 123 fair value method since our inception. 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 our 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 our stock-based awards to employees are
based on the single option valuation approach, forfeitures are recognized as they occur and it is assumed no dividends will be declared. The weighted-average fair value calculations were based on the following assumptions:



|                          |  |                     |   |  |      |   |  |      |  
|------------------------- |  | ------------------- | - |  | ---- | - |  | ---- | -
|                          |  | Year ended June 30, |  
|                          |  | 2005                |   |  | 2004 |   |  | 2003 |  
|Estimated life (in years) |  | 4.17                |   |  | 4.29 |   |  | 4.00 |  
|Risk-free interest rate   |  | 3.3                 | % |  | 3.0  | % |  | 2.7  | %
|Volatility                |  | 65                  | % |  | 61   | % |  | 74   | %



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



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



|                                                                                                                   |  |                     |         |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------------------------------------------------------------ |  | ------------------- | ------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                                                   |  | Year Ended June 30, |        
|                                                                                                                   |  | 2005                |         |   | 2004 |   |          | 2003 | 
|Reported net income (loss):                                                                                        |  |                     |         |   |      |   |          |      |  |   |          |  
|Continuing operations                                                                                              |  | $                   | (10,505 | ) |      | $ | (159,175 | )    |  | $ | (299,912 | )
|Discontinued operations                                                                                            |  |                     | 57,252  |   |      |   | (32,205  | )    |  |   | (29,491  | )
|Cumulative effect of change in accounting principle                                                                |  |                     |        |   |      |   |         |      |  |   | (579,338 | )
|                                                                                                                   |  |                     |         |   |      |   |          |      |  |   |          |  
|Net income (loss)                                                                                                  |  |                     | 46,747  |   |      |   | (191,380 | )    |  |   | (908,741 | )
|Add: Employee stock-based compensation expense included in reported net income (loss), net of income taxes:        |  |                     |         |   |      |   |          |      |  |   |          |  
|Continuing operations                                                                                              |  |                     | 1,493   |   |      |   | 307      |      |  |   | 544      |  
|Discontinued operations                                                                                            |  |                     | 386     |   |      |   | 11       |      |  |   | 252      |  
|                                                                                                                   |  |                     |         |   |      |   |          |      |  |   |          |  
|Total stock-based compensation                                                                                     |  |                     | 1,879   |   |      |   | 318      |      |  |   | 796      |  
|Less: Employee stock-based compensation determined under the fair value method for all awards, net of income taxes |  |                     | (49,008 | ) |      |   | (60,284  | )    |  |   | (74,752  | )
|                                                                                                                   |  |                     |         |   |      |   |          |      |  |   |          |  
|Pro forma net loss                                                                                                 |  | $                   | (382    | ) |      | $ | (251,346 | )    |  | $ | (982,697 | )
|                                                                                                                   |  |                     |         |   |      |   |          |      |  |   |          |  
|Basic and diluted loss per share:                                                                                  |  |                     |         |   |      |   |          |      |  |   |          |  
|As reported                                                                                                        |  | $                   | 0.87    |   |      | $ | (3.37    | )    |  | $ | (17.07   | )
|Pro forma                                                                                                          |  | $                   | (0.01   | ) |      | $ | (4.43    | )    |  | $ | (18.45   | )



Foreign Currency
TransactionsThe functional currencies of our 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 periods presented. Translation adjustments are included in stockholders equity as accumulated other comprehensive income and as part
of comprehensive loss.



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.



Earnings Per ShareBasic earnings per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding, less shares subject to repurchase. Diluted earnings per
share was the same as basic earnings per share for all periods presented as the effect of potentially dilutive securities is excluded, as their inclusion would be antidilutive due to our net loss from continuing operations.



Concentration of Credit RiskFinancial instruments that
potentially subject us 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 certificates of deposit. Short-term
investments consist primarily of corporate notes and bonds, U.S. Government and municipalities notes and bonds, floating rate investments, foreign debt issues, asset-backed securities, commercial paper, and certificates of deposit, and are regularly
monitored by management. Our investment policy limits the percentage of assets that can be invested in any one issuer of debt and any one type of short-term investment.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



We sell our products to companies in diverse industries and generally do not require our customers to
provide collateral to support accounts receivable. Credit reviews are performed on significant customers prior to extending credit. The determination of a customers ability to pay requires significant judgment and failure to collect from a
customer can adversely affect our revenue and net income. To reduce credit risk, management also performs ongoing credit evaluations of our customers financial condition. We maintain an allowance for potential credit losses.



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



Recently Issued Accounting StandardsIn December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment. This statement
replaces SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires companies to apply a fair-value-based measurement method
in accounting for shared-based payment transactions with employees and to record compensation cost for all stock awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. In addition, the
Company is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. SFAS No. 123(R) will be effective for years
beginning after June 15, 2005, which is our fiscal year 2006. Management has not yet determined the impact that SFAS No. 123(R) will have on its financial position and results of operations, but expects that the impact will be
material.



In June 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections. SFAS No. 154 replaces APBO No. 20 (APBO 20) and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and applies to all voluntary changes in accounting principle,
and changes the requirements for accounting for and reporting of a change in accounting principle. APBO No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of
change a cumulative effect of changing to the new accounting principle whereas SFAS No. 154 requires retrospective application to prior periods financial statements of a voluntary change in accounting principle, unless it is
impracticable. SFAS No. 154 enhances the consistency of financial information between periods. SFAS No. 154 will be effective for years beginning after December 15, 2005, which is our fiscal year 2007. We do not expect that the
adoption of SFAS No. 154 will have a material impact on our results of operations or financial position.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



2.    Discontinued Operations



On March 26, 2005, we entered into a definitive agreement to sell our
WebTrends web analytics business to WebTrends Inc. (formerly Spider Holding Inc.), an affiliate of Francisco Partners, L.P., a technology-focused private equity investment firm. The transaction closed on April 30, 2005 and we received
$93.0 million in gross proceeds less deal costs of $1.9 million. As part of the transaction, we transferred $42.5 in assets and $16.9 in liabilities, as shown below, to WebTrends and incurred $8.7 million in tax and other expense for a net gain
of approximately $56.8 million. In addition, the employment of approximately 237 of our employees was assumed by WebTrends Inc. as of April 30, 2005. As a result of this transaction, we have presented historical NetIQ financial statements
to exclude the following from continuing operations:



Discontinued operations income statement detail

(In thousands)



|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------- |  | ------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                          |  | Year Ended June 30, |       
|                                                          |  | 2005                |        |   | 2004 |   |         | 2003 | 
|Software license revenue                                  |  | $                   | 13,165 |   |      | $ | 17,762  |      |  | $ | 21,792  |  
|Service revenue                                           |  |                     | 25,626 |   |      |   | 26,881  |      |  |   | 24,295  |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|Total revenue                                             |  |                     | 38,791 |   |      |   | 44,643  |      |  |   | 46,087  |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|Cost of software license revenue                          |  |                     | 147    |   |      |   |        |      |  |   |        |  
|Cost of service revenue                                   |  |                     | 6,934  |   |      |   | 9,654   |      |  |   | 10,056  |  
|Amortization of purchased technology                      |  |                     | 472    |   |      |   | 12,042  |      |  |   | 15,984  |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|Total cost of revenue                                     |  |                     | 7,553  |   |      |   | 21,696  |      |  |   | 26,040  |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|Gross profit                                              |  |                     | 31,238 |   |      |   | 22,947  |      |  |   | 20,047  |  
|Operating expenses:                                       |  |                     |        |   |      |   |         |      |  |   |         |  
|Sales and marketing                                       |  |                     | 17,874 |   |      |   | 17,585  |      |  |   | 19,999  |  
|Research and development                                  |  |                     | 9,583  |   |      |   | 12,856  |      |  |   | 15,287  |  
|General and administration                                |  |                     | 2,801  |   |      |   | 46      |      |  |   |        |  
|Amortization of other intangible assets                   |  |                     | 142    |   |      |   | 6,419   |      |  |   | 8,564   |  
|Employee stock-based compensation                         |  |                     | 385    |   |      |   | 11      |      |  |   | 252     |  
|Restructuring charge                                      |  |                     | 5      |   |      |   | 685     |      |  |   | 769     |  
|Impairment of goodwill                                    |  |                     |       |   |      |   | 16,587  |      |  |   | 14,447  |  
|Write-off of acquired in-process research and development |  |                     |       |   |      |   | 773     |      |  |   |        |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|Total operating expenses                                  |  |                     | 30,790 |   |      |   | 54,962  |      |  |   | 59,318  |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|Income taxes                                              |  |                     | (30    | ) |      |   | (190    | )    |  |   | 9,780   |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  
|Income (loss) from discontinued operations                |  | $                   | 418    |   |      | $ | (32,205 | )    |  | $ | (29,491 | )
|                                                          |  |                     |        |   |      |   |         |      |  |   |         |  



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Years Ended June 30, 2005, 2004, and 2003



Discontinued operations balance sheet detail

(In thousands)



|                                             |  |                |       
|-------------------------------------------- |  | -------------- | ------
|                                             |  | April 30, 2005
|                                             |  | (Unaudited)   
|ASSETS                                       |  |                |       
|Accounts receivable, net                     |  | $              | 4,754 
|Prepaid expenses and other                   |  |                | 673   
|Property and equipment, net                  |  |                | 4,560 
|Other intangibles                            |  |                | 2,602 
|Goodwill                                     |  |                | 29,875
|                                             |  |                |       
|Total assets of discontinued operations      |  | $              | 42,464
|                                             |  |                |       
|                                             | 
|LIABILITIES                                  |  |                |       
|Accounts payable                             |  | $              | 1,308 
|Accrued compensation and related benefits    |  |                | 1,277 
|Other liabilities                            |  |                | 854   
|Deferred revenue                             |  |                | 12,819
|Restructuring liability, current portion     |  |                | 662   
|                                             |  |                |       
|Total liabilities of discontinued operations |  | $              | 16,920
|                                             |  |                |       



3.    Business
Combinations



Fiscal 2005 acquisitions



There were no acquisitions for fiscal 2005.



