<PAGE> 1
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, 2000
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)
<TABLE>
<S> <C>
CALIFORNIA 33-0231678
------------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
8001 IRVINE CENTER DRIVE
IRVINE, CALIFORNIA 92618
---------------------------------------- ---------------
(Address of principal executive offices) (Zip code)
</TABLE>
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 [ ]
The number of shares outstanding of the Registrant's Common Stock, no par
value, as of November 9, 2000 was 88,265,607.
<PAGE> 2
QUEST SOFTWARE, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
-----------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2000 (unaudited)
and December 31, 1999......................................................... 2
Consolidated Statements of Operations for the Three and Nine
Months Ended September 30, 2000 and 1999 (unaudited).......................... 3
Consolidated Statements of Comprehensive Operations for the Three and Nine
Months Ended September 30, 2000 and 1999 (unaudited).......................... 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2000 and 1999 (unaudited)................................. 5
Notes to Consolidated Financial Statements (unaudited)............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 12
Item 3. Quantitative and Qualitative Disclosure about Market Risk........................... 24
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds........................................... 26
Item 6. Exhibits and Reports on Form 8-K.................................................... 26
Signatures.................................................................................. 27
</TABLE>
ii
<PAGE> 3
PART I
FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
QUEST SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
ASSETS 2000 1999
--------- -----------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 34,675 $ 39,643
Short-term marketable securities 35,271 11,000
Accounts receivable, net 25,036 18,771
Prepaid expenses and other current assets 8,651 3,244
Deferred income taxes 5,467 2,089
--------- ---------
Total current assets 109,100 74,747
Property and equipment, net 41,594 7,179
Long-term marketable securities 143,472 4,484
Goodwill and purchased intangible assets, net 263,499 11,452
Deferred income taxes 415 415
Other assets 4,242 872
--------- ---------
Total assets $ 562,322 $ 99,149
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,135 $ 3,436
Accrued compensation 8,224 4,966
Other accrued expenses 14,776 7,062
Income taxes payable 515 2,030
Deferred support revenue 19,267 13,932
Deferred license revenue 7,610 4,651
--------- ---------
Total current liabilities 57,527 36,077
Long-term liabilities and other 6,174 403
Shareholders' equity:
Preferred stock, no par value, 10,000 shares authorized;
no shares issued or outstanding -- --
Common stock, no par value, 150,000 shares authorized;
88,034 and 77,810 issued and outstanding at September 30,
2000 and December 31, 1999, respectively 561,894 94,010
Retained (deficit) earnings (14,490) 1,864
Accumulated other comprehensive loss (129) (26)
Notes receivable from sale of common stock (18,590) (3,115)
Capital distribution in excess of basis in common stock (30,064) (30,064)
--------- ---------
Total shareholders' equity 498,621 62,669
--------- ---------
Total liabilities and shareholders' equity $ 562,322 $ 99,149
========= =========
</TABLE>
See accompanying notes to the consolidated financial statements.
2
<PAGE> 4
QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Licenses $ 34,036 $ 13,995 $ 84,459 $ 35,360
Services 10,086 4,313 25,043 11,237
--------- --------- --------- ---------
Total revenues 44,122 18,308 109,502 46,597
Cost of revenues:
Licenses 874 734 2,379 2,138
Services 2,911 1,154 7,034 2,892
Amortization of purchased intangible assets 1,244 -- 3,002 --
--------- --------- --------- ---------
Total cost of revenues 5,029 1,888 12,415 5,030
--------- --------- --------- ---------
Gross profit 39,093 16,420 97,087 41,567
Operating expenses:
Sales and marketing 20,581 8,321 51,457 20,479
Research and development 11,118 4,502 27,820 10,536
General and administrative 5,052 2,787 11,777 6,776
Amortization of purchased intangible assets and
other compensation costs 10,456 186 25,865 961
--------- --------- --------- ---------
Total operating expenses 47,207 15,796 116,919 38,752
--------- --------- --------- ---------
Income (loss) from operations (8,114) 624 (19,832) 2,815
Other income, net 3,680 278 8,317 360
--------- --------- --------- ---------
Income (loss) before income tax provision (4,434) 902 (11,515) 3,175
Income tax provision 1,825 380 4,838 1,339
--------- --------- --------- ---------
Net income (loss) $ (6,259) 522 $ (16,353) 1,836
========= =========
Preferred stock dividends 250 590
--------- ---------
Net income applicable to common shareholders $ 272 $ 1,246
========= =========
Net income (loss) per share:
Basic $ (0.07) $ 0.00 $ (0.19) $ 0.02
========= ========= ========= =========
Diluted $ (0.07) $ 0.00 $ (0.19) $ 0.01
========= ========= ========= =========
Weighted average shares:
Basic 86,536 68,898 84,420 80,216
Diluted 86,536 80,842 84,420 85,074
</TABLE>
See accompanying notes to the consolidated financial statements.
3
<PAGE> 5
QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (loss) applicable to common shareholders $ (6,259) $ 272 $(16,353) $ 1,246
Other comprehensive gain (loss):
Unrealized gain (loss) on available-for-sale securities 412 -- (103) --
-------- -------- -------- --------
Comprehensive income (loss) $ (5,847) $ 272 $(16,456) $ 1,246
======== ======== ======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
4
<PAGE> 6
QUEST SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (16,353) $ 1,836
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 28,020 1,617
Compensation expense associated with stock option grants 2,778 246
Accrued interest receivable from shareholders (313) (142)
Changes in assets and liabilities, net of effects
of acquisitions:
Accounts receivable (3,514) (5,916)
Prepaid expenses and other current assets (4,293) (731)
Deferred taxes 29 --
Other assets (2,516) (262)
Accounts payable 2,673 (300)
Accrued compensation 2,740 1,794
Income taxes payable 3,032 --
Other accrued expenses (2,833) 2,362
Deferred revenue 6,106 5,670
--------- ---------
Net cash provided by operating activities 15,556 6,174
Cash flows used in investing activities:
Purchases of property and equipment (35,489) (3,437)
Purchases of software licenses (1,265) (234)
Cash paid for acquisitions, net of cash acquired (78,502) (496)
Purchases of marketable securities (291,895) (12,153)
Sales and maturities of marketable securities 128,532 --
--------- ---------
Net cash used in investing activities (278,619) (16,320)
Cash flows from financing activities:
Repayment of notes payable (1,910) (10,000)
Repurchase of common stock (33) (35,000)
Repayment of capital lease obligations (390) --
Redemption of preferred stock -- (10,000)
Dividends paid on redeemable preferred stock -- (590)
Repayment of note payable to related party -- (8)
Proceeds from note payable -- 10,000
Proceeds from issuance of preferred stock -- 25,000
Payment on notes receivable from shareholders for
purchase of common stock -- 230
Proceeds from exercise of stock options 3,449 33
Proceeds from employee stock purchase plan 3,438 --
Proceeds from issuance of common stock, net 253,469 64,858
--------- ---------
Net cash provided by financing activities 258,023 44,523
Effect of exchange rate changes on cash and cash equivalents 72 --
--------- ---------
Net (decrease) increase in cash and cash equivalents (4,968) 34,377
Cash and cash equivalents, beginning of period 39,643 8,981
--------- ---------
Cash and cash equivalents, end of period $ 34,675 $ 43,358
========= =========
Supplemental disclosures of consolidated cash flow information:
Cash paid for:
Interest $ 137 $ 256
========= =========
Income taxes $ 1,709 $ 1,812
========= =========
Supplemental schedule of noncash investing and financing activities:
Accrued interest receivable from shareholders $ 707 $ 142
========= =========
Unrealized loss from available-for-sale securities $ (103) $ --
========= =========
Tax benefit related to stock option exercises $ (4,547) $ --
========= =========
Conversion of Series A Redeemable Preferred Stock into common stock $ -- $ 15,000
========= =========
</TABLE>
See Note 2 for details of assets acquired and liabilities assumed in
purchase transactions.
