OPSWARE INC - 10-Q Quarterly Report

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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 whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES ¨ NO x

There were 79,159,666 shares of the Company’s Common Stock, par value $0.001, outstanding on May 31, 2003.

This Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to our, and in some cases our customers’ or partners’, future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements. These forward-looking statements include, but are not limited to, statements regarding anticipated market trends and uncertainties, revenue generated from the sale of our Opsware software, cost of revenue, operating expenses, anticipated capital expenditures and lease commitments, the adequacy of our capital resources to fund our operations, operating losses and negative cash flow, the anticipated increase in customers and expansion of our product offerings and target markets, our expectation with respect to our obligations to indemnify EDS, our expectations regarding ongoing development of our Opsware software and other technical capabilities, and potential expansion in our direct and indirect sales organizations.

These statements involve known and unknown risks, uncertainties and other factors that may cause industry trends or our actual results, level of activity, performance or achievements to be materially different from the outcomes expressed or implied by these statements. These factors include those listed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Factors That May Affect Future Results” in this Quarterly Report on Form 10-Q.

Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We will not necessarily update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or changes in our expectations, except as required by law. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q.

The condensed consolidated financial statements and related information contained in this Quarterly Report on Form 10-Q reflect our results as they existed for the quarter ended April 30, 2003 and the other periods presented. On August 15, 2002, we completed the sale of our Managed Services Business to EDS and are now focused solely on our Software Business. As a result, historical financial information relating to the periods prior to August 15, 2002 is not related to our Software Business and is not indicative of future results from our Software Business.

Opsware Inc. (“Opsware,” “the Company,” or “we”), was incorporated as VCellar, Inc. on September 9, 1999 in the state of Delaware. Prior to August 15, 2002, the Company primarily provided managed Internet services for corporations and government agencies that operate mission-critical Internet applications. The Company refers to this business as its Managed Services Business.

On August 15, 2002, the Company completed the sale of its Managed Services Business to Electronic Data Systems Corporation (“EDS”). The Company used its proprietary Opsware automation technology in the Managed Services Business, and has since developed this technology into its Opsware System software. As a result, the operations and cash flows of the Managed Services Business could not clearly be distinguished from the Software Business, either operationally or for financial reporting purposes. Therefore, the Managed Services Business was not considered a discontinued operation.

The Company currently sells its Opsware System software to enterprises, government agencies and service providers looking to reduce costs and increase IT efficiencies. The Company refers to this business as the Software Business. The Opsware System automates key server and software operations in data centers, including provisioning, changing, configuring, scaling, securing, recovering, auditing, and reallocating servers and business applications across geographically disparate locations and heterogeneous data center environments.

The condensed consolidated financial statements have been prepared by the Company, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission and include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances have been eliminated. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. While in the opinion of the Company, the unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial position at April 30, 2003 and the operating results and cash flows for the three-month period ended April 30, 2003, these condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and notes for the year ended January 31, 2003 included in the Company’s Annual Report on Form 10-K filed on May 1, 2003. The condensed balance sheet at January 31, 2003 has been derived from audited financial statements as of that date.

The results of operations for the three-month period ended April 30, 2003 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending January 31, 2004.

The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that materially affect the amounts reported in the condensed consolidated financial statements. Actual results could differ from these estimates. In addition, certain amounts that were previously reported have been reclassified to conform to the current period presentation. The methods, estimates and judgments the Company uses in applying its most critical accounting policies have a significant impact on the results reported in its financial statements. The U.S. Securities and Exchange Commission has described the most critical accounting policies as the ones that are most important to the portrayal of the Company’s financial condition and results, and require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based

on this description, the Company’s most critical accounting policies include those relating to revenue recognition, impairment of long-lived assets, restructuring costs and accruals and contingencies.

The Company considers all highly liquid investment securities with maturity from the date of purchase of three months or less to be cash equivalents and investment securities with maturity from the date of purchase of more than three months, but less than twelve months, to be short-term investments.

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

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, restricted cash and accounts receivable. The Company places all of its cash equivalents and restricted cash with high-credit quality issuers. Carrying amounts of financial instruments held by the Company, which include cash equivalents, restricted cash and accounts receivable, approximate fair value due to their short duration. The Company performs ongoing credit evaluations and maintains reserves for potential losses.

For the three-month period ended April 30, 2003, EDS accounted for 94% of the Company’s net revenue. For the three-month period ended April 30, 2002, Atriax accounted for 10% of the Company’s net revenue. As of April 30, 2003, EDS accounted for 99% of the Company’s accounts receivable balance.

As part of its Software Business, the Company recognizes revenue in accordance with the American Institute of Certified Public Accountants’ (“AICPA”) Statement of Position No. 97-2 (“SOP 97-2”), “Software Revenue Recognition”, as amended by Statement of Position No. 98-4, “Deferral of the Effective Date of SOP 97-2, ‘Software Revenue Recognition”’(“SOP 98-4”), Statement of Position No. 98-9, “Modification of SOP 97-2 with Respect to Certain Transactions”(“SOP 98-9”), and Statement of Position No. 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts”(“SOP 81-1”). For each transaction, the Company determines whether evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all criteria are met. The Company considers all arrangements with payment terms extending beyond twelve months and other arrangements with payment terms longer than normal not to be fixed or determinable. If collectibility is not considered probable, revenue is recognized when the fee is collected. Generally, no customer has the right of return.

The Company generates revenue from the sale of software licenses and services related to the Software Business, including from maintenance and support agreements and professional service agreements. Sales of software licenses and maintenance are the primary components of the Company’s revenue.

License revenue is comprised of fees for multi-year or perpetual licenses, which are derived from contracts with customers. Once the Company establishes vendor specific objective evidence of fair value for maintenance, the Company will recognize license revenue based upon the residual method after all elements other than maintenance have been delivered as prescribed by SOP 98-9. The Company will recognize maintenance revenue over the term of the maintenance contract once vendor specific objective evidence of fair value for all undelivered elements including maintenance exists. In accordance with paragraph 10 of SOP 97-2, vendor specific objective evidence of fair value of maintenance is determined by reference to the price the customer will be required to pay when maintenance is sold separately (that is, the stated rate). Customers that enter into maintenance contracts generally have the ability to renew these contracts at the renewal rate. Maintenance contracts are typically one year in duration. Until the Company establishes vendor specific objective evidence of fair value for maintenance, both the license and maintenance revenue will be recognized ratably over the maintenance period. For term licenses accompanied by maintenance, the entire arrangement is recognized ratably over the term of the license period. See

Note 3 for further discussion on the treatment of revenue recognition in connection with the $52.0 million license and maintenance agreement with EDS, which comprises 94% of the revenue recognized during the three month period ended April 30, 2003. Services revenue during the three-month period ended April 30, 2003 was not significant. As a result, license and services revenue were not presented separately in the financial statements.

Services revenue is comprised of revenue from maintenance and support agreements and professional services arrangements. In all cases, the Company assesses whether the service element of the arrangement is essential to the functionality of the other elements of the arrangement. When services are considered essential or the arrangement involves customization or modification of the Company’s software and when reliable estimates are available for the costs and efforts necessary to complete the services, both the license and services revenues under the arrangement are recognized under the percentage of completion method of accounting based upon input measures of hours. When such estimates are not available, the completed contract method is utilized. When an arrangement includes contractual milestones, the Company recognizes revenues as such milestones are achieved provided the milestones are not subject to any additional acceptance criteria. For those arrangements where the Company has concluded that the services element is not essential to the other elements of the arrangement, the Company then determines whether the services are available for other customers, do not involve a significant degree of risk or unique acceptance criteria and whether it is able to provide the services in order to separately account for the services revenue. When the services qualify for separate accounting, the Company uses vendor specific objective evidence of fair value for the services and maintenance to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. Revenue allocable to services is recognized as the services are performed.

Vendor specific objective evidence of fair value of consulting services is based upon hourly rates. The Company enters into stand-alone contracts for professional services and these contracts provide for payment upon a time and materials basis. The hourly rates associated with these contracts are used to assess the vendor specific objective evidence of fair value in multi-element arrangements.

The Company intends to recognize revenue associated with software licenses and services sold to distributors, system integrators and value added resellers (collectively “resellers”). Unless it is aware that a reseller does not have a purchase order or other contractual agreement from an end user, the Company will recognize revenue from resellers. In connection with these arrangements, there is no right of return or price protection for sales to resellers.

Prior to August 15, 2002, the closing of the sale of the Company’s Managed Services Business to EDS, the Company generated revenue in its Managed Services Business through the sale of managed Internet services. Substantially all revenue recognized prior to August 15, 2002 was generated from the Managed Services Business. The Company recognized revenue ratably over the managed services contract period as services were fulfilled, provided that for each transaction, evidence of an arrangement existed, delivery had occurred, the fee was fixed or determinable, and collection was probable. If obligations remained after services were delivered, revenue was recognized after such obligations were fulfilled. In addition, the Company provided certain guarantees regarding scheduled uptime to its customers on a monthly basis.

The Company reduced revenue generated in the Managed Service Business for credits given for estimated unscheduled downtime on a monthly basis. According to its accounting policy and customer contracts, the revenue credits were based on the cause of downtime, the length of the downtime and the customer’s monthly price of the services. The estimated credit reduced revenue in the month in which the unscheduled downtime occurred. In addition to the service credits, the Company occasionally issued credits for events that were outside of the contractual service level agreements. These types of credits were not financially significant. The process for estimating these types of credits included analyzing the historical experiences with such credits and comparing them to events that occurred in the then-current month.

If any of the criteria for revenue recognition are not met, the Company defers revenue recognition until such time as all criteria are met. If the Company receives cash from a customer, but has not met the criteria for revenue recognition, the amounts received are included in advances from customers. If the Company has met the criteria for revenue recognition, whether or not it received cash from the customer, the amounts are recorded as deferred revenue except for the amounts recognized in the then current period revenue.

The Company grants stock options and stock purchase rights for a fixed number of shares to employees and directors with an exercise price equal to the fair value of the shares at the date of grant. As permitted under the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) as amended by FAS 148, the Company accounts for stock option grants and stock purchase rights to employees and directors in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB Opinion No. 25”) and, accordingly, recognizes no compensation expense for stock option grants or stock purchase rights with an exercise price equal to the fair value of the shares at the date of grant. If compensation cost for the Company’s stock-based compensation plans had been determined consistent with SFAS 123, “Accounting for Stock Based Compensation,” the Company’s net loss and net loss per share would have been increased to the pro forma amounts indicated below (in thousands, except per share data):

For purposes of this disclosure, the estimated fair value of the stock purchase rights and stock options is amortized to expense over the stock purchase rights and options’ vesting periods. The fair value of stock purchase rights and options granted during all periods was estimated at the date of the option grant using the Black-Scholes option pricing model with the following assumptions:

The Black-Scholes option pricing model was developed for use in estimating the value of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions including the expected stock price volatility. The Company uses projected data for expected volatility and expected life of its stock options based upon historical and other economic data trended into future years. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the estimate, in

management’s opinion, the existing valuation models do not provide a reliable measure of the fair value of the Company’s employee stock options.

The weighted average grant date fair value per share was $1.46 and $1.72 for stock purchase rights and stock options granted in the three-month period ended April 30, 2003 and 2002, respectively.