Fiscal 2004 acquisitions



There were no material acquisitions for fiscal 2004.



Fiscal 2003 acquisitions



Acquisition of PentaSafe Security Technologies, Inc:



On December 9, 2002, we acquired all outstanding shares of PentaSafe
Security Technologies, Inc. (PentaSafe) for cash of $185.0 million and approximately 4.2 million shares of common stock, valued at approximately $55.7 million. We also assumed warrants to purchase approximately 60,000 shares of our
common stock valued at approximately $606,000, and assumed employee stock options to purchase approximately 3.8 million shares of common stock valued at approximately $35.0 million, of which approximately $1.8 million was recorded as
deferred employee stock-based compensation to be amortized over the remaining vesting period of the options. We also incurred approximately $5.2 million of direct acquisition costs, for a total purchase price of approximately
$281.5 million. PentaSafe provided integrated security management software solutions designed to ensure continuous compliance with security policies as well as to defend against security threats. We acquired PentaSafe to accelerate our
penetration of the security management market, broaden our customer base, and strengthen our security product portfolio and domain expertise.



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Years Ended June 30, 2005, 2004, and 2003



The fair value of our common stock was determined based on the average closing price per share of our
common stock over a 5-day period beginning two trading days before and ending two trading days after the terms of the acquisition were agreed to and announced (October 1, 2002). The fair values of the warrants and options assumed are calculated
based on the Black-Scholes options pricing model using the single option valuation approach and the following assumptions:



|                                           |  |           |  |        
|------------------------------------------ |  | --------- |  | -------
|                                           |  | Warrants  |  | Options
|Estimated weighted-average life (in years) |  | 2.8-5.9   |  | 2.9    
|Risk-free interest rate                    |  | 2.0%-3.4% |  | 1.97%  
|Volatility                                 |  | 85%-103%  |  | 103%   



The results of
operations of PentaSafe from the date of acquisition have been included in our consolidated financial statements. The assets acquired and liabilities assumed at the date of acquisition were recorded at estimated fair values. Fair values of
intangible assets acquired are based on an independent valuation prepared using estimates and assumptions provided by management. Fair value of tangible assets acquired and liabilities assumed were determined by management using estimates of current
replacement cost, present value of amounts to be collected in the future, and other techniques. The purchase price has been allocated as follows (in thousands):



|                                                 |  |   |         |  
|------------------------------------------------ |  | - | ------- | -
|Current assets                                   |  | $ | 10,041  |  
|Property and equipment, net                      |  |   | 2,743   |  
|Other assets                                     |  |   | 294     |  
|Other intangible assets subject to amortization: |  |   |         |  
|Purchased technology                             |  |   | 16,014  |  
|Customer contracts                               |  |   | 23,853  |  
|Publishing rights                                |  |   | 1,262   |  
|Tradename                                        |  |   | 633     |  
|Deferred employee stock-based compensation       |  |   | 1,812   |  
|In-process research and development costs        |  |   | 1,368   |  
|Goodwill                                         |  |   | 245,384 |  
|                                                 |  |   |         |  
|Total assets acquired                            |  |   | 303,404 |  
|                                                 |  |   |         |  
|Current liabilities                              |  |   | (13,009 | )
|Deferred revenue                                 |  |   | (8,919  | )
|                                                 |  |   |         |  
|Total liabilities assumed                        |  |   | (21,928 | )
|                                                 |  |   |         |  
|Net assets acquired                              |  | $ | 281,476 |  
|                                                 |  |   |         |  



We are amortizing
other intangible assets on a straight-line basis over an estimated useful life of three years.



Approximately $1.4 million of the purchase price was allocated to the estimated fair value of in-process research and development projects. At the date of acquisition, these projects had not reached technological
feasibility and had no future alternative minimum use. Accordingly, the value allocated to these projects was immediately expensed in operations on the acquisition date during fiscal 2003. The estimated fair value of these projects was determined by
applying the income approach, which considers the present value of the projected free cash flows that will be generated by the products, incorporating the acquired technologies under development, assuming they will be successfully completed. The
discount rate used was 25% to take into account the novelty of the technology, the extent of our familiarity with the technology, the stage of completion and the



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Years Ended June 30, 2005, 2004, and 2003



risks surrounding the successful development and commercialization of each of the in-process research and development projects that were valued.



The goodwill recorded as a result of the acquisition is not deductible for
income tax purposes.



PentaSafe had approximately 310 employees
at the date of the acquisition. Prior to December 31, 2002 and in connection with the acquisition, we gave termination notices to 55 PentaSafe employees made redundant and accrued $1.7 million related to their severance benefits. The
estimated cost of eliminating these positions was accounted for as part of the purchase price. As of June 30, 2004, all redundant employees were no longer employed by the Company. During fiscal 2003, $1.6 million was paid as termination
benefits and $48,000 was paid in fiscal 2004.



The following
unaudited pro forma information shows the results of operations for fiscal 2003 as if the PentaSafe acquisition had occurred at the beginning of the period presented and at the purchase price established at the time of the acquisition (in thousands,
except per share amounts):



|                                                                |  |                         |          |  
|--------------------------------------------------------------- |  | ----------------------- | -------- | -
|                                                                |  | Year EndedJune 30, 2003 |         
|Revenue                                                         |  | $                       | 325,420  |  
|                                                                |  |                         |          |  
|Loss before cumulative effect of change in accounting principle |  | $                       | (347,144 | )
|                                                                |  |                         |          |  
|Net loss                                                        |  | $                       | (926,482 | )
|                                                                |  |                         |          |  
|Basic and diluted net loss per share:                           |  |                         |          |  
|Loss before cumulative effect of change in accounting principle |  | $                       | (6.30    | )
|                                                                |  |                         |          |  
|Net loss per share                                              |  | $                       | (16.81   | )
|                                                                |  |                         |          |  



The pro forma results
for fiscal 2003 exclude $1.4 million in charges for write-off of acquired in-process research and development as such charges are non-recurring. The pro forma results for fiscal 2003 include amortization of other intangible assets and
$11.0 million related to non-recurring charges incurred by PentaSafe.



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.



Acquisition of Marshal Software Ltd.:



On December 20, 2002 we acquired all of the outstanding shares of Marshal Software Ltd. (Marshal) for cash of $22.7 million and incurred approximately $300,000 of direct acquisition costs, for a total purchase price of
approximately $23.0 million. Marshal provided enterprise content security solutions. We acquired Marshal to address our customers requirements for controlling and monitoring electronic data entering and leaving the organization and to add
content security to our comprehensive range of solutions for messaging environments.



The results of operations of Marshal from the date of acquisition have been included in our condensed consolidated financial statements. In connection with the acquisition, intangible assets of $23.8 million were
acquired, comprising $4.7 million of other intangible assets that are being amortized over three years, and goodwill of $19.1 million. Additionally, net liabilities of $823,000 were assumed in the acquisition. The goodwill recorded as a
result of the acquisition is not deductible for income tax purposes.



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Years Ended June 30, 2005, 2004, and 2003



The pro forma effects to the consolidated financial statements of acquiring Marshal as of the
beginning of fiscal 2003 are not presented as such effects are not significant.



4.    Change in Accounting Principle



We adopted SFAS No. 142, Goodwill and Other Intangible Assets,on July 1, 2002. SFAS No. 142 requires that companies stop amortizing goodwill and certain intangible assets with an indefinite
useful life. Instead, it requires that goodwill and intangible assets deemed to have an indefinite useful life be reviewed for impairment upon adoption of SFAS No. 142, and at least annually thereafter. Under SFAS No. 142, goodwill
impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value.