See accompanying notes to the consolidated financial statements.
5
<PAGE> 7
QUEST SOFTWARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements of
Quest Software, Inc., a California corporation (the "Company" or "Quest"), as of
September 30, 2000 and for the three and nine months ended September 30, 2000
and 1999 reflect all adjustments (consisting of normal recurring accruals)
which, 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 generally accepted accounting principles of
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.
These financial statements should be read in conjunction with the
audited financial statements included in the Company's Annual Report on Form
10-K for the year ended December 31, 1999.
Operating results for the three and nine month periods ended September
30, 2000 are not necessarily indicative of the results that may be expected for
the full year ending December 31, 2000.
NEW ACCOUNTING PRONOUNCEMENTS:
In September 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS No. 133"), which the
Company is required to adopt effective in its fiscal year 2001. SFAS No. 133
will require the Company to record all derivatives on the balance sheet at fair
value. The Company does not currently engage in hedging activities but will
continue to evaluate the effects of adopting SFAS No. 133.
On December 6, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB
101"). SAB 101 summarizes the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 101 is
effective for the fourth quarter in fiscal year 2000. The adoption of SAB 101 is
not expected to have a material impact on the Company's financial statements, as
the Company believes its revenue recognition policies comply with SAB 101.
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of APB
Opinion No. 25 ("FIN 44"). FIN 44 clarifies the definition of an employee for
purposes of applying Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees ("APB 25"), the criteria for determining whether a
plan qualifies as a noncompensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000 but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998 or January 12, 2000. The provisions of FIN 44 change the
accounting for an exchange of unvested employee stock options and restricted
stock awards in a purchase business combination. The new rules require the
intrinsic value of the unvested awards be allocated to deferred compensation and
recognized as non-cash compensation expense over the remaining future vesting
period. The adoption of FIN 44 did not have a material impact on the Company's
financial statements, other than the effect of the application of FIN 44 as it
relates to the Company's acquisition of FastLane Technologies, Inc. as described
in Note 2.
6
<PAGE> 8
2. ACQUISITIONS
On January 7, 2000, the Company acquired all of the outstanding common
stock of Foglight Software, Inc. ("Foglight") in exchange for 2.4 million shares
of the Company's common stock valued at $101.8 million, cash payments of $0.5
million, and the assumption of unvested Foglight stock options valued at $2.2
million. The acquisition was accounted for as a purchase, and the purchase
price, including $0.4 million of direct acquisition costs, was allocated as
follows (in thousands):
Current assets $ 637
Deferred taxes 3,140
Fixed assets 865
Goodwill and other intangibles 105,547
Other assets 28
Liabilities assumed (5,728)
---------
Total purchase price $ 104,489
=========
On September 11, 2000, the Company acquired all of the outstanding
common stock of FastLane Technologies, Inc. ("FastLane") in exchange for 1.1
million exchangeable shares of a subsidiary of the Company valued at $63.1
million (each of which is exchangeable for one share of common stock of the
Company), cash payments of $33.5 million and the assumption of FastLane stock
options (exchangeable into options of the Company) valued at $12.6 million. In
accordance with FIN 44, the Company excluded from the purchase price the
intrinsic value of the unvested stock options of FastLane of $5.3 million, which
has been allocated to deferred compensation and will be recognized as non-cash
compensation expense over the remaining future vesting period of two and
one-half years. The acquisition was accounted for as a purchase, and the
purchase price, including $0.6 million of direct acquisition costs, was
allocated as follows (in thousands):
Current assets $ 3,598
Fixed assets 1,888
Goodwill and other intangibles 109,648
Liabilities assumed (10,639)
---------
Total purchase price $ 104,495
=========
During fiscal year 2000, the Company also completed the acquisitions of
five other companies in exchange for approximately 202,000 shares of the
Company's common stock valued at $8.1 million, total cash payments of $51.1
million, and the assumption of stock options valued at $0.2 million. The
Company, acting as escrow agent, has withheld a total of $2.3 million for
indemnification obligations of the former principal shareholders of two of the
companies acquired. Each acquisition was accounted for as a purchase, and the
aggregate purchase price, including $1.1 million of direct acquisition costs,
was allocated as follows (in thousands):
Current assets $ 2,238
Fixed assets 385
Deferred taxes 267
Goodwill and other intangibles 61,303
Liabilities assumed (3,685)
--------
Total purchase price $ 60,508
========
7
<PAGE> 9
The results of operations of the acquired companies are included in the
consolidated financial statements from the dates of acquisition. The pro forma
statement of operations data below assumes that each of the companies had been
acquired at the beginning of fiscal 1999. This pro forma data includes
amortization of goodwill and identified intangibles from that date. This pro
forma data is presented for informational purposes only, and is not necessarily
indicative of the results of future operations nor of the results that would
have been achieved had the acquisitions taken place at the beginning of fiscal
1999.
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2000 1999
-------- --------
(in thousands, except per share data)
Revenue $117,934 $ 57,188
Net loss (47,472) (56,762)
Net loss per share - basic and diluted $ (0.55) $ (0.68)
3. NET INCOME (LOSS) PER SHARE
The Company computes net income (loss) per share in accordance with SFAS
No. 128, Earnings per Share. Basic earnings per share is computed by dividing
net income (loss) by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution of
securities by including other common stock equivalents, including stock options,
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
earnings per share calculations (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Shares used in computing basic net income (loss) per share 86,536 68,898 84,420 80,216
Dilutive effect of stock options -- (1) 5,376 -- (1) 2,300
Convertible preferred stock -- 6,568 -- 2,558
-------- -------- -------- --------
Shares used in computing diluted net income (loss) per share 86,536 80,842 84,420 85,074
======== ======== ======== ========
</TABLE>
---------------
(1) Effect would have been anti-dilutive, accordingly, the amount is excluded
from shares used in computing diluted net income (loss) per share. The
dilutive effect of stock options would have been 5,784 and 5,875 for the
three and nine months ended September 30, 2000, respectively.
8
<PAGE> 10
4. ACCUMULATED OTHER COMPREHENSIVE LOSS
In September 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 requires enterprises to report comprehensive income and its
components in general-purpose financial statements. SFAS No. 130 was effective
for the Company beginning January 1, 1998. Accordingly, the Company has prepared
Statements of Comprehensive Operations for the three and nine months ended
September 30, 2000 and 1999. Accumulated other comprehensive operations as of
September 30, 2000 is comprised of the following (in thousands):
UNREALIZED
LOSS ON
AVAILABLE-FOR-SALE
SECURITIES
----------
Balance, December 31, 1999 ...................... $ (26)
Current period changes ........................ (103)
-----
Balance, September 30, 2000 ..................... $(129)
=====
5. SHAREHOLDERS' EQUITY
In February 2000, approximately 238,000 shares of common stock were
issued under the Company's Employee Stock Purchase Plan at a price of $5.95 per
share.
