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EX-31.2 - SECTION 302 CFO CERTIFICATION - QUEST SOFTWARE INCdex312.htm
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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2009

OR

 

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

For the transition period from              to             

COMMISSION FILE NO. 000-26937

 

 

QUEST SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   33-0231678

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

5 Polaris Way

Aliso Viejo, California

  92656
(Address of principal executive offices)   (Zip code)

Registrant’s telephone number, including area code: (949) 754-8000

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨        No  ¨

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

The number of shares outstanding of the registrant’s Common Stock, par value $0.001 per share, as of November 3, 2009, was 90,365,364.

 

 

 


Table of Contents

QUEST SOFTWARE, INC.

FORM 10-Q

TABLE OF CONTENTS

 

          Page
Number

PART I. FINANCIAL INFORMATION

  
Item 1.   

Financial Statements (unaudited)

  
  

Condensed Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008

   2
  

Condensed Consolidated Income Statements for the Three and Nine Months Ended September 30, 2009 and 2008

   3
  

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008

   4
  

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2009 and 2008

   5
  

Notes to Condensed Consolidated Financial Statements

   6
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   20
Item 3.   

Quantitative and Qualitative Disclosures about Market Risk

   30
Item 4.   

Controls and Procedures

   32
PART II. OTHER INFORMATION   
Item 1.    Legal Proceedings    34
Item 1A.    Risk Factors    34
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    34
Item 6.    Exhibits    35
SIGNATURES    36


Table of Contents

QUEST SOFTWARE, INC.

PART I—FINANCIAL INFORMATION

 

Item 1: Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

     September 30,
2009
    December 31,
2008
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 303,465      $ 215,895

Restricted cash

     900        2,425

Short-term investments

     58,549        632

Accounts receivable, net of allowances of $5,632 and $8,384 at September 30, 2009 and December 31, 2008, respectively

     124,545        153,892

Prepaid expenses and other current assets

     19,116        17,362

Deferred income taxes

     30,776        18,460
              

Total current assets

     537,351        408,666

Property and equipment, net

     71,587        77,394

Long-term investments

     —          41,410

Intangible assets, net

     79,918        104,567

Goodwill

     659,195        655,777

Deferred income taxes

     23,313        28,026

Other assets

     26,274        29,819
              

Total assets

   $ 1,397,638      $ 1,345,659
              
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 4,579      $ 3,798

Accrued compensation

     40,325        45,079

Other accrued expenses

     27,414        39,760

Litigation loss provision

     29,400        —  

Current portion of loans payable

     34,213        —  

Current portion of income taxes payable

     6,090        167

Current portion of deferred revenue

     258,189        272,626
              

Total current liabilities

     400,210        361,430

Long-term liabilities:

    

Long-term portion of deferred revenue

     76,790        66,086

Long-term portion of income taxes payable

     38,697        40,846

Long-term portion of loans payable

     33,428        —  

Other long-term liabilities

     7,228        3,545
              

Total long-term liabilities

     156,143        110,477

Commitments and contingencies (Notes 7, 8 and 15)

    

Stockholders’ equity:

    

Preferred stock, $0.001 par value, 10,000 shares authorized; no shares issued or outstanding

     —          —  

Common stock, $0.001 par value; 200,000 shares authorized; 89,594 and 94,298 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively

     90        94

Additional paid-in capital

     675,089        740,887

Retained earnings

     166,108        132,771

Accumulated other comprehensive loss

     (2     —  
              

Total stockholders’ equity

     841,285        873,752
              

Total liabilities and stockholders’ equity

   $ 1,397,638      $ 1,345,659
              

See accompanying Notes to Condensed Consolidated Financial Statements.

 

2


Table of Contents

QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED INCOME STATEMENTS

(In thousands, except per share data)

(Unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
     2009     2008     2009    2008

Revenues:

         

Licenses

   $ 67,323      $ 86,700      $ 191,333    $ 241,128

Services

     103,526        100,865        309,371      292,650
                             

Total revenues

     170,849        187,565        500,704      533,778

Cost of revenues:

         

Licenses

     2,197        1,921        5,740      6,110

Services

     14,607        15,167        42,867      46,571

Amortization of purchased technology

     4,983        5,026        14,924      14,619
                             

Total cost of revenues

     21,787        22,114        63,531      67,300
                             

Gross profit

     149,062        165,451        437,173      466,478

Operating expenses:

         

Sales and marketing

     64,704        76,957        196,732      234,604

Research and development

     34,721        37,169        107,928      114,687

General and administrative

     18,971        21,120        55,170      66,811

Amortization of other purchased intangible assets

     3,258        2,418        9,925      7,730

In-process research and development

     —          —          —        955

Litigation loss provision

     29,400        —          29,400      —  
                             

Total operating expenses

     151,054        137,664        399,155      424,787
                             

Income (loss) from operations

     (1,992     27,787        38,018      41,691

Other income (expense), net

     2,703        (6,526     3,338      4,385
                             

Income before income tax provision (benefit)

     711        21,261        41,356      46,076

Income tax provision (benefit)

     (2,238     3,944        8,019      7,204
                             

Net income

   $ 2,949      $ 17,317      $ 33,337    $ 38,872
                             

Net income per share:

         

Basic

   $ 0.03      $ 0.16      $ 0.36    $ 0.37
                             

Diluted

   $ 0.03      $ 0.16      $ 0.35    $ 0.36
                             

Weighted average shares:

         

Basic

     88,968        105,434        92,540      104,334

Diluted

     91,846        107,450        94,483      106,697

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Nine Months Ended
September 30,
 
     2009     2008  

Cash flows from operating activities:

    

Net income

   $ 33,337      $ 38,872   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     36,596        34,859   

Compensation expense associated with share-based payments

     11,366        14,306   

Deferred income taxes

     1,184        (421

Unrealized (gain)/loss on short-term investments and put option

     (483     —     

Excess tax benefit related to share-based compensation

     (639     (3,328

Provision for bad debts

     120        756   

In-process research and development

     —          955   

Litigation loss provision

     29,400        —     

Other non-cash adjustments, net

     (61     —     

Changes in operating assets and liabilities, net of effects of acquisitions:

    

Accounts receivable

     32,128        37,663   

Prepaid expenses and other current assets

     (34     1,178   

Other assets

     1,687        (348

Accounts payable

     (1,988     (1,557

Accrued compensation

     (7,691     (7,840

Other accrued expenses

     (10,584     (3,738

Income taxes payable

     (8,280     (7,657

Deferred revenue

     (3,733     10,671   

Other liabilities

     3,508        33   
                

Net cash provided by operating activities

     115,833        114,404   

Cash flows from investing activities:

    

Purchases of property and equipment

     (8,277     (8,181

Cash paid for acquisitions, net of cash acquired

     (96     (135,226

Change in restricted cash

     1,690        46,554   

Purchases of cost method investments

     (3,000     (3,160

Purchases of investment securities

     (11,993     (52,003

Sales and maturities of investment securities

     1,289        39,322   
                

Net cash used in investing activities

     (20,387     (112,694

Cash flows from financing activities:

    

Proceeds from loans payable

     68,428        —     

Repayments of loans payable

     (782     —     

Repurchase of common stock

     (101,119     —     

Repayment of capital lease obligations

     (193     (205

Cash paid for line of credit fees

     (1,979     —     

Proceeds from the exercise of stock options

     27,600        38,644   

Excess tax benefit related to share-based compensation

     639        3,328   

Proceeds received from certain executive officers as part of our restatement remedial actions

     —          200   
                

Net cash provided by (used in) financing activities

     (7,406     41,967   

Effect of exchange rate changes on cash and cash equivalents

     (470     1,246   
                

Net increase in cash and cash equivalents

     87,570        44,923   

Cash and cash equivalents, beginning of period

     215,895        235,568   
                

Cash and cash equivalents, end of period

   $ 303,465      $ 280,491   
                

Supplemental disclosures of consolidated cash flow information:

    

Cash paid for interest

   $ 2,858      $ 529   
                

Cash paid for income taxes

   $ 13,514      $ 15,948   
                

Supplemental schedule of non-cash investing and financing activities:

    

Unrealized loss on available-for-sale securities

   $ —        $ 1,822   
                

Capital lease additions

   $ 164      $ 167   
                

Unpaid purchases of property and equipment

   $ 1,015      $ 391   
                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4


Table of Contents

QUEST SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
     2009     2008    2009     2008  

Net income

   $ 2,949      $ 17,317    $ 33,337      $ 38,872   

Other comprehensive income (loss):

         

Unrealized gain (loss) on available-for-sale securities, net of tax

     —          156      —          (1,822

Net unrealized loss on derivative instruments, net of tax

     (2     —        (2     —     
                               

Comprehensive income

   $ 2,947      $ 17,473    $ 33,335      $ 37,050   
                               

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Organization and Basis of Presentation

Quest Software, Inc. (“Quest,” the “Company,” “we,” “us” or “our”) was incorporated in California in 1987 and reincorporated in Delaware in 2009 and is a leading developer and vendor of application, database, Windows and virtualization management software products. We also provide consulting, training, and support services to our customers. Our accompanying unaudited condensed consolidated financial statements as of September 30, 2009 and for the three and nine months ended September 30, 2009 and 2008, reflect all adjustments (consisting of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and the Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in Quest’s Annual Report on Form 10-K for the year ended December 31, 2008 (“2008 Form 10-K”). The results for the interim periods presented are not necessarily indicative of the results that may be expected for any future period.

Recent Accounting Pronouncements

Fair Value Measurements

The Financial Accounting Standards Board (“FASB”) issued new accounting guidance on fair value measurements. The new guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. On January 1, 2008, we adopted the new guidance for financial assets and financial liabilities measured at fair value on a recurring basis (see Note 13 for further details). On January 1, 2009, we adopted the new guidance for non-financial assets and non-financial liabilities measured at fair value on a nonrecurring basis. In April 2009, the FASB issued additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased and is effective for us in the second quarter of fiscal 2009. This includes guidance on identifying circumstances that indicate a transaction is not orderly. In August 2009, the FASB issued clarifying guidance that in circumstances in which a quoted price in an active market for an identical liability is not available, a reporting entity is required to measure fair value of such liability using one or more of the of the techniques prescribed by the update. The adoption of fair value measurements guidance has not had a material impact on our consolidated financial position or results of operations.

Business Combinations

The FASB issued new accounting guidance on business combinations. This guidance has significantly changed the accounting for business combinations by requiring an acquiring entity to recognize assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. In addition, it requires that: acquisition costs be generally expensed as incurred; non-controlling interests (formerly known as “minority interests”) be valued at fair value at the acquisition date; acquired contingent liabilities be recorded at fair value at the acquisition date and subsequently measured at either the higher of such amount or the amount determined under existing guidance for non-acquired contingencies; in-process research and development be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination be generally expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. There are also a substantial number of new disclosure requirements. We adopted this guidance effective January 1, 2009. In April 2009, the FASB issued new guidance that amends and clarifies the initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. We have not completed any acquisitions in 2009 and, therefore, there was not a significant impact from adoption of this standard on our consolidated financial position or results of operations. We expect the new guidance will have an impact on accounting for future business combinations but the impact will be dependent upon the nature, terms and size of future acquisitions.

 

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Table of Contents

QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Other Accounting Pronouncements

In May 2009, the FASB issued new accounting guidance for subsequent events, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. This guidance was effective for us in the second quarter of fiscal 2009. The adoption of this guidance did not have a material impact on our consolidated financial position or results of operations.

In June 2009, the FASB issued an amendment to its consolidation guidance for variable interest entities and the definition of a variable interest entity and requires enhanced disclosures to provide more information about an enterprise’s involvement in a variable interest entity. This amendment also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and is effective for us January 1, 2010. We are currently evaluating the impact this amendment will have on our consolidated financial position and results of operations.