Upon adoption of SFAS No. 142, we recorded a non-cash transitional impairment charge of $579.3 million to reduce the carrying value of goodwill
from previous acquisitions. The charge is reflected as the cumulative effect of a change in accounting principle in the accompanying condensed consolidated statements of operations and comprehensive loss. In calculating the impairment charge, the
fair values of the reporting units were estimated using the discounted cash flow method supplemented by the market approach. As a result of the adoption of SFAS No. 142, $2.4 million relating to acquired workforce was reclassified from other
intangible assets to goodwill.



5.    Short-term
Investments



Short-term investments consist of the
following (in thousands):



|                                                 |  |               |         |                             |   |                              |  |   |            |   |  |   |        
|------------------------------------------------ |  | ------------- | ------- | --------------------------- | - | ---------------------------- |  | - | ---------- | - |  | - | -------
|                                                 |  | June 30, 2005
|                                                 |  | AmortizedCost |         | GrossUnrealizedHoldingGains |   | GrossUnrealizedHoldingLosses |  |   | Fair Value
|US government and municipalities notes and bonds |  | $             | 126,609 |                             | $ | 7                            |  | $ | (678       | ) |  | $ | 125,938
|Corporate notes and bonds                        |  |               | 42,999  |                             |   | 19                           |  |   | (153       | ) |  |   | 42,865 
|Asset-backed securities                          |  |               | 19,968  |                             |   | 4                            |  |   | (62        | ) |  |   | 19,910 
|Certificates of deposit                          |  |               | 6,601   |                             |   |                             |  |   | (3         | ) |  |   | 6,598  
|                                                 |  |               |         |                             |   |                              |  |   |            |   |  |   |        
|Short-term investments                           |  | $             | 196,177 |                             | $ | 30                           |  | $ | (896       | ) |  | $ | 195,311
|                                                 |  |               |         |                             |   |                              |  |   |            |   |  |   |        
|                                                 | 
|                                                 |  | June 30, 2004
|                                                 |  | AmortizedCost |         | GrossUnrealizedHoldingGains |   | GrossUnrealizedHoldingLosses |  |   | Fair Value
|US government and municipalities notes and bonds |  | $             | 165,334 |                             | $ | 5                            |  | $ | (449       | ) |  | $ | 164,891
|Corporate notes and bonds                        |  |               | 44,658  |                             |   | 120                          |  |   | (169       | ) |  |   | 44,609 
|Asset-backed securities                          |  |               | 16,619  |                             |   |                             |  |   | (84        | ) |  |   | 16,535 
|Certificates of deposit                          |  |               | 3,762   |                             |   |                             |  |   | (16        | ) |  |   | 3,746  
|                                                 |  |               |         |                             |   |                              |  |   |            |   |  |   |        
|Short-term investments                           |  | $             | 230,373 |                             | $ | 125                          |  | $ | (718       | ) |  | $ | 229,781
|                                                 |  |               |         |                             |   |                              |  |   |            |   |  |   |        



At June 30, 2005
short-term investments with remaining maturities of greater than three months but less than one year at the time of purchase, had an amortized cost of $31.6 million and fair value of $31.5 million and



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Years Ended June 30, 2005, 2004, and 2003



short-term investments with remaining maturities between one to two years at the time of purchase, had an amortized cost of $164.6 million and fair value of
$163.8 million. As of June 30, 2005 unrealized losses of $756,000 represented investments that have been in an unrealized loss position for less than 12 months, and $140,000 represented investments that have been in an unrealized loss
position for more than 12 months.



Any gains and losses on
sales of securities are computed on a specific identification basis. Gross realized gains on the sale of investments for fiscal 2005, 2004 and 2003, were $4,000, $14,000 and $534,000, respectively. Gross realized losses on sale of investments for
fiscal 2005, 2004 and 2003 were $1,000, $8,000, $22,000, respectively.



6.    Long-term Investments



During the three months ended December 31, 2004, @Stake, Inc., a company in which we held a long-term investment, was acquired by a third party. Under the terms of the acquisition agreement, we received a $5.0 million payment resulting
in a $4.1 million gain, which has been included in other income. No impairments of long-term investments were assessed and recorded in fiscal 2005. In fiscal 2004 we incurred a charge of $4.1 million from a write down of @Stake, Inc., and in
fiscal 2003 a charge of $1.4 million resulting from a write down of an investment in an affiliate, based on managements assessments that the declines in value were other-than-temporary.



7.    Property and Equipment



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



|                                |  |      |         |   |      |   |         |  
|------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                |  | 2005 |         |   | 2004 |  
|Land and building               |  | $    | 33,936  |   |      | $ | 33,911  |  
|Computer equipment and software |  |      | 40,433  |   |      |   | 47,402  |  
|Leasehold improvements          |  |      | 3,229   |   |      |   | 7,424   |  
|Furniture and fixtures          |  |      | 3,884   |   |      |   | 4,654   |  
|Construction in progress        |  |      | 390     |   |      |   |        |  
|                                |  |      |         |   |      |   |         |  
|                                |  |      | 81,872  |   |      |   | 93,391  |  
|Less accumulated depreciation   |  |      | (41,278 | ) |      |   | (43,685 | )
|                                |  |      |         |   |      |   |         |  
|Property and equipment, net     |  | $    | 40,594  |   |      | $ | 49,706  |  
|                                |  |      |         |   |      |   |         |  



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Years Ended June 30, 2005, 2004, and 2003



8.    Other Intangible Assets



Other intangible assets consist of the following (in thousands):



|                     |  |                |         |                         |   |         |  |   |       
|-------------------- |  | -------------- | ------- | ----------------------- | - | ------- |  | - | ------
|                     |  | Carryingamount |         | AccumulatedAmortization |   | Net    
|                     |  | June 30, 2005 
|Purchased technology |  | $              | 49,154  |                         | $ | 37,332  |  | $ | 11,822
|Customer contracts   |  |                | 16,465  |                         |   | 16,465  |  |   |      
|Customer lists       |  |                | 24,829  |                         |   | 21,171  |  |   | 3,658 
|Publishing rights    |  |                | 1,262   |                         |   | 1,077   |  |   | 185   
|Tradenames           |  |                | 1,894   |                         |   | 1,801   |  |   | 93    
|                     |  |                |         |                         |   |         |  |   |       
|                     |  | $              | 93,604  |                         | $ | 77,846  |  | $ | 15,758
|                     |  |                |         |                         |   |         |  |   |       
|                     | 
|                     |  | June 30, 2004 
|Purchased technology |  | $              | 99,636  |                         | $ | 73,968  |  | $ | 25,668
|Customer contracts   |  |                | 24,829  |                         |   | 12,895  |  |   | 11,934
|Customer lists       |  |                | 43,078  |                         |   | 42,686  |  |   | 392   
|Publishing rights    |  |                | 1,262   |                         |   | 656     |  |   | 606   
|Tradenames           |  |                | 3,190   |                         |   | 2,750   |  |   | 440   
|                     |  |                |         |                         |   |         |  |   |       
|                     |  | $              | 171,995 |                         | $ | 132,955 |  | $ | 39,040
|                     |  |                |         |                         |   |         |  |   |       



The net decrease in
intangible assets during fiscal year 2005 includes $2.6 million as a result of the sale of WebTrends web analytics business to WebTrends Inc and $21 million as a result of normal amortization.



Estimated future amortization of other intangible assets as of June 30,
2005 is as follows (in thousands):



|                            |  |                       |        |                         |   |      
|--------------------------- |  | --------------------- | ------ | ----------------------- | - | -----
|Fiscal year ending June 30, |  | Purchased Technology* |        | Other Intangible Assets
|2006                        |  | $                     | 8,216  |                         | $ | 3,751
|2007                        |  |                       | 3,758  |                         |   |     
|2008                        |  |                       | 33     |                         |   |     
|                            |  |                       |        |                         |   |      
|Total                       |  | $                     | 12,007 |                         | $ | 3,751
|                            |  |                       |        |                         |   |      

---

|* | Includes publishing rights
|- | --------------------------



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Years Ended June 30, 2005, 2004, and 2003



9.    Goodwill



Changes in goodwill during fiscal 2004 and fiscal 2005 are as follows (in thousands):



|                                                                |  |   |          |  
|--------------------------------------------------------------- |  | - | -------- | -
|Balance, June 30, 2003                                          |  | $ | 272,561  |  
|Impairment charge                                               |  |   | (150,842 | )
|Goodwill recorded in the acquisition of a business              |  |   | 3,991    |  
|Changes to purchase price allocation for acquired assets        |  |   | (1,629   | )
|                                                                |  |   |          |  
|Balance, June 30, 2004                                          |  |   | 124,081  |  
|Discontinued operations                                         |  |   | (29,875  | )
|Cash payments in accordance with earn out from 2004 acquisition |  |   | 1,828    |  
|                                                                |  |   |          |  
|Balance, June 30, 2005                                          |  | $ | 96,034   |  
|                                                                |  |   |          |  



In September 30,
2003 we reduced our forecasted revenues, operating results and cash flows. This significant change in estimated future results was deemed to be a circumstance requiring an interim review of goodwill for impairment, as prescribed by SFAS
No. 142. This resulted in a non-cash impairment charge of $150.8 million in the quarter ended September 30, 2003. The annual reviews of impairment of goodwill conducted as of April 30, 2004 and April 30, 2005 indicated no
impairment.



