<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 JUNE 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)
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)
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 July 31, 2000 was 85,714,855.
<PAGE> 2
QUEST SOFTWARE, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
-----------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2000 (unaudited)
and December 31, 1999.......................................................2
Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 2000 and 1999 (unaudited).............................3
Consolidated Statements of Comprehensive Operations for the Three and Six
Months Ended June 30, 2000 and 1999 (unaudited).............................4
Consolidated Statements of Cash Flows for the Six Months
Ended June 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..........................................................................11
Item 3. Quantitative and Qualitative Disclosure about Market Risk...........................23
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...........................................25
Item 4. Submission of Matters to a Vote of Security Holders.................................25
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>
JUNE 30, DECEMBER 31,
2000 1999
--------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .............................................. $ 83,290 $ 39,643
Short-term marketable securities ....................................... 40,163 11,000
Accounts receivable, net ............................................... 19,719 18,771
Prepaid expenses and other current assets .............................. 7,740 3,244
Deferred income taxes .................................................. 5,499 2,089
--------- --------
Total current assets ................................................ 156,411 74,747
Property and equipment, net ................................................ 33,033 7,179
Long-term marketable securities ............................................ 137,461 4,484
Goodwill and purchased intangible assets, net .............................. 142,969 11,452
Deferred income taxes ...................................................... 415 415
Other assets ............................................................... 4,365 872
--------- --------
Total assets ........................................................ $ 474,654 $ 99,149
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ....................................................... $ 3,918 $ 3,436
Accrued compensation ................................................... 6,132 4,966
Other accrued expenses ................................................. 10,187 7,062
Income taxes payable ................................................... 1,903 2,030
Deferred support revenue ............................................... 16,693 13,932
Deferred license revenue ............................................... 8,495 4,651
--------- --------
Total current liabilities ........................................... 47,328 36,077
Long-term liabilities and other ............................................ 3,148 403
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; 85,677 and 77,810
issued and outstanding at June 30, 2000 and December 31, 1999,
respectively ........................................................ 465,616 94,010
Retained earnings (deficit) ............................................ (8,231) 1,864
Accumulated other comprehensive loss ................................... (541) (26)
Notes receivable from sale of common stock ............................. (2,602) (3,115)
Capital distribution in excess of basis in common stock ................ (30,064) (30,064)
--------- --------
Total shareholders' equity .......................................... 424,178 62,669
--------- --------
Total liabilities and shareholders' equity .......................... $ 474,654 $ 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ----------------------
2000 1999 2000 1999
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Revenues:
Licenses ......................................... $ 28,528 $ 11,825 $ 50,423 $21,365
Services ......................................... 8,126 3,625 14,956 6,924
-------- -------- -------- -------
Total revenues ............................... 36,654 15,450 65,379 28,289
Cost of revenues:
Licenses ......................................... 870 720 1,505 1,404
Services ......................................... 2,252 834 4,122 1,738
Amortization of purchased developed technology ... 1,101 -- 1,758 --
-------- -------- -------- -------
Total cost of revenues ....................... 4,223 1,554 7,385 3,142
-------- -------- -------- -------
Gross profit ......................................... 32,431 13,896 57,994 25,147
Operating expenses:
Sales and marketing .............................. 16,962 7,122 30,876 12,158
Research and development ......................... 9,336 3,276 16,702 6,034
General and administrative ....................... 3,635 2,051 6,732 3,989
Other compensation costs and goodwill amortization 8,031 775 15,409 775
-------- -------- -------- -------
Total operating expenses ..................... 37,964 13,224 69,719 22,956
-------- -------- -------- -------
Income (loss) from operations ........................ (5,533) 672 (11,725) 2,191
Other income (expense), net .......................... 3,665 (31) 4,644 82
-------- -------- -------- -------
Income (loss) before income tax provision ............ (1,868) 641 (7,081) 2,273
Income tax provision ................................. 2,541 270 3,013 959
-------- -------- -------- -------