In June 2009, the FASB issued its Accounting Standards Codification (“Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”). The Codification eliminates the GAAP hierarchy and establishes one level of authoritative GAAP. All other literature is considered non-authoritative. This Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We adopted the Codification in the third quarter of fiscal 2009. There will be no change to our consolidated financial statements due to the implementation of the Codification other than changes in reference to various authoritative accounting pronouncements in our Notes to Condensed Consolidated Financial Statements.

In September 2009, the FASB issued new accounting guidance for revenue arrangements with multiple deliverables, which addresses the unit of accounting for arrangements involving multiple deliverables and how consideration should be allocated to separate units of accounting, when applicable. This guidance will not be effective for us until the first quarter of 2011. Early adoption is permitted. This guidance will not have a material impact on our consolidated financial position or results of operations.

In September 2009, the FASB issued new accounting guidance for software revenue recognition. The new guidance excludes from software revenue recognition all tangible products containing both software and non-software components that function together to deliver the product’s essential functionality. This guidance will not be effective for us until the first quarter of 2011. Early adoption is permitted. We are currently evaluating the impact of its pending adoption on our consolidated financial statements.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year’s presentation within the stockholders’ equity section of our December 31, 2008 condensed consolidated balance sheet as a result of changing our state of incorporation from California to Delaware during the second quarter of 2009 and assigning a par value to our common stock.

2. Cash and Cash Equivalents and Investments

The following table summarizes our cash and cash equivalents and investments by balance sheet classification at the dates indicated (in thousands):

 

     September 30, 2009

Classification on balance sheet

   Cost    Fair Value (1)

Cash and cash equivalents

   $ 303,465    $ 303,465

Short-term investments

     61,286      58,549
             

Total cash and cash equivalents and investments

   $ 364,751    $ 362,014
             

 

(1) See Note 13 for further details regarding fair value measurements.

 

7


Table of Contents

QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following table summarizes our investments by major security type at the dates indicated (in thousands):

 

     September 30, 2009

Major security type:

   Cost    Fair Value

Available-for-sale securities: Term Deposits and United States Treasury Bills

   $ 12,211    $ 12,211

Trading securities: Municipal Auction Rate Securities

     49,075      46,338
             

Total investments

   $ 61,286    $ 58,549
             

At September 30, 2009, we held $49.1 million par value (with a fair value of $46.3 million) in municipal notes with an auction reset feature (“auction rate securities” or “ARSs”). These securities are collateralized long-term debt instruments that provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined intervals, typically every 35 days. Due to a decrease in liquidity in the global credit markets, in February 2008 auctions began failing for the ARSs we held. Regularly scheduled auctions for these securities have continued to fail since that time. As of September 30, 2009, we continue to earn and receive interest on all of our ARSs. All of the underlying assets of our ARSs were in securities collateralized by student loan portfolios, which are guaranteed by the United States government.

In October 2008, we entered into agreements (the “Agreements”) with the investment firm that sold us our ARSs. By entering into the Agreements, we (1) received the right (“Put Options”) to sell all of our ARSs back to the investment firm at par, at our sole discretion, anytime during the period from June 30, 2010 through July 2, 2012, (2) gave the investment firm the right to purchase all of our ARSs or sell them on our behalf at par anytime after the execution of the Agreements through July 2, 2012, (3) received an offer for a “no net cost” loan for up to 70% of the par value of the ARSs until June 30, 2010, and (4) agreed to release the investment firm from certain potential claims related to the collateralized ARSs in certain specified circumstances. On July 6, 2009, we drew down $34.4 million, or 70%, of the par value against the value of our ARSs (see Note 7 for additional details). We elected to measure the Put Options under the fair value option. During the three months ended September 30, 2009, we recorded within other income (expense), net a pretax unrealized $0.1 million gain on our Put Options with no corresponding offset to our ARSs. During the nine months ended September 30, 2009, we recorded within other income (expense), net a pretax unrealized $5.3 million loss on our Put Options which was offset by a pretax unrealized $5.8 million gain on our ARSs. The corresponding offset to the unrealized gains and losses on our Put Options is recorded within prepaid expenses and other current assets. We anticipate that any future changes in the fair value of the Put Options will primarily be offset by the changes in the fair value of the related ARSs with no material net impact to our Condensed Consolidated Income Statements. The Put Options will continue to be measured at fair value until the earlier of their maturity or exercise. See Note 13 for further details regarding fair value measurements.

3. Share-Based Payments

We have authorized the issuance of 29.3 million shares of common stock to employees, directors and consultants under our 2008 Stock Incentive Plan (the “2008 Plan”). The 2008 Plan is the successor to the Quest Software, Inc. 1999 Stock Incentive Plan, as amended (the “1999 Plan”) and the Quest Software, Inc. 2001 Stock Incentive Plan (the “2001 Plan” and, together with the 1999 Plan, the “Prior Plans”). The 2008 Plan became effective July 1, 2008. All outstanding stock awards granted under the Prior Plans remain subject to the terms and conditions of those predecessor plans. All stock awards granted after July 1, 2008 will be subject to the terms of the 2008 Plan.

The 2008 Plan provides for the discretionary grant of incentive stock options, non-statutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, and other forms of equity compensation to its employees. We use stock awards under the 2008 Plan to secure and retain the services of our employees and directors providing such eligible individuals with an opportunity to benefit from increases in the value of our Common Stock, and thereby aligning the long-term compensation and interests of those individuals with our stockholders. As of September 30, 2009, there were 16.8 million shares available for grant under the 2008 Plan.

 

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Table of Contents

QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Option Awards

Incentive stock options and non-statutory stock options (“option awards”) are granted with an exercise price not less than the market price of our stock at the date of grant. Option awards generally vest based on four to five years of continuous service and generally have 10-year contractual terms.

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. The fair value of these awards is amortized on a straight-line basis over the vesting period. As of January 1, 2009, expected volatilities are based on historical volatilities of Quest’s stock, which is a departure from past practice of using implied volatilities derived from the market prices of our traded options with similar terms. We decided to make this change because we have significantly reduced the level of option award granting activity and both analyses produced similar results. We use historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The risk-free rate is based on the U.S. Treasury zero-coupon issues in effect at the time of option grant for equivalent remaining terms. We do not expect to pay any dividends and, therefore, we use an expected dividend yield of zero. We used the following weighted-average assumptions for option awards during the three and nine months ended September 30, 2009 and 2008:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2009     2008     2009     2008  

Expected volatility

   38.0   43.3   39.5   43.4

Expected term (in years)

   5.9      7.0      5.9      6.9   

Risk-free interest rate

   3.0   3.6   2.3   3.5

Expected dividend yield

   None      None      None      None   

A summary of the activity of option awards during the nine months ended September 30, 2009, and details regarding the option awards outstanding and exercisable at September 30, 2009, are as provided below:

 

     Number of Shares
(in thousands)
    Weighted-Average
Exercise Price
(per share)
   Weighted-Average
Remaining
Contractual Term
(in years)
   Aggregate
Intrinsic Value
(in thousands) (1)

Outstanding at December 31, 2008

   15,262      $ 16.05      

Granted

   686      $ 13.10      

Exercised

   (2,286   $ 12.07      

Canceled/forfeited/expired

   (584   $ 20.32      
              

Outstanding at September 30, 2009

   13,078      $ 16.40    3.88    $ 42,676
                  

Vested or expected to vest at September 30, 2009

   12,913      $ 16.44    3.81    $ 42,147
                  

Exercisable at September 30, 2009

   11,529      $ 16.73    3.38    $ 38,188
                  

 

(1) These amounts represent the difference between the weighted-average exercise price and $16.85, the closing price of Quest Software, Inc. stock on September 30, 2009 as reported on the NASDAQ National Market, for all in-the-money options outstanding.

The weighted-average fair value of options granted during the nine months ended September 30, 2009 and 2008 was $5.39 and $7.51, respectively. The total intrinsic value of options exercised was $8.2 million and $21.4 million for the nine months ended September 30, 2009 and 2008, respectively. The total fair value of options vested during the nine months ended September 30, 2009 and 2008 was approximately $6.9 million and $13.2 million, respectively.

Restricted Stock Unit Awards (“RSUs”)

RSUs have been granted to selected executives pursuant to our Executive Incentive Plan. We have also granted RSUs to key employees pursuant to a key employee incentive plan. All of our outstanding RSUs vest over three years with vesting contingent upon continuous service and meeting certain company-wide performance goals, including sales, operating profit margin, and cash flow targets. We estimate the fair value of RSUs using the market price of our common stock on the date of the grant. The fair value of these awards is amortized on a straight-line basis over the vesting period.

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

A summary of our RSUs activity during the nine months ended September 30, 2009 is provided below:

 

     Number of Shares     Weighted-Average
Grant Date Fair Value
(per share)

Nonvested at January 1, 2009

   266,290      $ 13.83

Granted (1)

   819,821      $ 12.49

Vested

   (272,975   $ 13.02

Forfeited

   (17,557   $ 12.49
        

Nonvested at September 30, 2009

   795,579      $ 12.74
        

 

(1) Granted RSUs include 135,225 shares that are subject to performance conditions whereby the final number of awards will be determined by the application of the awards to the Company’s actual performance during the 2009 performance period against the established financial objectives. The number disclosed is the maximum deliverable assuming 100% of the 2009 financial objectives are achieved.

The total fair value of RSUs vested during the nine months ended September 30, 2009 and 2008 was $4.3 million and $0.8 million, respectively.

Share-Based Compensation Expense

The following table presents the income statement classification of all share-based compensation expense for the three and nine months ended September 30, 2009 and 2008 (in thousands):

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2009    2008    2009    2008

Cost of licenses

   $ —      $ 1    $ —      $ 3

Cost of services

     185      150      522      685

Sales and marketing

     1,047      1,588      3,767      5,537

Research and development

     1,473      1,283      4,073      4,505

General and administrative

     1,330      2,212      3,004      4,492
                           

Total share-based compensation expense

     4,035      5,234      11,366      15,222

Tax benefit associated with share-based compensation expense (1)

     1,614      2,094      4,546      6,089
                           

Reduction of net income

   $ 2,421    $ 3,140    $ 6,820    $ 9,133
                           

 

(1) The recognized tax benefit related to share-based compensation expense was estimated to be 40% in order to approximate the blended Federal and State statutory tax rate after the benefit for state taxes. Historically we have used the effective tax rate for all periods presented. However, due to variances in the effective tax rate between comparative interim periods, we utilized a blended statutory tax rate which provides a more accurate estimate of the current and deferred tax benefits ultimately received from share-based compensation.

As of September 30, 2009, total unrecognized share-based compensation cost related to unvested option awards was $10.1 million, which is expected to be recognized over a weighted-average period of 2.1 years and total unrecognized share-based compensation expense related to unvested RSUs was $8.3 million, which is expected to be recognized over a weighted-average period of 2.0 years.