In calculating the impairment charge, the fair
values of the reporting units were estimated using a combination of the discounted cash flows and comparable transactions methodologies.



10.    Other Liabilities



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



|                                  |  |      |        |      |   |       
|--------------------------------- |  | ---- | ------ | ---- | - | ------
|                                  |  | 2005 |        | 2004
|Income tax payable                |  | $    | 4,793  |      | $ | 3,182 
|Accrued sales and marketing costs |  |      | 2,826  |      |   | 4,120 
|Sales tax payable                 |  |      | 613    |      |   | 933   
|Facilities reserve                |  |      |       |      |   | 379   
|Other                             |  |      | 4,291  |      |   | 3,198 
|                                  |  |      |        |      |   |       
|Other liabilities                 |  | $    | 12,523 |      | $ | 11,812
|                                  |  |      |        |      |   |       



11.    Restructurings



Fiscal 2004 restructuring



During the quarter
ended June 30, 2004 we recorded a restructuring charge of $2.5 million related to restructuring of the information technology group and continued cost reduction efforts. Of the $2.5 million charge to restructuring, $1.8 million related to
continuing operation and $685,000 was related to discontinued operations.



Pursuant to the restructuring plan, we notified 86 employees that their employment would be terminated. As of June 30, 2005, 83 of these employees had left our employment and 3 employees had their termination
rescinded. As of June 30, 2005, $1.7 million had been paid as termination benefits and related costs pursuant to the restructuring.



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Years Ended June 30, 2005, 2004, and 2003



As part of the restructuring plan, we determined that we no longer required certain office space in
Portland, Oregon, and established an accrual of $764,000 for fair value of the facilities consolidation. There is no outstanding liability as of June 30, 2005.



We leased approximately 12,000 square feet of office space in Manukau, New Zealand under a lease that expired in April of
2005. The space was vacated in July of 2004 and a subsequent adjustment of $92,000 was made to the restructuring liability to reflect the estimated remaining obligation under this lease. There is no outstanding liability as of June 30, 2005.



The following summarizes the 2004 restructuring plan activity
(in thousands):



|                                                   |  |                                            |        |   |                         |   |      |       |  |   |        |  
|-------------------------------------------------- |  | ------------------------------------------ | ------ | - | ----------------------- | - | ---- | ----- |  | - | ------ | -
|                                                   |  | EmployeeSeverance andOther RelatedBenefits |        |   | FacilitiesConsolidation |   |      | Total | 
|Restructuring charge (Quarter ended June 30, 2004) |  | $                                          | 1,738  |   |                         | $ | 764  |       |  | $ | 2,502  |  
|Cash payments                                      |  |                                            | (1,377 | ) |                         |   | (78  | )     |  |   | (1,455 | )
|                                                   |  |                                            |        |   |                         |   |      |       |  |   |        |  
|Restructuring liability at June 30, 2004           |  |                                            | 361    |   |                         |   | 686  |       |  |   | 1,047  |  
|Cash payments                                      |  |                                            | (231   | ) |                         |   | (97  | )     |  |   | (328   | )
|Adjustments to restructuring, net                  |  |                                            | (73    | ) |                         |   | 92   |       |  |   | 19     |  
|                                                   |  |                                            |        |   |                         |   |      |       |  |   |        |  
|Restructuring liability at September 30, 2004      |  |                                            | 57     |   |                         |   | 681  |       |  |   | 738    |  
|Cash payments                                      |  |                                            | (57    | ) |                         |   | (96  | )     |  |   | (153   | )
|Adjustments to restructuring, net                  |  |                                            |        |   |                         |   | (27  | )     |  |   | (27    | )
|                                                   |  |                                            |        |   |                         |   |      |       |  |   |        |  
|Restructuring liability at December 31, 2004       |  |                                            |       |   |                         |   | 558  |       |  |   | 558    |  
|Cash payments                                      |  |                                            |       |   |                         |   | (112 | )     |  |   | (112   | )
|Adjustments to restructuring, net                  |  |                                            |       |   |                         |   | 32   |       |  |   | 32     |  
|Classified as discontinued operations              |  |                                            |       |   |                         |   | (470 | )     |  |   | (470   | )
|                                                   |  |                                            |        |   |                         |   |      |       |  |   |        |  
|Restructuring liability at March 31, 2004          |  |                                            |       |   |                         |   | 8    |       |  |   | 8      |  
|Adjustments to restructuring, net                  |  |                                            |        |   |                         |   | (8   | )     |  |   | (8     | )
|                                                   |  |                                            |        |   |                         |   |      |       |  |   |        |  
|Restructuring liability at June 30, 2005           |  | $                                          |       |   |                         | $ |     |       |  | $ |       |  
|                                                   |  |                                            |        |   |                         |   |      |       |  |   |        |  



Fiscal 2003
restructuring



Payments made during fiscal 2005 represent
the final payments due under the Houston lease obligation, net of sublease income.



The following summarizes the 2003 restructuring plan activity (in thousands):



|                                         |  |                                            |   |                         |   |      |       |  |   |      |  
|---------------------------------------- |  | ------------------------------------------ | - | ----------------------- | - | ---- | ----- |  | - | ---- | -
|                                         |  | EmployeeSeverance andOther RelatedBenefits |   | FacilitiesConsolidation |   |      | Total | 
|Restructuring liability at June 30, 2004 |  | $                                          |  |                         | $ | 275  |       |  | $ | 275  |  
|Cash payments, net of sub-lease income   |  |                                            |  |                         |   | (275 | )     |  |   | (275 | )
|                                         |  |                                            |   |                         |   |      |       |  |   |      |  
|Restructuring liability at June 30, 2005 |  | $                                          |  |                         | $ |     |       |  | $ |     |  
|                                         |  |                                            |   |                         |   |      |       |  |   |      |  





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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



12.    Stockholders Equity



Employee Stock-Based CompensationIn connection with the
acquisition of PentaSafe and the assumption of unvested options, we recorded deferred stock-based compensation of $1.8 million in December 2002. Stock options assumed in the acquisitions 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 related deferred stock-based compensation is being amortized straight-line over the vesting period of
the options through October 2006 for PentaSafe assumed options.



Employee stock-based compensation expense of $1.5 million, $307,000 and $544,000 was recognized during fiscal 2005, 2004 and 2003, respectively.



WarrantsIn connection with the acquisition of PentaSafe, we assumed three warrants to purchase a total of approximately 60,000 shares of
common stock at exercise prices ranging from $10.98 to $12.18 per share, valued at approximately $606,000 and included as part of the total purchase price of PentaSafe. The warrants were exercised in fiscal 2004 and 6,396 net shares were issued.



In March 2002 we issued a warrant to purchase 140,000
shares of common stock at an exercise price of $21.81 per share to an executive search firm in connection with the search for our new chief executive officer. The warrant was immediately vested and exercisable. The warrant was valued at
$1.5 million using the Black-Scholes pricing model with the following assumptions: contractual life of 16 months, risk free interest rate of 3.87%, volatility of 111%, and no dividends paid during the contractual term. The fair value of the
warrant was expensed in March 2002 and is included in general and administrative expenses in the accompanying consolidated statement of operations and comprehensive loss. No shares were issued pursuant to the warrant and it expired unexercised
in fiscal 2004.



Common Shares Reserved for
IssuanceAt June 30, 2005 we had reserved shares of common stock for issuance as follows:



|                                            |  |           
|------------------------------------------- |  | ----------
|Issuance under stock option plans           |  | 19,293,342
|Issuance under Employee Stock Purchase Plan |  | 2,334,523 
|                                            |  |           
|Total                                       |  | 21,627,865
|                                            |  |           



Stock Option
PlansUnder the NetIQ Corporation 1995 Stock Plan (1995 Stock Plan) 19,708,003 shares are reserved for issuance to employees, consultants and directors. The 1995 Plan, approved by stockholders, provides for annual increases in the number of
shares available for issuance on the first day of each fiscal year equal to the lowest of (i) 2,600,000 shares, (ii) 5% of the outstanding shares of common stock on the first day of the fiscal year, or (iii) a number of shares as
authorized by the Board of Directors. At June 30, 2005, the number of shares available for grant was 3,132,929. No increase was authorized for fiscal 2006. The 1995 Stock Plan expires on November 1, 2005.