Net income (loss) .................................... $ (4,409) 371 $(10,094) 1,314
======== ========
Preferred stock dividends ............................ 340 340
-------- -------
Net income applicable to common shareholders ......... $ 31 $ 974
======== =======
Basic and diluted net income (loss) per share ........ $ (0.05) $ 0.00 $ (0.12) $ 0.01
======== ======== ======== =======
Weighted average shares:
Basic ............................................ 85,526 66,283 83,351 77,617
Diluted .......................................... 85,526 76,439 83,351 85,128
</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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- -------------------
2000 1999 2000 1999
------- ---- -------- ----
<S> <C> <C> <C> <C>
Net income (loss) applicable to common shareholders $(4,409) $31 $(10,094) $974
Other comprehensive loss:
Unrealized loss on available-for-sale securities (60) -- (515) --
------- --- -------- ----
Comprehensive income (loss) ........................ $(4,469) $31 $(10,609) $974
======= === ======== ====
</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>
SIX MONTHS ENDED
JUNE 30,
------------------------
2000 1999
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) .......................................................... $ (10,094) $ 1,314
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization ........................................... 16,783 1,002
Compensation expense associated with stock option grants ................ 1,579 60
Accrued interest receivable from shareholders ........................... (98) (96)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable ................................................... (204) (3,004)
Prepaid expenses and other current assets ............................. (4,355) (888)
Deferred taxes ........................................................ 27 --
Other assets .......................................................... (2,657) (383)
Accounts payable ...................................................... 218 (97)
Accrued compensation .................................................. 1,186 1,319
Income taxes payable .................................................. 2,736 --
Other accrued expenses ................................................ (2,520) 1,471
Deferred revenue ...................................................... 6,009 3,623
--------- --------
Net cash provided by operating activities ............................. 8,610 4,321
Cash flows used in investing activities:
Purchases of property and equipment ........................................ (24,206) (1,520)
Purchases of software licenses ............................................. (1,265) (234)
Cash paid for acquisitions, net of cash acquired ........................... (30,824) --
Purchases of marketable securities ......................................... (258,233) --
Sales and maturities of marketable securities .............................. 95,580 --
--------- --------
Net cash used in investing activities ................................. (218,948) (1,754)
Cash flows from financing activities:
Repayment of notes payable ................................................. (1,410) (8)
Proceeds from note payable ................................................. -- 10,000
Repayment of capital lease obligations ..................................... (332) --
Proceeds from issuance of preferred stock .................................. -- 25,000
Repurchase of common stock ................................................. -- (35,000)
Payment on notes receivable from shareholders for purchase of common stock . -- 230
Proceeds from exercise of stock options .................................... 803 7
Proceeds from employee stock purchase plan ................................. 1,417 --
Proceeds from issuance of common stock, net ................................ 253,469 --
--------- --------
Net cash provided by financing activities ............................. 253,947 229
Effect of exchange rate changes on cash and cash equivalents .................... 38 --
--------- --------
Net increase in cash and cash equivalents ....................................... 43,647 2,796
Cash and cash equivalents, beginning of period .................................. 39,643 8,891
--------- --------
Cash and cash equivalents, end of period ........................................ $ 83,290 $ 11,777
========= ========
Supplemental disclosures of consolidated cash flow information:
Cash paid for:
Interest ................................................................ $ 120 $ 69
========= ========
Income taxes ............................................................ $ 270 $ 1,787
========= ========
Supplemental schedule of noncash investing and financing activities:
Accrued interest receivable from shareholders .............................. $ 492 $ 96
========= ========
Unrealized loss from available-for-sale securities ......................... $ (515) $ --
========= ========
Tax benefit related to stock option exercises .............................. $ (2,843) $ --
========= ========
Dividends payable on Series B Redeemable Preferred Stock ................... $ -- $ 340
========= ========
</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
1. BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements of
Quest Software, Inc., a California corporation (the "Company" or "Quest"), as of
June 30, 2000 and for the three and six months ended June 30, 2000 and 1999,
respectively, 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 six month periods ended June 30,
2000, respectively, are not necessarily indicative of the results that may be
expected for the full year ending December 31, 2000.