The Company continually reviews the carrying value of long-lived assets, including property and equipment to determine whether there are any indications of impairment losses. According to its accounting policy, when such indicators are present, if the undiscounted cash flows expected to be generated from its customers is less than the carrying value of its long-lived assets, the Company compares the estimated discounted future net cash flows to be generated from its customers to the carrying value of the long-lived assets to determine any impairment charges. The Company reduces the carrying value of the long-lived assets if the carrying value of the long-lived assets is greater than the estimated discounted future net cash flow.

During fiscal 2002 and 2003, the Company restructured its business under plans approved by the Board of Directors by reducing its headcount, consolidating its facilities and disposing of excess and obsolete property and equipment. As a result of these actions, the Company recorded restructuring and other related charges consisting of cash severance payments made to terminated employees and lease payments related to property vacated as a result of its consolidation of facilities. The Company is attempting to sublet non-cancelable leased facilities that it has vacated. If the length of time before the Company finds tenants for these facilities or the market rental rates differ significantly from its estimates, its actual costs will differ from the charge that was initially recorded. The Company’s estimates include the review of the financial condition of its existing sublessees as well as the state of the regional real estate markets. Each reporting period, the Company will review these estimates based on the status of execution of its restructuring plan and, to the extent that these assumptions change due to changes in market conditions and its business, the ultimate restructuring expenses could vary by material amounts, and could result in additional expenses or the recovery of amounts previously recorded.

The Company evaluates contingent liabilities including threatened or pending litigation in accordance with SFAS No. 5, “Accounting for Contingencies.” If the potential loss from any claim or legal proceedings is considered probable and the amount can be estimated, the Company accrues a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based on the best information available at the time. As additional information becomes available, the Company reassesses the potential liability related to its pending claims and litigation and may revise its estimates. Such revisions in the estimates of the potential liabilities could have a material impact on its results of operations and financial position. In addition, the Company has retained various liabilities related to its Managed Services Business. The outcome of these liabilities could result in a material difference from its current estimates, and could result in additional expenses or the recovery of amounts previously recorded. See Note 8 for a description of the Company’s material legal proceedings.

Research and development expenditures are charged to operations as incurred. SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed,” requires the capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company’s product development process, technological feasibility is established upon the completion of a working model. Costs incurred by the Company between the completion of the working model and the point at which the product is ready for general release have been insignificant. Accordingly, the Company has charged all such costs to research and development expense in the accompanying statements of operations.

The Company’s total consolidated comprehensive net loss was $3.9 million and $30.3 million for the three-month periods ended April 30, 2003 and 2002, respectively. The reasons for the differences between the total consolidated comprehensive net loss were related to foreign currency translation and unrealized gains on investments.

In May 2001, while operating the Managed Services Business, the Company announced a restructuring program to improve utilization of its existing technology and infrastructure. This restructuring program included a worldwide workforce reduction of 122 employees, consolidation of the resulting excess facilities and a provision for excess and obsolete property and equipment. As a result of the restructuring program, the Company recorded restructuring costs of $30.2 million classified as operating expenses in the quarter ended July 31, 2001. Included in the $30.2 million was a noncash charge of $2.9 million related to accelerating the vesting of options for certain employees. The Company recorded a recovery of $0.6 million through the sale of assets and liabilities related to the Managed Services Business, during the fiscal year ended January 31, 2003. The recovery consisted of $0.1 million related to workforce reduction and $0.5 million related to the disposal of property and equipment.

A summary of the May 2001 restructuring charges is outlined as follows (in millions):

In June 2002, the Company announced a restructuring program in connection with its entering into an agreement to sell the assets and liabilities of the Managed Services Business to EDS, which included a worldwide workforce reduction and a provision for the impairment of excess and obsolete property and equipment. As a result, the Company recorded restructuring costs of $7.0 million classified as operating expenses in the quarter ended July 31, 2002.

A summary of the June 2002 restructuring charges is outlined as follows (in millions):

In August 2002, the Company announced a restructuring program in connection with the closing of the sale of its Managed Services Business to EDS. The restructuring program was accounted for under the provisions of SFAS 146, which we adopted in July 2002. The restructuring program included a provision for the resulting excess facilities and a provision for excess and obsolete property and equipment. The lease payments on excess facilities were based on management’s estimates of its ability to sublease excess facilities based on known prevailing real estate market conditions at that time. As a result, the Company recorded restructuring costs of $13.3 million classified as operating expenses in the quarter ended October 31, 2002. In accordance with SFAS 146, the Company recorded an adjustment to the restructuring charge of approximately $1.0 million in the three-month period ended April 30, 2003. The adjustment was a result of a change in the Company’s estimate due to a decrease in sublease

income based upon the financial condition of the subtenant. In addition, the Company recorded a recovery for property and equipment of $140,000 during the three-month period ended April 30, 2003.

A summary of the August 2002 restructuring charges is outlined as follows (in millions):

On August 15, 2002, the Company received $63.5 million in cash proceeds from the sale of its Managed Services Business to EDS. The sale included the disposal of $31.6 million of assets, including $19.6 million of property and equipment, $10.3 million of accounts receivable, $1.7 million of other current assets and $0.05 million of other assets, and $21.4 million of liabilities, including $2.6 million of accounts payable, $5.7 million of accrued liabilities, $11.2 million of deferred revenue and $1.9 million of capital leases. In addition, the Company incurred transaction costs of $2.3 million. The Company recognized a gain on the sale of the assets and liabilities of its Managed Services Business in the amount of $50.7 million in the three month period ended October 31, 2002.

In addition to the amounts above, the Company also transferred to EDS the liabilities of the Managed Services Business incurred subsequent to August 15, 2002. The Company used its proprietary Opsware automation technology in the Managed Services Business, and has since developed this technology into its Opsware System software. As a result, the operations and cash flows of the Managed Services Business could not clearly be distinguished from the Software Business, either operationally or for financial reporting purposes. Therefore, the Managed Services Business is not considered a discontinued operation in accordance with Statement of Financial Accounting Standard No. 144 (SFAS 144), “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company accounted for the sale of assets and liabilities related to the Managed Services Business as a gain in the three-month period ended October 31, 2002.

Under the asset purchase agreement with EDS, the Company has retained various liabilities relating to the Managed Services Business and has agreed to indemnify EDS for periods ranging from twelve to eighteen months following the closing date of the transaction up to a maximum of $27.0 million, for any breach of its representations and warranties contained in the asset purchase agreement and for other matters, including certain liabilities retained by it under that agreement, subject to limitations. The Company believes that the likelihood of its obligation to indemnify EDS for these matters is remote.

As part of the purchase price, the Company granted EDS a license to use its Opsware System software to service those customers that were transferred to EDS, and undertook certain maintenance obligations with respect to the license. The Company recorded a deferred gain of $388,000 for the maintenance of software for customers transferred to EDS of which approximately $188,000 was recognized as of April 30, 2003. The remaining balance will be amortized through January 15, 2004. The Company retained title to all of its proprietary Opsware software. In addition, the Company issued a $4.0 million letter of credit in favor of EDS to cover any post-closing liabilities related to the net asset adjustment test contained in the asset purchase agreement with EDS. On November 22, 2002, the Company agreed with EDS that there would be no adjustment to the purchase price under the net asset adjustment test contained in the asset purchase agreement and EDS released the letter of credit.

In addition to the license and maintenance agreements entered into pursuant to the asset purchase agreement, concurrently with execution of the asset purchase agreement, the Company executed a license and maintenance agreement with EDS pursuant to which the Company granted EDS a non-exclusive, worldwide hosting and integration license whereby EDS will have certain rights to license the Company’s Opsware software. Under the Opsware license and maintenance agreement, EDS will pay the Company (subject to the Company’s development of specified features and functions) a minimum license and maintenance fee of $52.0 million in the aggregate over a

term of three years. The Company delivered and received acceptance on all of the specified features and functions owing to EDS under the Opsware license agreement during the three-month period ended April 30, 2003.

The Company believes it has sufficient objective and reliable evidence of fair value for both the value of the Managed Services Business sold to EDS and the $52.0 million license and maintenance agreement (based on renewal rates). The Company further believes that the $52.0 million license and maintenance agreement is a separate earnings process and does not affect the quality of use or the value to EDS of the $63.5 million sale of the Managed Services Business. Given that the license and maintenance agreement contains extended payment terms and the Company has not established vendor specific objective evidence of fair value for maintenance, the Company is recognizing the license fees from EDS when the monthly minimum commitment is due, as the Company delivered all specified features and functions during the three-month period ended April 30, 2003. Payments received prior to delivery of the specified features and functions are being amortized as revenue by the Company on a straight-line basis over the remaining term of the contract. The payments from EDS will be equal to the greater of the monthly minimum commitment or the actual monthly fees, based upon a defined license fee per device per month. Under the Opsware license agreement, EDS is required to pay the Company monthly minimum commitment fees of $333,000 for the first six months of the initial term, $1.3 million for the next two months, $1.7 million in the following month, and $2.0 million per month thereafter. The Company is recognizing the fees from EDS as license revenue over the initial term of the license, beginning in the three month period ended April 30, 2003.

At the end of the initial three-year license term, EDS is required to either (1) pay annual license fees at the higher of the then current rate of usage, based on the defined license fee per device or the contractual minimum in order to renew the license or (2) discontinue all use of the technology if the license is not renewed. The license and maintenance agreements expire after year five (the initial term plus two one-year periods) and any additional use of the software by EDS would require a new license agreement.

In June 2002, at the request of its President and Chief Executive Officer, the Company cancelled an option to purchase 500,000 shares with an exercise price of $18.00 per share held by him. The cancellation of this option resulted in variable accounting expense with respect to another option to purchase 500,000 shares with an exercise price of $3.68 held by him. Variable accounting requires recognition of compensation expense, adjusted for increases or decreases in intrinsic value, until the options are exercised, forfeited or expire. The Company recognized $100,000 of stock compensation expense with respect to this option during the three-month period ended April 30, 2003.

As of April 30, 2003, the Company extended the exercise period from 90 days to 1 year for stock options held by certain terminated employees. The modification of the option resulted in the recognition of compensation expense upon termination, calculated as the difference between the intrinsic value on the date of grant and the intrinsic value at the date of termination. The Company recognized approximately $290,000 of stock compensation expense with respect to these modifications during the three-month period ended April 30, 2003.

The Company recorded deferred stock compensation prior to its initial public offering related to grants of stock purchase rights and options with exercise prices below the deemed fair value of its common stock. Stock-based compensation expense of $58,000 and $5.9 million was recognized using the graded vesting method for the three-month period ended April 30, 2003 and 2002, respectively. In addition, the Company reversed $511,000 from deferred compensation expense related to employees that were terminated during the three-month period ended April 30, 2003 and reflected previously recognized expense on stock awards for which the terminated employees had not vested in the underlying shares. As a result, the difference between the expense taken under the graded vesting method and the expense that would have been taken under the straight-line vesting method was required to be reversed upon termination of these employees. The Company’s policy is to use the graded vesting method for recognizing compensation cost for fixed awards with pro rata vesting. The Company amortizes the deferred stock-based compensation on the graded vesting method over the vesting periods of the applicable stock purchase rights and stock options, generally four years. The graded vesting method provides for vesting of portions of the overall awards at interim dates and results in greater vesting in earlier years than the straight-line method. In addition, the Company reversed $99,000 of unamortized deferred stock compensation related to the terminated employees.

See Note 1 for a description of the Company’s policy with respect to accounting treatment for stock-based compensation pursuant to SFAS 123 and APB Opinion No. 25.

Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for reporting information about operating segments in the Company’s financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the Chief Executive Officer of the Company. Prior to August 15, 2002, the Company was organized geographically between the United States and Europe. While the Chief Executive Officer of the Company evaluates results in a number of different ways, the geographic structure was the primary basis for which allocation of resources and financial performance was assessed. Since August 15, 2002, the Company has only one worldwide geographic segment and one operating segment focusing on the Software Business.

Net long-lived assets and total assets by geographic location were as follows (in thousands):

In February 2003, the Company entered into a settlement agreement with Atriax, a former Managed Services Business customer, pursuant to which Atriax paid the Company $2.4 million. The Company recognized this settlement payment as other income during the three-month period ended April 30, 2003. In addition, the Company recorded an obligation for certain items of equipment retained by it pursuant to its asset purchase agreement with EDS.

The Company follows the provisions of Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Basic and diluted net loss per share is computed by dividing the consolidated net loss by the weighted average number of common shares outstanding during the period less outstanding nonvested shares. Outstanding nonvested shares are not included in the computation of basic consolidated net loss per share until the time-based vesting restrictions have lapsed. The following table presents the calculation of basic and diluted net loss per share:

The Company has excluded the impact of all shares of common stock subject to repurchase, warrants for common stock and stock options from the calculation of historical diluted consolidated net loss per common share because all such securities are antidilutive for all periods presented. The total number of shares excluded from the calculations of historical diluted consolidated net loss per share was 15.8 million and 20.1 million for the three-month period ended April 30, 2003 and 2002, respectively.

On April 9, 2003, the Company entered into a stipulation of settlement with the plaintiffs in connection with the consolidated securities class action lawsuit related to the Company’s initial public offering claiming that the Company, certain of its officers, directors and the underwriters of its initial public offering violated federal securities laws by providing materially false and misleading information in its prospectus. The stipulation of settlement, which is subject to court approval, provides for the full and final settlement and dismissal and release of all litigation brought by the plaintiffs and an insignificant settlement payment. The settlement payment will be paid by the Company’s directors’ and officers’ insurance policy and, therefore, will not impact its financial position or results of operations.

On March 7, 2003, EDS filed suit against Knight Ridder Digital, a former customer of the Company that was transferred to EDS as part of the sale of its Managed Services Business. On March 24, 2003, the Company received notice that Knight Ridder Digital filed a cross complaint against both EDS and the Company in the Superior Court of California, County of Santa Clara, alleging in part that the Company breached its customer service agreement with Knight Ridder Digital by assigning the agreement to EDS. The cross complaint seeks an unspecified amount of damages and asks for certain equitable relief. The Company believes that it has not breached the customer service agreement and will defend itself vigorously. On March 31, 2003, the Company filed a cross complaint against Knight Ridder Digital alleging theft of trade secrets and breach of contract, among other claims, and also joined in EDS’s then-pending motion for a preliminary injunction. On April 10, 2003, the Company entered into a Stipulation and Order with EDS and Knight Ridder Digital limiting Knight Ridder Digital’s use of certain of the Company’s intellectual property. The outcome of litigation is inherently uncertain, and there can be no assurance that the Company will not be materially affected. The Company anticipates that it will incur ongoing litigation expenses in connection with this litigation and believes that EDS is obligated to indemnify it for some or all of these expenses pursuant to the terms of the asset purchase agreement.

On July 31, 2002, the Company received notice that Qwest Communications Corporation filed a demand for arbitration under the Commercial Arbitration Rules of the American Arbitration Association, claiming that the Company breached the amended and restated ethernet collocation internet access service agreement, amended and restated reseller agreement and confidentiality agreement that the Company entered into with Qwest in fiscal 2002. Qwest is seeking monetary damages, title to certain items of equipment and declaratory relief. Under the amended and restated ethernet collocation internet access service agreement, the Company received a $7.5 million non-

refundable prepayment from Qwest in fiscal 2002 in consideration for providing services in connection with the provisioning and maintaining of three of Qwest’s data centers. The prepayment received from Qwest was originally included in deferred revenue and the residual balance as of April 30, 2003 has since been reclassified to accrued data center facility costs. The Company believes that it has not breached any of the agreements and will defend itself vigorously. However, the outcome of arbitration is inherently uncertain, and there can be no assurance that the Company will not be materially affected. The Company anticipates that it will incur ongoing expenses in connection with this arbitration.

Financial Accounting Standards Board Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), requires that the Company recognize the fair value for guarantee and indemnification arrangements issued or modified by the Company after December 31, 2002, if these arrangements are within the scope of FIN 45. In addition, the Company must continue to monitor the conditions that are subject to the guarantees and indemnifications, as required under previously existing generally accepted accounting principles, in order to identify if a loss has occurred. If the Company determines it is probable that a loss has occurred then any such estimable loss would be recognized under those guarantees and indemnifications.

In some cases, the Company may provide warranties with respect to its software products. Consistent with FIN 45, the Company will accrue for known warranty claims if a loss is probable and can be reasonably estimated and will accrue for estimated but unidentified warranty claims based on historical activity. To date the Company has had no warranty claims. As a result, the Company has not recorded a warranty accrual to date.

The Company has entered into certain real estate leases that require it to indemnify property owners against certain environmental claims. However, the Company only engages in the development, marketing and distribution of software, and has never had any environmental related claim. The Company believes that the likelihood of these indemnifications is remote. As a result, the Company has not recorded an accrual with respect to potential environmental claims. The Company is also responsible for certain costs of restoring leased premises to their original condition, and in accordance with the recognition and measurement provisions of Statements of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (“SFAS 143”), measured the fair value of these obligations and accrued them.

In January 2003, the FASB issued Financial Interpretation No. 46, or FIN 46, “Consolidation of Variable Interest Entities.” FIN 46 requires an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from the other parties. The Company adopted FIN 46 in January 2003. The Company does not currently have any interest in variable interest entities and, accordingly, does not expect the adoption of FIN 46 to have any impact on its historical financial position, results of operations or cash flows.

In November 2002, the FASB issued Financial Interpretation No. 45, or FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit, and provides new disclosure requirements regarding indemnification provisions, including indemnification provisions typically included in a software license arrangement. It also clarifies that at the time a guarantee is issued, the Company must recognize an initial liability for the fair value of the obligations it assumes under the guarantee and must disclose that information in its financial statements. The provisions related to recognizing a liability at inception of the guarantee do not apply to product warranties, indemnification provisions in the Company’s software license arrangements, or to guarantees accounted for as derivatives. The initial recognition and measurement provisions apply to guarantees issued or modified after December 31, 2002, and the disclosure requirements apply to guarantees outstanding as of December 31, 2002. The Company adopted FIN 45 in December 2002. The Company does not expect the adoption of Interpretation 45 to have a material effect on its consolidated financial position, results of operations or cash flows.

In July 2002, the FASB issued SFAS 145, “Rescission of FASB Statements No. 4, No. 44 and No. 64, Amendment of FASB Statement No. 13, and Technical Corrections”. SFAS 145 rescinds SFAS 4 and SFAS 64 related to classification of gains and losses on debt extinguishment such that most debt extinguishment gains and losses will no longer be classified as extraordinary. SFAS 145 also amends SFAS 13 with respect to sale-leaseback transactions. The Company adopted SFAS 145 as of February 1, 2003, which requires the reclassification of the gain on the extinguishment of debt from an extraordinary item in the Company’s results of operations beginning in the period ending July 31, 2003.

The following information should be read in conjunction with our Annual Report on Form 10-K filed on May 1, 2003 with the Securities and Exchange Commission and “Factors That May Affect Future Results” herein.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

The condensed consolidated financial statements and related information contained in this Quarterly Report on Form 10-Q reflect our results as they existed for the three-month period ended April 30, 2003 and the other periods presented. On August 15, 2002, we completed the sale of our Managed Services Business to EDS and are now focused solely on our Software Business. As a result, historical financial information relating to the periods prior to August 15, 2002 is not related to our Software Business and is not indicative of future results from our Software Business.

We are a provider of data center automation software for enterprises, government agencies and service providers seeking to reduce costs and increase the quality of data center operations. Our software automates key server and software operations in data centers, including provisioning, changing, configuring, scaling, securing, recovering, auditing, and reallocating servers and business applications. We refer to our software as the Opsware System. The Opsware System works across geographically disparate locations and heterogeneous data center environments. By using the Opsware System, our customers can more quickly deploy new servers and applications, speed operations to respond quickly to changing business needs, and increase the efficiency of their data center operations. The Opsware System enables our customers to reduce the number of IT staff required to operate the data center, better utilize server and software assets, increase IT efficiencies and achieve higher service quality.

Prior to August 2002, we primarily provided managed Internet services for corporations and government agencies that operate mission-critical Internet applications. We used our proprietary Opsware automation technology in the Managed Services Business, and have since developed this technology into our Opsware System software. In August 2002, we sold our Managed Services Business to EDS for a total purchase price of $63.5 million in cash. In addition to the license and maintenance agreements entered into pursuant to the asset purchase agreement, concurrently with execution of the asset purchase agreement, we executed separate license and maintenance agreements with EDS pursuant to which we granted EDS a non-exclusive, worldwide hosting and integration license whereby EDS will have certain rights to use our Opsware software. Under the Opsware license and maintenance agreement, EDS will pay us (subject to our developing specified features and functions) a minimum license and maintenance fee of $52.0 million in the aggregate over a term of three years. We delivered and received acceptance of all of the specified features and functions owing to EDS under the Opsware license agreement during the three-month period ended April 30, 2003. We believe we have sufficient objective and reliable evidence of fair value for both the value of the Managed Services Business sold to EDS and the $52.0 million license and maintenance agreement (based on renewal rates). We further believe that the $52.0 million license and maintenance agreement is a separate earnings process and does not affect the quality of use or the value to EDS of the $63.5 million sale of the Managed Services Business. Accordingly, we began recognizing the fees from EDS as license revenue over the initial term of the license, beginning in the three-month period ended April 30, 2003. We expect that our operating results will be largely dependent on our relationship with EDS for the foreseeable future.

Our customers in the Managed Services Business typically purchased our services through customer service agreements, which generally had terms of one to three years. Our customer service agreements were generally renewed automatically for periods ranging from three months to one year, unless terminated prior to the expiration of the initial term. We generally recognized revenue related to these agreements ratably over the period the managed services were provided to the respective customers.

In the Software Business, we derive a significant portion of our revenue from sales of software licenses. We sell our products principally through our direct sales force and intend to develop indirect channels with corporate partners, such as distributors, value-added resellers, hardware providers and systems integrators. We also derive revenue from sales of annual support and maintenance agreements and professional services.

In May 2001, while operating the Managed Services Business, we announced a restructuring program to improve utilization of our existing technology and infrastructure. This restructuring program included a worldwide workforce reduction, consolidation of the resulting excess facilities and a provision for excess and obsolete property and equipment. As a result of the restructuring program, we recorded restructuring costs of $30.2 million classified as operating expenses. Included in the $30.2 million was a non-cash charge of $2.9 million related to the acceleration of vesting of options held by certain employees. Of the total charge, $0.6 million was recovered through the sale of assets and liabilities related to the Managed Services Business, during the fiscal year ended January 31, 2003.