On December 17, 2001 the Board of Directors approved and adopted the
NetIQ Corporation Approved UK Sub Plan (UK Sub Plan) under the NetIQ Amended and Restated 1998 Stock Incentive Compensation Plan (1998 Stock Plan) and reserved 500,000 shares for issuance there under. On October 21, 2003, the Board of Directors
approved the reduction of the number of shares reserved for issuance under the UK Sub Plan from 500,000 shares to 250,000 shares. The UK Sub Plan was approved by the United Kingdom Inland Revenue in February 2002 and we have used the shares
available under the UK Sub Plan for the purpose of granting options to our



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



employees in the Untied Kingdom. At June 30, 2005 the number of shares available for grant under the UK Sub Plan was 152,226.



On January 25, 2002 the Board of Directors approved and adopted the
NetIQ Corporation 2002 Stock Plan (2002 Plan), and reserved 1,500,000 shares for issuance thereunder. At June 30, 2005, the number of shares of common stock subject to outstanding options under the 2002 Plan is 925,753, and the number of shares
of common stock that may be granted under the 2002 Plan is 519,283. The 2002 Plan has not been approved by stockholders, may be used for non-statutory grants only and no options may be granted to officers or directors.



Incentive stock options are granted at fair market value at the date of
grant; non-statutory options may be offered at not less than 85% of fair market value, but are generally issued at fair market value. Generally, options become exercisable over four years and expire between 5 and 10 years after the date of grant.



On June 27, 2005, our Board of Directors awarded
restricted stock purchase rights, under the Companys 1995 Stock Plan, or restricted stock units, under the Companys 1998 Stock Plan, covering a total of 1,461,836 shares, to substantially all of the Companys active employees
(approximately 950 employees). The program did not include employees resident in certain countries outside the United States where the cost of regulatory compliance (given the number of employees in that jurisdiction or the regulatory scheme) were
deemed excessive for the benefits conferred. Restricted stock purchase rights covering a total of 270,000 restricted shares were granted to executive officers, exclusive of the Companys Chief Executive Officer, who did not participate in this
program. These awards vest over an approximately 2 year period.



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



|                                                                                                |  |            |   |  |                               |      
|----------------------------------------------------------------------------------------------- |  | ---------- | - |  | ----------------------------- | -----
|                                                                                                |  | Shares     |   |  | Weighted-AverageExercisePrice
|Outstanding, June 30, 2002 (4,669,142 shares exercisable at a weighted-average price of $31.00) |  | 13,638,049 |   |  | $                             | 31.36
|Granted and assumed (weighted-average fair value of $8.36)                                      |  | 8,821,109  |   |  | $                             | 14.24
|Exercised                                                                                       |  | (1,174,385 | ) |  | $                             | 5.45 
|Canceled                                                                                        |  | (8,669,889 | ) |  | $                             | 32.15
|                                                                                                |  |            |   |  |                               |      
|Outstanding, June 30, 2003 (4,402,405 shares exercisable at a weighted-average price of $25.36) |  | 12,614,884 |   |  | $                             | 21.26
|Granted and assumed (weighted-average fair value of $7.32)                                      |  | 6,774,998  |   |  | $                             | 13.69
|Exercised                                                                                       |  | (888,285   | ) |  | $                             | 9.98 
|Canceled                                                                                        |  | (3,259,892 | ) |  | $                             | 19.85
|                                                                                                |  |            |   |  |                               |      
|Outstanding June 30, 2004 ( 7,104,132 shares exercisable at a weighted-average price of $22.39) |  | 15,241,705 |   |  | $                             | 18.86
|Granted and assumed (weighted-average fair value of $4.39)                                      |  | 4,194,806  |   |  | $                             | 9.67 
|Exercised                                                                                       |  | (467,604   | ) |  | $                             | 7.31 
|Canceled                                                                                        |  | (3,808,777 | ) |  | $                             | 17.54
|                                                                                                |  |            |   |  |                               |      
|Outstanding June 30, 2005                                                                       |  | 15,160,130 |   |  | $                             | 17.00
|                                                                                                |  |            |   |  |                               |      



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



The following table summarizes information concerning options outstanding as of June 30, 2005:



|                        |                  |                             |            |                                                  |      |                               |   |                        |  |                               |  |   |      
|----------------------- | ---------------- | --------------------------- | ---------- | ------------------------------------------------ | ---- | ----------------------------- | - | ---------------------- |  | ----------------------------- |  | - | -----
|                        |                  | Options Outstanding         |            | Options Vested                                  
|Range ofExercise Prices |                  | Number ofOptionsOutstanding |            | Weighted AverageRemainingContractual Life(Years) |      | WeightedAverageExercise Price |   | Vested atJune 30, 2005 |  | WeightedAverageExercise Price
|$                       | 0.0600-$  0.9250 |                             | 156,813    |                                                  | 2.56 |                               | $ | 0.43                   |  | 156,813                       |  | $ | 0.43 
|$                       | 1.5000-$  8.9500 |                             | 2,384,965  |                                                  | 5.99 |                               | $ | 8.82                   |  | 2,329,897                     |  | $ | 8.82 
|$                       | 9.0000-$12.0000  |                             | 1,918,371  |                                                  | 4.98 |                               | $ | 11.37                  |  | 906,089                       |  | $ | 11.38
|$                       | 12.0900-$13.8700 |                             | 920,542    |                                                  | 5.27 |                               | $ | 12.54                  |  | 346,631                       |  | $ | 12.56
|$                       | 13.9500-$13.9500 |                             | 2,954,121  |                                                  | 5.08 |                               | $ | 13.95                  |  | 1,770,375                     |  | $ | 13.95
|$                       | 13.9900-$14.3500 |                             | 1,586,740  |                                                  | 5.05 |                               | $ | 14.18                  |  | 1,110,355                     |  | $ | 14.17
|$                       | 14.3900-$16.4800 |                             | 1,549,961  |                                                  | 1.69 |                               | $ | 16.01                  |  | 1,409,239                     |  | $ | 16.01
|$                       | 16.9970-$28.7300 |                             | 2,262,404  |                                                  | 6.29 |                               | $ | 25.02                  |  | 1,937,450                     |  | $ | 25.11
|$                       | 28.8000-$94.8750 |                             | 1,426,213  |                                                  | 4.33 |                               | $ | 40.80                  |  | 1,351,263                     |  | $ | 41.41
|                        |                  |                             |            |                                                  |      |                               |   |                        |  |                               |  |   |      
|$                       | 0.0600-$94.8750  |                             | 15,160,130 |                                                  | 4.96 |                               | $ | 17.00                  |  | 11,318,112                    |  | $ | 17.92
|                        |                  |                             |            |                                                  |      |                               |   |                        |  |                               |  |   |      



Tender
OffersOn November 13, 2002 we announced a voluntary stock option exchange program for our employees, excluding the Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, and Chief Technology Officer.
Replacement options have a five-year term from the original grant date, vest on the same schedule as the tendered options, and are subject generally to a six-month restriction on exercisability commencing June 20, 2003. On December 18,
2002 employees tendered options to purchase a total of 5,276,953 shares in connection with this offer. The replacement options were granted according to exchange ratios, which depend upon the exercise price of the tendered options, as follows:



| |  | for options tendered with an exercise price less than or equal to $24.00 per share, options were granted for the same number of shares subject to the options tendered;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | for options tendered with an exercise price greater than $24.00 per share but less than $30.00 per share, options were granted for two shares for every three shares subject to the
options tendered; and
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | for options tendered with an exercise price greater than or equal to $30.00 per share, options were granted for one share for every two shares subject to the options tendered.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition, 50% of the net shares recaptured as
a result of the exchange ratios were retired from the option plans.



As a result of the tender offer, a total of 1,038,664 shares were retired from the plan and 1,038,271 shares returned to the plans for future grant. New options for a total of 2,848,145 shares were granted on June 20, 2003 at an
exercise price of $16.00 per share, with a five-year term from the original grant date, the same vest schedule as the tendered options and are subject generally to a six-month restriction on exercisability commencing June 20, 2003. A total of
351,873 shares were cancelled or expired as a result of employee terminations.



The exchange was organized to comply with FIN 44 and did not result in any additional compensation charges or variable plan accounting.



Employee Stock Purchase PlanUnder the NetIQ Corporation 1999 Employee Stock Purchase Plan (Purchase Plan)
eligible employees are permitted to have up to 15% of salary withholdings to purchase shares of



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



common stock at a price equal to 85% of the lower of the fair market value of the stock at the beginning or end of the defined purchase period, subject to an
annual limitation. During fiscal 2005, 2004 and 2003, 611,247, 630,468 and 609,274 shares of common stock were issued under the Purchase Plan at a weighted-average price of $9.75, $10.20 and $12.07, respectively.