NEW ACCOUNTING PRONOUNCEMENTS:
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, 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 Company is currently
evaluating the impact of SAB 101 will have on its financial statements, if any.
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):
<TABLE>
<S> <C>
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
=========
</TABLE>
6
<PAGE> 8
On February 1, 2000, the Company acquired all of the outstanding common
stock of QMaster Software Solutions ("QMaster") for a cash payment of $15.0
million, including $0.1 million in direct acquisition costs. The acquisition was
accounted for as a purchase, and the purchase price was allocated as follows (in
thousands):
<TABLE>
<S> <C>
Current assets ............... $ 565
Fixed assets ................. 106
Goodwill and other intangibles 14,953
Liabilities assumed .......... (521)
--------
Total purchase price ...... $ 15,103
========
</TABLE>
On April 17, 2000, the Company acquired all of the outstanding common
stock of Client/Server Solutions, Inc. ("CSSI") for a cash payment of $12.7
million. The Company, acting as escrow agent, has withheld $1.3 million of this
amount. The acquisition was accounted for as a purchase, and the purchase price,
including $0.3 million of direct acquisition costs, was allocated as follows (in
thousands):
<TABLE>
<S> <C>
Current assets ............... $ 339
Fixed assets ................. 17
Goodwill and other intangibles 13,238
Liabilities assumed .......... (601)
--------
Total purchase price ...... $ 12,993
========
</TABLE>
On April 27, 2000, the Company acquired all of the outstanding common
stock of MessageWise, Inc. ("MessageWise") in exchange for 202,000 exchangeable
shares of a subsidiary of the Company valued at $8.1 million (each of which is
exchangeable for one share of common stock of the Company) and cash payments of
$4.1 million. The acquisition was accounted for as a purchase, and the purchase
price, including $0.3 million of direct acquisition costs, was allocated as
follows (in thousands):
<TABLE>
<S> <C>
Current assets ............... $ 630
Deferred taxes ............... 267
Fixed assets ................. 70
Goodwill and other intangibles 12,403
Liabilities assumed .......... (861)
--------
Total purchase price ...... $ 12,509
========
</TABLE>
On June 29, 2000, the Company signed a definitive agreement to acquire
FastLane Technologies for a combination of cash and stock totaling approximately
$100 million. The acquisition, which the Company expects to complete in the
third quarter of 2000, will be accounted for as a purchase.
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.
7
<PAGE> 9
The table below sets forth the reconciliation of the denominator of the
earnings per share calculations (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Shares used in computing basic net income (loss)
per share ................................... 85,526 66,283 83,351 77,617
Dilutive effect of stock options ............... --(1) 4,002 --(1) 4,417
Convertible preferred stock .................... -- 6,154 -- 3,094
------ ------ ------ ------
Shares used in computing diluted net income
(loss) per share ............................ 85,526 76,439 83,351 85,128
====== ====== ====== ======
</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 5,922 and 6,098 for
the three and six months ended June 30, 2000, respectively.
4. ACCUMULATED OTHER COMPREHENSIVE LOSS
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (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 month
period ended March 31, 2000. Accumulated other comprehensive operations as of
March 31, 2000 is comprised of the following (in thousands):
<TABLE>
<CAPTION>
UNREALIZED
LOSS ON
AVAILABLE-FOR-SALE
SECURITIES
------------------
<S> <C>
Balance, December 31, 1999 $ (26)
Current period changes (515)
-----
Balance, June 30, 2000 ... $(541)
=====
</TABLE>
5. SHAREHOLDERS' EQUITY
In February 2000, 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 plans to use the proceeds of the offering for general
corporate purposes, including working capital, expanding sales and marketing
efforts, product development, expansion of its customer support organization,
possible acquisitions and capital expenditures. 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 financials 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.