4. Acquisitions

2008 Acquisitions

NetPro Computing, Inc. – In September 2008 we acquired NetPro Computing, Inc. (“NetPro”), a leading provider of Microsoft infrastructure optimization solutions, for purchase consideration of approximately $79.1 million, including $0.4 million in transaction costs. The acquisition of NetPro allows Quest to further extend our product portfolio to deliver a comprehensive set of products to manage complex Microsoft infrastructures. The combined product offering is expected to provide robust solutions to better migrate,

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

manage and secure Microsoft Active Directory, Exchange, SharePoint and SQL Server environments. The acquisition has been accounted for as a purchase and the purchase price was allocated primarily to goodwill and other intangible assets. Total goodwill of $54.1 million was assigned $32.4 million and $21.7 million to the license and service segments of our business, respectively, and is not expected to be deductible for tax purposes. The goodwill allocation of 60% to licenses and 40% to services is based on both historical and projected relative contribution from licenses and services revenues. Actual results of operations of NetPro are included in our consolidated financial statements from the date of acquisition. Our allocation of the purchase price to assets and liabilities based upon the fair value determinations as of September 30, 2009 was as follows (in thousands):

 

Cash and cash equivalents

   $ 3,798   

Other current assets

     3,877   

Acquired technologies with a useful life of 4.0 years

     16,500   

Customer relationships with a weighted average useful life of 4.1 years

     18,300   

Non-compete agreements with a useful life of 3.0 years

     1,000   

Goodwill

     54,082   

Other non-current assets

     1,134   

Other current liabilities

     (4,736

Deferred revenue

     (7,061

Non-current liabilities

     (7,797
        

Total purchase price

   $ 79,097   
        

PassGo Technologies Limited – In January 2008 we acquired PassGo Technologies Limited (“PassGo”), a privately held, UK-based leader in access and identity management solutions, for purchase consideration of approximately $52.2 million, including $1.1 million in transaction costs. The acquisition has been accounted for as a purchase and the purchase price was allocated primarily to goodwill and other intangible assets. Total goodwill of $34.2 million was assigned $12.0 million and $22.2 million to the license and service segments of our business, respectively, and is not expected to be deductible for tax purposes. The goodwill allocation of 35% to licenses and 65% to services is based on both historical and projected relative contribution from licenses and services revenues. Actual results of operations of PassGo are included in our condensed consolidated financial statements from the date of acquisition. Our allocation of the purchase price to assets and liabilities based upon the fair value determinations finalized in June 2008 was as follows (in thousands):

 

Cash and cash equivalents

   $ 3,070   

Other current assets

     4,329   

Acquired technologies with a weighted average useful life of 4.8 years

     9,360   

Customer relationships with a weighted average useful life of 5.6 years

     9,680   

Non-compete agreements with a useful life of 2.0 years

     170   

Trade name with a useful life of 2.0 years

     90   

Goodwill

     34,158   

Other non-current assets

     4,443   

Other current liabilities

     (5,578

Deferred revenue

     (6,951

Non-current liabilities

     (546
        

Total purchase price

   $ 52,225   
        

Other Acquisitions – We completed two other acquisitions during the nine months ended September 30, 2008. The aggregate consideration paid for these transactions was $11.7 million paid in cash and was allocated as follows: $7.6 million to goodwill, $1.0 million to in-process research and development which was written off on the date of acquisition, $4.2 million to intangible assets and $(1.1) million to assumed liabilities, net of tangible assets acquired. Actual results of operations of these acquisitions are included in our condensed consolidated financial statements from the effective dates of the acquisitions.

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following represents the aggregate allocation of the purchase price for these two acquisitions to amortizing intangible assets (table in thousands):

 

Acquired technology with a weighted average useful life of 4.9 years

   $ 2,249

Customer relationships with a useful life of 4.5 years

     891

Non-compete agreements with a weighted average useful life of 2.5 years

     1,018
      

Total intangible assets

   $ 4,158
      

The pro forma effects of all 2008 acquisitions, individually or in the aggregate, would not have been material to our results of operations for the three and nine months ended September 30, 2008 and, therefore, are not presented.

5. Goodwill and Intangible Assets, Net

Intangible assets, net are comprised of the following (in thousands):

 

     September 30, 2009    December 31, 2008
     Gross Carrying
Amount
   Accumulated
Amortization
    Net    Gross Carrying
Amount
   Accumulated
Amortization
    Net

Acquired technology

   $ 151,746    $ (112,945   $ 38,801    $ 151,526    $ (98,000   $ 53,526

Customer relationships

     69,627      (36,706     32,921      69,627      (28,225     41,402

Non-compete agreements

     12,919      (11,903     1,016      12,919      (11,100     1,819

Trademarks and trade names (1)

     12,680      (5,500     7,180      12,680      (4,860     7,820
                                           
   $ 246,972    $ (167,054   $ 79,918    $ 246,752    $ (142,185   $ 104,567
                                           

 

(1) Trademarks and trade names include $6.2 million in a trade name related to our acquisition of ScriptLogic Corporation (“ScriptLogic”) in August 2007 that has an indefinite useful life, and as such is not being amortized.

Amortization expense for intangible assets was $8.2 million and $24.8 million for the three and nine months ended September 30, 2009, respectively. This compares to $7.4 million and $22.4 million for the three and nine months ended September 30, 2008, respectively. Estimated annual amortization expense related to amortizing intangible assets reflected on our September 30, 2009 balance sheet is as follows (in thousands):

 

     Estimated Annual
Amortization Expense

2009 (remaining quarter)

   $ 7,653

2010

     26,485

2011

     22,438

2012

     14,878

2013

     2,264
      

Total accumulated amortization

   $ 73,718
      

The changes in the carrying amount of goodwill by reportable operating segment for the nine months ended September 30, 2009 are as follows (in thousands):

 

     Licenses    Services    Total

Balance as of December 31, 2008

   $ 463,194    $ 192,583    $ 655,777

Adjustments (1)

     2,065      1,353      3,418
                    

Balance as of September 30, 2009

   $ 465,259    $ 193,936    $ 659,195
                    

 

(1) Primarily from finalization of purchase price allocations for various acquisitions.

6. Cost Method Investments

We invested $3.0 million in an early stage private company during the nine months ended September 30, 2009. Our investments in early stage private companies do not have a readily determined market value and were accounted for under the cost method, given that we do not have the ability to exercise significant influence. We periodically monitor our investments for impairment and will record reductions in carrying values if and when necessary. The fair value of a cost method investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. No such

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

events were noted during the three and nine months ended September 30, 2009. Our cumulative investments are included as part of other assets in our condensed consolidated balance sheet at September 30, 2009 and December 31, 2008 and were carried at $14.4 million and $11.5 million, respectively.

7. Debt

On February 17, 2009, we entered into a two year revolving line of credit agreement with Wells Fargo Foothill, LLC as the arranger, administrative agent and lender (the “Credit Agreement”). We intend to use any proceeds from the Credit Agreement for working capital and other general corporate purposes. The Credit Agreement allows for cash borrowings and letters of credit under a secured revolving credit facility of up to a maximum of $100 million. Interest will accrue at a floating rate based on, at the Company’s election, (i) LIBOR (subject to reserve requirements and a minimum LIBOR of 2.75%) or (ii) the greatest of (a) 4.0%, (b) the Federal Funds Rate plus 0.5% or (c) Wells Fargo’s prime rate, in each case, plus an applicable margin. The Credit Agreement includes limitations on the Company’s ability to, among other things, incur debt, grant liens, make acquisitions and other investments, make certain restricted payments such as dividend payments, and dispose of assets. The Credit Agreement is secured by substantially all of the Company’s assets, subject to certain exceptions, and includes certain financial covenants. Total fees associated with this line of credit paid upfront were approximately $2.0 million and will be amortized over the life of the Credit Agreement as interest expense. During the three and nine months ended September 30, 2009, $0.2 million and $0.6 million, respectively, in amortization of these fees was recognized as interest expense within other income (expense), net. As of September 30, 2009, we have a zero balance outstanding under this line of credit.

On July 6, 2009, we drew down $34.4 million, or 70%, of the par value against the value of our ARSs. As this credit line was structured as a “net no cost” loan, any interest charges will be offset by interest earned on the underlying ARSs. See Note 2 for additional details regarding these investments. As of September 30, 2009, we have a $33.7 million balance outstanding all of which is recorded on the balance sheet in current portion of loans payable.

On August 3, 2009, we entered into a loan agreement (the “Loan”) with Mutual of Omaha Bank whereby we borrowed an aggregate principal amount of $34 million. The Loan is secured by our real property at our headquarters in Aliso Viejo, California. We intend to use the proceeds from the Loan for working capital and other general corporate purposes. The Loan matures in five years, during which time we will make equal monthly principal and interest payments at a 7.03% interest rate on a fixed rate, 25-year amortization schedule. Events of default include, among other things, payment defaults, breaches of covenants and bankruptcy events. In the case of a continuing event of default, the lender may accelerate the payment of all unpaid principal and interest amounts, increase the then-current interest rate by 5% and foreclose on the real estate collateral. As of September 30, 2009, we have a $33.9 million balance outstanding with $33.4 million recorded as long-term and $0.5 million recorded as current portion of loans payable.

We were in compliance with all debt-related covenants at September 30, 2009.

8. Derivatives

Foreign Exchange Risk Management Policy

In February 2009, our Board of Directors approved our Foreign Exchange Risk Management Policy. The policy identifies target exposures such as balance sheet, cash flow and income statement risks, program objectives, approved financial instruments and counterparties, accounting and tax treatment, as well as oversight, reporting and controls. The functional currency of all our subsidiaries is the U.S. Dollar. Our exposure to foreign exchange risk is composed of the combination of our foreign operations net profits and losses denominated in currencies other than the U.S. Dollar, as well as our net balances of monetary assets and liabilities within our foreign subsidiaries. These exposures have the potential to produce either gains or losses depending on the directional movement of the foreign currencies versus the U.S. Dollar and our operational profile in foreign subsidiaries. Certain balance sheet items are re-measured each period and the changes in value are recorded within other income (expense), net.

In March 2009, we initiated a limited balance sheet hedging program with the stated objective of reducing volatility within other income (expense), net. Under this program we use derivatives in the form of forward foreign currency contracts to hedge certain balance sheet exposures. Since these derivatives hedge existing exposures that are denominated in foreign currencies, the contracts

 

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do not require hedge accounting. Accordingly, these outstanding non-designated derivatives are recognized on the consolidated balance sheet at fair value and the changes in fair value from these contracts are recorded in other income (expense), net, in the consolidated income statement. These derivative contracts settled on November 3, 2009.

In September 2009, we initiated a limited cash flow hedging program primarily focused on reducing volatility in our forecasted research and development cash expenses; some of which are denominated in non-U.S. Dollar currencies. Under this program we use derivatives in the form of forward foreign currency contracts to hedge certain forecasted cash expense transactions. These contracts require hedge accounting; as such these derivatives are designated as hedging instruments with durations ranging from less than one month to nine months.

As of September 30, 2009, we had the following net notional forward foreign currency contracts outstanding (in thousands):

 

Foreign Currency

   Currency
Denomination

Australian dollars

   AUD 2,760

Canadian dollars

   CAD  12,355

Danish krone

   DKK 6,000

Euro

   EUR 3,500

British pounds sterling

   GBP 3,000

Israeli shekels

   ILS 7,320

Russian roubles

   RUB 165,580

The Effect of Derivative Instruments on Financial Performance

The following tables provide the effect derivative instruments had on other comprehensive income (loss) (“OCI”) and results of operations for the three and nine months ended September 30, 2009 (in thousands):

 

     Amount of gain (loss) recognized
in OCI (effective portion)
   Location of gain (loss)
reclassified from
accumulated OCI into
income (effective portion)
   Amount of gain (loss)
reclassified from accumulated
OCI (effective portion)

Derivatives designated as hedging instruments

   Three Months    Nine Months       Three Months    Nine Months

Forward foreign currency contracts

   $ 2    $ 2    n/a    $ —      $ —  

 

         Amount of gain (loss)
recognized in income on
derivative instruments
 

Derivatives not designated as hedging instruments

   Location of gain (loss) recognized in income
on derivative instruments
  Three Months    Nine Months  

Forward foreign currency contracts

   Other income (expense), net   $ 4    $ (1,405

There was no material ineffectiveness in our cash flow hedging program in the periods presented.