The Purchase Plan provides for annual increases in the number of shares
available for issuance under the stock purchase plan on the first day of each fiscal year equal to the lowest of (i) 800,000 shares, (ii) 2% of the outstanding shares of common stock on the first day of the fiscal year, or (iii) a
number of shares as authorized by the Board of Directors. At June 30, 2005, the number of shares available for issuance was 2,334,523. No increase was authorized for fiscal 2006.



Common Stock RepurchasesWe repurchased and cancelled 8,840,000 shares of our common stock during fiscal 2005
for $98.3 million, pursuant to repurchase programs approved by our Board of Directors in September 2004 and May 2005. We purchased and cancelled 2,850,000 shares of our common stock during fiscal 2004 for $36.9 million, pursuant to a repurchase
program approved by our Board of Directors in October 2003.



13.    Income Taxes



The
current income tax provision for the years ended June 30, are (in thousands):



|                                        |  |      |       |      |   |       |  |   |        |  
|--------------------------------------- |  | ---- | ----- | ---- | - | ----- |  | - | ------ | -
|                                        |  | 2005 |       | 2004 |   | 2003  | 
|Current:                                |  |      |       |      |   |       |  |   |        |  
|Federal                                 |  | $    | 6,451 |      | $ | 122   |  | $ | 1,450  |  
|State                                   |  |      | 2,991 |      |   | 375   |  |   | 115    |  
|Foreign                                 |  |      | 450   |      |   | 3,303 |  |   | 445    |  
|                                        |  |      |       |      |   |       |  |   |        |  
|Total                                   |  | $    | 9,892 |      | $ | 3,800 |  | $ | 2,010  |  
|                                        |  |      |       |      |   |       |  |   |        |  
|Allocated to:                           |  |      |       |      |   |       |  |   |        |  
|Continuing Operations                   |  | $    | 1,597 |      | $ | 3,610 |  | $ | 11,790 |  
|Discontinued Operations                 |  |      | 30    |      |   | 190   |  |   | (9,780 | )
|Gain on sale of discontinued operations |  |      | 8,265 |      |   |      |  |   |       |  
|                                        |  |      |       |      |   |       |  |   |        |  
|                                        |  | $    | 9,892 |      | $ | 3,800 |  | $ | 2,010  |  
|                                        |  |      |       |      |   |       |  |   |        |  



No deferred income
taxes were provided for during fiscal 2005, 2004 and 2003.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



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



|                                                             |  |      |         |   |      |   |         |  
|------------------------------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                                             |  | 2005 |         |   | 2004 |  
|Deferred tax assets:                                         |  |      |         |   |      |   |         |  
|Net operating loss carryforwards                             |  | $    | 6,710   |   |      | $ | 23,540  |  
|Research and development and alternative minimum tax credits |  |      | 5,476   |   |      |   | 13,746  |  
|Accruals deductible in different periods                     |  |      | 11,848  |   |      |   | 7,840   |  
|                                                             |  |      |         |   |      |   |         |  
|                                                             |  |      | 24,034  |   |      |   | 45,126  |  
|Deferred tax liability:                                      |  |      |         |   |      |   |         |  
|Other intangible assets                                      |  |      | (5,767  | ) |      |   | (14,835 | )
|                                                             |  |      |         |   |      |   |         |  
|Net deferred tax assets                                      |  |      | 18,267  |   |      |   | 30,291  |  
|Valuation allowance                                          |  |      | (18,267 | ) |      |   | (30,291 | )
|                                                             |  |      |         |   |      |   |         |  
|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 future realizability.



The valuation allowance decreased by $12.0 million in fiscal 2005, increased by $18.9 million in fiscal 2004, and decreased by $3.3 million during
fiscal 2003. As of June 30, 2005, $ 15.7 million of the valuation allowance is attributable to the tax benefit of stock options and will be credited to equity when realized. In addition, when approximately $6.7 million of net
operating losses related to certain business combinations are utilized against future income, the related tax benefit of $2.3 million will be reflected as a goodwill reduction and not as a tax expense reduction.



Income / (loss) from continuing operations before income taxes and cumulative
effect of change in accounting principle consists of (in thousands):



|             |  |                     |        |   |      |   |          |      |  |   |          |  
|------------ |  | ------------------- | ------ | - | ---- | - | -------- | ---- |  | - | -------- | -
|             |  | Year Ended June 30, |       
|             |  | 2005                |        |   | 2004 |   |          | 2003 | 
|Domestic     |  | $                   | (9,423 | ) |      | $ | (163,404 | )    |  | $ | (274,526 | )
|Foreign, net |  |                     | 515    |   |      |   | 7,840    |      |  |   | (13,596  | )
|             |  |                     |        |   |      |   |          |      |  |   |          |  
|             |  | $                   | (8,908 | ) |      | $ | (155,564 | )    |  | $ | (288,122 | )
|             |  |                     |        |   |      |   |          |      |  |   |          |  



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



Our effective tax rate from continuing operations differs from the expected benefit at the federal
statutory rate as follows (in thousands):



|                                                          |  |                     |        |   |      |   |         |      |  |   |          |  
|--------------------------------------------------------- |  | ------------------- | ------ | - | ---- | - | ------- | ---- |  | - | -------- | -
|                                                          |  | Year Ended June 30, |       
|                                                          |  | 2005                |        |   | 2004 |   |         | 2003 | 
|Federal statutory tax benefit                             |  | $                   | (3,118 | ) |      | $ | (54,447 | )    |  | $ | (100,842 | )
|Impairment of goodwill                                    |  |                     |       |   |      |   | 48,424  |      |  |   | 110,613  |  
|Losses not benefited                                      |  |                     | 3,861  |   |      |   | 8,689   |      |  |   |         |  
|Effect of international operations                        |  |                     | 270    |   |      |   | 559     |      |  |   | 4,916    |  
|Write-off of acquired in-process research and development |  |                     |       |   |      |   |        |      |  |   | 489      |  
|State tax expense                                         |  |                     | 538    |   |      |   | 275     |      |  |   | 1,245    |  
|Research and development tax credit                       |  |                     |       |   |      |   |        |      |  |   | (4,052   | )
|Other                                                     |  |                     | 46     |   |      |   | 110     |      |  |   | (579     | )
|                                                          |  |                     |        |   |      |   |         |      |  |   |          |  
|Tax on continuing operations                              |  | $                   | 1,597  |   |      | $ | 3,610   |      |  | $ | 11,790   |  
|                                                          |  |                     |        |   |      |   |         |      |  |   |          |  



At June 30, 2005
we had net operating loss (NOL) carryforwards of approximately $19.2 million for federal income tax purposes. The federal NOL carryforwards expire through 2024. In addition, at June 30, 2005 we had $4.5 million of research and development
tax credit and alternative minimum tax credit carryforwards for federal and $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.



The American Jobs Creation Act of 2004 provides for a tax benefit in connection with repatriations of foreign profits in either fiscal 2005 or 2006. The
Company has analyzed these provisions and has concluded that there are currently no significant benefits to realize. No applicable repatriations were made in fiscal 2005. Any possible repatriations in fiscal 2006 are not expected to have a material
impact on the Companys fiscal 2006 tax provision.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



14.    Earnings 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, |        
|                                                                      |  | 2005                |         |   | 2004 |   |          | 2003 | 
|Net income (loss) numerator,                                          |  |                     |         |   |      |   |          |      |  |   |          |  
|Continuing operations                                                 |  | $                   | (10,505 | ) |      | $ | (159,175 | )    |  | $ | (299,912 | )
|Discontinued operations                                               |  |                     | 57,252  |   |      |   | (32,205  | )    |  |   | (29,491  | )
|Cumulative effect of change in accounting principle                   |  |                     |        |   |      |   |         |      |  |   | (579,338 | )
|Shares denominator:                                                   |  |                     |         |   |      |   |          |      |  |   |          |  
|Weighted-average common shares outstanding                            |  |                     | 54,019  |   |      |   | 56,729   |      |  |   | 53,601   |  
|Less weighted-average common shares outstanding subject to repurchase |  |                     |        |   |      |   |         |      |  |   | (348     | )
|                                                                      |  |                     |         |   |      |   |          |      |  |   |          |  
|Shares used in computation, basic and diluted                         |  |                     | 54,019  |   |      |   | 56,729   |      |  |   | 53,253   |  
|                                                                      |  |                     |         |   |      |   |          |      |  |   |          |  
|Net earnings (loss) per share, basic and diluted                      |  |                     |         |   |      |   |          |      |  |   |          |  
|Continuing operations                                                 |  | $                   | (0.19   | ) |      | $ | (2.81    | )    |  | $ | (5.63    | )
|Discontinued operations                                               |  |                     | 1.06    |   |      |   | (0.57    | )    |  |   | (0.55    | )
|Cumulative effect of change in accounting principle                   |  |                     |        |   |      |   |         |      |  |   | (10.88   | )
|                                                                      |  |                     |         |   |      |   |          |      |  |   |          |  
|Net earnings (loss) per share                                         |  | $                   | 0.87    |   |      | $ | (3.37    | )    |  | $ | (17.07   | )
|                                                                      |  |                     |         |   |      |   |          |      |  |   |          |  