8
<PAGE> 10
6. STOCK OPTION PLANS
The following table summarizes information about stock options
outstanding as of June 30, 2000 (in thousands, except for per share data):
<TABLE>
<CAPTION>
Number of Options
Number of Exercisable as of
Shares Price per Share June 30, 2000
--------- --------------- -----------------
<S> <C> <C> <C>
Balance at December 31, 1999 10,512 $0.50 - $40.25
Granted 3,302 0.05 - 40.02
Exercised (1,345) 0.05 - 1.19
Canceled (722) 0.50 - 40.25
------
Balance at June 30, 2000 11,747 $0.50 - $40.25 1,229
======
</TABLE>
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.
9
<PAGE> 11
Operating segment data for the three and six months ended June 30, 2000
and 1999, respectively, was as follows (in thousands):
<TABLE>
<CAPTION>
LICENSES SERVICES TOTAL
-------- -------- -------
<S> <C> <C> <C>
Three months ended June 30, 2000:
Revenues $28,528 $ 8,126 $36,654
Cost of revenues 1,971(1) 2,252 4,223
------- ------- -------
Gross profit $26,557 $ 5,874 $32,431
======= ======= =======
Three months ended June 30, 1999:
Revenues $11,825 $ 3,625 $15,450
Cost of revenues 720 834 1,554
------- ------- -------
Gross profit $11,105 $ 2,791 $13,896
======= ======= =======
Six months ended June 30, 2000:
Revenues $50,423 $14,956 $65,379
Cost of revenues 3,263(1) 4,122 7,385
------- ------- -------
Gross profit $47,160 $10,834 $57,994
======= ======= =======
Six months ended June 30, 1999:
Revenues $21,365 $ 6,924 $28,289
Cost of revenues 1,404 1,738 3,142
------- ------- -------
Gross profit $19,961 $ 5,186 $25,147
======= ======= =======
</TABLE>
(1) Includes amortization of purchased developed technology of $1,101 and $1,758
for the three and six months ended June 30, 2000, respectively, which is
included in total cost of revenues in the accompanying Consolidated Statements
of Operations.
Revenues are attributed to geographic areas based on the location of
the entity to 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 June 30, 2000:
Revenues $ 30,365 $ 8,332 $(2,043) $ 36,654
Gross profit 28,800 5,669 (2,038) 32,431
Long-lived assets 175,555(1) 1,886 -- 177,441
Three months ended June 30, 1999:
Revenues $ 12,788 $ 3,019 $ (357) $ 15,450
Gross profit 11,368 2,886 (358) 13,896
Long-lived assets 2,142 525 -- 2,667
Six months ended June 30, 2000:
Revenues $ 53,874 $15,439 $(3,934) $ 65,379
Gross profit 51,779 10,196 (3,981) 57,994
Long-lived assets 175,555(1) 1,886 -- 177,441
Six months ended June 30, 1999:
Revenues $ 24,573 $ 4,799 $(1,083) $ 28,289
Gross profit 21,662 4,574 (1,089) 25,147
Long-lived assets 2,142 525 -- 2,667
</TABLE>
(1) Includes $1,439 of other intangible assets (net), which are included in
other assets in the accompanying Consolidated Balance Sheet.
10
<PAGE> 12
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, 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 the United States, Canada, the United Kingdom, Germany and
Australia. We intend to expand our international sales activities as part of our
business strategy. All of our current international revenues are derived from
the operations of our four wholly-owned subsidiaries in Canada, the United
Kingdom, Germany, and Australia, 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, 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.