In June 2002, we repurchased from Morgan Stanley & Co. Incorporated our 13% Senior Discount Notes due 2005 for $42.0 million of cash and issued 2,046,385 shares of common stock, representing $3.0 million worth of our common stock at that time. As a result, an extraordinary gain of $8.7 million was recognized during the fiscal year ended January 31, 2003. The extraordinary gain was calculated by taking the difference between the carrying value of the notes at the time of retirement and the $45.0 million given in total consideration. In July 2002, the FASB issued SFAS 145, related to classification of gains and losses on debt extinguishment such that most debt extinguishment gains and losses will no longer be classified as extraordinary. We adopted SFAS 145 as of February 1, 2003, which requires the reclassification of the gain on the extinguishment of debt from an extraordinary item in our results of operations beginning in the period ending July 31, 2003.

In June 2002, we announced a restructuring program in connection with our entering into an agreement to sell the assets and liabilities of our Managed Services Business to EDS, which included a worldwide workforce reduction and a provision for the impairment of excess and obsolete property and equipment. As a result of the restructuring program, we recorded restructuring costs of $7.0 million classified as operating expenses.

In August 2002, we announced a restructuring program in connection with the closing of the sale of our Managed Services Business to EDS. The restructuring program was accounted for under the provisions of SFAS No. 146, which we adopted in July 2002. The restructuring program included a provision for the resulting excess facilities and a provision for excess and obsolete property and equipment. The lease payments on excess facilities were based on management’s estimates of its ability to sublease excess facilities based on prevailing real estate market conditions at that time. As a result, we recorded restructuring costs of $13.3 million classified as operating expenses. In accordance with SFAS 146, we recorded an adjustment to the restructuring charge of approximately $1.0 million in the three-month period ended April 30, 2003. The adjustment was a result of a change in our estimate due to a decrease in sublease income based upon the financial condition of the subtenant. In addition, we recorded a recovery for property and equipment of $140,000 during the three-month period ended April 30, 2003.

In May 2003, we entered into a software distribution license with Hewlett-Packard. In addition to distributing our Opsware System software with its HP Utility Data Center solution, Hewlett-Packard will provide consulting and implementation services related to our Opsware System software in conjunction with its HP Utility Data Center solution.

Since inception, we have financed our operations primarily through the private placement of our preferred stock, our initial public offering of common stock, customer revenue, the sale of our Managed Services Business, the sale of our senior discount notes and, to a lesser extent, operating equipment lease financing and capital equipment lease financing. As of April 30, 2003, we had approximately $61.8 million in cash, cash equivalents and restricted cash. On August 15, 2002, we received $63.5 million in gross cash proceeds ($61.2 million net of transactions expenses) from the sale of our Managed Services Business to EDS. On March 14, 2001, we received approximately $163 million in net cash proceeds from the sale of our common stock in an initial public offering and a private placement.

Net cash used in operating activities was $5.7 million for the three-month period ended April 30, 2003 and $21.7 million for the three-month period ended April 30, 2002. Net cash used in operating activities for the three-month period ended April 30, 2003 was primarily the result of a net loss, the increase in accounts receivable, and the decrease in accrued liabilities and advances from customers, partially offset by depreciation and amortization and

the increase in deferred revenue. Net cash used in operating activities for the three-month period ended April 30, 2002 was primarily the result of a net loss, partially offset by depreciation and amortization, non-cash stock compensation expense, and decreases in accounts receivable, prepaid and other current assets, other assets, other accrued liabilities, deferred revenue and accrued restructuring costs.

Net cash used in investing activities was $158,000 for the three-month period ended April 30, 2003. Net cash provided by investing activities was $6.8 million for the three-month period ended April 30, 2002. Net cash used in investing activities for the three-month period ended April 30, 2003 consisted of investments in capital equipment. Net cash provided by investing activities for the three-month period ended April 30, 2002 consisted of maturities and sales of short-term investments and a reduction in restricted cash, partially offset by investments in capital equipment.

Net cash provided by financing activities was $593,000 for the three-month period ended April 30, 2003 and $432,000 for the three-month period ended April 30, 2002. Net cash provided by financing activities for the three-month period ended April 30, 2003 was primarily attributable to proceeds from the exercise of stock options and the payments received from stockholder notes receivables. Net cash provided by financing activities for the three-month period ended April 30, 2002 was primarily attributable to net proceeds from the sale of common stock through our employee stock purchase program, offset by payment on lease obligations.

Under the asset purchase agreement with EDS, we have retained various liabilities relating to the Managed Services Business and have agreed to indemnify EDS for periods ranging from twelve to eighteen months following the closing date of the transaction up to a maximum of $27.0 million, for any breach of our representations and warranties contained in the asset purchase agreement and for other matters, including certain liabilities retained by us under that agreement, subject to limitations. We believe that the likelihood of our obligation to indemnify EDS for these matters is remote. However, if EDS makes a claim for indemnification, we may be required to expend significant cash resources in defense and settlement of the claim.

As of April 30, 2003, our principal commitments consisted of obligations outstanding under operating leases for facilities and capital leases. The following summarizes our contractual obligations at April 30, 2003 and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

We believe that our current cash balances, including cash, cash equivalents and restricted cash, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. Nevertheless, we may restructure existing obligations or seek additional capital through private equity, equipment lease facilities, bank financings or arrangements with strategic partners. Capital requirements will depend on many factors, including the rate of sales growth, market acceptance of our products, costs of providing our products and services, the timing and extent of research and development projects and increases in our operating expenses. To the extent that existing cash and cash equivalents balances and any cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. We cannot be sure that additional financing will be available if necessary or available on reasonable terms. We may from time to time evaluate potential acquisitions of other businesses, services, products and technologies, which could increase our capital requirements.

Net revenue, cost of revenue, research and development expenses, sales and marketing expenses and general and administrative expenses include the results of our Managed Services Business for the three-month period ended April 30, 2002. As a result, historical financial information relating to the three-month period ended April 30, 2002 is not related to our Software Business and is not indicative of future results from our Software Business.

Net revenue. Net revenue decreased to $2.5 million during the three-month period ended April 30, 2003 from $17.4 million during the three-month period ended April 30, 2002. The decrease was primarily the result of the sale of our Managed Services Business to EDS. For the three-month period ended April 30, 2003, EDS accounted for 94% of our net revenue. For the three-month period ended April 30, 2002, Atriax accounted for 10% of our net revenue.

Cost of revenue. In the Software Business, cost of revenue consists primarily of salaries and related personnel expenses of employees who provide services to our customers, costs related to third-party technologies included in our software and depreciation and amortization of capitalized equipment and software. In the Managed Services Business, cost of revenue consisted primarily of payments on rental equipment, salaries and related personnel expenses of our employees who provided services to our customers, leases of data center space in third-party facilities, customer support services, including network monitoring and support, and depreciation and amortization of capitalized equipment and software. Cost of revenue decreased in absolute dollars and decreased as a percentage of net revenue, to $943,000, or 37% of net revenue, during the three-month period ended April 30, 2003 from $25.3 million, or 145% of net revenue, during the three-month period ended April 30, 2002. The decrease was primarily the result of the sale of our Managed Services Business to EDS and the ongoing effects of our restructuring programs. We expect that our cost of revenue will increase in absolute dollars in the next fiscal quarter.

Research and development. In both the Software Business and the Managed Services Business, research and development expenses consist primarily of salaries and related personnel expenses and depreciation and amortization of purchased equipment and software. Research and development expenses decreased in absolute dollars but increased as a percentage of net revenue, to $2.2 million, or 86% of net revenue, during the three-month period ended April 30, 2003 from $3.9 million, or 23% of net revenue, during the three-month period ended April 30, 2002. The decrease in absolute dollars was primarily the result of reduced headcount and facility costs resulting from our restructuring programs and the sale of our Managed Services Business to EDS. We expect that our research and development expenses will increase in absolute dollars in the next fiscal quarter.

Sales and marketing. In the Software Business, sales and marketing expenses consist primarily of salaries and related personnel expenses, trade shows and other promotional expenses. In the Managed Services Business, sales and marketing expenses consisted primarily of salaries, commissions and related personnel expenses, as well as advertising, trade shows and other promotional expenses. Sales and marketing expenses decreased in absolute dollars but increased as a percentage of net revenue, to $2.0 million, or 79% of net revenue, during the three-month period ended April 30, 2003 from $6.6 million, or 38% of net revenue, during the three-month period ended April 30, 2002. The decrease in absolute dollars was primarily the result of reduced headcount and facility costs resulting from our restructuring programs and the sale of our Managed Services Business to EDS. We expect that our sales and marketing expenses will increase in absolute dollars in the next fiscal quarter.

General and administrative. In the Software Business, general and administrative expenses consist primarily of salaries and related personnel expenses, fees for outside professional services and compensation charges for the cancellation and modification of stock option awards. In the Managed Services Business, general and administrative expenses consist primarily of salaries and related personnel expenses and fees for outside professional services. General and administrative expenses decreased in absolute dollars but increased as a percentage of net revenue, to $2.1 million, or 85% of net revenue, during the three-month period ended April 30, 2003 from $4.1 million, or 24% of net revenue, during the three-month period ended April 30, 2002. The decrease in absolute dollars was primarily the result of reduced headcount and facility costs resulting from our restructuring programs and the sale of our Managed Services Business to EDS. We expect that our general and administrative expenses will increase in absolute dollars in the next fiscal quarter.

Restructuring costs. In fiscal 2003, we announced two restructuring programs executed in connection with the sale of our Managed Services Business to EDS. We recorded restructuring costs of $13.3 million in the quarter

ended July 31, 2002 and $7.0 million in the quarter ended October 31, 2002. The restructuring programs included a worldwide workforce reduction, a provision for the resulting excess facilities and provisions for excess and obsolete property and equipment. In accordance with SFAS 146, we recorded an adjustment to the restructuring charge of approximately $1.0 million in the three-month period ended April 30, 2003. The adjustment was a result of a change in our estimate due to a decrease in sublease income based upon the financial condition of the subtenant. In addition, we recorded a recovery for property and equipment of $140,000 during the three-month period ended April 30, 2003.

Stock-based compensation. Stock-based compensation expense was $58,000 in the three-month period ended April 30, 2003 compared to $5.9 million in the three-month period ended April 30, 2002. The decrease in the three-month period ended April 30, 2003 from the three-month period ended April 30, 2002 was due to the reversal of $511,000 of stock-based compensation expense related to the termination of employees in the quarter ended April 30, 2003, and reflected previously recognized expense on stock awards for which the terminated employees had not vested in the underlying shares. As a result, the difference between the expense taken under the graded vesting method and the expense that would have been reflected under the straight-line vesting method was required to be reversed upon termination of these employees. In addition, amortization of stock-based compensation decreased each quarter as a result of our use of the graded vesting method. The remaining deferred stock-based compensation as of April 30, 2003 was $997,000.

Interest and other income (expense), net. Interest and other income (expense), net, increased to a benefit of $1.8 million in the three-month period ended April 30, 2003 from an expense of $(2.0) million in the three-month period ended April 30, 2002. The increase to a benefit was primarily due to proceeds of $2.4 million received from the settlement payment received from Atriax, offset by our obligation to EDS for certain items of equipment retained by us pursuant to our asset purchase agreement with EDS.

Provision for income taxes. We have incurred losses for both income tax and financial statement purposes for all periods presented. Accordingly, no provision for income taxes has been recorded. As of January 31, 2003, we had federal net operating loss carryforwards of approximately $253.0 million and state net operating loss carryforwards of $176.0 million available to offset future taxable income, which may be used, subject to limitations, to offset future state and federal taxable income through 2010 and 2023, respectively. We have recorded a valuation allowance against the entire net operating loss carry-forwards because of the uncertainty that we will be able to realize the benefit of the net operating loss carryforwards before they expire.