For the
above-mentioned periods, we had securities outstanding which were excluded from the computation of diluted net loss per share in the periods presented as their effect would have been antidilutive. Such outstanding securities at June 30, 2005
consist of the following (in thousands):



|                                                |  |        |  |        |  |       
|----------------------------------------------- |  | ------ |  | ------ |  | ------
|                                                |  | 2005   |  | 2004   |  | 2003  
|Common shares outstanding subject to repurchase |  |       |  |       |  | 420   
|Outstanding options                             |  | 15,160 |  | 15,242 |  | 12,615
|                                                |  |        |  |        |  |       
|Total                                           |  | 15,160 |  | 15,242 |  | 13,035
|                                                |  |        |  |        |  |       



15.    Commitments and Contingencies



Operating LeasesWe lease certain facilities under noncancelable operating leases that expire through fiscal 2015 and certain equipment under operating leases. Under the terms of the facility leases, we
are responsible for our proportionate share of maintenance, property tax and insurance expenses. Some agreements provide an option to extend the lease for additional specified periods.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



Future minimum annual lease commitments, which include lease payments accrued as part of our
restructuring liability and facility reserve, are as follows (in thousands):



|                            |  |   |       
|--------------------------- |  | - | ------
|Fiscal year ending June 30, |  |  
|2006                        |  | $ | 4,751 
|2007                        |  |   | 4,596 
|2008                        |  |   | 3,700 
|2009                        |  |   | 3,068 
|2010                        |  |   | 2,862 
|Thereafter                  |  |   | 9,471 
|                            |  |   |       
|Total                       |  | $ | 28,448
|                            |  |   |       



Rent expense under
operating leases was approximately $5.0 million, $5.2 million, and $5.1 million for fiscal 2005, 2004 and 2003, respectively.



Royalty AgreementsWe have non-exclusive worldwide licenses to certain third-party technologies. Based on these agreements, we are required to
pay specified royalties based on a percentage of revenue from products incorporating the technologies.



Future minimum annual royalty payments are as follows (in thousands):



|                            |  |   |      
|--------------------------- |  | - | -----
|Fiscal year ending June 30, |  |  
|2006                        |  | $ | 753  
|2007                        |  |   | 350  
|2008                        |  |   | 350  
|Thereafter                  |  |   |     
|                            |  |   |      
|Total                       |  | $ | 1,453
|                            |  |   |      



Total royalty expense
was $3.4 million, $7.2 million, and $6.3 million for fiscal 2005, 2004 and 2003, respectively.



IndemnificationWe enter into standard indemnification agreements with many of our customers and certain other business partners in the
ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third-party to the extent any such claim alleges that a NetIQ product infringes a patent, copyright or trademark,
misappropriates a trade secret, or violates any other proprietary rights of that third-party. It is not possible to estimate the maximum potential amount of future payments we could be required to make under these indemnification agreements. To
date, we have not incurred significant costs to defend lawsuits or settle claims related to indemnification agreements. As of June 30, 2005 we recorded a $400,000 liability on our balance sheet in accordance with FIN 45 Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. The liability represents the estimated value of the indemnification provided to the acquirer of WebTrends. We had no liabilities
recorded for indemnification agreements at June 30, 2004.



At our discretion and in the ordinary course of business, we perform and subcontract the performance of certain services. Accordingly, we enter into standard indemnification agreements with our customers to indemnify them for damage caused
by our employees and subcontractors. It is not possible to estimate the



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



maximum potential amount of future payments we could be required to make under these indemnification agreements. We maintain insurance policies that may
enable us to recover a portion of any such claim. We have not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements. We have not recorded any liabilities for these indemnification agreements at
June 30, 2005 or June 30, 2004.



As permitted under
Delaware law, we have agreements indemnifying our executive officers, directors and some other employees for certain events and occurrences while the officer, director and employee is, or was, serving at our request in such capacity. The maximum
potential amount of future payments we could be required to make under these indemnification agreements is not estimable. We maintain directors and officers liability insurance designed to enable us to recover a portion of any future amounts paid.
We have not recorded any liabilities for these indemnification agreements at June 30, 2005 or June 30, 2004.



ContingenciesIn January 2003 BMC Software, Inc. (BMC) filed suit against us in the U.S. District Court for the Southern District of
Texas (Court) for patent and trademark infringement. In August 2003 the Court ordered the litigation stayed, pending arbitration. In September 2003 BMC submitted to the American Arbitration Association a statement of claim seeking a
declaratory judgment that BMCs claims are not subject to arbitration and alleging that it believes that at least AppManager and our former Operations Manager product, the underlying technology of which is licensed to Microsoft, infringe the
BMC patent. In October 2003 we submitted our initial answer, denying the claims of infringement asserted by BMC. In November 2003 we filed an amended answer and counterclaim in the arbitration proceeding alleging that BMC infringes a valid
patent that we own. BMC has denied the allegations in our counterclaim. In April 2005, BMC amended its statement of claim to assert that one or more of our products infringes an additional patent owned by BMC. We have denied the allegations in the
amended claim. Each party is seeking injunctive relief, compensatory and treble damages, interest, and attorneys fees with respect to its claims. Currently, discovery is in the very early stages.



We may also 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 reimbursed by insurance or otherwise, will not have a
material adverse effect on our financial condition or results of operations.



16.    Employee Benefit Plans



We sponsor a 401(k) Savings and Retirement Plan (the Plan) for all eligible employees in the United States. Participants may contribute, on a pre-tax basis, between 1% and 30% of their annual compensation, but not to exceed a maximum
contribution amount pursuant to Section 401(k) of the Internal Revenue Code. Effective July 1, 2001 the Board of Directors authorized a matching contribution whereby we will match 50% of each employees contributions up to a maximum
of 6% of their compensation or $3,500. Employer matching contributions will vest ratably over five years.



Employer matching contributions under the plans for fiscal 2005, 2004 and 2003 were $2,184,000, $2,317,000 and $2,312,000, respectively.



Contributory pension programs as permissible under the applicable laws of
foreign subsidiaries are offered to employees in most foreign subsidiaries.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



17.    Major Customers



No single customer accounted for greater than 10% of accounts receivable at June 30, 2005 and June 30, 2004. No
single customer accounted for greater than 10% of total revenue in fiscal 2005 and 2004 and Microsoft Corporation accounted for 19% of total revenue during fiscal 2003.



18.    Related Party Transactions



Royalty expense included amounts to an affiliate of $26,800 and $375,000 during fiscal 2004 and 2003, respectively. There
were no related party transactions during fiscal 2005.



In the
normal course of business we sell our products and services to various businesses, some of which may own our common stock. The terms of any such sales, in the opinion of management, are generally comparable to those offered to other customers based
on the products purchased and the size of the transaction.



19.    Segment and Geographical Information



We operate in one reportable segment: the design, development, marketing, support and sales of systems and security management solutions. 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,
|                                                                    |  | 2005                |         | 2004 |   | 2003   
|Total revenue:                                                      |  |                     |         |      |   |         |  |   |        
|United States                                                       |  | $                   | 135,221 |      | $ | 138,880 |  | $ | 198,104
|Foreign                                                             |  |                     | 77,995  |      |   | 78,120  |  |   | 66,034 
|                                                                    |  |                     |         |      |   |         |  |   |        
|Total revenue*                                                      |  | $                   | 213,216 |      | $ | 217,000 |  | $ | 264,138
|                                                                    |  |                     |         |      |   |         |  |   |        
|Long-lived assets (excluding goodwill and other intangible assets): |  |                     |         |      |   |         |  |   |        
|United States                                                       |  | $                   | 43,064  |      | $ | 53,867  |  | $ | 62,265 
|Foreign                                                             |  |                     | 2,173   |      |   | 2,942   |  |   | 3,288  
|                                                                    |  |                     |         |      |   |         |  |   |        
|Total long-lived assets                                             |  | $                   | 45,237  |      | $ | 56,809  |  | $ | 65,553 
|                                                                    |  |                     |         |      |   |         |  |   |        

---

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



20.    Subsequent Event



On July 18, 2005, the Audit Committee authorized management to prepare and implement a plan of organizational restructuring to take place principally
in the first and second quarters of fiscal year 2006, consisting of headcount reductions and realignment and movement of operations.