11
<PAGE> 13
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 Six months ended
June 30, June 30,
------------------ ----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Licenses 78% 77% 77% 76%
Services 22 23 23 24
---- --- ---- ---
Total revenues 100 100 100 100
Cost of revenues:
Licenses 3 5 2 5
Services 6 5 6 6
Amortization of purchased developed technology 3 -- 3 --
---- --- ---- ---
Total cost of revenues 12 10 11 11
---- --- ---- ---
Gross profit 88 90 89 89
Operating expenses:
Sales and marketing 46 46 47 43
Research and development 25 21 26 21
General and administrative 10 13 10 14
Other compensation costs and goodwill amortization 22 5 24 3
---- --- ---- ---
Total operating expenses 103 85 107 81
---- --- ---- ---
Income (loss) from operations (15) 5 (18) 8
Other income (expense), net 10 -- 7 --
---- --- ---- ---
Income (loss) before income tax provision (5) 5 (11) 8
Income tax provision 7 2 4 3
---- --- ---- ---
Net income (loss) (12)% 3 (15)% 5
==== ====
Preferred stock dividends 3 2
--- ---
Net income applicable to common shareholders 0% 3%
=== ===
</TABLE>
THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 1999
REVENUES
Total revenues for the three and six months ended June 30, 2000 were
$36.7 million and $65.4 million, respectively, an increase of 137% and 131%,
respectively, from the comparable periods of 1999. International revenues for
the three and six months ended June 30, 2000 were $8.3 million and $15.4
million, respectively, an increase of 176% and 222%, respectively, from the
comparable periods of 1999.
LICENSES
Licenses revenues for the three and six months ended June 30, 2000 were
$28.5 million and $50.4 million, respectively, an increase of 141% and 136%,
respectively, from the comparable periods of 1999. The increase resulted both
from the 119% increase in the size of our worldwide sales organization since
June 30, 1999 as well as the availability of new products, primarily the
Foglight enterprise monitoring product. Licenses revenues represented 78% and
77% of total revenues for the three and six months ended June 30, 2000,
respectively, compared to 77% and 76%, respectively, for the comparable periods
of 1999. International licenses revenues for the three and six months ended June
30, 2000 were $4.9 million and $9.2 million, respectively, an increase of 32%
and 76%, 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 six months ended June 30, 2000 were
$8.1 million and $15.0 million, respectively, an increase of 124% and 116%,
respectively, from the comparable periods of 1999. The increase in services for
the three and six months of 2000 reflected increases in the installed base of
customers that purchased maintenance. Services revenues represented 22% and 23%
of total revenues for the three and six months of 2000, respectively, compared
to 23% and 24%, respectively, in the comparable periods of 1999. International
services revenues for the three and six months ended June 30, 2000 were $1.5
million and $2.4 million, respectively, an increase of 185% and 135%,
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 six months ended June
30, 2000 were $0.9 million and $1.5 million, respectively, an increase of 21%
and 7%, 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 the three and six months ended June 30, 2000 were 3%,
compared to 6% and 7%, respectively, in the comparable periods of 1999. The
decreases for the three and six months of 2000 as a percentage of licenses
revenues resulted from increased licenses revenues without a corresponding
increase in amortization of software licenses, which do 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 six months
ended June 30, 2000 were $2.3 million and $4.1 million, respectively, an
increase of 170% and 137%, respectively, from the comparable periods of 1999.
The increases were primarily due to a 121% 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 June 30, 1999. Also
contributing to the increased costs were related training and travel expenses.
We have also formed a professional services 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 six months ended June 30, 2000 were 28%,
compared to 23% and 25% in the respective periods of 1999. We expect the cost of
services to increase in absolute dollars for the foreseeable future as
additional customer support and consulting personnel are retained.
AMORTIZATION OF PURCHASED DEVELOPED TECHNOLOGY
Amortization of purchased developed technology of $1.1 million and $1.8
million for the three and six months ended June 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 six months ended June
30, 2000 were $17.0 million and $30.9 million, respectively, an increase of 138%
and 154%, respectively, from the comparable periods of 1999. The increases
reflect increased salaries and related expenses due to the 112% increase in our
sales and marketing organization personnel since June 30, 1999. Also
contributing to the increases were an increase in sales commissions due to
revenue growth, as well as increases in trade show and conference expenses due
to greater participation in such activities. Sales and marketing expenses as a
percentage of total revenues in the three and six months ended June 30, 2000
were 46% and 47%, respectively, compared to 46% and 43%, in the respective
periods of 1999. We expect that sales and marketing expenses will continue to
increase in absolute dollars for the
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<PAGE> 15
foreseeable future as commissions increase with expected increases in revenues
and as we continue to expand the size of our sales and marketing organization.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of salaries and
benefits for software developers, software product managers and quality
assurance personnel, and payments to outside software development contractors.