In March 2000, the Company and certain selling shareholders sold 8.4
million shares of its common stock as part of a secondary offering. Of the
shares sold in the offering, 3.8 million shares were sold by the Company and 4.6
million shares were sold by existing shareholders. The Company's net proceeds
from its sale of stock were $253.6 million, after underwriting and offering
expenses. The Company did not receive any proceeds from the shares sold by
existing shareholders.
In March 2000, the Company completed a 2-for-1 stock split of its common
stock, effective on March 31, 2000, for shareholders of record on March 20,
2000. The consolidated financial statements have been adjusted to reflect the
split, for all periods presented. In connection with the stock split, the
Company amended its articles of incorporation to increase the total number of
shares of stock which the Company is authorized to issue to 160 million,
consisting of 150 million shares of no par value common stock and 10 million of
no par value preferred stock.
In August 2000, approximately 50,000 shares of common stock were issued
under the Company's Employee Stock Purchase Plan at a price of $40.42 per share.
6. STOCK OPTION PLANS
The following table summarizes information about stock options
outstanding as of September 30, 2000 (in thousands, except for per share data):
<TABLE>
<CAPTION>
Number of Options
Number of Exercisable as of
Shares Price per Share September 30, 2000
--------- ---------------- ------------------
<S> <C> <C> <C>
Balance at December 31, 1999 10,512 $ 0.50- $ 40.25
Granted 3,718 0.05- 50.06
Exercised (2,164) 0.05- 25.38
Canceled (1,236) 0.50- 47.13
------
Balance at September 30, 2000 10,830 $ 0.50- $ 50.06 1,348
======
</TABLE>
9
<PAGE> 11
7. OPERATING SEGMENT DATA
Operating segments are defined as components of an enterprise about
which separate financial information is available that is evaluated regularly by
the Company's chief operating decision maker, or decision making group, in
deciding how to allocate resources and in assessing performance. The operating
segments of the Company are managed separately because each segment represents a
strategic business unit that offers different products or services.
The Company's reportable operating segments include Licenses and
Services. The Licenses segment develops and markets the Company's software
products. The Services segment provides after-sale support for software products
and fee-based training and consulting services related to the Company's
products.
The Company does not separately allocate operating expenses to these
segments, nor does it allocate specific assets to these segments. Therefore,
segment information reported includes only revenues, cost of revenues and gross
profit, as this information and the geographic information described below are
the only information provided to the chief operating decision maker.
Operating segment data for the three and nine months ended September 30,
2000 and 1999 was as follows (in thousands):
<TABLE>
<CAPTION>
LICENSES SERVICES TOTAL
-------- -------- --------
<S> <C> <C> <C>
Three months ended September 30, 2000:
Revenues $ 34,036 $ 10,086 $ 44,122
Cost of revenues 2,118(1) 2,911 5,029
-------- -------- --------
Gross profit $ 31,918 $ 7,175 $ 39,093
======== ======== ========
Three months ended September 30, 1999:
Revenues $ 13,995 $ 4,313 $ 18,308
Cost of revenues 734 1,154 1,888
-------- -------- --------
Gross profit $ 13,261 $ 3,159 $ 16,420
======== ======== ========
Nine months ended September 30, 2000:
Revenues $ 84,459 $ 25,043 $109,502
Cost of revenues 5,381(1) 7,034 12,415
-------- -------- --------
Gross profit $ 79,078 $ 18,009 $ 97,087
======== ======== ========
Nine months ended September 30, 1999:
Revenues $ 35,360 $ 11,237 $ 46,597
Cost of revenues 2,138 2,892 5,030
-------- -------- --------
Gross profit $ 33,222 $ 8,345 $ 41,567
======== ======== ========
</TABLE>
(1) Includes amortization of purchased intangible assets of $1,244 and $3,002
for the three and nine months ended September 30, 2000, respectively, which is
included in total cost of revenues in the accompanying Consolidated Statements
of Operations.
10
<PAGE> 12
Revenues are attributed to geographic areas based on the location of the
entity from which the products or services were sold. Revenues and gross profit
from operations and long-lived assets concerning principal geographic areas in
which the Company operates are as follows (in thousands):
<TABLE>
<CAPTION>
UNITED STATES INTERNATIONAL ELIMINATIONS TOTAL
------------- ------------- ------------ --------
<S> <C> <C> <C> <C>
Three months ended September 30, 2000:
Revenues $ 38,211 $ 10,659 $ (4,748) $ 44,122
Gross profit 33,851 7,543 (2,301) 39,093
Long-lived assets 300,876 4,217 -- 305,093
Three months ended September 30, 1999:
Revenues $ 16,293 $ 5,008 $ (2,993) $ 18,308
Gross profit 14,575 3,039 (1,194) 16,420
Long-lived assets 3,387 1,068 -- 4,455
Nine months ended September 30, 2000:
Revenues $ 96,706 $ 26,099 $(13,303) $109,502
Gross profit 85,630 17,740 (6,283) 97,087
Long-lived assets 300,876 4,217 -- 305,093
Nine months ended September 30, 1999:
Revenues $ 40,866 $ 12,559 $ (6,828) $ 46,597
Gross profit 36,237 7,613 (2,283) 41,567
Long-lived assets 3,387 1,068 -- 4,455
</TABLE>
11
<PAGE> 13
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this report, including statements regarding the
Company's strategy, financial performance and revenue sources, are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of
1934, as amended, and Section 27A of the Securities Act of 1933, as amended, and
are subject to the safe harbors created by those sections. These forward-looking
statements are based on current expectations and entail various risks and
uncertainties that could cause actual results to differ materially from those
expressed in such forward-looking statements. The Company's actual results could
differ materially from the results anticipated in these forward-looking
statements as a result of certain factors set forth under "Risk Factors" and
elsewhere in this report. Readers are urged to carefully review and consider the
various disclosures made by the Company in this report and in the Company's
other reports filed with the SEC, including the Company's Annual Report on Form
10-K for the year ended December 31, 1999 and our subsequent reports on Forms
10-Q and 8-K, that attempt to advise interested parties of certain risks and
factors that may affect the Company's business. Readers are cautioned not to
place undue reliance on these forward-looking statements to reflect events or
circumstances occurring after the date hereof. The following discussion should
be read in conjunction with the Company's consolidated financial statements and
notes thereto.
OVERVIEW
We provide application and information availability software solutions
that enhance the performance and reliability of an organization's e-business,
packaged and custom applications, and enable the delivery of information across
the extended enterprise.
We derive our revenues primarily from the sale of software licenses and
related services. Pricing of our software licenses is based on the number of
servers, workstations and/or users of our products. Services consist primarily
of annual maintenance contracts for technical support and product enhancements,
and consulting services. Maintenance fees are generally renewable annually at
the customer's option and the fees are recognized over the term of each
agreement.
We recognize software license revenues when a non-cancelable license
agreement has been signed with a customer, the software is shipped, no
significant post delivery vendor obligations remain and collection is deemed
probable. Maintenance revenues are recognized ratably over the contract term,
which is typically one year. Revenues for consulting services are recognized as
such services are performed.
We market our software and services primarily through our direct sales
organization in North America, South America, Europe, Australia and the Middle
East. We intend to expand both our domestic and international sales activities
as part of our business strategy. All of our current international revenues are
derived from the operations of our wholly-owned international subsidiaries,
which consist of both direct sales and sales through distributors. Our
international subsidiaries conduct business in the currency of the country in
which they operate (with the exception of Mexico and Brazil where the U.S.