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. Actual results could differ from these estimates. In addition, our estimates may change based upon changed circumstances and as we reassess our underlying assumptions from time to time. The Securities and Exchange Commission has described the most critical accounting policies as the ones that are most important to the portrayal of our financial condition and results, and require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.

We believe the following are our critical accounting policies, which affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.

Revenue Recognition. As part of the our Software Business we recognize revenue in accordance with the American Institute of Certified Public Accountants’, or AICPA, Statement of Position, or SOP, No. 97-2, “Software Revenue Recognition”, as amended by SOP No. 98-4, “Deferral of the Effective Date of SOP 97-2, ‘Software Revenue Recognition’”, SOP No. 98-9, “Modification of SOP 97-2 with Respect to Certain Transactions”, and SOP No. 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts”. For each transaction, we determine whether evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all criteria are met. We consider all arrangements with payment terms extending beyond twelve months and other arrangements with payment terms longer than normal not to be fixed or determinable. If

collectibility is not considered probable, revenue is recognized when the fee is collected. Generally, no customer has the right of return.

We generate revenue from the sale of software licenses and services related to the Software Business, including from maintenance and support agreements and professional service agreements. Sales of software licenses and maintenance are the primary components of our revenue.

License revenue is comprised of fees for multi-year or perpetual licenses, which are derived from contracts with customers. Once we establish vendor specific objective evidence of fair value for maintenance, we will recognize license revenue based upon the residual method after all elements other than maintenance have been delivered as prescribed by SOP 98-9. We will recognize maintenance revenue over the term of the maintenance contract once vendor specific objective evidence of fair value for all undelivered elements including maintenance exists. In accordance with paragraph 10 of SOP 97-2, vendor specific objective evidence of fair value of maintenance is determined by reference to the price the customer will be required to pay when maintenance is sold separately (that is, the stated rate). Customers that enter into maintenance contracts generally have the ability to renew these contracts at the renewal rate. Maintenance contracts are typically one year in duration. Until we establish vendor specific objective evidence of fair value for maintenance, both the license and maintenance, revenue will be recognized ratably over the maintenance period. For term licenses accompanied by maintenance, the entire arrangement fee is recognized over the term of the license period. See Note 3, “Transactions with EDS,” in the Notes to Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for a further discussion on our treatment of revenue recognition in connection with the $52.0 million license and maintenance agreement with EDS, which comprised 94% of the revenue recognized during the three month period ended April 30, 2003. Services revenue during the three-month period ended April 30, 2003 was not significant. As a result, license and services revenue were not presented separately in our financial statements.

Services revenue is comprised of revenue from maintenance and support agreements and professional services arrangements. In all cases, we assess whether the service element of the arrangement is essential to the functionality of the other elements of the arrangement. When services are considered essential or the arrangement involves customization or modification of our software and when reliable estimates are available for the costs and efforts necessary to complete the services, both the license and services revenues under the arrangement are recognized under the percentage of completion method of accounting based upon input measures of hours. When such estimates are not available, the completed contract method is utilized. When an arrangement includes contractual milestones, we recognize revenue as such milestones are achieved provided the milestones are not subject to any additional acceptance criteria. For those arrangements where we have concluded that the services element is not essential to the other elements of the arrangement, we then determine whether the services are available for other customers, do not involve a significant degree of risk or unique acceptance criteria and whether we are able to provide the service in order to separately account for the services revenue. When the services qualify for separate accounting, we use vendor specific objective evidence of fair value for the services and maintenance to account for the arrangement using the residual method, regardless of any separate prices stated within the contract for each element. Revenue allocable to services is recognized as the services are performed.

Vendor specific objective evidence of fair value of consulting services is based upon hourly rates. We enter into stand-alone contracts for professional services and these contracts provide for payment upon a time and materials basis. The hourly rates associated with these contracts are used to assess the vendor specific objective evidence of fair value in multi-element arrangements.

We intend to recognize revenue associated with software licenses and services sold to distributors, system integrators and value added resellers (collectively “resellers”). Unless we are aware that a reseller does not have a purchase order or other contractual agreement from an end user, we will recognize revenue from resellers. In connection with these arrangements, there is no right of return or price protection for sales to resellers.

The timing of our recognition of revenue will depend upon the mix of revenue that is recognized under the residual method, pursuant to SOP 97-2, under the percentage of completion method or completed contract of accounting, pursuant to SOP 81-1, under the ratable method, or in connection with multi-year licenses, as well as the timing of our establishment of vendor specific objective evidence of fair value for maintenance. If vendor specific objective evidence of maintenance is not established, both the license and maintenance revenue will be recognized

ratably over the maintenance period. A significant portion of our revenue recognized during the three-month period ended April 30, 2003 was recognized under the ratable method of accounting. Given our limited experience operating our Software Business, we cannot currently predict what the mix of our revenue will be in the next fiscal quarter.

Prior to August 15, 2002, the closing of the sale of our Managed Services Business to EDS, we generated revenue in our Managed Services Business through the sale of managed Internet services. Substantially all revenue recognized prior to August 15, 2002 was generated from our Managed Services Business. We recognized revenue ratably over the managed services contract period as services were fulfilled, provided that for each transaction, evidence of an arrangement existed, delivery had occurred, the fee was fixed or determinable, and collection was probable. If obligations remained after services were delivered, revenue was recognized after such obligations were fulfilled. In addition, we provided certain guarantees regarding scheduled uptime to our customers on a monthly basis.

We reduced revenue generated in the Managed Service Business for credits given for estimated unscheduled downtime on a monthly basis. According to our accounting policy and customer contracts, the revenue credits were based on the cause of downtime, the length of the downtime and the customer’s monthly price of the services. The estimated credit reduced revenue in the month in which the unscheduled downtime occurred. In addition to the service credits, we occasionally issued credits for events that were outside of the contractual service level agreements. These types of credits were not financially significant. The process for estimating these types of credits included analyzing the historical experiences with such credits and comparing them to events that occurred in the then-current month.

If any of the criteria for revenue recognition are not met, we defer revenue recognition until such time as all criteria are met. If we receive cash from a customer, but have not met the criteria for revenue recognition, the amounts received are included in advances from customers. If we have met the criteria for revenue recognition, whether or not we have received cash from the customer, the amounts are recorded as deferred revenue except for the amounts recognized in the then current period revenue.

Impairment of Long-Lived Assets. We continually review the carrying value of long-lived assets, including property and equipment to determine whether there are any indications of impairment losses. According to our accounting policy, when such indicators are present, if the undiscounted cash flows expected to be generated from our customers is less than the carrying value of our long-lived assets, we compare the estimated discounted future net cash flows to be generated from our customers to the carrying value of the long-lived assets to determine any impairment charges. We reduce the carrying value of the long-lived assets if the carrying value of the long-lived assets is greater than the estimated discounted future net cash flow.

Restructuring Costs. During fiscal 2002 and 2003, we restructured our business under plans approved by the Board of Directors by reducing our headcount, consolidating our facilities and disposing of excess and obsolete property and equipment. As a result of these actions, we recorded restructuring and other related charges consisting of cash severance payments to be made to severed employees and lease payments related to property abandoned as a result of our facilities consolidation. We are attempting to sublet non-cancelable leased facilities that we have vacated. If the length of time before we find tenants for these facilities or the market rental rates differ significantly from our estimates, our actual costs will differ from the charge that was initially recorded. Our estimates include the review of the financial condition of our existing sublessees as well as the state of the regional real estate markets. Each reporting period, we will review these estimates based on the status of execution of our restructuring plan and, to the extent that these assumptions change due to changes in market conditions and our business, the ultimate restructuring expenses could vary by material amounts, and could result in additional expenses or the recovery of amounts previously recorded.

Accruals and Contingencies. We evaluate contingent liabilities including threatened or pending litigation in accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies”. If the potential loss from any claim or legal proceedings is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of

the potential liabilities could have a material impact on our results of operations and financial position. In addition, we have retained various liabilities related to our Managed Services Business. The outcome of these liabilities could result in a material difference from our current estimates, and could result in additional expenses or the recovery of amounts previously recorded. Under our amended and restated ethernet collocation internet access service agreement with Qwest, we received a $7.5 million non-refundable prepayment from Qwest in fiscal 2002 in consideration for providing services in connection with the provisioning and maintaining of three of Qwest’s data centers and the migration of our Managed Services Business operations into these three data centers. The prepayment received from Qwest was originally included in deferred revenue and the residual balance as of April 30, 2003 has since been reclassified to accrued data center facility costs. See Note 8 to the condensed consolidated financial statements for a description of our material legal proceedings.

We do not currently record any compensation expense in connection with stock options granted to employees and directors. See Note 1 to the condensed consolidated financial statements for a description of our policy with respect to our accounting treatment for stock-based compensation pursuant to SFAS 123 and APB Opinion No. 25.

Set forth below and elsewhere in this Quarterly Report on Form 10-Q and in other documents we file with the Securities and Exchange Commission are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in the Quarterly Report on Form 10-Q.

We have limited experience operating our Software Business, which makes it difficult to evaluate our future prospects.

As a result of the sale of our Managed Services Business to EDS, our business model has shifted from providing managed Internet services to primarily licensing our Opsware System software. Due to our limited experience operating our Software Business, we have limited ability to forecast future demand for our products and limited financial data upon which you may evaluate our business and prospects. Our potential for future profitability must be considered in light of the risks, uncertainties, and difficulties frequently encountered by companies in their early stages of development, particularly companies in new and rapidly evolving markets. Some of these risks relate to our potential inability to:

We may not successfully address these risks. If we do not successfully address these risks, we may not realize sufficient revenue to reach or sustain profitability.

Our financial results may fluctuate significantly, which could cause our stock price to decline.

Our revenue and operating results could vary significantly from period to period. These fluctuations could cause our stock price to fluctuate significantly or decline. Important factors that could cause our quarterly and annual results to fluctuate materially include:

Our current and future levels of operating expenses and capital expenditures are based to an extent on our growth plans and estimates of future revenue. These expenditure levels are, to a large extent, fixed in the short term. We may not be able to adjust spending in a timely manner to compensate for any unexpected revenue shortfall, and any significant shortfall in revenue relative to planned expenditures could negatively impact our business and results of operations.

Due to these and other factors, period-to-period comparisons of our operating results may not be meaningful. You should not rely on our results for any one period as an indication of our future performance. In future periods, our operating results may fall below the expectations of public market analysts or investors. If this occurs, the market price of our common stock would likely decline. In addition, on August 15, 2002, we completed the sale of our Managed Services Business to EDS and are now focused solely on our Software Business. As a result, historical financial information relating to the periods prior to August 15, 2002 is not related to our Software Business and is not indicative of future results from our Software Business.

Our operating results will be highly dependent upon our relationship with EDS and any deterioration of our relationship with EDS could adversely affect the success of our Software Business.

Concurrently with the execution of the asset purchase agreement with EDS, we entered into a three-year $52.0 million license and maintenance agreement with EDS. For the three-month period ended April 30, 2003, EDS accounted for 94% of our net revenue. We expect that our operating results will be largely dependent on our relationship with EDS for the foreseeable future. If the health of our relationship with EDS were to deteriorate, our business and results of operations would be adversely affected. In addition, if EDS’ financial position were to deteriorate, our business and results of operations could be adversely affected.