Research and development expenses for the three and six months ended June 30,
2000 were $9.3 million and $16.7 million, respectively, an increase of 185% and
177%, respectively, from the comparable periods of 1999. The increases were
primarily related to a 167% increase in the number of R&D personnel since June
30, 1999, resulting primarily from additions to our domestic, Australian, and
Canadian development operations. These expenses as a percentage of total
revenues in the three and six months ended June 30, 2000 were 25% and 26%,
respectively, compared to 21%, in the comparable periods of 1999. We expect that
research and development expenses will continue to increase in absolute dollars
for the foreseeable future as additional development personnel are hired.
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 six months ended June 30, 2000 were $3.6 million and $6.7 million,
respectively, an increase of 77% and 69%, 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 six months ended June 30, 2000 were 10%, compared to 13% and 14%,
respectively, 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
staff 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.
OTHER COMPENSATION COSTS AND GOODWILL AMORTIZATION
Other compensation costs and goodwill amortization for the three and
six months ended June 30, 2000 were $8.0 million and $15.4 million,
respectively, compared to $0.8 million in the same periods of 1999. The increase
in these costs was primarily attributable to amortization of goodwill associated
with acquisitions during the first six months of 2000. Goodwill amortization for
the three and six months ended June 30, 2000 was $7.1 million and $12.8 million,
respectively, versus none in the same periods of 1999.
OTHER INCOME (EXPENSE), NET
Other income (expense), net is comprised of interest income, interest
expense and foreign currency transaction gains and losses. Other income
(expense), net for the three and six months ended June 30, 2000 were $3.7
million and $4.6 million, respectively, compared to $0.0 million and $0.1
million in the same periods of 1999. The increases during the three and six
months of 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.
PROVISION FOR INCOME TAXES
Provision for income taxes for the three and six months ended June 30,
2000 were $2.5 million and $3.0 million, respectively. Excluding other
compensation costs and amortization of goodwill as well as amortization of
purchased intangible assets, our effective income tax rate for the three and six
months ended June 30, 2000 was 40%, compared to 42% for the comparable periods
of 1999.
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NET INCOME (LOSS)
Net loss for the three and six months ended June 30, 2000 was $4.4
million and $10.1 million, respectively, compared with net income of $0.3
million and $1.3 million, respectively, in the comparable periods of 1999 due to
the factors noted above.
NET INCOME APPLICABLE TO COMMON SHAREHOLDERS
Net income applicable to common shareholders for the three and six
months ended June 30, 1999 was $0.0 million and $1.0 million, respectively,
resulting from cumulative dividends paid on the Series B Redeemable Preferred
Stock. There were no comparable costs during the first three and six months of
2000.
INFLATION
Inflation has not had a significant effect on our results of operations
or financial position for the three and six months ended June 30, 2000 or the
comparable periods of 1999.
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 June 30, 2000 consisted
principally of cash and cash equivalents of $83.3 million and $177.6 million in
high grade corporate and government short-term and long-term marketable
securities.
Net cash provided by operating activities was $8.6 million and $4.3
million for the six months ended June 30, 2000 and 1999, respectively.
Investing activities used $218.9 million and $1.8 million for the six
months ended June 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 $258.2 million for the six
months ended June 30, 2000 versus none in the same period of 1999. Cash paid for
acquisitions, net of cash acquired was $30.8 million in the six months ended
June 30, 2000 versus none in the same period of 1999.