9. Stockholders’ Equity

In March 2009, our board of directors authorized a stock repurchase of up to $100 million of our common stock. This stock repurchase authorization was terminated in connection with the commencement of the June 2009 tender offer as discussed below. During the nine months ended September 30, 2009, we repurchased 341,639 shares under this stock repurchase authorization at a weighted-average price per share of $11.37, for a total cost of $3.9 million.

In June 2009, our board of directors authorized a modified “Dutch Auction” tender offer to purchase up to 10,715,000 shares of our common stock at a price not greater than $14.00 nor less than $12.50 per share. This offer expired on June 30, 2009. The tendered shares were accepted for purchase and paid for in July 2009. We accepted for purchase 6,850,871 shares in the tender offer, at a price of $14.00 per share, for a total cost of $95.9 million excluding approximately $1.3 million in fees and expenses related to the tender offer.

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

On August 9, 2009, the Board of Directors authorized a plan to repurchase up to $100 million of Quest’s common stock. Any stock repurchases may be made through open market and privately negotiated transactions, at times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans. Rule 10b5-1 permits Quest to establish, while not in possession of material nonpublic information, prearranged plans to buy stock at a specific price in the future, regardless of any subsequent possession of material nonpublic information. The timing and actual number of shares repurchased will depend on a variety of factors including market conditions, corporate and regulatory requirements, and capital availability. The stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice. As of September 30, 2009 we have not repurchased any shares under this plan.

10. Other Income (Expense), Net

Other income (expense), net consisted of the following (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2009     2008     2009     2008  

Interest income

   $ 325      $ 2,837      $ 1,519      $ 8,738   

Interest expense

     (962     (52     (1,687     (161

Foreign currency gain (loss), net (1)

     3,360        (9,499     4,347        (4,827

Forward foreign currency contracts gain (loss)

     4        —          (1,405     —     

Unrealized gain (loss) on ARSs (2)

     (1     —          5,777        —     

Unrealized gain (loss) on Put Options (2)

     79        —          (5,297     —     

Other income and expense

     (102     188        83        635   
                                

Total other income (expense), net

   $ 2,703      $ (6,526   $ 3,337      $ 4,385   
                                

 

(1) Our foreign currency gains or losses within other income (expense), net are predominantly attributable to translation gains or losses on the re-measurement of our net balances of monetary assets and liabilities in our foreign subsidiaries, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar. The foreign currency translation adjustments to these balance sheet items reflect a change in currency spot rates at the end of the quarter compared to spot rates from the previous quarter.
(2) See Note 2 for details.

11. Income Tax Provision (Benefit)

The income tax provision (benefit) was $(2.2) million and $8.0 million for the three and nine months ended September 30, 2009, respectively, which compares to $3.9 million and $7.2 million in the same periods of 2008. The change is primarily related to the mix of pre-tax income between high and low tax jurisdictions as well as the settlement of the shareholder class action relating to alleged stock option backdating and items all discretely impacting the three and nine months ended September 30, 2009. Such discrete items include adjustments made as part of our adoption of the new business combination accounting guidance, enactment of changes to the California income tax legislation, and resolution of the US-France Mutual Agreement Procedure during the period. The provision for income taxes for the nine months ended September 30, 2008 also included the discrete effect related to the closure of an Internal Revenue Service examination of the tax filing for the year December 31, 2004. The effective income tax rate for the three and nine months ended September 30, 2009 was approximately (314.8)% and 19.4%, respectively, compared to 18.6% and 15.6% in the comparable periods of 2008.

Significant Event for Accounting for Uncertainty in Income Taxes

During the nine months ended September 30, 2009, we received notification from the French Tax Authorities of a resolution reached with the Internal Revenue Service pursuant to the Mutual Agreement Procedure provided for in Article 26 of the US-France Income Tax treaty. The resolution provided for additional income to be recognized in France and less income to be recognized in the United States for the tax years ended December 31, 2000 through March 31, 2003. As a result, we revised the balance of our

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

unrecognized tax benefit to reflect the impact of these adjustments. Furthermore, we reassessed and revised the existing balance of our unrecognized tax benefit related to tax years ended during the second quarter of 2003 through 2008 in light of the recent resolution. The impact of these items resulted in a net increase in the gross unrecognized tax benefit of $3.5 million during the nine months ended September 30, 2009, of which $3.4 million was recorded as a non-current deferred tax asset on the condensed consolidated balance sheet. The overall effective tax rate impact of these items recorded during the nine months ended September 30, 2009 is a benefit of approximately $0.1 million.

12. Net Income Per Share

Basic net income per share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution of securities by including other common stock equivalents, including stock options and RSUs, in the weighted-average number of common shares outstanding for a period, if dilutive.

The table below sets forth the reconciliation of the denominator of the net income per share calculation (in thousands):

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2009    2008    2009    2008

Shares used in computing basic net income per share

   88,968    105,434    92,540    104,334

Dilutive effect of stock options and RSUs (1)

   2,878    2,016    1,943    2,363
                   

Shares used in computing diluted net income per share

   91,846    107,450    94,483    106,697
                   

 

(1) Options to purchase 3.7 million and 8.2 million shares of common stock during the three months ended September 30, 2009 and 2008, respectively, and 8.9 million and 8.6 million shares of common stock during the nine months ended September 30, 2009 and 2008, respectively, were outstanding but were not included in the computation of net income per share as inclusion would have been anti-dilutive.

13. Fair Value Measurements

Effective January 1, 2009, we adopted FASB’s new guidance for nonfinancial assets and nonfinancial liabilities measured at fair value on a nonrecurring basis. We did not perform fair value measurements on a nonrecurring basis for nonfinancial assets and nonfinancial liabilities during the nine months ended September 30, 2009 since we test goodwill for impairment at the reporting unit level on an annual basis in the fourth quarter, or more frequently if we believe indicators of impairment exist, and there were no acquisitions during the nine months ended September 30, 2009.

New accounting guidance on fair value measurements for certain financial assets and liabilities requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

 

   

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

   

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

 

   

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions when there is little or no market data.

As of September 30, 2009, we held certain assets that are required to be measured at fair value on a recurring basis. These assets included cash equivalents and investments. Included in our investments at September 30, 2009 was $49.1 million par value (with a fair value of $46.3 million) in ARSs. We estimated the fair values of the ARSs and related Put Options we held at September 30, 2009 based on a discounted cash flow model that we prepared. Key considerations to our discounted cash flow model included, among other items, the general climate of interest rates, the collateralization underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows, and the expectation of the next time the security is expected to have a successful auction. Using our discounted cash flow model we determined that the fair values of the ARSs we held at September 30, 2009 were less than par.

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The following table represents our fair value hierarchy for financial assets (cash equivalents and investments) measured at fair value on a recurring basis by major security type as of September 30, 2009 (in thousands):

 

     Fair Value Measurements at September 30, 2009

Major Security Type

   Total    Quoted Prices
in Active
Markets for
Identical Assets

(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Money market funds

   $ 160,069    $ 160,069    $ —      $ —  

U.S. Treasuries

     31,993      31,993      —        —  

Certificates of deposit

     536      536      —        —  

Commercial paper

     39,990      39,990      —        —  

Auction rate securities

     46,338      —        —        46,338

Put options (1)

     2,575      —        —        2,575
                           

Total

   $ 281,501    $ 232,588    $ —      $ 48,913
                           

 

(1) See Note 2 for details.

The following table presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at September 30, 2009 (in thousands):

 

     Significant
Unobservable Inputs
(Level 3)
 

Balance at December 31, 2008

   $ 49,283   

Unrealized gains on ARSs included within other income, net

     5,778   

Unrealized losses on put options included within other income (expense), net

     (5,298

Net settlements

     (850
        

Balance at September 30, 2009

   $ 48,913   
        

Other Financial Assets and Liabilities

The carrying amounts of our financial instruments including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values because of the relatively short period of time between origination of the instruments and their expected realization or because they are carried at fair value.

The book value and fair value of our current and long-term portion of loans payable are as follows (in thousands):

 

     September 30, 2009
     Book
Value
   Fair
Value

Current portion of loans payable

   $ 34,213    $ 34,213

Long-term portion of loans payable

     33,428      33,428
             
   $ 67,641    $ 67,641
             

14. Geographic and Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by our chief operating decision maker, or decision-making group, in assessing performance and in deciding how to allocate resources.

Our reportable operating segments are Licenses and Services. The Licenses segment develops and markets licenses to use our software products. The Services segment provides after-sale support for software products and fee-based training and consulting services related to our software products.

We do not separately allocate operating expenses to these segments, nor do we allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of revenues, and gross profit.

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Reportable segment data for the three and nine months ended September 30, 2009 and 2008, respectively, is as follows (in thousands):

 

     Licenses    Services    Total

Three months ended September 30, 2009

        

Revenues

   $ 67,323    $ 103,526    $ 170,849

Cost of Revenues

     7,180      14,607      21,787
                    

Gross profit

   $ 60,143    $ 88,919    $ 149,062
                    

Three months ended September 30, 2008

        

Revenues

   $ 86,700    $ 100,865    $ 187,565

Cost of Revenues

     6,947      15,167      22,114
                    

Gross profit

   $ 79,753    $ 85,698    $ 165,451
                    

Nine months ended September 30, 2009

        

Revenues

   $ 191,333    $ 309,371    $ 500,704

Cost of Revenues

     20,664      42,867      63,531
                    

Gross profit

   $ 170,669    $ 266,504    $ 437,173
                    

Nine months ended September 30, 2008

        

Revenues

   $ 241,128    $ 292,650    $ 533,778

Cost of Revenues

     20,729      46,571      67,300
                    

Gross profit

   $ 220,399    $ 246,079    $ 466,478
                    

Revenues are attributed to geographic areas based on the location of the entity to which the products or services were invoiced. Revenues and long-lived assets concerning principal geographic areas in which we operate are as follows (in thousands):

 

     United States    United Kingdom    Ireland    Other
International (2)
   Total

Three months ended September 30, 2009:

              

Revenues

   $ 108,656    $ 14,731    $ 15,951    $ 31,511    $ 170,849

Long-lived assets (1)

   $ 84,625    $ 3,917    $ 15    $ 9,305    $ 97,862

Three months ended September 30, 2008:

              

Revenues

   $ 114,385    $ 20,148    $ 13,811    $ 39,221    $ 187,565

Long-lived assets (1)

   $ 79,486    $ 8,694    $ 30    $ 10,472    $ 98,682

Nine months ended September 30, 2009:

              

Revenues

   $ 314,543    $ 46,365    $ 45,645    $ 94,151    $ 500,704

Long-lived assets (1)

   $ 84,625    $ 3,917    $ 15    $ 9,305    $ 97,862

Nine months ended September 30, 2008:

              

Revenues

   $ 310,385    $ 62,995    $ 39,785    $ 120,613    $ 533,778

Long-lived assets (1)

   $ 79,486    $ 8,694    $ 30    $ 10,472    $ 98,682

 

(1) Includes property and equipment, net and other assets.
(2) No single country within Other International accounts for greater than 10% of revenues.

15. Commitments and Contingencies

Securities Litigation. In October 2006, a purported shareholder class action was filed in the U.S. District Court for the Central District of California against Quest and certain of its current or former officers and directors (the “Options Class Action”). The plaintiff alleges that (i) the Company improperly backdated stock options, resulting in false or misleading disclosures concerning, among other things, Quest’s financial condition and (ii) the individual defendants sold Quest stock while in possession of material nonpublic information resulting in damages to the putative plaintiff class, in violation of Sections 10(b), 20(a) and 20A of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. On September 8, 2009, the Court granted the plaintiff’s motion to certify the class. Pursuant to a Stipulation and Agreement of Settlement entered into on November 6, 2009, the Company, the class representative and certain current and former officers and directors of the Company, agreed to settle the Options Class Action for a payment of $29.4 million. The settlement agreement is subject to approval by the U.S. District Court.