Our Opsware license and maintenance agreement with EDS is for an initial term of three years and we cannot predict whether EDS will extend the license beyond three years. Whether or not EDS continues to license our software may depend, in large part, on its level of customer satisfaction. We cannot assure you that EDS will be able to deploy our software successfully or in the time frames contemplated by the Opsware license agreement, each of which may affect their willingness to renew the license. If EDS does not renew the license, our operating results

will be adversely affected. In addition, if EDS does not renew its license, this may negatively impact our reputation and our ability to license our Opsware software to customers more broadly.

The asset purchase agreement we entered into with EDS in connection with the sale of our Managed Services Business exposes us to contingent liabilities.

Under the asset purchase agreement with EDS, we have retained various liabilities relating to the Managed Services Business and have agreed to indemnify EDS for periods ranging from twelve to eighteen months following the closing date of the transaction, up to a maximum of $27.0 million, for any breach of our representations and warranties contained in the asset purchase agreement and for other matters, including certain liabilities retained by us under that agreement, subject to limitations. Although we believe that the likelihood of our obligation to indemnify EDS for these matters is remote, if EDS makes a claim for indemnification, we may be required to expend significant cash resources in defense and settlement of the claim.

We must satisfy the criteria of revenue recognition in order to recognize the cash received from customers under our license agreements as revenue.

In order to recognize the cash received from our customers under our license agreements as revenue, we must demonstrate that the license arrangement satisfies the criteria for revenue recognition including that a persuasive evidence of an arrangement exists, delivery of the product has occurred, no significant obligations with regard to implementation remain, the fee is fixed or determinable and collectibility is probable. If we are unable to satisfy the criteria for revenue recognition, our operating results may suffer or may fluctuate significantly from period to period. In addition, the timing of our recognition of revenue will depend upon the mix of revenue that is recognized under the residual method, pursuant to SOP 97-2, under the percentage of completion or completed contract method of accounting, pursuant to SOP 81-1, under the ratable method, or in connection with multi-year licenses, as well as the timing of our establishment of vendor specific objective evidence of fair value for maintenance. If vendor specific objective evidence of fair value for maintenance is not established, both the license and maintenance revenue will be recognized ratably over the maintenance period. A significant portion of our revenue recognized during the three-month period ended April 30, 2003 was recognized under the ratable method of accounting. Given our limited experience operating our Software Business, we cannot currently predict what the mix of our revenue will be in the next fiscal quarter.

Future changes in accounting standards or our interpretation of current standards, particularly changes affecting revenue recognition, could cause unexpected revenue fluctuations.

Future changes in accounting standards or our interpretation of current standards, particularly those affecting revenue recognition, could require us to change our accounting policies. These changes could cause deferral of revenue recognized in current periods to subsequent periods or accelerate recognition of deferred revenue to current periods, each of which could impair our ability to meet securities analysts’ and investors’ expectations, which could cause a decline in our stock price.

If we are required by law or elect to account for stock options under our stock option plans as a compensation expense, our results of operations would be materially affected.

There has been increasing public debate about the proper accounting treatment for stock options. Although we are not currently required to record any compensation expense in connection with option grants that have an exercise price at or above fair market value, it is possible that future laws or regulations will require us to treat all stock options as a compensation expense or that we may elect to do so. If there is any such change in accounting regulations or if we elect to account for options in this way, this could result in our reporting increased operating expenses, which would decrease any reported net income or increase any reported net loss. Note 1 of our condensed consolidated financial statements shows the impact that such a change in accounting treatment would have had on our net loss and net income loss per share if it had been in effect during the reporting periods shown and if the compensation expense were calculated as described in Note 1.

Our operating results may suffer if we fail to achieve expected benefits from strategic relationships.

We have relied on in the past, and intend to continue to form in the future, strategic relationships with other technology companies in order to obtain a broader reach for our products and services. We have entered into an

agreement with BEA Systems, an application infrastructure software provider, under which BEA will refer prospects for the Opsware System to us from BEA’s existing customer base. In addition, we have been selected by Sun Microsystems as a member of its Blade Solutions Community and have developed Opsware Blade Edition to support blade server environments. We have also entered into a software distribution license with Hewlett-Packard to distribute our Opsware System software with its HP Utility Data Center solution. Hewlett-Packard will provide consulting and implementation services related to our Opsware System software in conjunction with its HP Utility Data Center solution. We cannot guarantee that a significant amount of new customer relationships or revenue will result from these agreements. In fact, we may not achieve any significant benefits from these relationships or similar relationships with other companies. In addition, in the event that our strategic partners, including BEA, Hewlett-Packard, Sun or EDS, experience financial difficulties, we may not be able to realize the expected benefits of these relationships.

Recent unfavorable economic conditions and reductions in information technology spending could limit our ability to grow our business.

Our business and operating results are subject to the effects of changes in general economic conditions. There has been a rapid and severe downturn in the worldwide economy. We expect this downturn to continue, but are uncertain as to its future severity and duration. This uncertainty has increased because of the potential impact of terrorist attacks and the resulting military actions against terrorism. In the future, fears of continued global recession, war and additional acts of terrorism may continue to impact global economies negatively. We believe that these conditions, as well as the decline in worldwide economic conditions, have led to reduced IT spending. If these conditions worsen, demand for our products may be reduced.

Our management is required to make forecasts with respect to economic trends and general business conditions in order to develop budgets, plan research and development strategies and perform a wide variety of general management functions. To the extent that our forecasts are in error, our performance may suffer because of a failure to properly align our corporate strategy with economic conditions.

As we develop our software products and refocus our operations, we may continue to incur significant operating losses and negative cash flow, and we may never be profitable.

We will be required to spend significant funds to continue developing our software products and refocus our operations, research and development and sales and marketing organizations to fit the needs of our Software Business. We have incurred significant operating and net losses and negative cash flow and have not achieved operating profitability. As of April 30, 2003, we had an accumulated deficit of $456.7 million, which includes approximately $179.4 million related to non-cash deferred stock compensation. We expect to continue to experience operating losses for the foreseeable future.

To achieve positive cash flow and operating profitability, we will need to establish a customer base for our software. However, we may not be able to increase our revenue or increase our operating efficiencies as planned. If our revenue grows more slowly than we anticipate or if our operating expenses increase more than we expect, our cash flow and operating results will suffer. Consequently, it is possible that we will never achieve positive cash flow or profitability. Even if we do achieve positive cash flow or profitability in any one quarter, we may not sustain or increase positive cash flow or profitability on a quarterly or annual basis in the future.

In addition, any decision to restructure our operations, to exit any activity or to eliminate any excess capacity could result in significant accounting charges. These restructuring charges could also result from future business combinations. Restructuring charges, individually or in aggregate, could create losses in future periods.

Sales efforts involving large enterprises involve lengthy sales and deployment cycles, which may cause our financial results to suffer.

We intend to focus our sales efforts on enterprises, government agencies and service providers. Sales to these entities generally have a long sales cycle and the length of this sales cycle has increased in response to current economic conditions. The length of the average sales cycle could make it more difficult for us to predict revenue and plan expenditures accordingly. The sales cycle associated with the purchase of our products is subject to a number of significant risks over which we have little or no control, including:

In addition, the time it takes to deploy our software with these accounts may be longer than a non-enterprise customer, which may delay our ability to recognize revenue from sales to these accounts.

If we do not develop our direct sales organization we will have difficulty acquiring and retaining customers.

Our products require a sophisticated sales effort targeted at a limited number of key people within our prospective customers’ organizations. Because the market for our technology and services is new, many prospective customers are unfamiliar with the products we offer. As a result, our sales effort requires highly trained sales personnel. We may need to expand our sales organization in order to increase market awareness of our products to a greater number of organizations and, in turn, to generate increased revenue. We are in the process of developing our direct sales force, and we may require additional qualified sales personnel. Competition for these individuals is intense, and we may not be able to hire the type and number of sales personnel we need. Moreover, even after we hire these individuals, they require extensive training. If we decide to but are unable to expand our direct sales force and train new sales personnel as rapidly as necessary, we may not be able to increase market awareness and sales of our products, which may prevent us from growing our revenue and achieving and maintaining profitability.

If we do not develop our distribution channels, we will have to rely more heavily on our direct sales force to develop our business, which could limit our ability to increase revenue and grow our business.

Our ability to sell our products will be impaired if we fail to develop our distribution channels. In addition to our relationships with BEA, Hewlett-Packard and Sun Microsystems, we intend to establish other indirect marketing channels to increase the number of customers licensing our products. Moreover, our channel partners must market our products effectively and be qualified to provide timely and cost- effective customer support and service, which requires us to provide proper training and technical support. If our channel partners do not effectively market and sell our products or choose to place greater emphasis on products of their own or those offered by our competitors, our ability to grow our business and sell our products may be negatively affected.

If we do not develop and maintain productive relationships with systems integrators, our ability to deploy our software, generate sales leads and increase our revenue sources may be limited.

We intend to develop and rely on additional relationships with a number of computing and systems integration firms to enhance our sales, support, service and marketing efforts, particularly with respect to the implementation and support of our products, as well as to help generate sales leads and assist in the sales process. Many such firms have similar, and often more established, relationships with our competitors. These systems integrators may not be able to provide the level and quality of service required to meet the needs of our customers. If we are unable to develop and maintain effective relationships with systems integrators, or if they fail to meet the needs of our customers, our business could be adversely affected.

The market for our technology and services is competitive and we may not have the resources required to compete effectively.

The market for our technology is relatively new and therefore subject to rapid and significant change. While we believe our technology is more comprehensive than and superior to that of our competitors, we cannot assure you of the success of our strategy going forward. Our competitors may succeed in developing technologies and products that are more effective than our software, which could render our products obsolete and noncompetitive. Some of our competitors have substantially greater financial, technical and marketing resources, larger customer bases, longer operating histories, more developed infrastructures, greater brand recognition, international presence and more established relationships in the industry than we have. As a result, some of our competitors may be able to develop and expand their technology offerings more rapidly, adapt to new or emerging technologies and changes in customer requirements more quickly, take advantage of acquisitions and other opportunities more readily, achieve greater economies of scale, devote greater resources to the marketing and sale of their technology and adopt more

aggressive pricing policies than we can. Some of our competitors have lower priced offerings and offer point solutions that may be easier to sell and demonstrate to prospective customers. In addition, certain large competitors may be able to distribute their software products at minimal cost or free of charge to customers. Furthermore, the open source community may develop competing software products which could erode our market share and force us to lower our prices. Our competitors include large software and systems companies as well as small, privately-held companies.

Because some of our current competitors have pre-existing relationships with our current and potential customers, we might not be able to achieve sufficient market penetration to achieve or sustain profitability. These existing relationships can also make it difficult for us to obtain additional customers due to the substantial investment that these potential customers might have already made based on our competitors’ technology. Furthermore, our competitors may be able to devote substantial resources aimed at preventing us from establishing or enhancing our customer relationships.

Our competitors and other companies may form strategic relationships with each other to compete with us. These relationships may take the form of strategic investments, joint-marketing agreements, licenses or other contractual arrangements, any of which may increase our competitors’ ability to address customer needs with their product offerings. Our competitors may consolidate with one another or acquire other technology providers, enabling them to more effectively compete with us. This consolidation could affect prices and other competitive factors in ways that could impede our ability to compete successfully and harm our business.