Dollar is used), exposing us to currency fluctuations and currency transaction
losses or gains that are outside of our control. Historically, fluctuations in
foreign currency exchange rates have not had a material effect on our business.
We have not to date conducted any hedging transactions to reduce our risk to
currency fluctuations.
In the development of new products and enhancements of existing
products, the technological feasibility of the software is not established until
substantially all product development is complete. Historically, our software
development costs eligible for capitalization have been insignificant and all
costs related to internal research and development have been expensed as
incurred.
12
<PAGE> 14
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statements of
operations data as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Licenses 77% 76 % 77 % 76%
Services 23 24 23 24
----- ------ ------ -----
Total revenues 100 100 100 100
Cost of revenues:
Licenses 2 4 2 5
Services 7 6 6 6
Amortization of purchased intangible assets 3 -- 3 --
----- ------ ------ -----
Total cost of revenues 12 10 11 11
----- ------ ------ -----
Gross profit 88 90 89 89
Operating expenses:
Sales and marketing 47 45 47 43
Research and development 25 25 25 23
General and administrative 11 15 11 15
Amortization of purchased intangible
assets and other compensation costs 24 1 24 2
----- ------ ------ -----
Total operating expenses 107 86 107 83
----- ------ ------ -----
Income (loss) from operations (19) 4 (18) 6
Other income, net 8 1 8 1
----- ------ ------ -----
Income (loss) before income tax provision (11) 5 (10) 7
Income tax provision 4 2 4 3
----- ------ ------ -----
Net income (loss) (15% 3 % (14)% 4%
===== ====== ====== =====
</TABLE>
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
REVENUES
Total revenues for the three and nine months ended September 30, 2000
were $44.1 million and $109.5 million, respectively, an increase of 141% and
135%, respectively, from the comparable periods of 1999. International revenues,
after eliminations, for the three and nine months ended September 30, 2000 were
$8.4 million and $19.9 million, respectively, an increase of 126% and 99%,
respectively, from the comparable periods of 1999.
LICENSES
Licenses revenues for the three and nine months ended September 30, 2000
were $34.0 million and $84.5 million, respectively, an increase of 143% and
139%, respectively, from the comparable periods of 1999. The increases were
primarily the result of continued growth in market acceptance of our software
products, the 87% increase in the size of our worldwide sales organization since
September 30, 1999, a greater volume of larger end-user transactions, as well as
the availability of new products. Licenses revenues represented 77% of total
revenues for both the three and nine months ended September 30, 2000, compared
to 76% for the comparable periods of 1999. International licenses revenues,
after eliminations, for the three and nine months ended September 30, 2000 were
$6.6 million and $15.7 million, respectively, an increase of 127% and 94%,
respectively, from the comparable periods of 1999 due to the growth of our
international sales organization.
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SERVICES
Services revenues for the three and nine months ended September 30, 2000
were $10.1 million and $25.0 million, respectively, an increase of 134% and
123%, respectively, from the comparable periods of 1999. The increases were due
primarily to increased renewals of support and maintenance contracts, an
increase in the installed base of customers that purchased maintenance and an
increase in demand for consulting and training services. Services revenues
represented 23% of total revenues for both the three and nine months ended
September 30, 2000, compared to 24% from the comparable periods of 1999.
International services revenues, after eliminations, for the three and nine
months ended September 30, 2000 were $1.8 million and $4.2 million,
respectively, an increase of 121% and 119%, respectively, from the comparable
periods of 1999.
COST OF LICENSES
Cost of licenses includes amortization of software licenses, product
media, printing and duplication costs, and royalties to former owners of
acquired technologies. Cost of licenses for the three and nine months ended
September 30, 2000 were $0.9 million and $2.4 million, respectively, an increase
of 19% and 11%, respectively, from the comparable periods of 1999. This increase
was principally a result of an increase in product media, duplication costs and
printing compared to the comparable periods of 1999. These costs as a percentage
of license revenues in both the three and nine months ended September 30, 2000
were 3%, compared to 5% and 6%, respectively, in the comparable periods of 1999.
The decreases for the three and nine months ended September 30, 2000 as a
percentage of licenses revenues resulted from increased licenses revenues
without a corresponding increase in amortization of acquired software licenses,
which does not vary by the number of licenses sold.
COST OF SERVICES
Cost of services includes salaries and related costs for customer
support and consulting personnel. Cost of services for the three and nine months
ended September 30, 2000 were $2.9 million and $7.0 million, respectively, an
increase of 152% and 143%, respectively, from the comparable periods of 1999.
The increases were primarily due to a 94% increase in the number of customer
support personnel required to manage and support our growing customer base as
well as the increased number of product offerings since September 30, 1999. We
also formed a professional service consulting organization during the first half
of 2000, which did not exist in 1999. Cost of services as a percentage of
services revenues in the three and nine months ended September 30, 2000 were 29%
and 28%, respectively, compared to 27% and 26% in the respective periods of
1999. Our gross margin on services revenues could fluctuate on a quarterly basis
in the future, reflecting the timing differences between increasing our
organizational investments and the corresponding revenue growth that we expect
as a result. We expect the cost of services to increase in absolute dollars for
the foreseeable future as additional customer support and consulting personnel
are hired.
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS
Amortization of purchased intangible assets of $1.2 million and $3.0
million for the three and nine months ended September 30, 2000, respectively,
relates to amortization of developed technology of companies acquired. There
were no similar costs in the same periods of 1999.
OPERATING EXPENSES
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, commissions
earned by sales personnel, recruiting costs, trade shows, travel and
entertainment, and other marketing communications costs such as advertising and
promotion. Sales and marketing expenses for the three and nine months ended
September 30, 2000 were $20.6 million and $51.5 million, respectively, an
increase of 147% and 151%, respectively, from the comparable periods of 1999.
The increases reflect increased salaries and related expenses due to the 119%
increase in our sales and marketing organization personnel since September 30,
1999. Sales and marketing expenses as a percentage of total revenues in the
three and nine months ended September 30, 2000 were 47%, compared to 45% and
43%, in the respective periods of 1999. We expect that sales and marketing
expenses will continue to increase in absolute dollars for the foreseeable
future as commissions increase with expected increases in revenues and as we
continue to expand the size of our sales and marketing organization.
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<PAGE> 16
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of salaries and
benefits for software developers, software product managers, quality assurance
personnel, and payments made to outside software development contractors.
Research and development expenses for the three and nine months ended September
30, 2000 were $11.1 million and $27.8 million, respectively, an increase of 147%
and 164%, respectively, from the comparable periods of 1999. The increases were
primarily related to a 106% increase in the number of R&D personnel since
September 30, 1999, resulting primarily from personnel additions to our
domestic, Australian, and Canadian development operations. These expenses as a
percentage of total revenues in the three and nine months ended September 30,
2000 were 25%, compared to 25% and 23%, respectively, in the comparable periods
of 1999. We believe that a significant level of research and development
investment is required to remain competitive, and expect these expenses will
continue to increase in absolute dollars in future periods.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of salaries,
benefits and related costs for our executive, finance, administrative and
information services personnel. General and administrative expenses for the
three and nine months ended September 30, 2000 were $5.1 million and $11.8
million, respectively, an increase of 81% and 74%, respectively, from the
comparable periods of 1999. The increases were primarily due to increases in
salaries and related expenses due to an increase in headcount necessary to
support our expanding operations. These expenses as a percentage of total
revenues in the three and nine months ended September 30, 2000 were 11%,
compared to 15% in the comparable periods of 1999. We expect that general and
administrative expenses will continue to increase in absolute dollars for the
foreseeable future as a result of the continued expansion of administrative and
management personnel, and expenses associated with being a public company
including annual and other public reporting costs, directors' and officers'
liability insurance premiums, investor relations programs and professional
services fees.