 

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QUEST SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Acquisitions. The Company has entered into escrow agreements with acquired companies to satisfy certain indemnification obligations of selling shareholders. Certain of these escrow agreements designate Quest as the holder of the escrow money. As of September 30, 2009, we hold approximately $0.7 million in cash related to these agreements, all of which is included in restricted cash.

General. The Company and its subsidiaries are also involved in other legal proceedings, claims and litigation arising in the ordinary course of business. The foregoing discussion includes material developments that occurred during the three months ended September 30, 2009 or thereafter in our material legal proceedings.

In the normal course of our business, we enter into certain types of agreements that require us to indemnify or guarantee the obligations of other parties. These commitments include (i) intellectual property indemnities to licensees of our software products, (ii) indemnities to certain lessors under office space leases for certain claims arising from our use or occupancy of the related premises, or for the obligations of our subsidiaries under leasing arrangements, (iii) indemnities to customers, vendors and service providers for claims based on negligence or willful misconduct of our employees and agents, (iv) indemnities to our directors and officers to the maximum extent permitted under applicable law, and (v) letters of credit and similar obligations as a form of credit support for our international subsidiaries and certain resellers. The terms and duration of these commitments varies and, in some cases, may be indefinite, and certain of these commitments do not limit the maximum amount of future payments we could become obligated to make thereunder; accordingly, our actual aggregate maximum exposure related to these types of commitments cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for obligations of this nature, and no liabilities have been recorded for these obligations in our financial statements included in this report.

16. Subsequent Events

We have evaluated subsequent events through November 9, 2009, which is the date our financial statements were issued.

Pursuant to a Stipulation and Agreement of Settlement entered into on November 6, 2009, the Company, the class representative and certain current and former officers and directors of the Company, agreed to settle the shareholder class action for alleged stock option backdating filed in October 2006 for a payment of $29.4 million. The settlement agreement is subject to approval by the U.S. District Court. Because the agreement in principle provided additional evidence about conditions that existed at the balance sheet date, we recognized the full $29.4 million as a litigation loss provision in our condensed consolidated financial statements presented in this report.

 

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Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations (“MD&A”) should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this Report. Certain statements in this Report, including statements regarding our business strategies, operations, financial condition and prospects are forward-looking statements. Use of the words “believe,” “expect,” “anticipate,” “will,” “contemplate,” “would” and similar expressions that contemplate future events may identify forward-looking statements.

Numerous important factors, risks and uncertainties affect our operations and could cause actual results to differ materially from those expressed or implied by these or any other forward-looking statements made by us or on our behalf. Readers are urged to carefully review and consider the various disclosures described under Item 1A – “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2008, and in other filings with the SEC that attempt to advise interested parties of certain risks and factors that may affect our business. Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management’s opinions only as of the date thereof. We do not assume any obligation to revise or update forward-looking statements. Finally, our historic results should not be viewed as indicative of future performance.

Overview

Our Company and Business Model

Quest Software, Inc., together with our subsidiaries ScriptLogic and Vizioncore, delivers innovative products that help IT organizations derive enhanced performance from their computing environment. Our product areas are Application Management, Database Management, Windows Management and Virtualization Management. Our products improve the performance, manageability and productivity of our customers’ IT infrastructure.

Quarterly Update

As discussed in more detail throughout our MD&A, for the three months ended September 30, 2009 compared to the three months ended September 30, 2008, we delivered the following financial performance:

 

   

Total revenues decreased by $16.7 million, or 8.9%, to $170.8 million;

 

   

Total expenses increased by $13.1 million, or 8.2%, to $172.8 million;

 

   

Income from operations decreased by $29.8 million, or 107.2%, to a loss of $2.0 million;

 

   

Other income (expense), net increased by $9.2 million, from a loss of $6.5 million in 2008 to a gain of $2.7 million in 2009;

 

   

Diluted earnings per share decreased by $0.13, or 80.1%, to $0.03.

Our third quarter 2009 revenue performance continued to be affected by the generally weak macro-economic conditions. Total revenues within our EMEA and America sales regions were down approximately 17% and 6%, respectively, when compared to the comparable period of the prior year, while our Asia Pacific sales regions were up by approximately 9%.

Along product lines, total revenues from sales of all four of our product areas declined with the most notable declines coming from our Database Management product area. Our third quarter 2009 total revenues were also negatively impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009. This resulted in a lesser U.S. Dollar equivalent for several currencies including the Euro and British Pound. Since certain of our international sales are denominated in these non-U.S. Dollar currencies, the impact from foreign currency comprised approximately 18%, or $2.9 million, of the overall decrease in total revenues.

 

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Although total revenues continued to decline, we decreased our discretionary and headcount related expenses. This focus, combined with the benefit from foreign currency exchange rates resulted in an increase in our operating margin.

The increase in total expenses was due to a $29.4 million litigation loss provision recorded with our settlement of the shareholder class action relating to alleged stock option backdating. See Note 15 of our Notes to Condensed Consolidated Financial Statements for additional information. During the three months ended September 30, 2009, we experienced a significant decrease in personnel related costs, which include compensation, benefits and payroll related taxes compared against the same period in 2008. Our full-time employee headcount at the end of the third quarter of 2009 was 3,364, as compared to 3,477 at the end of the third quarter of 2008. Our full-time employee headcount in locations outside of the United States was 1,583 at the end of the third quarter of 2009 compared to 1,672 at the end of the third quarter of 2008. We continue to realize benefit from certain cost management initiatives we have undertaken since mid-2008 which include reduced headcount, travel costs, and other measures. Our third quarter 2009 total expenses were also impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009, which resulted in a lesser U.S. Dollar equivalent for several currencies as noted above. Since certain of our international expenses are denominated in these non-U.S. Dollar currencies, our total expenses in the third quarter of 2009 were reduced by approximately $6.4 million compared against the same period in 2008 as a result of the impact of foreign currency exchange rates.

Foreign Currency

While we are a U.S. Dollar functional company on a world-wide basis, we transact business and operate using multiple foreign currencies. As such, the value of our revenues, expenses, certain account balances and cash flows are exposed to fluctuations in foreign currencies against the value of the U.S. Dollar. For example, when the U.S. Dollar strengthens against several non-U.S. Dollar currencies as has recently occurred, our foreign revenues and thus our total revenues can be negatively impacted. Similarly, a stronger U.S. Dollar translates into lower expenses in those entities where we have operations and our personnel and occupancy expenses are denominated in non-U.S. Dollars. Thus our total expenses would be lower. Conversely, a weaker U.S. Dollar would have the opposite effect on total revenues and expenses all other things being equal. In certain geographic regions and within specific currencies, there are partial offsets between revenues and expenses or balance sheet positions that may reduce this exposure. In other instances, we can manage our operations to reduce foreign currency exposure or utilize derivative instruments to manage this exposure.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. On an on-going basis, we make and evaluate estimates and judgments, including those related to revenue recognition, asset valuations (including accounts receivable, goodwill and intangible assets), share-based compensation, income taxes and functional currencies for purpose of consolidation. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Our estimates form the basis for making judgments about amounts and timing of revenue and expenses, the carrying values of assets, and the recorded amounts of liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. We have discussed the development and selection of the critical accounting policies with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures. The critical accounting policies related to the estimates and judgments listed above are discussed further in our Annual Report on Form 10-K for fiscal 2008 under Management’s Discussion and Analysis of Financial Condition and Results of Operations. There have been no material changes to our critical accounting policies or estimates during the nine months ended September 30, 2009.

Recently Adopted Accounting Pronouncement

See Note 1 of our Notes to Condensed Consolidated Financial Statements for information regarding recent accounting pronouncements.

 

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Results of Operations

The following table sets forth selected condensed consolidated income statement data for each of the periods indicated as a percentage of total revenues:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2009     2008     2009     2008  

Revenues:

        

Licenses

   39.4   46.2   38.2   45.2

Services

   60.6      53.8      61.8      54.8   
                        

Total revenues

   100.0      100.0      100.0      100.0   

Cost of revenues:

        

Licenses

   1.3      1.0      1.1      1.1   

Services

   8.5      8.1      8.6      8.7   

Amortization of purchased technology

   2.9      2.7      3.0      2.7   
                        

Total cost of revenues

   12.7      11.8      12.7      12.5   
                        

Gross profit

   87.3      88.2      87.3      87.5   

Operating expenses:

        

Sales and marketing

   37.9      41.0      39.3      44.0   

Research and development

   20.3      19.8      21.6      21.5   

General and administrative

   11.1      11.3      11.0      12.5   

Amortization of other purchased intangible assets

   1.9      1.3      2.0      1.4   

In-process research and development

   —        —        —        0.2   

Litigation loss provision

   17.2      —        5.9      —     
                        

Total operating expenses

   88.4      73.4      79.8      79.6   
                        

Income (loss) from operations

   (1.1   14.8      7.5      7.9   

Other income (expense), net

   1.6      (3.5   0.7      0.8   
                        

Income before income tax provision (benefit)

   0.5      11.3      8.2      8.7   

Income tax provision (benefit)

   (1.3   2.1      1.6      1.3   
                        

Net income

   1.8   9.2   6.6   7.4
                        

Comparison of Three Months Ended September 30, 2009 and 2008

Revenues

Total revenues and year-over-year changes are as follows (in thousands, except for percentages):

 

     Three Months Ended
September 30,
   Increase/(Decrease)  
     2009    2008    Dollars     Percentage  

Revenues:

          

Licenses

          

Americas

   $ 44,009    $ 54,473    $ (10,464   (19.2 )% 

Rest of World

     23,314      32,227      (8,913   (27.7 )% 
                        

Total license revenues

     67,323      86,700      (19,377   (22.3 )% 
                        

Services

          

Americas

     69,049      66,375      2,674      4.0

Rest of World

     34,477      34,490      (13   0.0
                        

Total service revenues

     103,526      100,865      2,661      2.6
                        

Total revenues

   $ 170,849    $ 187,565    $ (16,716   (8.9 )% 
                        

Licenses Revenues — The decrease in license revenues was due primarily to decreased sales of our Database Management products across all geographic regions and Windows Management products in our Europe, the Middle East and Africa (“EMEA”) region. Our third quarter license revenues were also negatively impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009. This resulted in a lesser U.S. Dollar equivalent for several currencies including the Euro and British Pound. Since certain of our international sales are denominated in these non-U.S. Dollar currencies, the impact from foreign currency comprised approximately 13% of the overall decrease in license revenues.

 

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Services Revenues — Services revenues are derived from post-contract technical support services (“maintenance”) and consulting and training services. The largest component of our services revenues is maintenance revenue. Maintenance revenues are generated from support and maintenance services relating to current year sales of new software products and from the renewal of existing maintenance agreements for software licenses sold in prior periods. The main driver of our growth in services revenues was maintenance renewals on our Windows Management products in the Americas. Also contributing to the growth in services revenues were maintenance renewals on our Virtualization Management products across all geographic regions. Maintenance revenues from our Database Management products decreased particularly in the EMEA region. Revenue from consulting and training services as a percentage of total service revenues was approximately 9.3% and 9.6% of total service revenues in the three months ended September 30, 2009 and 2008, respectively.

Maintenance revenues continue to contribute a larger percentage of our total revenues for three primary reasons: growth of our installed base of customers; acquisitions and their related maintenance contracts; and, multi-year pre-paid support programs. As our maintenance customer base grows, maintenance renewals have a larger influence on the maintenance revenue growth rate and the amount of new software license revenues has a diminishing effect. Therefore, the growth rate of total revenues does not necessarily correlate directly to the growth rate of new software license revenues in a given period. The primary determinant of changes in our maintenance revenue profile is the extent to which our customers renew their annual maintenance agreements, taking into account the number of products and licenses for which each customer renews, and the timing of the renewals by each such customer. If our maintenance renewals were to decline materially, our maintenance revenues, total revenues and cash flows would likely decline materially as well.