Financing activities provided $253.9 million and $0.2 million for the
six months ended June 30, 2000 and 1999, respectively. In March 2000, we raised
net proceeds of $253.6 million from a secondary public offering of 8.4 million
shares 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 existing shareholders. We did not receive any proceeds from the
shares sold by the selling shareholders.
We plan to continue to use the proceeds of the offerings for general
corporate purposes, including working capital, expanding sales and marketing
efforts, product development, expansion of our customer support organization,
possible acquisitions and capital expenditures.
We believe that our existing cash and investment balances and cash from
operations will be sufficient to finance our operations through at least the
next 12 months. 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.
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<PAGE> 17
RISK FACTORS
The following information should be read in conjunction with the
consolidated historical financial information and the notes thereto included in
Item 1 of this report and Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-K as filed with the Securities and Exchange Commission.
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:
o 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."
o increased expenses, whether related to sales and marketing,
product development or administration;
o our ability to attain market acceptance of new products and
services and enhancements to our existing products;
o delays in introducing new products;
o new product introductions by competitors;
o lack of order backlog;
o changes in our pricing policies or the pricing policies of
our competitors;
o costs related to acquisitions of technologies or businesses;
o the timing of releases of new versions of third-party
software products that our products support, including,
without limitation, product releases by Oracle; and
o the amount and timing of expenditures related to expansion
of our operations.
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 ORACLE'S TECHNOLOGIES AND IF ORACLE'S
TECHNOLOGIES LOSE MARKET SHARE OR BECOME INCOMPATIBLE WITH OUR PRODUCTS, THE
DEMAND FOR OUR PRODUCTS COULD SUFFER
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 specifically to be used
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. If Oracle for any reason decides to promote technologies and standards
that are not compatible with our technology, or if Oracle
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<PAGE> 18
loses market share for its 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. In this regard, we
recently acquired Client Server Solutions, Inc. and MessageWise, Inc. 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 may suffer because of acquisition-related costs or
amortization costs for acquired goodwill and other 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
Our ability to increase revenues in the future substantially depends on
our ability to expand our indirect sales channel.
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. During this period, we
have experienced an increase in the number of our employees, increasing demands
on our operating and financial systems and personnel, and an expansion in the
geographic coverage of our operations. The number of our full-time employees
increased from 415 as of June 30, 1999 to 1,000 as of June 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 addition, we will be required to hire additional management,
financial, and
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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.
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:
o increase our sales and marketing activities, including
expanding our direct sales and telesales forces;
o increase our research and development activities;
o expand our general and administrative activities; and
o 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 our four wholly-owned subsidiaries in Canada, the United
Kingdom, Germany, and Australia. Revenues from licenses and services to
customers outside of the United States were $8.3 million and $15.4 million for
the three and six months ended June 30, 2000, respectively, compared to $3.0 and
$4.8 million in the same periods of 1999. International revenues, after
eliminations, represented 17% and 18% of total revenues for the three and six
months ended June 30, 2000, respectively, compared with 17% and 13% in the same
periods of 1999. As a result, we face increasing risks from doing business on an
international basis, including, among others:
o difficulties in staffing and managing foreign operations;
o longer payment cycles;
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o seasonal reductions in business activity in Europe;
o increased financial accounting and reporting burdens and
complexities;
o potentially adverse tax consequences;
o delays in localizing our products;
o compliance with a wide variety of complex foreign laws and
treaties;
o reduced protection for intellectual property rights in some
countries; and
o licenses, tariffs and other trade barriers.
In addition, because our international subsidiaries 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
ad 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.
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.
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
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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:
o loss of or delay in revenues and loss of market share;
o loss of customers;
o damage to our reputation;
o failure to achieve market acceptance;
o diversion of development resources;
o increased service and warranty costs;
o legal actions by customers against us which could, whether
or not successful, increase costs and distract our
management; and
o 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
Our SQL Navigator, TOAD, Vista Plus and Foglight products contain
components developed and maintained by third-party software vendors. For
example, we incorporate software licensed from Inso Corporation and Artifex
Software into add-on options for our Vista Plus products. Similarly, our
Foglight product incorporates software licensed from Inxight. 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 there are adequate alternate sources for the technology
licensed to us by Inso, Artifex, and Inxight, such alternate sources may not
provide us with the same functionality as that currently provided to us.