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS AND OTHER COMPENSATION COSTS
Amortization of purchased intangible assets and other compensation costs
includes the amortization of goodwill and other purchased intangible assets
associated with the acquisitions described in Note 2 and compensation expense
associated with the issuance of stock options below fair market value. These
costs for the three and nine months ended September 30, 2000 were $10.5 million
and $25.9 million, respectively, compared to $0.2 million and $1.0 million,
respectively, in the comparable periods of 1999. The increase in these costs was
primarily attributable to amortization of goodwill associated with acquisitions
during the first nine months of 2000. Goodwill amortization for the three and
nine months ended September 30, 2000 was $8.7 million and $21.5 million,
respectively, compared to no goodwill amortization in the same periods of 1999.
OTHER INCOME, NET
Other income, net is comprised of interest income, interest expense and
the net of foreign currency transaction gains and losses. Other income, net for
the three and nine months ended September 30, 2000 was $3.7 million and $8.3
million, respectively, compared to $0.3 million and $0.4 million, respectively,
in the same periods of 1999. The increases during the three and nine months
ended September 30, 2000 were primarily due to increases in interest income from
larger cash and marketable securities balances related to the proceeds from our
initial and secondary offerings in August 1999 and March 2000, respectively.
INCOME TAX PROVISION
Provision for income taxes for the three and nine months ended September
30, 2000 was $1.8 million and $4.8 million, respectively. Excluding amortization
of purchased intangible assets and other compensation costs, our effective
income tax rate for the three and nine months ended September 30, 2000 was 40%,
compared to 42% for the comparable periods of 1999.
INFLATION
Inflation has not had a significant effect on our results of operations
or financial position for the three and nine months ended September 30, 2000 or
the comparable periods of 1999.
15
<PAGE> 17
LIQUIDITY AND CAPITAL RESOURCES
We have funded our business to date primarily from cash generated by our
operations, net proceeds of $64.9 million from our initial public offering in
August 1999, and net proceeds of $253.6 million from our secondary offering in
March 2000. Our sources of liquidity as of September 30, 2000 consisted
principally of cash and cash equivalents of $34.7 million and $178.7 million in
high grade corporate and government short-term and long-term marketable
securities.
Net cash provided by operating activities was $15.6 million and $6.2
million for the nine months ended September 30, 2000 and 1999, respectively. The
increase is due to increases in net income after excluding non-cash depreciation
and amortization expense, partially offset by changes in operating assets and
liabilities.
Investing activities used $278.7 million and $16.3 million for the nine
months ended September 30, 2000 and 1999, respectively. The increase is due
primarily of purchases and sales of marketable securities, acquisitions, and
capital expenditures. Purchases of marketable securities were $291.9 million for
the nine months ended September 30, 2000 versus $12.2 million in the same period
of 1999. Cash paid for acquisitions, net of cash acquired, was $78.5 million in
the nine months ended September 30, 2000. There was no acquisition activity in
the same period of 1999.
Financing activities provided $258.0 million and $44.5 million for the
nine months ended September 30, 2000 and 1999, respectively. In March 2000, we
raised net proceeds of $253.6 million from a secondary public offering of our
common stock at a price of $70.00 per share. Of the shares sold in the offering,
3.8 million shares were sold by the Company and 4.6 million shares were sold by
selling shareholders. We did not receive any proceeds from the shares sold by
the selling shareholders.
We believe that our existing cash, cash equivalents and investment
balances and cash flow from operations will be sufficient to finance our working
capital and capital expenditure requirements through at least the next 12
months. We may require additional funds to support our working capital
requirements or for other purposes and may seek to raise additional funds
through public or private equity or debt financing or from other sources. If
additional financing is needed, we can not assure you that such financing will
be available to us at commercially reasonable terms or at all.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard, or SFAS, No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133 establishes methods
for derivative financial instruments and hedging activities related to those
instruments, as well as other hedging activities. Because we do not currently
hold any derivative instruments and do not currently engage in hedging
activities, we expect that the adoption of SFAS No. 133 will not have a material
impact on our financial position or results of operations. We will be required
to implement SFAS No. 133 for the year ending December 31, 2001.
On December 6, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB
101"). SAB 101 summarizes the staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 101 is
effective for the fourth quarter in fiscal year 2000. The adoption of SAB 101 is
not expected to have a material impact on the Company's financial statements, as
the Company believes its revenue recognition policies comply with SAB 101.
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of APB
Opinion No. 25 ("FIN 44"). FIN 44 clarifies the definition of an employee for
purposes of applying Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees ("APB 25"), the criteria for determining whether a
plan qualifies as a noncompensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000 but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998 or January 12, 2000. The provisions of FIN 44 change the
accounting for an exchange of unvested employee stock options and restricted
stock awards in a purchase business combination. The new rules require the
intrinsic value of the unvested awards be allocated to deferred compensation and
recognized as non-cash
16
<PAGE> 18
compensation expense over the remaining future vesting period. The adoption of
FIN 44 did not have a material impact on the Company's financial statements,
other than the effect of the application of FIN 44 as it relates to the
Company's acquisition of FastLane Technologies, Inc. as described in Note 2 to
the consolidated financial statements.
17
<PAGE> 19
RISK FACTORS
In addition to other information in this Quarterly Report on Form 10-Q,
you should consider carefully the following factors in evaluating Quest and our
business.
RISKS RELATED TO OUR BUSINESS
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS, AND, AS A
RESULT, WE MAY FAIL TO MEET EXPECTATIONS OF INVESTORS AND ANALYSTS, CAUSING OUR
STOCK PRICE TO FLUCTUATE OR DECLINE
Our revenues and operating results may vary significantly from quarter
to quarter due to a number of factors. These factors include the following:
- the size and timing of customer orders. See "The size and timing
of our customer orders may vary significantly from quarter to
quarter which could cause fluctuations in our revenues."
- increased expenses, whether related to sales and marketing,
product development or administration;
- our ability to attain market acceptance of new products and
services and enhancements to our existing products;
- delays in introducing new products;
- new product introductions by competitors;
- lack of order backlog;
- changes in our pricing policies or the pricing policies of our
competitors;
- costs related to acquisitions of technologies or businesses,
including amortization of purchased intangible assets;
- the timing of releases of new versions of third-party software
products that our products support, including, without
limitation, product releases by Oracle; and
- the amount and timing of expenditures related to expansion of
our operations.
Fluctuations in our results of operations are likely to affect the
market price of our common stock in a manner that may not be related to our
long-term operating performance.
THE SIZE AND TIMING OF OUR CUSTOMER ORDERS MAY VARY SIGNIFICANTLY FROM QUARTER
TO QUARTER WHICH COULD CAUSE FLUCTUATIONS IN OUR REVENUES
In any given quarter, sales of some of our products have involved large
financial commitments from a relatively small number of customers, and
cancellation or deferral of these large contracts would reduce our revenues. In
addition, the sales cycles for Vista Plus and SharePlex have been up to six
months and often require pre-purchase evaluation periods and customer education.