Because our success depends on our proprietary technology, if third parties infringe our intellectual property or if we are unable to rely upon the legal protections for our technology, we may be forced to expend significant resources enforcing our rights or suffer competitive injury.

Our success depends in large part on our proprietary technology. We have a number of pending patent applications, and we currently rely on a combination of copyright, trademark, trade secret and other laws and restrictions on disclosure to protect our intellectual property rights. These legal protections afford only limited protection, and our means of protecting our proprietary rights may not be adequate.

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

We may be required to spend significant resources to monitor and police our intellectual property rights. We may not be able to detect infringement and may lose our competitive position in the market before we are able to ascertain any such infringement. In addition, competitors may design around our proprietary technology or develop competing technologies. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Any such litigation could result in significant costs and diversion of resources, including the attention of senior management.

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

If we are forced to take any of the foregoing actions, our business may be seriously harmed. In addition, any of these could have the effect of increasing our costs and reducing our revenue. Our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed.

Our business will suffer if we do not enhance our products or introduce new products and upgrades to meet changing customer requirements.

The market for our products and services is characterized by rapid technological change, uncertain product life cycles, changes in customer demands and evolving industry standards. Any delays in responding to these changes and developing and releasing enhanced or new products and upgrades could hinder our ability to retain existing and obtain new customers. In particular, our technology is designed to support a variety of hardware and software products that we believe to be proven and among the most widely used. We cannot be certain, however, that present and future customers will continue to use these products. Even if they do, new versions of these products are likely to be released and we will need to adapt our technology to these new versions. We must, therefore, constantly modify and enhance our technology to keep pace with changes made to our customers’ hardware and software configurations. If we fail to promptly modify or enhance our technology in response to evolving customer needs and demands, fail to introduce new products and upgrades or fail to fully develop our new product offerings, our technology may not achieve widespread acceptance and could become obsolete, which would significantly harm our business.

As we introduce new products or technologies into existing customer architectures, we may experience performance problems associated with incompatibility among different versions of hardware, software and networking products. To the extent that such problems occur, we may face adverse publicity, loss of sales, and delay in market acceptance of our products or customer claims against us, any of which could harm our business.

In addition, implementation of our products may be difficult, costly and time consuming. Customers could become dissatisfied with our products if implementation requires more time, expense or personnel than they expected. Additionally, we may be unable or choose not to bill our customers for the time and expenses incurred in connection with these implementation issues, which would adversely affect our operating results. As part of the implementation, our products must integrate with many of our customers’ existing computer systems and software programs, which can also be time consuming and expensive and could lead to customer dissatisfaction and increased expenses.

The information technology automation software market is relatively new, and our business will suffer if the market does not develop as we expect.

The market for our products and services is relatively new and may not grow or be sustainable. Potential customers may choose not to purchase automation software from a third-party provider due to concerns about security, reliability, cost or system compatibility. It is possible that our products may never achieve broad market acceptance. In addition, we have not yet sold or deployed our software on the scale that is anticipated in the future. We will incur operating expenses based to an extent on anticipated revenue trends that are difficult to predict given the recent emergence of the information technology automation software market. If this market does not develop, or develops more slowly than we expect, we may not achieve significant market acceptance for our software, our rate of revenue growth may be constrained and our operating results may suffer.

We rely on third-party software to develop and deliver our products to our customers, and the loss of access to this software could harm our business.

As part of our normal operations in connection with the development and delivery of our software, we license software from third-party commercial vendors. These products may not continue to be available on commercially reasonable terms, or at all. The loss of these products could result in delays in the sale of our software until equivalent technology, if available, is identified, procured and integrated, and these delays could result in lost revenue. Further, to the extent that we incorporate these products into our software and the vendors from whom we purchase these products increase their prices, our gross margins could be negatively impacted.

Defects in our products or claims asserted against us could result in the loss of customers, a decrease in revenue, unexpected expenses, loss of competitive market share and liability claims.

Our products depend on complex software, both internally developed and licensed from third parties. Also, our customers may use our products with other companies’ products that also contain complex software. If our software does not meet performance requirements, our customer relationships will suffer. Complex software often contains errors and is susceptible to computer viruses. Any failure or poor performance of our software or the third party software with which it is integrated could result in:

Although our agreements with customers contain provisions designed to limit our exposure to potential liability claims, these provisions may not be effective to the extent warranty exclusions or similar limitations of liability are unenforceable. In addition, the extent of these limitations may require negotiation. If any claim is made against us, we may be required to expend significant cash resources in defense and settlement of the claim.

We may require additional capital to fund our operations, and we may be unable to obtain additional financing.

We believe that our current cash balances, including cash, cash equivalents and restricted cash, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. However, if we need to raise additional capital in the future, we cannot be sure that we will be able to secure additional financing on acceptable terms, or at all. If our licensing revenues do not meet our expectations, if we encounter unforeseen expenses or if our business plan changes, we may require additional debt or equity financing after 12 months. If existing or potential customers perceive that our cash balances are inadequate to support our operations, they may choose not to continue licensing our software.

Additionally, holders of any future debt instruments or preferred stock may have rights senior to those of the holders of our common stock, and any future issuance of common stock would result in dilution of existing stockholders’ equity interests. Any debt financing we raise could involve substantial restrictions on our ability to conduct our business and to take advantage of new opportunities. If we are unable to obtain additional financing on acceptable terms or at all, our business and financial results may suffer.

Our revenue and operating results will be highly dependent upon our ability to provide high levels of customer satisfaction.

We provide technical support to our customers pursuant to contracts that are renewable annually. Our customers’ willingness to renew their maintenance and support agreements will depend in large part on our ability to provide high levels of customer service. If we fail to provide the level of support demanded by our customers, these customers may not renew their maintenance and support agreements, which could have a material adverse impact on our revenue and operating results.

The rates we charge our customers for our Opsware automation software may decline over time, which would reduce our revenue and adversely affect our financial results.

As our business model gains acceptance and attracts the attention of additional competitors, we may experience pressure to decrease the fees we charge for our Opsware System software, which could adversely affect our revenue and our gross margins. If we are unable to sell our software at acceptable prices, or if we fail to offer additional products with sufficient profit margins, our revenue growth could slow, our margins may not improve and our business and financial results could suffer. In addition, any amendments of existing contracts could adversely affect our results of operations.

If we are unable to retain our executive officers and key technical personnel, we may not be able to successfully manage our business or achieve our objectives.

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

Our business will suffer if we are unable to retain our highly qualified employees.

Our future success depends on our ability to retain our highly qualified technical, sales and managerial personnel. We have completed several restructuring programs, which resulted in significant workforce reductions. As a result, employee morale may have been adversely affected, and it may be more difficult to retain our highly qualified employees or recruit new employees. Our failure to retain our qualified personnel could seriously disrupt our operations and increase our costs by forcing us to use more expensive outside consultants and by reducing the rate at which we can increase revenue. If our customer base and revenue grow, we may need to hire additional qualified personnel. Competition for qualified personnel can be intense, and we may not be able to attract, train, integrate or retain a sufficient number of qualified personnel if we need to do so in the future.

Important components of the compensation of our personnel are stock options and restricted stock, which typically vest over a four-year period. We may face significant challenges in retaining our employees if the value of our stock declines. To retain our employees, we expect to continue to grant new options subject to vesting schedules, which will be dilutive to our stockholders. A large number of our employees hold options at higher exercise prices than the price at which our common stock is currently trading. If our stock price does not increase in the future, we may need to exchange options for new options or restricted stock, issue new options or grant additional shares of stock to motivate and retain our employees. To the extent we issue additional options or shares of restricted stock, existing stockholders will be diluted. Furthermore, potential changes in practices regarding accounting for stock plans could result in significant accounting charges, which could raise our costs and impair our ability to use stock options for compensation purposes.

The market price of our common stock has fluctuated significantly in the past, will likely continue to fluctuate in the future and may decline. The market for technology stocks has been extremely volatile and frequently reaches levels that bear no relationship to the past or present operating performance of those companies. Delays in closing sales or completing installations could result in material variations in our quarterly results and quarter-to-quarter growth in the foreseeable future. This could result in greater volatility in our stock price. In addition, our stock is thinly traded and, therefore, our stock price can swing significantly on low trading volume.

We are a defendant in an arbitration action brought by Qwest Communications Corporation and a cross defendant in an action brought by Knight Ridder Digital and these litigations could harm our business whether or not determined adversely.

On July 31, 2002, we received notice that Qwest Communications Corporation filed a demand for arbitration under the Commercial Arbitration Rules of the American Arbitration Association, claiming that we have breached our amended and restated ethernet collocation internet access service agreement, amended and restated reseller agreement and confidentiality agreement we entered into with Qwest in fiscal 2002. Qwest is seeking monetary damages, title to certain items of equipment and declaratory relief. Under the amended and restated ethernet collocation internet access service agreement we received a $7.5 million non-refundable prepayment from Qwest in fiscal 2002 in consideration for providing services in connection with the provisioning and maintaining of three of Qwest’s data centers. The prepayment received from Qwest was originally included in deferred revenue and the residual balance as of April 30, 2003 has since been reclassified to accrued data center facility costs. We believe that we have not breached any of the agreements and will defend ourselves vigorously. However, the outcome of arbitration is inherently uncertain and there can be no assurance that we will not be materially affected. In addition, we anticipate that we will incur ongoing expenses in connection with this arbitration.

On March 7, 2003, EDS filed suit against Knight Ridder Digital, a former customer of ours that was transferred to EDS as part of the sale of our Managed Services Business. On March 24, 2003, we received notice that Knight Ridder Digital filed a cross complaint against both EDS and us in the Superior Court of California, County of Santa Clara, alleging in part that we breached our customer service agreement with Knight Ridder Digital by assigning the agreement to EDS. The cross complaint seeks an unspecified amount of damages and asks for certain equitable relief. We believe that we have not breached the customer service agreement and will defend ourselves vigorously. On March 31, 2003, we filed a cross complaint against Knight Ridder Digital alleging theft of trade secrets and breach of contract, among other claims, and we joined in EDS’s then-pending motion for a preliminary injunction. On April 10, 2003, we entered into a Stipulation and Order with EDS and Knight Ridder Digital limiting Knight Ridder Digital’s use of certain of our intellectual property. The outcome of litigation is inherently uncertain, and there can be no assurance that we will not be materially affected. We anticipate that we will incur ongoing litigation expenses in connection with this litigation and believe that EDS is obligated to indemnify us for some or all of these expenses pursuant to the terms of the asset purchase agreement.

In the future, we may be subject to other lawsuits. Any litigation, even if not successful against us, could result in substantial costs and divert management’s attention and other resources away from the operation of our business.

Insiders have substantial control over us and this could delay or prevent a change in control and could negatively affect your investment.

As of May 31, 2003, our officers and directors and their affiliates beneficially own, in the aggregate, approximately 43.4% of our outstanding common stock. These stockholders are able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could have the effect of delaying or preventing a third party from acquiring control over us and could affect the market price of our common stock. In addition, the interests of certain large stockholders may not always coincide with our interests or the interests of other stockholders, and, accordingly, these stockholders could cause us to enter into transactions or agreements that we would not otherwise consider.

We have implemented anti-takeover provisions that could make it more difficult to acquire us.