Over the past twelve months we have experienced declining growth in our maintenance revenues and expect this trend to continue through at least 2010. The three main reasons for this decline are: reduced sales of new software licenses during 2009; fewer acquisitions which resulted in less revenue contribution from acquired deferred maintenance revenues; and changes in foreign currency exchange rates.

Cost of Revenues

Total cost of revenues and year-over-year changes are as follows (in thousands, except for percentages):

 

     Three Months Ended
September 30,
   Increase/(Decrease)  
     2009    2008    Dollars     Percentage  

Cost of revenues:

          

Licenses

   $ 2,197    $ 1,921    $ 276      14.4

Services

     14,607      15,167      (560   (3.7 )% 

Amortization of purchased technology

     4,983      5,026      (43   (0.9 )% 
                        

Total cost of revenues

   $ 21,787    $ 22,114    $ (327   (1.5 )% 
                        

Cost of Licenses — Cost of licenses primarily consists of third-party software royalties, product packaging, documentation, duplication, delivery and personnel costs. Cost of licenses as a percentage of license revenues was 3.3% and 2.2% for the three months ended September 30, 2009 and 2008. The increase in cost of licenses, both in terms of absolute dollars and as a percentage of license revenues, was due to an impairment charge of $0.6 million taken on one of our prepaid royalty obligations. The royalty obligation was tied to a product that Quest discontinued selling in the third quarter of 2009. Excluding this charge cost of licenses was down $0.4 million, or 18% over the three months ended September 30, 2008 and cost of licenses as percentage of license revenues would have been 2.3%.

 

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Cost of Services — Cost of services primarily consists of personnel, outside consultants, facilities and systems costs used in providing maintenance, consulting and training services. Cost of services does not include development costs related to bug fixes and upgrades which are classified in research and development and which are not separately determinable. Personnel related costs decreased by $0.5 million. Cost of services as a percentage of service revenues was 14.1% and 15.0% in the three months ended September 30, 2009 and 2008, respectively.

Amortization of Purchased Technology — Amortization of purchased technology includes amortization of the fair value of purchased technology associated with acquisitions. We expect amortization of purchased technology within the cost of revenues arising from acquisitions completed prior to September 30, 2009 to be approximately $4.5 million for the remaining three months of 2009.

Operating Expenses

Total operating expenses and year-over-year changes are as follows (in thousands, except for percentages):

 

     Three Months Ended
September 30,
   Increase/(Decrease)  
     2009    2008    Dollars     Percentage  

Operating expenses:

          

Sales and marketing

   $ 64,704    $ 76,957    $ (12,253   (15.9 )% 

Research and development

     34,721      37,169      (2,448   (6.6 )% 

General and administrative

     18,971      21,120      (2,149   (10.2 )% 

Amortization of other purchased intangible assets

     3,258      2,418      840      34.7

Litigation loss provision

     29,400      —        29,400      —  
                        

Total operating expenses

   $ 151,054    $ 137,664    $ 13,390      9.7
                        

Sales and Marketing — Sales and marketing expenses consist primarily of compensation and benefit costs for sales and marketing personnel, sales commissions, and costs of trade shows, travel and entertainment and various discretionary marketing programs. The decrease in sales and marketing expense, both in terms of absolute dollars and as a percentage of total revenues, was due primarily to a $9.4 million decrease in personnel related costs and a $0.7 million decrease in travel costs. The decrease in personnel related costs was due primarily to reductions in commissions, base salary and related payroll taxes, share-based compensation and bonuses. We also had a $0.5 million decrease in trade show costs and a $0.4 million decrease in advertising costs. The impact from foreign currency comprised approximately 25% of the overall decrease in sales and marketing expense.

Research and Development — Research and development expenses consist primarily of compensation and benefit costs for software developers who develop new products, bug fixes and upgrades to existing products and at times provide engineering support for maintenance services, software product managers, quality assurance and technical documentation personnel, and payments made to outside software development consultants in connection with our ongoing efforts to enhance our core technologies and develop additional products. The decrease in research and development expense during the three months ended September 30, 2009 over the comparable period in 2008 was due primarily to reduced expenditures related to certain post-acquisition contingent payment obligations that were tied to technology milestones. These obligations resulted in 2008 expenses of approximately $1.4 million, while in 2009 the charges were reduced to $0.2 million. Also, personnel and travel related costs decreased by $0.9 million. The impact from foreign currency comprised approximately 83% of the overall decrease in research and development expense.

General and Administrative — General and administrative expenses consist primarily of compensation and benefit costs for our executive, finance, legal, human resources, administrative and IS personnel, and professional fees for audit, tax and legal services. The decrease in general and administrative expense during the three months ended September 30, 2009 as compared to the same period in 2008 was due primarily to a decrease of $2.0 million in personnel related costs. Share-based compensation, which is included in personnel related costs, decreased by approximately $0.9 million in the 2009 period. Professional accounting, tax and legal fees increased by approximately $1.3 million due primarily to our ongoing litigation matters as described in Note 15 of our Notes to Condensed Consolidated Financial Statements, offset by a $1.0 million decrease in corporate insurance, recruiting fees and taxes. The impact from foreign currency comprised approximately 27% of the overall decrease in general and administrative expenses.

 

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Amortization of Other Purchased Intangible Assets — Amortization of other purchased intangible assets includes the amortization of customer lists, trademarks, non-compete agreements and maintenance contracts associated with acquisitions. The increase in amortization of other purchased intangible assets was due primarily to a full quarter of amortization of intangible assets acquired in August and September of 2008, offset slightly by other intangible assets that were fully amortized prior to the three months ended September 30, 2009. We expect amortization of other purchased intangible assets within operating expenses arising from acquisitions completed prior to September 30, 2009 to be approximately $3.2 million for the remaining three months of 2009.

Litigation Loss Provision — Litigation loss provision of $29.4 million relates to our settlement of the shareholder class action for alleged stock option backdating filed in October 2006 in the U.S. District Court for the Central District of California against Quest and certain of its current or former officers and directors. See Note 15 of our Notes to Condensed Consolidated Financial Statements for additional information.

Other Income (Expense), Net

Other income (expense), net increased to $2.7 million in income in the third quarter of 2009 from a $6.5 million expense in the third quarter of 2008. The largest impact to other income (expense), net was attributed to a foreign currency gain of $3.4 million compared to a loss of $9.5 million in the third quarter of 2009 and 2008, respectively. Our foreign currency gains or losses are predominantly attributable to translation gains or losses relative to the U.S. Dollar on the re-measurement of net monetary assets, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar. Interest expense was $1.0 million and $0.1 million in the three months ended September 31, 2009 and 2008, respectively. The increase in interest expense is due to debt agreements entered into in 2009. See Note 7 of our Notes to Condensed Consolidated Financial Statements for additional information regarding our debt agreements. Interest income was $0.3 million and $2.8 million in the three months ended September 30, 2009 and 2008, respectively. The decrease in interest income was due primarily to lower average investment yields and average cash and investment balances.

Income Tax Provision (Benefit)

The income tax provision (benefit) was $(2.2) million for the three months ended September 30, 2009 compared to $3.9 million in the same period of 2008. The reduction is primarily related to the discrete tax impact of the settlement of the shareholder class action relating to alleged stock option backdating and the mix of pre-tax income between high and low tax jurisdictions. The effective income tax rate for the three months ended September 30, 2009 was (314.8)% compared to 18.6% in the comparable period of 2008.

Comparison of Nine Months Ended September 30, 2009 and 2008

Revenues

Total revenues and year-over-year changes are as follows (in thousands, except for percentages):

 

     Nine Months Ended
September 30,
   Increase/(Decrease)  
     2009    2008    Dollars     Percentage  

Licenses

          

Americas

   $ 121,022    $ 139,088    $ (18,066   (13.0 )% 

Rest of World

     70,311      102,040      (31,729   (31.1 )% 
                        

Total license revenues

     191,333      241,128      (49,795   (20.7 )% 
                        

Services

          

Americas

     210,376      190,664      19,712      10.3

Rest of World

     98,995      101,986      (2,991   (2.9 )% 
                        

Total service revenues

     309,371      292,650      16,721      5.7
                        

Total revenues

   $ 500,704    $ 533,778    $ (33,074   (6.2 )% 
                        

 

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Licenses Revenues — The decrease in license revenues was due primarily to decreased sales of our Database Management products across all geographic regions and Windows Management products in our EMEA region. Our third quarter license revenues were also negatively impacted by the strengthening U.S. Dollar relative to certain non-U.S. Dollar currencies in the third quarter of 2009. This resulted in a lesser U.S. Dollar equivalent for several currencies including the Euro and British Pound. Since certain of our international sales are denominated in these non-U.S. Dollar currencies, the impact from foreign currency comprised approximately 25% of the overall decrease in license revenues and approximately 40% of the decrease in our rest of world license revenues.

Services Revenues — The primary reason for growth in services revenues was maintenance renewals on our Windows Management products in the Americas. Also contributing to the growth in services revenues were maintenance renewals on our Virtualization Management products across all geographic regions. Maintenance revenues from our Database Management products decreased with most notable declines in the EMEA region. Revenue from consulting and training services as a percentage of total service revenues was approximately 8.8% and 10.3% of total service revenues in the nine months ended September 30, 2009 and 2008, respectively.

Cost of Revenues

Total cost of revenues and year-over-year changes are as follows (in thousands, except for percentages):

 

     Nine Months Ended September 30,    Increase/(Decrease)  
     2009    2008    Dollars     Percentage  

Cost of revenues:

          

Licenses

   $ 5,740    $ 6,110    $ (370   (6.1 )% 

Services

     42,867      46,571      (3,704   (8.0 )% 

Amortization of purchased technology

     14,924      14,619      305      2.1
                        

Total cost of revenues

   $ 63,531    $ 67,300    $ (3,769   (5.6 )% 
                        

Cost of Licenses — The decrease in cost of licenses was due primarily to a $0.5 million reduction in hardware and inventory purchases that are sold with certain of our software products and a $0.3 million reduction in delivery costs, partially offset by a $0.7 million increase in royalty expense related primarily to the prepaid royalty impairment charge recognized during the three months ended September 30, 2009. Cost of licenses as a percentage of license revenues was 3.0% and 2.5% for the nine months ended September 30, 2009 and 2008, respectively.

Cost of Services — The decrease in cost of services was due primarily to a $2.3 million decrease in personnel related costs and a $0.9 million decrease in travel costs. An additional $0.7 million of the overall decrease was due to reduced consulting and other professional fees. The impact from foreign currency comprised approximately 84% of the overall decrease in cost of services. Cost of services as a percentage of service revenues was 13.9% and 15.9% in the nine months ended September 30, 2009 and 2008, respectively.

Amortization of Purchased Technology — The increase in amortization of purchased technology during the nine months ended September 30, 2009 over the comparable period in 2008 was due primarily to a full nine months of amortization of technology acquired during the last half of 2008, resulting in an increase of $3.8 million. A majority of the increase was offset by reduced amortization in 2009 for purchased technologies that became fully amortized by the end of 2008.