These relatively long sales cycles may cause significant periodic variation in
our license revenues. Also, we have often booked a significant portion of our
orders in the last month of a quarter and delays in the closing of orders near
the end of a quarter could cause quarterly revenues to fall short of anticipated
levels. Finally, while a portion of our revenues each quarter is recognized from
previously deferred revenue, our quarterly performance will depend primarily
upon entering into new contracts to generate revenues for that quarter.
MANY OF OUR PRODUCTS ARE DEPENDENT ON THIRD PARTY TECHNOLOGIES, SUCH AS ORACLE
AND IBM DB2, AND THE DEMAND FOR OUR PRODUCTS COULD SUFFER IF THESE TECHNOLOGIES
LOSE MARKET SHARE OR BECOME INCOMPATIBLE WITH OUR PRODUCTS.
We believe that our success has depended in part, and will continue to
depend in part for the foreseeable future, upon our relationship with Oracle and
our status as a complementary software provider for Oracle's database and
application products. Many versions of our principal products, including
SharePlex, SQLab Xpert, and SQL Navigator, are designed for use specifically
with Oracle databases. Although a number of our products work with other
environments, our competitive advantage consists in substantial part on the
integration between our products and Oracle's products, and our extensive
knowledge of Oracle's technology. Currently, a significant portion of our total
revenues is derived from products that specifically support Oracle-based
products. We recently announced our formal entry into the IBM DB2 Universal
Database market with Quest Central, a tightly integrated suite of database
management solutions designed for the growing DB2 market. As the DB2 market
continues to grow, we can expect to become increasingly dependent on our ability
to address this market segment.
18
<PAGE> 20
If Oracle or IBM for any reason decide to promote technologies and
standards that are not compatible with our technology, or if Oracle or IBM lose
market share for their database products, our business, operating results and
financial condition would be materially adversely affected.
MANY OF OUR PRODUCTS ARE VULNERABLE TO DIRECT COMPETITION FROM ORACLE
We currently compete with Oracle in the market for database management
solutions. We expect that Oracle's commitment to and presence in the database
management product market will increase in the future and therefore
substantially increase competitive pressures. We believe that Oracle will
continue to incorporate database management technology into its server software
offerings, possibly at no additional cost to its users. We believe that Oracle
will also continue to enhance its database management technology. Furthermore,
Oracle could attempt to increase its presence in this market by acquiring or
forming strategic alliances with our competitors, and Oracle may be in better
position to withstand and respond to the current factors impacting this
industry. Oracle has a longer operating history, a larger installed base of
customers and substantially greater financial, distribution, marketing and
technical resources than we do. In addition, Oracle has well-established
relationships with many of our present and potential customers. As a result, we
may not be able to compete effectively with Oracle in the future, which could
materially adversely affect our business, operating results and financial
condition.
ACQUISITIONS OF COMPANIES OR TECHNOLOGIES MAY RESULT IN DISRUPTIONS TO OUR
BUSINESS AND DIVERSION OF MANAGEMENT ATTENTION
We have in the past made and we expect to continue to make acquisitions
of complementary companies, products or technologies. If we make any additional
acquisitions, we will be required to assimilate the operations, products and
personnel of the acquired businesses and train, retain and motivate key
personnel from the acquired businesses. We may be unable to maintain uniform
standards, controls, procedures and policies if we fail in these efforts.
Similarly, acquisitions may subject us to liabilities and risks that are not
known or identifiable at the time of the acquisition or may cause disruptions in
our operations and divert management's attention from day-to-day operations,
which could impair our relationships with our current employees, customers and
strategic partners. We may have to incur debt or issue equity securities to pay
for any future acquisitions. The issuance of equity securities for any
acquisition could be substantially dilutive to our shareholders. In addition,
our profitability will be affected because of acquisition-related costs or
amortization of goodwill and other purchased intangible assets. In consummating
acquisitions, we are also subject to risks of entering geographic and business
markets in which we have no or limited prior experience. If we are unable to
fully integrate acquired businesses, products or technologies with our existing
operations, we may not receive the intended benefits of acquisition.
OUR ABILITY TO INCREASE OUR REVENUES DEPENDS ON OUR ABILITY TO EXPAND OUR
INDIRECT SALES CHANNELS
In certain domestic and international markets we may miss sales
opportunities if we are unable to enter into successful relationships with
locally based resellers. In the future, we intend to augment our current limited
indirect sales distribution methods through additional third-party distribution
arrangements and, therefore, we will likely become more dependent on these types
of relationships. There can be no assurance that we will successfully augment
these arrangements or that the expansion of indirect sales distribution methods
will increase revenues.
OUR PAST AND FUTURE GROWTH MAY STRAIN OUR MANAGEMENT, ADMINISTRATIVE,
OPERATIONAL AND FINANCIAL INFRASTRUCTURE
We have recently experienced a period of rapid growth in our operations
that has placed and will continue to place a strain on our management,
administrative, operational and financial infrastructure. The number of our
full-time employees increased from 513 as of September 30, 1999 to 1,274 as of
September 30, 2000. Our ability to manage our operations and growth requires us
to continue to improve our operational, financial and management controls, and
reporting systems and procedures. In the future, we may need to expand our
facilities or relocate some or all of our employees or operations from time to
time to support growth. These relocations could result in temporary disruptions
of our operations or a diversion of management's attention and resources. In
addition, we will be required to hire additional management, financial, and
sales and marketing personnel to manage our expanding operations. If we are
unable to manage this growth effectively, our business, operating results and
financial condition may be materially adversely affected.
19
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WE MAY NOT GENERATE INCREASED BUSINESS FROM OUR CURRENT CUSTOMERS WHICH COULD
SLOW OUR REVENUE GROWTH IN THE FUTURE
Most of our customers initially make a purchase of our products for a
single department or location. Many of these customers may choose not to expand
their use of our products. If we fail to generate expanded business from our
current customers, our business, operating results and financial condition could
be materially adversely affected. In addition, as we deploy new modules and
features for our existing products or introduce new products, our current
customers may choose not to purchase this new functionality or these new
products. Moreover, if customers elect not to renew their maintenance
agreements, our service revenues would be materially adversely affected.
BECAUSE THE MARKET FOR E-BUSINESS SOLUTIONS IS NEW AND EVOLVING, WE CANNOT
ACCURATELY PREDICT THE FUTURE GROWTH RATE OF THIS MARKET OR ITS ULTIMATE SIZE
We are increasingly focusing our selling efforts on providing
application and information availability solutions for e-business applications
and we expect such sales to constitute an increasing portion of our future
revenue growth. We believe that most companies currently are not yet aware of
our products and capabilities within this evolving market, and, as a result,
such companies have not deployed our solutions. While we have devoted
significant resources to promoting awareness of our products and the problems
these products address for this evolving market, these efforts may not be
sufficient to build market awareness of the need for our products. Failure of a
significant market for e-business application and information availability
products to develop, or failure of our products to achieve broad market
acceptance, could have a material adverse effect on our business, operating
results and financial condition.
WE EXPECT TO INCUR SIGNIFICANT INCREASES IN OUR OPERATING EXPENSES IN THE
FORESEEABLE FUTURE, WHICH MAY AFFECT OUR FUTURE PROFITABILITY
We intend to substantially increase our operating expenses for the
foreseeable future as we:
- increase our sales and marketing activities, including expanding
our direct sales and telesales forces;
- increase our research and development activities;
- expand our general and administrative activities; and
- expand our customer support organizations.