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NetIQ CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

Years Ended June 30, 2005, 2004, and 2003



Quarterly Results (Unaudited)



A summary of quarterly financial information for each of the last two fiscal years is set forth in the table below. We
believe 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, 2005              |       
|                                                  |  | FirstQuarter                          |        |   |  |  | SecondQuarter |   |        |  | ThirdQuarter |  |   |        |   | FourthQuarter | 
|                                                  |  | (In thousands, except per share data) |       
|Total revenue:                                    |  | $                                     | 53,884 |   |  |  |               | $ | 58,130 |  |              |  | $ | 51,098 |   |               |  |  | $ | 50,104 |  
|Gross profit:                                     |  |                                       | 43,078 |   |  |  |               |   | 47,390 |  |              |  |   | 40,241 |   |               |  |  |   | 39,284 |  
|Gain (loss) from continuing operations            |  |                                       | (4,472 | ) |  |  |               |   | 3,368  |  |              |  |   | (3,230 | ) |               |  |  |   | (6,171 | )
|Gain from discontinued operation                  |  |                                       | 593    |   |  |  |               |   | 1,639  |  |              |  |   | 167    |   |               |  |  |   | 54,853 |  
|Net income (loss)                                 |  |                                       | (3,879 | ) |  |  |               |   | 5,007  |  |              |  |   | (3,063 | ) |               |  |  |   | 48,682 |  
|                                                  |  |                                       |        |   |  |  |              
|Basic earnings (loss) per share:(1)               |  |                                       |        |   |  |  |               |   |        |  |              |  |   |        |   |               |  |  |   |        |  
|Continuing operations                             |  | $                                     | (0.08  | ) |  |  |               | $ | 0.06   |  |              |  | $ | (0.06  | ) |               |  |  | $ | (0.12  | )
|Discontinued operations                           |  |                                       | 0.01   |   |  |  |               |   | 0.03   |  |              |  |   | 0.00   |   |               |  |  |   | 1.06   |  
|                                                  |  |                                       |        |   |  |  |               |   |        |  |              |  |   |        |   |               |  |  |   |        |  
|Net earnings (loss) per share                     |  | $                                     | (0.07  | ) |  |  |               | $ | 0.09   |  |              |  | $ | (0.06  | ) |               |  |  | $ | 0.94   |  
|                                                  |  |                                       |        |   |  |  |               |   |        |  |              |  |   |        |   |               |  |  |   |        |  
|                                                  |  |                                       |        |   |  |  |              
|Diluted earnings (loss) per share:(1)             |  |                                       |        |   |  |  |               |   |        |  |              |  |   |        |   |               |  |  |   |        |  
|Continuing operations                             |  | $                                     | (0.08  | ) |  |  |               | $ | 0.06   |  |              |  | $ | (0.06  | ) |               |  |  | $ | (0.12  | )
|Discontinued operations                           |  |                                       | 0.01   |   |  |  |               |   | 0.03   |  |              |  |   | 0.00   |   |               |  |  |   | 1.06   |  
|                                                  |  |                                       |        |   |  |  |               |   |        |  |              |  |   |        |   |               |  |  |   |        |  
|Net earnings (loss) per share                     |  | $                                     | (0.07  | ) |  |  |               | $ | 0.09   |  |              |  | $ | (0.06  | ) |               |  |  | $ | 0.94   |  
|                                                  |  |                                       |        |   |  |  |               |   |        |  |              |  |   |        |   |               |  |  |   |        |  
|                                                  |  |                                       |        |   |  |  |              
|Shares used to compute basic earnings per share   |  |                                       | 55,143 |   |  |  |               |   | 54,958 |  |              |  |   | 54,162 |   |               |  |  |   | 51,792 |  
|Shares used to compute diluted earnings per share |  |                                       | 55,143 |   |  |  |               |   | 55,859 |  |              |  |   | 54,162 |   |               |  |  |   | 51,792 |  

---

|(1) | The sum of quarterly per share amounts do 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 quarters.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                            |  |                                       |          |   |  |  |               |   |         |   |  |              |  |   |         |   |               |  |  |   |        |  
|----------------------------------------------------------- |  | ------------------------------------- | -------- | - |  |  | ------------- | - | ------- | - |  | ------------ |  | - | ------- | - | ------------- |  |  | - | ------ | -
|                                                            |  | Year Ended June 30, 2004              |         
|                                                            |  | FirstQuarter                          |          |   |  |  | SecondQuarter |   |         |   |  | ThirdQuarter |  |   |         |   | FourthQuarter | 
|                                                            |  | (In thousands, except per share data) |         
|Total revenue:                                              |  | $                                     | 52,579   |   |  |  |               | $ | 52,297  |   |  |              |  | $ | 55,428  |   |               |  |  | $ | 56,696 |  
|Gross profit:                                               |  |                                       | 42,608   |   |  |  |               |   | 42,678  |   |  |              |  |   | 45,223  |   |               |  |  |   | 46,129 |  
|Loss from continuing operations                             |  |                                       | (141,966 | ) |  |  |               |   | (6,109  | ) |  |              |  |   | (5,338  | ) |               |  |  |   | (5,762 | )
|Loss from discontinued operation                            |  |                                       | (21,648  | ) |  |  |               |   | (4,138  | ) |  |              |  |   | (5,269  | ) |               |  |  |   | (1,150 | )
|Net loss:                                                   |  |                                       | (163,614 | ) |  |  |               |   | (10,247 | ) |  |              |  |   | (10,607 | ) |               |  |  |   | (6,912 | )
|                                                            |  |                                       |          |   |  |  |              
|Basic and diluted loss per share(1)                         |  |                                       |          |   |  |  |               |   |         |   |  |              |  |   |         |   |               |  |  |   |        |  
|Continuing operations                                       |  | $                                     | (2.52    | ) |  |  |               | $ | (0.11   | ) |  |              |  | $ | (0.09   | ) |               |  |  | $ | (0.10  | )
|Discontinued operations                                     |  |                                       | (0.38    | ) |  |  |               |   | (0.07   | ) |  |              |  |   | (0.09   | ) |               |  |  |   | (0.02  | )
|                                                            |  |                                       |          |   |  |  |               |   |         |   |  |              |  |   |         |   |               |  |  |   |        |  
|Net loss per share                                          |  | $                                     | (2.91    | ) |  |  |               | $ | (0.18   | ) |  |              |  | $ | (0.19   | ) |               |  |  | $ | (0.12  | )
|                                                            |  |                                       |          |   |  |  |               |   |         |   |  |              |  |   |         |   |               |  |  |   |        |  
|Shares used to compute basic and diluted earnings per share |  |                                       | 56,306   |   |  |  |               |   | 56,870  |   |  |              |  |   | 57,045  |   |               |  |  |   | 55,953 |  

---

|(1) | The sum of quarterly per share amounts do 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 quarters.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

SCHEDULE II



VALUATION AND
QUALIFYING ACCOUNTS

(In thousands)



|                                     |  |                              |       |                                      |   |       |       |  |   |                        |   |  |                        |        |   |  |   |      
|------------------------------------ |  | ---------------------------- | ----- | ------------------------------------ | - | ----- | ----- |  | - | ---------------------- | - |  | ---------------------- | ------ | - |  | - | -----
|                                     |  | Balance atbeginningof period |       | Charged(credited)to cost andexpenses |   |       | Other |  |   | Recoveries(Deductions) |   |  | Balance atend ofperiod
|Year ended June 30, 2003             |  |                              |       |                                      |   |       |       |  |   |                        |   |  |                        |        |   |  |   |      
|Allowance for uncollectible accounts |  | $                            | 1,419 |                                      | $ | (165  | )     |  | $ | 161                    |   |  | $                      | (310   | ) |  | $ | 1,105
|Allowance for sales returns          |  | $                            | 1,610 |                                      | $ | 1,072 |       |  | $ |                       |   |  | $                      | (1,581 | ) |  | $ | 1,101
|                                     |  |                              |       |                                      |  
|Year ended June 30, 2004             |  |                              |       |                                      |   |       |       |  |   |                        |   |  |                        |        |   |  |   |      
|Allowance for uncollectible accounts |  | $                            | 1,105 |                                      | $ | (152  | )     |  | $ | (161                   | ) |  | $                      | (121   | ) |  | $ | 671  
|Allowance for sales returns          |  | $                            | 1,101 |                                      | $ | 1,106 |       |  | $ |                       |   |  | $                      | (1,344 | ) |  | $ | 863  
|                                     |  |                              |       |                                      |  
|Year ended June 30, 2005             |  |                              |       |                                      |   |       |       |  |   |                        |   |  |                        |        |   |  |   |      
|Allowance for uncollectible accounts |  | $                            | 671   |                                      | $ | (65   | )     |  | $ | (112                   | ) |  | $                      | 61     |   |  | $ | 555  
|Allowance for sales returns          |  | $                            | 863   |                                      | $ | 586   |       |  | $ | (110                   | ) |  | $                      | (758   | ) |  | $ | 581  



80