Operating Expenses

Total operating expenses and year-over-year changes are as follows (in thousands, except for percentages):

 

     Nine Months Ended September 30,    Increase/(Decrease)  
     2009    2008    Dollars     Percentage  

Operating expenses:

          

Sales and marketing

   $ 196,732    $ 234,604    $ (37,872   (16.1 )% 

Research and development

     107,928      114,687      (6,759   (5.9 )% 

General and administrative

     55,170      66,811      (11,641   (17.4 )% 

Amortization of other purchased intangible assets

     9,925      7,730      2,195      28.4

In-process research and development

     —        955      (955   (100.0 )% 

Litigation loss provision

     29,400      —        29,400      —  
                        

Total operating expenses

   $ 399,155    $ 424,787    $ (25,632   (6.0 )% 
                        

 

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Sales and Marketing — The decrease in sales and marketing expense during the nine months ended September 30, 2009 over the comparable period in 2008 was due primarily to a $23.8 million decrease in personnel related costs and a $4.9 million decrease in travel costs. The decrease in personnel related costs was due primarily to reductions in commissions, base salary and related payroll taxes, share-based compensation and bonuses. We also had a $3.1 million decrease in conferences and trade show costs and a $1.3 million decrease in advertising costs. The impact from foreign currency comprised approximately 39% of the overall decrease in sales and marketing expense.

Research and Development — The decrease in research and development expense during the nine months ended September 30, 2009 as compared to the same period in 2008 was due primarily to a $4.2 million decrease in personnel related costs and a $1.8 million decrease in travel costs. Also, expenditures related to certain post-acquisition contingent payment obligations that were tied to technology milestones decreased by approximately $1.7 million. These decreases were partially offset by a $1.2 million increase in consulting and other professional fees, outside services costs and recruiting costs. The impact from foreign currency comprised approximately $8.6 million to reducing our overall research and development expenses.

General and Administrative — The decrease in general and administrative expense during the nine months ended September 30, 2009 over the comparable period in 2008 was due primarily to a decrease of $6.8 million in personnel related costs and a $0.5 million decrease in travel costs. Lower professional accounting, tax and legal fees, corporate insurance and recruiting costs contributed $3.8 million to the overall decrease in general and administrative costs. The impact from foreign currency comprised approximately 23% of the overall decrease in general and administrative expenses.

Amortization of Other Purchased Intangible Assets — The increase in amortization of other purchased intangible assets during the nine months ended September 30, 2009 over the comparable period in 2008 was due primarily to a full nine months of amortization of intangibles acquired during the last half of 2008, resulting in an increase of $3.7 million. The increase from 2008 acquired intangibles was partially offset by certain other purchased intangible assets that were fully amortized prior to the nine months ended September 30, 2009.

In-Process Research and Development — In-process research and development expenses relate to in-process technology acquired in May 2008. These costs were charged to operations as the technologies had not reached technological feasibility and did not have alternative future uses at the date of acquisition.

Litigation Loss Provision — Litigation loss provision of $29.4 million relates to our settlement of the shareholder class action for alleged stock option backdating filed in October 2006 in the U.S. District Court for the Central District of California against Quest and certain of its current or former officers and directors. See Note 15 of our Notes to Condensed Consolidated Financial Statements for additional information.

Other Income (Expense), Net

Other income (expense), net was $3.3 million in the nine months ended September 30, 2009 compared to $4.4 million in the same period of 2008. Interest expense was $1.7 million and $0.2 million in the nine months ended September 31, 2009 and 2008, respectively. The increase in interest expense is due to debt agreements entered into in 2009. See Note 7 of our Notes to Condensed Consolidated Financial Statements for additional information regarding our debt agreements. Interest income was $1.5 million and $8.7 million in the nine months ended September 30, 2009 and 2008, respectively. The decrease in interest income was due primarily to lower average investment yields and average cash and investment balances. We had a foreign currency gain of $2.9 million and a loss of $4.8 million in the 2009 and 2008 periods, respectively. Our foreign currency gains or losses are predominantly attributable to translation gains or losses relative to the U.S. Dollar on the re-measurement of net monetary assets, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar.

 

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Income Tax Provision

The income tax provision was $8.0 million for the nine months ended September 30, 2009 compared to $7.2 million in the same period of 2008. The change is primarily related to the mix of pre-tax income between high and low tax jurisdictions as well as the settlement of the shareholder class action relating to alleged stock option backdating, resolution of the US-France Mutual Agreement Procedure which is described in more detail in Note 11 of our Notes to Condensed Consolidated Financial Statements, adjustments due to adoption of new business combination accounting guidance and enactment of changes to the California income tax legislation all discretely impacting the nine months ended September 30, 2009. A combination of other factors also influenced the change including the impact of net operating losses and associated valuation allowances in certain foreign jurisdictions. The closure of the Internal Revenue Service’s examination of income tax returns through December 31, 2004 resulted in a tax benefit of $5.5 million for the reversal of income tax and related interest accrued during the nine months ended September 30, 2008. The effective income tax rate for the nine months ended September 30, 2009 was 19.4% versus 15.6% in the comparable period of 2008.

Liquidity and Capital Resources

Cash and cash equivalents and short-term and long-term investments were approximately $362.0 million and $257.9 million as of September 30, 2009 and December 31, 2008, respectively.

At September 30, 2009, we held within short-term investments $49.1 million (with a fair value of $46.3 million) of investment grade municipal notes with an auction reset feature (“auction rate securities” or “ARSs”). These securities are collateralized by higher education funded student loans which are supported by the federal government as part of the Federal Family Education Loan Program (FFELP). We do not have reason to believe that any of the underlying issuers of our ARSs are presently at risk or that the underlying credit quality of the assets backing our auction rate security investments has been impacted by the reduced liquidity of these investments. Based on our current ability to access cash and other short-term investments, our expected operating cash flows, and other sources of cash that we expect to be available, we do not anticipate the current lack of liquidity of these investments to have a material impact on our business strategy, financial condition, results of operations or cash flows. Additionally, in October 2008, we entered into a put agreement with the investment firm that sold us our ARSs. Under the terms of the agreement, we have the ability to put all of our ARSs to the investment firm at any time during the period beginning June 30, 2010 and ending June 30, 2012 at par value. The investment firm also has the right to repurchase these ARSs at par value on or before June 30, 2010. For more information concerning our ARSs see Notes 2 and 13 of our Notes to Condensed Consolidated Financial Statements.

Summarized cash flow information is as follows (in thousands):

 

     Nine Months Ended September 30,  
     2009     2008  

Cash provided by operating activities

   $ 115,833      $ 114,404   

Cash used in investing activities

     (20,387     (112,694

Cash provided by (used in) financing activities

     (7,406     41,967   

Effect of exchange rate changes

     (470     1,246   
                

Net increase in cash and cash equivalents

   $ 87,570      $ 44,923   
                

Operating Activities

Cash provided by operating activities is primarily comprised of net income, adjusted for non-cash activities such as depreciation and amortization and the litigation loss provision. These non-cash adjustments represent charges reflected in net income, therefore, to the extent that non-cash items increase or decrease our future operating results, there will be no corresponding impact on our cash flows. After excluding the effects of these non-cash charges, the primary changes in cash flows relating to operating activities resulted from changes in operating assets and liabilities. The analyses of the changes in our operating assets and liabilities are as follows:

 

   

Accounts receivable decreased to $124.5 million at September 30, 2009 from $153.9 million at December 31, 2008 due to increased collections, which resulted in a decrease in operating assets, reflecting a cash inflow of $32.1 million for the nine months ended September 30, 2009. The remaining change in accounts receivable related to the impact of non-cash foreign

 

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currency translation adjustments and is included as part of the “effect of exchange rate changes on cash and cash equivalents” section of our condensed consolidated statements of cash flows. Day’s sales outstanding, or DSO, were 67 days and 70 days as of September 30, 2009 and December 31, 2008, respectively, and our daily sales decreased to $1.9 million for the quarter ended September 30, 2009 compared to $2.2 million for the quarter ended December 31, 2008. Collection of accounts receivable and related DSO could fluctuate in future periods due to the timing and amount of our revenues and their linearity and the effectiveness of our collection efforts.

 

   

Deferred revenue decreased to $335.0 million at September 30, 2009 from $338.7 million at December 31, 2008, resulting in a decrease in operating liabilities and reflecting a cash outflow of $3.7 million for the nine months ended September 30, 2009. The decrease in deferred revenue was due primarily to slower growth in our software post-contract technical support services customer base. Also, there were no acquisitions, which traditionally have resulted in an increase in deferred revenue.

 

   

Other accrued expenses decreased to $27.4 million at September 30, 2009 from $39.8 million at December 31, 2008, resulting in a decrease in operating liabilities and reflecting a cash outflow of $10.6 million for the nine months ended September 30, 2009. The decrease in other accrued expenses was due primarily to payments of certain acquisition related liabilities.

One of the primary cash outflows within operating assets and liabilities during the nine months ended September 30, 2009 was $13.5 million paid for taxes, a decrease of $2.4 million over the comparable 2008 period.

Investing Activities

Cash used in investing activities in the nine months ended September 30, 2009 included $12.0 million for purchases of investment securities, $8.3 million in capital expenditures and $3.0 million for a cost method investment in an early stage private company. We will continue to purchase property and equipment needed in the normal course of our business. We also plan to use cash generated from operations and/or proceeds from our investment securities to fund other strategic investment and acquisition opportunities that we continue to evaluate. We plan to use excess cash generated from operations to invest in short and long-term investments consistent with past investment practices.

Financing Activities

In the nine months ended September 30, 2009 we received net proceeds of $27.6 million from the issuance of our common stock due to exercises of stock options.

On February 17, 2009, we entered into a two year revolving line of credit agreement with Wells Fargo Foothill, LLC as the arranger, administrative agent and lender (the “Credit Agreement”). We intend to use the proceeds from the Credit Agreement for working capital and other general corporate purposes. The Credit Agreement allows for cash borrowings and letters of credit under a secured revolving credit facility of up to a maximum of $100 million. Interest will accrue at a floating rate based on, at the Company’s election, (i) LIBOR (subject to reserve requirements and a minimum LIBOR of 2.75%) or (ii) the greatest of (a) 4.0%, (b) the Federal Funds Rate plus 0.5% or (c) Wells Fargo’s prime rate, in each case, plus an applicable margin. The Credit Agreement includes limitations on the Company’s ability to, among other things, incur debt, grant liens, make acquisitions and other investments, make certain restricted payments such as dividend payments, and dispose of assets. The Credit Agreement is secured by substantially all of the Company’s assets, subject to certain exceptions including the company headquarters facility. As of September 30, 2009, we have a zero balance outstanding under this line of credit. In the nine months ended September 30, 2009 $2.0 million was paid for the total fees associated with this line of credit and will be amortized over the life of the Credit Agreement as interest expense.

In March 2009, our board of directors authorized a stock repurchase of up to $100 million of our common stock. This stock repurchase authorization was terminated in connection with the commencement of the June 2009 tender offer as discussed below. During the nine months ended September 30, 2009, we repurchased 341,639 shares under this stock repurchase authorization at a weighted-average price per share of $11.37, for a total cost of $3.9 million.

 

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In June 2009, our board of directors authorized a modified “Dutch Auction” tender offer to purchase up to 10,715,000 shares of our common stock at a price not greater than $14.00 nor less than $12.50 per share. This offer expired on June 30, 2009. The tendered shares were accepted for purchase and paid for in July 2009. We accepted for purchase 6,850,871 shares in the tender offer, at a price of $14.00 per share, for a total cost of $95.9 million excluding approximately $1.3 million in fees and expenses related to the tender offer.

In August 2009, the Board of Directors authorized a plan to repurchase up to $100 million of our common stock. Any stock repurchases may be made through open market and privately negotiated transactions, at times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans. Rule 10b5-1 permits Quest to establish, while not in possession of material nonpublic information, prearranged plans to buy stock at a specific price in the future, regardless of any subsequent possession of material nonpublic information. The timing and actual number of shares repurchased will depend on a variety of factors including market conditions, corporate and regulatory requirements, and capital availability. The stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice. As of September 30, 2009 we have not repurchased any shares under this plan.