Accordingly, we will be required to significantly increase our revenues
in order to maintain profitability. These expenses will be incurred before we
generate any revenues by this increased spending. If we do not significantly
increase revenues from these efforts, our business and operating results would
be negatively impacted.
OUR INTERNATIONAL OPERATIONS AND OUR PLANNED EXPANSION OF OUR INTERNATIONAL
OPERATIONS EXPOSES US TO CERTAIN RISKS
Substantially all of our current international revenues are derived from
the operations of wholly-owned subsidiaries in Canada, the United Kingdom,
Germany, and Australia. Revenues from licenses and services, after eliminations,
to customers outside of the United States were $8.4 million and $19.9 million
for the three and nine months ended September 30, 2000, respectively, compared
to $3.7 million and $10.0 million, respectively, in the same periods of 1999.
International revenues, after eliminations, represented 19% and 18% of total
revenues for the three and nine months ended September 30, 2000, respectively,
compared with 20% and 21%, respectively, in the same periods of 1999. As a
result, we face increasing risks from doing business on an international basis,
including, among others:
- difficulties in staffing and managing foreign operations;
- longer payment cycles;
- seasonal reductions in business activity in Europe;
- increased financial accounting and reporting burdens and
complexities;
- potentially adverse tax consequences;
- delays in localizing our products;
20
<PAGE> 22
- compliance with a wide variety of complex foreign laws and
treaties;
- reduced protection for intellectual property rights in some
countries; and
- licenses, tariffs and other trade barriers.
In addition, because our international subsidiaries primarily conduct
business in the currency of the country in which they operate, we are subject to
currency fluctuations and currency transaction losses or gains that are outside
of our control.
We plan to expand our international operations as part of our business
strategy. The expansion of our existing international operations and entry into
additional international markets will require significant management attention
and financial resources and will place additional burdens on our management,
administrative, operational and financial infrastructure. We cannot be certain
that our investments in establishing facilities in other countries will produce
desired levels of revenue or profitability. In addition, we have sold our
products internationally for only a few years and we have limited experience in
developing localized versions of our products and marketing and distributing
them internationally. As our international operations expand, our exposure to
exchange rate fluctuations will increase as we use an increasing number of
foreign currencies. We have not yet entered into any hedging transactions to
date to mitigate our expense to currency fluctuations.
OUR RECENTLY-IMPLEMENTED STRATEGY OF INVESTING IN DEVELOPMENT STAGE COMPANIES
INVOLVES A NUMBER OF RISKS AND UNCERTAINTIES
We have and may continue to make investments in development-stage
companies that we believe provide strategic opportunities for the Company. Each
of these investments involves a number of risks and uncertainties, including
diversion of management attention, inability to identify strategic
opportunities, inability to value investments appropriately, inability to manage
investments effectively and loss of cash invested. We intend that these
investments will complement our own research and development efforts, provide
access to new technologies and emerging markets, and create opportunities for
additional sales of our products and services. However, we cannot assure you
that this initiative will have the above mentioned desired results, or even that
we will not lose all or any part of these investments.
FAILURE TO DEVELOP STRATEGIC RELATIONSHIPS COULD HARM OUR BUSINESS BY DENYING US
SELLING OPPORTUNITIES AND OTHER BENEFITS
Our current collaborative relationships may not prove to be beneficial
to us, and they may not be sustained. We also may not be able to enter into
successful new strategic relationships in the future, which could have a
material adverse effect on our business, operating results and financial
condition. From time to time, we have collaborated with other companies,
including Hewlett-Packard and Oracle and certain regional offices of a number of
the national accounting firms that provide system integration services, in areas
such as product development, marketing, distribution and implementation. We
could lose sales opportunities if we fail to work effectively with these
parties. Moreover, we expect that maintaining and enhancing these and other
relationships will become a more meaningful part of our business strategy in the
future. However, many of our current partners are either actual or potential
competitors with us. In addition, many of these third parties also work with
competing software companies and we may not be able to maintain these existing
relationships, due to the fact that these relationships are informal or, if
written, are terminable with little or no notice.
OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED, AND THERE IS RISK OF
INFRINGEMENT CLAIMS OR INDEPENDENT DEVELOPMENT OF COMPETING TECHNOLOGY THAT
COULD HARM OUR COMPETITIVE POSITION
Our success and ability to compete are dependent on our ability to
develop and maintain the proprietary aspects of our technology. We rely on a
combination of trademark, trade secret, copyright law and contractual
restrictions to protect the proprietary aspects of our technology.
Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy aspects of our products or to obtain and use
information that we regard as proprietary. Litigation may be necessary in the
future to enforce our intellectual property rights, to protect our trade
secrets, and to determine the validity and scope of the proprietary rights of
others. Any such resulting litigation could result in substantial costs and
diversion of resources.
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Our means of protecting our proprietary rights may prove to be
inadequate and competitors may independently develop similar or superior
technology. Policing unauthorized use of our products is difficult, and we
cannot be certain that the steps we have taken will prevent misappropriation of
our technology, particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States. We also believe that,
because of the rapid rate of technological change in the software industry,
trade secret and copyright protection are less significant than factors such as
the knowledge, ability and experience of our employees, frequent product
enhancements and the timeliness and quality of customer support services.
Our success and ability to compete are also dependent on our ability to
operate without infringing upon the proprietary rights of others. Third parties
may claim infringement by us of their intellectual property rights. In the event
of a successful claim of product infringement against us and our failure or
inability to either license the infringed or similar technology or develop
alternative technology on a timely basis, we may incur substantial licensing
fees, be liable for infringement damage, or be unable to market our products.
OUR BUSINESS WILL SUFFER IF OUR SOFTWARE CONTAINS ERRORS
The software products we offer are inherently complex. Despite testing
and quality control, we cannot be certain that errors will not be found in
current versions, new versions or enhancements of our products after
commencement of commercial shipments. Significant technical challenges also
arise with our products because our customers purchase and deploy our products
across a variety of computer platforms and integrate it with a number of
third-party software applications and databases. If new or existing customers
have difficulty deploying our products or require significant amounts of
customer support, our operating margins could be harmed. Moreover, we could face
possible claims and higher development costs if our software contains undetected
errors or if we fail to meet our customers' expectations. As a result of the
foregoing, we could experience:
- loss of or delay in revenues and loss of market share;
- loss of customers;
- damage to our reputation;
- failure to achieve market acceptance;
- diversion of development resources;
- increased service and warranty costs;
- legal actions by customers against us which could, whether or
not successful, increase costs and distract our management; and
- increased insurance costs.
In addition, a product liability claim, whether or not successful, could
harm our business by increasing our costs and distracting our management.
WE INCORPORATE SOFTWARE LICENSED FROM THIRD PARTIES INTO SOME OF OUR PRODUCTS
AND ANY SIGNIFICANT INTERRUPTION IN THE AVAILABILITY OF THESE THIRD-PARTY
SOFTWARE PRODUCTS OR DEFECTS IN THESE PRODUCTS COULD REDUCE THE DEMAND FOR, OR
PREVENT THE SHIPPING OF OUR PRODUCTS
Certain of our software products contain components developed and
maintained by third-party software vendors. We expect that we may have to
incorporate software from third-party vendors in our future products. We may not
be able to replace the functionality provided by the third-party software
currently offered with our products if that software becomes obsolete, defective
or incompatible with future versions of our products or is not adequately
maintained or updated. Any significant interruption in the availability of these
third-party software products or defects in these products could harm our sales
unless and until we can secure an alternative source. Although we believe that
there are adequate alternate sources for technology licensed to us by third
parties, such alternate sources may not provide the same functionality that is
currently provided to us.