Further, we may experience a delay in obtaining an alternate source for the file
viewing technology licensed to us by Inso if our license with Inso becomes
unavailable for any reason.
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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, 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:
o 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;
o avoiding difficulties that could delay or prevent the
successful development, introduction or marketing of these
products; or
o 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 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
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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 Company is currently
evaluating the impact of SAB 101 will have on its financial statements, if any.
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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 June 30, 2000, the net loss on available-for-sale
securities of $0.5 million comprised 58 positions, all with unrealized losses or
values equivalent to fair market value.
The following table provides information about our investment portfolio
at June 30, 2000:
<TABLE>
<CAPTION>
JUNE 30, 2000
-------------
(dollars in thousands)
<S> <C>
Cash and cash equivalents $83,290
Average interest rate 4.21%
Short-term marketable securities $40,163
Average interest rate 6.34%
Long-term marketable securities $137,461
Average interest rate 6.39%
Total portfolio $260,914
Average interest rate 5.69%
</TABLE>
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
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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.
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 April 27, 2000, we issued an aggregate of 202,000 exchangeable
shares of our Canadian subsidiary to the former shareholders of
MessageWise, Inc. in connection with our acquisition of MessageWise,
Inc. Each of the exchangeable shares of our Canadian subsidiary are
exchangeable for one share of the Company's common stock.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The Company's Annual Meeting of Shareholders was held on May
16, 2000.
(b) Proxies for the Annual Meeting were solicited pursuant to
Regulation 14 under the Securities Exchange Act of 1934, as
amended, there was no solicitation in opposition to the
management's nominees as listed in the proxy statement, and
all of such nominees were elected.
(c) At the Annual Meeting, our shareholders elected Vincent C.
Smith, David M. Doyle, Doran G. Machin and Jerry Murdock, Jr.
as directors, approved a proposal to amend the Company's 1999
Stock Incentive Plan to increase the aggregate number of
shares of Common Stock reserved for issuance thereunder to
17,500,000 shares and ratified the appointment of Deloitte &
Touche LLP as independent auditors of the Company for the
fiscal year ending December 31, 2000. Set forth below are the
number of votes cast for, against or withheld, as well as the
number of abstentions as to each matter (there were no broker
non-votes).
(1) Election of Directors:
<TABLE>
<CAPTION>
Nominee For Against Withheld
------- ---------- ------- --------
<S> <C> <C> <C>
Vincent C. Smith 68,506,274 0 6,767,726
David M. Doyle 68,506,274 0 6,767,726
Doran Machin 68,506,274 0 6,767,726
Jerry Murdock, Jr. 68,506,274 0 6,767,726
</TABLE>
(2) Amendment to 1999 Stock Incentive Plan:
For Against Abstentions
65,714,279 9,556,538 3,183
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(3) Ratification of Appointment of Deloitte & Touche LLP:
For Against Abstentions
75,270,224 2,397 1,379
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT NUMBER DESCRIPTION
3.3 Certificate of Amendment of Second Amended and
Restated Articles of Incorporation, as filed with the
California Secretary of State on March 31, 2000.
27.1 Financial Data Schedule
(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.
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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.
August 14, 2000 /s/ JOHN J. LASKEY
----------------------------------------
John J. Laskey
Chief Financial Officer and Vice
President, Finance (Principal Financial
and Accounting Officer)
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EXHIBIT INDEX
Exhibit Number Description
-------------- -----------
3.3 Certificate of Amendment of Second Amended and Restated
Articles of Incorporation, as filed with the California
Secretary of State on March 31, 2000.
27.1 Financial Data Schedule