On July 6, 2009, we drew down $34.4 million, or 70%, of the par value against the value of our ARSs. As this credit line was structured as a “net no cost” loan, any interest charges will be offset by interest earned on the underlying ARSs. See Note 2 for additional details regarding these investments.

On August 3, 2009, we entered into a loan agreement (the “Loan”) with Mutual of Omaha Bank whereby we borrowed an aggregate principal amount of $34 million. The Loan is secured by our real property at our headquarters in Aliso Viejo, California. We intend to use the proceeds from the Loan for working capital and other general corporate purposes. The Loan matures in five years, during which time we will make equal monthly principal and interest payments at a 7.03% interest rate on a fixed rate, 25-year amortization schedule. Events of default include, among other things, payment defaults, breaches of covenants and bankruptcy events. In the case of a continuing event of default, the lender may accelerate the payment of all unpaid principal and interest amounts, increase the then-current interest rate by 5% and foreclose on the real estate collateral.

As we continue to evaluate potential acquisitions, potential future stock repurchases or other general corporate expenditures which may be in excess of current cash available within certain operating entities, sourcing cash to fund these activities requires financial flexibility afforded by financing instruments. As such, we plan to continue to evaluate potential debt financings when and if reasonable financing terms become available to us.

Based on our current operating plan, we believe that our existing cash, cash equivalents, investment balances, cash flows from operations and available debt financing will be sufficient to finance our operational cash needs through at least the next 12 to 24 months. Our ability to generate cash from operations is subject to substantial risks as described in Item 1A – “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2008. One of these risks is that our future business does not stay at a level that is similar to, or better than, our recent past. In that event, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash, cash equivalents, investment balances and debt financing to support our working capital and other cash requirements. Also, acquisitions are an important part of our business model. As such, significant amounts of cash could and will likely be used in the future for additional acquisitions or strategic investments. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through public or private equity or, as discussed above, debt financing or from other sources. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Exchange Risk

We are a U.S. Dollar functional company and transact business in a number of different foreign countries around the world. In most instances, revenues are collected and operating expenses are paid in the local currency of the country in which we are transacting. Accordingly, we are exposed to both transaction and translation risk relating to changes in foreign exchange rates.

 

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Our exposure to foreign exchange risk is composed of the combination of our foreign operations net profits and losses denominated in currencies other than the U.S. Dollar, as well as our net balances of monetary assets and liabilities in our foreign subsidiaries. These exposures have the potential to produce either gains or losses depending on the directional movement of the foreign currencies versus the U.S. Dollar and our operational profile in foreign subsidiaries. Our cumulative currency gains or losses in any given period may be lessened by the economic benefits of diversification and low correlation between different currencies, but there can be no assurance that this pattern will continue to be true in future periods. During the three and nine months ended September 30, 2009, we had a negative effect, or reduction, of $2.9 million and $14.1 million, respectively, on total revenues and a positive effect in the form of a reduction to total expenses by $6.4 million and $29.1 million, respectively, related to foreign currency fluctuation. In addition, during the three and nine months ended September 30, 2009, within other income (expense), net we had foreign currency gains of $3.4 million and $2.9 million, respectively, compared to foreign currency losses of $9.5 million and $4.8 million in the comparable periods of 2008.

The foreign currencies to which we currently have the most significant exposure are the Euro, the Canadian Dollar, the British Pound, the Australian Dollar and the Russian Ruble. Prior to January 1, 2009, we did not use derivative financial instruments to hedge our foreign exchange exposures, nor did we use such instruments for speculative trading purposes. However, in 2009, we implemented a limited foreign exchange hedging program. We now enter into hedges in the form of forward foreign currency contracts to reduce our exposure to foreign currency rate changes on non-functional currency denominated forecasted transactions and balance sheet positions including certain monetary assets and liabilities denominated in foreign currencies. The forward foreign currency contracts are carried at fair value and denominated in various currencies as listed in the tables below. The duration of forward contracts ranges from less than one month to nine months. A description of our accounting for forward foreign currency contracts is included in Note 8 of our Notes to Condensed Consolidated Financial Statements.

The success of our hedging activities depends upon the accuracy of our estimates of various balances and transactions denominated in non-functional currencies. To the extent our estimates are correct, gains and losses on our forward foreign currency contracts will be offset by corresponding losses and gains on the underlying transactions. In order to monitor the financial impact of our foreign currency hedges, we subject our hedges to a stress test. This test is intended to quantify the impact to our financial statements of an abnormal change in the foreign currency rates in which we do business. When subjected to a 20% adverse change, we estimated that the fair value of our contracts listed in the table below would decline by $6.5 million.

We do not use forward foreign currency contracts for speculative or trading purposes. We enter into forward foreign currency contracts with reputable financial institutional counterparties whose financial health we monitor. To date, we have not experienced nonperformance by any of these counterparties and anticipate performance by all counterparties.

The following table summarizes the notional amounts and fair values of our outstanding forward foreign currency contracts at September 30, 2009. All contracts have maturities of nine months or less. Fair values represent estimated settlement amounts for contracts outstanding at September 30, 2009 (notional amounts and fair values in U.S. dollars in thousands):

 

Forward Foreign Currency Contracts

 

Currency

   Notional
Amount
   Fair
Value
 

Australian Dollar

   $ 2,390    $ 22   

Canadian Dollar

     11,566      (12

Danish Krone

     1,180      (1

Euro

     5,123      —     

British Pound

     4,796      (2

Israeli Shekel

     1,959      (18

Russian Ruble

     5,353      (9
               

Total

   $ 32,367    $ (20
               

 

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Interest Rate Risk

Our exposure to market interest-rate risk relates primarily to our investment portfolio. We traditionally do not use derivative financial instruments to hedge the market risks of our investments. We place our investments with high-quality issuers and money market funds and articulate allocation limits in our investment policy to any one issuer other than the United States government. Our investment portfolio as of September 30, 2009 consisted of money market funds, auction rate securities (“ARSs”), U.S. Treasuries, commercial paper and certificates of deposit. Investments purchased with an original maturity of three months or less are considered to be cash equivalents. We classify our ARSs as trading and all other investments as available-for-sale. Trading securities are carried at fair value, with changes in fair value reported in earnings. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of stockholders’ equity.

At September 30, 2009, we held within long-term investments $49.1 million (with a fair value of $46.3 million) of ARSs. The Dutch auction process that resets the applicable interest rate at predetermined calendar intervals is intended to provide liquidity to the holder of the ARSs by matching buyers and sellers within a market context enabling the holder to gain immediate liquidity by selling such interests at par or rolling over their investment. The auctions for these securities began failing in February of 2008. When auctions fail, our securities earn interest based on formulaic multiples of municipal bond indices such as the JJ Kenny Index or the S&P High Grade Index. The resulting interest rate has been highly sensitive to changes in the short term structure of interest rates and asset backed securities.

Information about our investment portfolio is presented in the table below, which states the amortized book value and related weighted-average interest rates by year of maturity (in thousands):

 

     Amortized
Book Value
   Weighted
Average Rate
 

Investments maturing by September 30,

     

2010 (1)

   $ 281,593    0.32

2011

     —      —     

2012

     —      —     

2013

     —      —     

2014

     —      —     

Thereafter

     —      —     
         

Total portfolio

   $ 281,593    0.32
         

 

(1) Includes $220.4 million in cash equivalents and $49.1 million in our ARSs, which become exercisable under Put Options in 2010 (see Note 2 of our Notes to Condensed Consolidated Financial Statements for additional information regarding our ARSs).

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the specified time periods and accumulated and communicated to management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2009 as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 of the Exchange Act.. Based on that evaluation, our chief executive officer and chief financial officer have concluded that, as of that date, our disclosure controls and procedures as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act were effective.

 

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Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

The information set forth under Note 15 of our Notes to Condensed Consolidated Financial Statements, included in Part I of this Report, is incorporated herein by reference. For an additional discussion of certain risks associated with legal proceedings, see the section entitled “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008.

 

Item 1A. Risk Factors

You should carefully consider the risks described in Item 1A – “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2008, as our business, financial condition and results of operations could be adversely affected by any of the risks and uncertainties described therein.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

The table below summarizes information about our purchases of equity securities registered pursuant to Section 12 of the Exchange Act during the quarterly period ended September 30, 2009.

 

Period

   Total Number
of
Shares of
Common
Stock
Purchased (1)
   Average Price
Paid per
Share (2)
   Total
Number of
Shares of
Common
Stock
Purchased as
Part of
Publicly
Announced
Plans or
Programs (1)
   Maximum
Approximate Dollar
Value of Shares of
Common Stock that
May Yet Be
Purchased Under the
Plans or Programs
(in millions) (3)

Jul. 1, 2009 through Jul. 31, 2009

   6,850,871    $ 14.00    6,850,871    $ 54.1

Aug. 1, 2009 through Aug. 31, 2009

   —      $ —      —      $ 100.0

Sep. 1, 2009 through Sep. 30, 2009

   —      $ —      —      $ 100.0
               

Total

   6,850,871    $ 14.00    6,850,871    $ 100.0
               

 

(1) In June 2009, our board of directors authorized a modified “Dutch Auction” tender offer to purchase up to 10,715,000 shares of our common stock at a price not greater than $14.00 nor less than $12.50 per share. This offer expired on June 30, 2009. The tendered shares were accepted for purchase and paid for in July 2009.
(2) The price paid per share of common stock does not include the related transaction costs.
(3) In August 2009, the Board of Directors authorized a plan to repurchase up to $100 million of our common stock. Any stock repurchases may be made through open market and privately negotiated transactions, at times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans. Rule 10b5-1 permits Quest to establish, while not in possession of material nonpublic information, prearranged plans to buy stock at a specific price in the future, regardless of any subsequent possession of material nonpublic information. The timing and actual number of shares repurchased will depend on a variety of factors including market conditions, corporate and regulatory requirements, and capital availability. The stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice.

 

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Item 6. Exhibits

 

Exhibit

Number

  

Exhibit Title

  3.1

   Certificate of Incorporation of Quest Software, Inc. (1)

  3.2

   Bylaws of Quest Software, Inc. (1)

  4.1

   Form of Registrant’s Specimen Common Stock Certificate. (2)

10.1

   Loan and Security Agreement, dated as of August 3, 2009, between Quest Software, Inc. as Borrower and Mutual of Omaha Bank as Lender. (3)

10.2

   Secured Promissory Note, dated as of August 3, 2009, from Quest Software, Inc. as Maker to Mutual of Omaha Bank as Payee. (3)

10.3

   Deed of Trust, Security Agreement, Assignment of Rents and Leases, and Fixture Filing, dated as of August 3, 2009, by and among Quest Software, Inc. as Trustor, Mutual of Omaha Bank as Beneficiary, and Fidelity National Title Company as Trustee. (3)

10.4

   Environmental Certification and Indemnity Agreement, dated as of August 3, 2009, by Quest Software, Inc. as Obligor in favor of Mutual of Omaha Bank as Lender. (3)

31.1

   Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

31.2

   Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

32.1

   Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(1) Incorporated herein by reference to our Current Report on Form 8-K filed April 30, 2009.
(2) Incorporated herein by reference to our Registration Statement on Form S-1 and all amendments thereto (File No. 333-80543) filed June 11, 1999.
(3) Incorporated herein by reference to our Current Report on Form 8-K filed August 7, 2009.

 

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Table of Contents

SIGNATURES

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

 

   QUEST SOFTWARE, INC.
Date: November 9, 2009   

/s/ Scott J. Davidson    

  

Scott J. Davidson

Senior Vice President, Chief Financial Officer

  

/s/ Scott H. Reasoner    

  

Scott H. Reasoner

Vice President, Corporate Controller

 

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