RISKS RELATED TO OUR INDUSTRY
YEAR 2000 ISSUES PRESENT TECHNOLOGICAL RISKS AND COULD CAUSE DISRUPTION TO OUR
BUSINESS
Although we have not experienced any Year 2000 problems, it is possible
that, even after January 1, 2000, Year 2000-related issues may cause problems or
disruptions. While we believe that all of our systems are Year 2000 compliant,
we cannot assure you that we will not discover a problem during 2000 that needs
to be upgraded,
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modified or replaced. In addition, we depend on a number of third-party vendors
to provide both information and non-information technology systems and services.
While we believe that our material third-party systems and services are Year
2000 compliant, we cannot be sure that we will not experience any problems
during 2000. We also cannot provide any assurance that governmental agencies,
utility companies, Internet access companies and others outside of our control
will not experience any future Year 2000 problems.
THE DEMAND FOR OUR PRODUCTS WILL DEPEND ON OUR ABILITY TO ADAPT TO RAPID
TECHNOLOGICAL CHANGE
Our future success will depend on our ability to continue to enhance our
current products and to develop and introduce new products on a timely basis
that keep pace with technological developments and satisfy increasingly
sophisticated customer requirements. Rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer demands and evolving industry standards characterize the market for
our products. The introduction of products embodying new technologies and the
emergence of new industry standards can render our existing products obsolete
and unmarketable. As a result of the complexities inherent in today's computing
environments and the performance demanded by customers for embedded databases
and Web-based products, new products and product enhancements can require long
development and testing periods. As a result, significant delays in the general
availability of such new releases or significant problems in the installation or
implementation of such new releases could have a material adverse effect on our
business, operating results and financial condition. We may not be successful
in:
- developing and marketing, on a timely and cost-effective basis,
new products or new product enhancements that respond to
technological change, evolving industry standards or customer
requirements;
- avoiding difficulties that could delay or prevent the successful
development, introduction or marketing of these products; or
- achieving market acceptance for our new products and product
enhancements.
WE MAY NOT BE ABLE TO ATTRACT AND RETAIN PERSONNEL
Our future success depends on the continued service of our executive
officers and other key administrative, sales and marketing and support
personnel, many of whom have recently joined our company. In addition, the
success of our business is substantially dependent on the services of our Chief
Executive Officer and our President and Chief Technical Officer. We intend to
hire a significant number of additional sales, support, marketing,
administrative and research and development personnel over at least the next 12
months. There has in the past been and there may in the future be a shortage of
personnel that possess the technical background necessary to sell, support and
develop our products effectively. Competition for skilled personnel is intense,
and we may not be able to attract, assimilate or retain highly qualified
personnel in the future. Our business may not be able to grow if we cannot
attract qualified personnel. Hiring qualified sales, marketing, administrative,
research and development and customer support personnel, is very competitive in
our industry, particularly in Southern California, where Quest is headquartered.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
FOREIGN CURRENCY HEDGING INSTRUMENTS
We transact business in various foreign currencies. Accordingly, we are
subject to exposure from adverse movements in foreign currency exchange rates.
This exposure is primarily related to revenues and operating expenses in Canada,
the United Kingdom, Germany, and Australia denominated in the respective local
currency.
To date, we have not used hedging contracts to hedge our
foreign-currency fluctuation risks. We will assess the need to utilize financial
instruments to hedge currency exposures on an ongoing basis. We also do not use
derivative financial instruments for speculative trading purposes.
INTEREST RATE RISK
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. We have not used derivative financial
instruments in our investment portfolio. We place our investments with
high-quality issuers and, by policy, limit the amount of credit exposure to any
one issuer. Our investments in marketable securities consist primarily of
high-grade corporate and government securities with maturities of less than two
years. Investments purchased with an original maturity of three months or less
are considered to be cash equivalents. We classify all of our investments as
available-for-sale. Available-for-sale securities are carried at fair value,
with unrealized gains and losses, net of tax, reported in a separate component
of shareholders' equity. At September 30, 2000, the net loss on
available-for-sale securities of $0.1 million comprised 63 positions, 13 of
which carry unrealized gains, and 50 of which carry unrealized losses.
The following table provides information about our investment portfolio
at September 30, 2000:
SEPTEMBER 30, 2000
----------------------
(dollars in thousands)
Cash and cash equivalents $ 34,675
Average interest rate 4.56%
Short-term marketable securities $ 35,271
Average interest rate 6.60%
Long-term marketable securities $143,472
Average interest rate 6.82%
Total portfolio $213,418
Average interest rate 6.42%
We consider the carrying value of our investment securities to
approximate their fair value due to the relatively short period of time between
origination of the investments and their expected realization. We also maintain
a level of cash and cash equivalents such that we have generally been able to
hold our investments to maturity. Accordingly, changes in the market interest
rate would not have a material effect on the fair value of such investments.
EUROPEAN MONETARY UNION
Within Europe, the European Economic and Monetary Union introduced a new
currency, the euro, on January 1, 1999. The new currency is in response to the
European Union's policy of economic convergence to harmonize trade policy,
eliminate business costs associated with currency exchange, and to promote the
free flow of capital, goods and services.
On January 1, 1999, the participating countries adopted the euro as
their local currency, initially available for currency trading on currency
exchanges and non-cash transactions such as banking. The existing local
currencies, or legacy currencies, will remain legal tender through January 1,
2002. Beginning on January 1, 2002, euro-denominated bills and coins will be
issued for cash transactions. For a period of up to six months from this date,
both legacy currencies and the euro will be legal tender. On or before July 1,
2002, the participating countries will withdraw all legacy currencies and
exclusively use the euro.
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Our transactions are recorded in both U.S. dollars and foreign
currencies. Future transactions may be recorded in the euro. We have not
incurred and do not expect to incur any significant costs from the continued
implementation of the euro. However, the currency risk of the euro could harm
our business.
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PART II
OTHER INFORMATION
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) SALES OF UNREGISTERED SECURITIES.
On August 1, 2000, we issued an aggregate of 339,000 shares of Common
Stock to Marshall Senk, our Vice President, Marketing, for an aggregate
purchase price of $15.8 million, which was paid by Mr. Senk's delivery
of a five-year full recourse promissory note bearing interest at 6.33%
per annum.
The foregoing transaction did not involve any underwriters, underwriting
discounts or commissions, or any public offering, and the Company
believes that the transaction was exempt from the registration
requirements of the Securities Act by virtue of Section 4(2) thereof.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C>
27.1 Financial Data Schedule.
</TABLE>
(b) REPORTS ON FORM 8-K
The Company filed a current report on July 13, 2000 reporting its
execution on June 28, 2000 of a definitive agreement to acquire
FastLane Technologies, Inc.
The Company filed a current report on September 26, 2000
reporting its completion of the FastLane Technologies, Inc.
acquisition. This report was amended on October 5, 2000 to
include the historical financial statements of FastLane
Technologies, Inc. and pro forma financial information.
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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.
November 14, 2000 /s/ JOHN J. LASKEY
-----------------------------------------
John J. Laskey
Chief Financial Officer and Vice
President, Finance
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<PAGE> 29
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
27.1 Financial Data Schedule.
</TABLE>