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

If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could fall. As of May 31, 2003, we had 79,159,666 shares of common stock outstanding. In connection with the repurchase of our senior discount notes, we issued 2,046,385 shares of our common stock to Morgan Stanley & Co. Incorporated and registered those shares for resale with the Securities and Exchange Commission. The subsequent sales of these shares could depress our stock price. Approximately 14.0 million of our outstanding shares continue to be held by venture capital firms that have not yet distributed their shares to their limited partners. If these venture capital firms were to distribute their shares to their limited partners, the subsequent sale of shares by those limited partners could depress our stock price.

Interest Rate Risk. We have limited exposure to financial market risks, including changes in interest rates. An increase or decrease in interest rates would not significantly increase or decrease interest expense on our debt obligations due to the fixed nature of our debt obligations. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since we primarily invest in short term investments. Due to the short-term nature of our investments, we believe that we are not subject to any material market risk exposure. A hypothetical 100 basis point increase in interest rates would result in less than $0.1 million decrease (less than 1%) in the fair value of our available-for-sale securities.

Foreign Currency Risk. As we expand into foreign markets, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets we plan to target. The majority of our sales are currently made in U.S. dollars and a strengthening of the dollar could make our services less competitive in the foreign markets we may target in the future.

Evaluation of Disclosure Controls and Procedures. Regulations under the Securities Exchange Act of 1934 require public companies to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our Chief Executive Officer and our Chief Financial Officer, based on their evaluation of our disclosure controls and procedures within 90 days before the filing date of this report, concluded that our disclosure controls and procedures were effective for this purpose.

Changes in Internal Controls. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced above.

On April 9, 2003, we entered into a stipulation of settlement with the plaintiffs in connection with the consolidated securities class action lawsuit related to our initial public offering claiming that we, certain of our officers, directors and the underwriters of our initial public offering violated federal securities laws by providing materially false and misleading information in our prospectus. The stipulation of settlement, which is subject to court approval, provides for the full and final settlement and dismissal and release of all litigation brought by the plaintiffs and an insignificant settlement payment. The settlement payment will be paid by our directors’ and officers’ insurance policy and, therefore, will not impact our financial position or results of operations.

On March 7, 2003, EDS filed suit against Knight Ridder Digital, a former customer of ours that was transferred to EDS as part of the sale of our Managed Services Business. On March 24, 2003, we received notice that Knight Ridder Digital filed a cross complaint against both EDS and us in the Superior Court of California, County of Santa Clara, alleging in part that we breached our customer service agreement with Knight Ridder Digital by assigning the agreement to EDS. The cross complaint seeks an unspecified amount of damages and asks for certain equitable relief. We believe that we did not breach the customer service agreement and will defend ourselves vigorously. On March 31, 2003, we filed a cross complaint against Knight Ridder Digital alleging theft of trade secrets and breach of contract, among other claims, and we joined in EDS’s then-pending motion for a preliminary injunction. On April 10, 2003, we entered into a Stipulation and Order with EDS and Knight Ridder Digital limiting Knight Ridder Digital’s use of certain of our intellectual property. The outcome of litigation is inherently uncertain, and there can be no assurance that we will not be materially affected. We anticipate that we will incur ongoing litigation expenses in connection with this litigation and believe that EDS is obligated to indemnify us for some or all of these expenses pursuant to the terms of the asset purchase agreement.

On July 31, 2002, we received notice that Qwest Communications Corporation filed a demand for arbitration under the Commercial Arbitration Rules of the American Arbitration Association, claiming that we have breached our amended and restated ethernet collocation internet access service agreement, amended and restated reseller agreement and confidentiality agreement we entered into with Qwest in fiscal 2002. Qwest is seeking monetary damages, title to certain items of equipment and declaratory relief. Under the amended and restated ethernet collocation internet access service agreement, we received a $7.5 million non-refundable prepayment from Qwest in fiscal 2002 in consideration for providing services in connection with the provisioning and maintaining of three of Qwest’s data centers. The prepayment received from Qwest was originally included in deferred revenue and the residual balance as of April 30, 2003 has since been reclassified to accrued data center facility costs. We believe that we have not breached any of the agreements and will defend ourselves vigorously. However, the outcome of arbitration is inherently uncertain, and there can be no assurance that we will not be materially affected. We anticipate that we will incur ongoing expenses in connection with this arbitration.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

OPSWARE INC

		/s/ Sharlene P. Abrams
		Sharlene P. Abrams
		Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)

I, Benjamin A. Horowitz, the Chief Executive Officer of Opsware Inc., certify that:

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Benjamin A. Horowitz

Benjamin A. Horowitz

President and Chief Executive Officer

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

/s/ Sharlene P. Abrams

Sharlene P. Abrams

Chief Financial Officer

		Page
PART I FINANCIAL INFORMATION		2
ITEM 1. FINANCIAL STATEMENTS		2
CONDENSED CONSOLIDATED BALANCE SHEETS		2
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS		3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS		4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS		5
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK		34
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES		34

PART II OTHER INFORMATION		35
ITEM 1. LEGAL PROCEEDINGS		35
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS		35
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		35
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		35
ITEM 5. OTHER INFORMATION		36
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K		36
SIGNATURE		37
OFFICER CERTIFICATIONS		38-39

	April 30, 2003			January 31, 2003
	(unaudited)			(A)
ASSETS
Current assets:
Cash and cash equivalents	$	57,933		$	63,162
Accounts receivable, net		3,012			—
Prepaid expenses and other current assets		2,646			2,094

Total current assets		63,591			65,256
Property and equipment, net		5,087			5,550
Restricted cash		3,821			3,821
Other assets		1,358			1,252

Total assets	$	73,857		$	75,879

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	464		$	493
Accrued data center facility costs		7,843			7,843
Other accrued liabilities		7,875			8,949
Advances from customers		1,241			2,539
Deferred revenue, current portion		2,113			—
Accrued restructuring costs, current portion		2,452			2,011
Capital lease obligations, current portion		47			43

Total current liabilities		22,035			21,878
Capital lease obligations, net of current portion		8			23
Deferred revenue, net of current portion		963			—
Accrued restructuring costs, net of current portion		7,901			7,840
Commitments and contingencies
Stockholders’ equity:
Common stock		79			79
Additional paid-in capital		501,308			500,976
Notes receivable from stockholders		(741	)		(793	)
Deferred stock compensation		(997	)		(1,665	)
Accumulated deficit		(456,734	)		(452,863	)
Accumulated other comprehensive income		35			404

Total stockholders’ equity		42,950			46,138

Total liabilities and stockholders’ equity	$	73,857		$	75,879

	Three Months Ended April 30,
	2003			2002
Net revenues	$	2,541		$	17,438
Cost of revenues*		943			25,267
Research and development*		2,184			3,926
Sales and marketing*		2,009			6,615
General and administrative*		2,149			4,108
Restructuring costs, net		846			—
Amortization of deferred stock compensation		58			5,936

Total costs and expenses		8,189			45,852
Loss from operations		(5,648	)		(28,414	)
Interest and other income (expense), net		1,777			(1,966	)

Net loss	$	(3,871	)	$	(30,380	)

Basic and diluted net loss per share	$	(0.05	)	$	(0.46	)

Shares used in computing basic and diluted net loss per share		74,308			66,487

*Excludes amortization (reversal) of deferred stock compensation of the following (1):
Cost of revenues	$	55		$	1,848
Research and development		105			1,255
Sales and marketing		57			779
General and administrative		(159	)		2,054

Total amortization (reversal) of deferred stock compensation	$	58		$	5,936

	Three Months Ended April 30,
	2003			2002
Operating activities:
Net loss	$	(3,871	)	$	(30,380	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		761			7,551
Accretion on notes payable		—			1,909
Accretion on warrants related to senior discount notes		—			491
Amortization of deferred stock compensation		58			5,936
Charges related to equity transactions		21			—
Loss (recovery) on disposal of property and equipment		(140	)		647
Changes in operating assets and liabilities:
Accounts receivable		(3,012	)		412
Prepaid expenses, other current assets and other assets		(658	)		449
Accounts payable		(29	)		567
Other accrued liabilities		(1,074	)		(4,876	)
Advances from customers		(1,298	)		—
Deferred revenue		3,076			(1,633	)
Accrued restructuring costs		502			(2,771	)

Net cash used in operating activities		(5,664	)		(21,698	)
Investing activities:
Purchases of property and equipment		(158	)		(842	)
Maturities and sales of available-for-sale investments		—			3,288
Decrease in restricted cash		—			4,353

Net cash (used in) provided by investing activities		(158	)		6,799
Financing activities:
Proceeds from issuance of common stock, net		565			1,015
Payments on lease obligations		(11	)		(638	)
Repayment of notes receivable		39			55

Net cash provided by financing activities		593			432

Net decrease in cash and cash equivalents		(5,229	)		(14,467	)
Cash and cash equivalents at beginning of period		63,162			91,415

Cash and cash equivalents at end of period	$	57,933		$	76,948
Supplemental disclosures of cash flow information:
Cash paid for interest	$	2		$	58
Supplemental schedule of noncash investing and financing activities:
Equipment purchased under capital lease	$	—		$	162
Cancellation of stockholder notes receivables for terminated employees related to unvested awards	$	13		$	25

	Three Months Ended April 30,
	2003			2002
As reported consolidated net loss applicable to common stockholders	$	(3,871	)	$	(30,380	)
Stock-based compensation included in reported net loss		448			5,936
Total stock-based employee compensation expense determined under the fair value based method for all awards		(1,823	)		(3,287	)

Consolidated pro forma net loss applicable to common stockholders	$	(5,246	)	$	(27,731	)

Earnings Per Share:
As reported consolidated net loss per share applicable to common stockholders—basic and diluted	$	(0.05	)	$	(0.46	)

Consolidated pro forma net loss per share applicable to common stockholders—basic and diluted	$	(0.07	)	$	(0.42	)

	Stock Awards				Employee Stock Purchase Plan
	Three Months Ended April 30,				Three Months Ended April 30,
	2003		2002		2003		2002
Risk-free interest yield	2.6	%	4.0	%	1.2	%	2.0	%
Expected life (years)	4.0		4.0		0.5		0.5
Volatility	106	%	135	%	89	%	110	%
Dividend yield	0	%	0	%	0	%	0	%

	Total Charge		Noncash Charges			Cash Payments			Restructuring Liabilities at April 30, 2003
Workforce reduction	$	5.4	$	(3.0	)	$	(2.4	)	$	—
Consolidation of excess facilities		20.6		—			(19.8	)		0.8
Disposal of property and equipment		4.2		(0.5	)		(3.7	)		—

Total	$	30.2	$	(3.5	)	$	(25.9	)	$	0.8

	Total Charge		Adjustment		Noncash Charges			Cash Payments			Restructuring Liabilities at April 30, 2003
Consolidation of excess facilities	$	12.1	$	1.0	$	—		$	(3.5	)	$	9.6
Disposal of property and equipment		1.2		—		(1.2	)		—			—

Total	$	13.3	$	1.0	$	(1.2	)	$	(3.5	)	$	9.6

	As of April 30, 2003		As of January 31, 2003
	(unaudited)
United States	$	5,087	$	5,550
Europe		—		—

Total	$	5,087	$	5,550

Contractual Obligations	Total		Less than 1 Year		1-3 Years		4-5 Years		Greater than 5 Years
Capital leases	$	60	$	52	$	8	$	—	$	—
Operating leases, net of subleases		26,104		3,634		8,609		6,573		7,288

Total contractual cash obligations	$	26,164	$	3,686	$	8,617	$	6,573	$	7,288

Exhibit Number		Description

99.1		Certification of Chief Executive Officer and Chief Financial Officer*