-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ay6iAJZarWuOWKgZzXja4TzGKn+GGudSqMoxjLfnRRv2+DZnrgjbW1qKYEE+yY2F 6iKL56tejMALtf5Qn5tIJA== 0000892569-00-000249.txt : 20000223 0000892569-00-000249.hdr.sgml : 20000223 ACCESSION NUMBER: 0000892569-00-000249 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 20000222 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUEST SOFTWARE INC CENTRAL INDEX KEY: 0001088033 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330231678 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-30816 FILM NUMBER: 549906 BUSINESS ADDRESS: STREET 1: 8001 IRVINE CENTER DRIVE CITY: IRVINE STATE: CA ZIP: 92618 MAIL ADDRESS: STREET 1: 8001 IRVINE CENTER DRIVE CITY: IRVINE STATE: CA ZIP: 92618 S-1 1 FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 22, 2000 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ QUEST SOFTWARE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 7372 33-0231678 (STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
8001 IRVINE CENTER DRIVE IRVINE, CA 92618 (949) 754-8000 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF THE REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ------------------------ MR. VINCENT C. SMITH CHIEF EXECUTIVE OFFICER QUEST SOFTWARE, INC. 8001 IRVINE CENTER DRIVE IRVINE, CA 92618 (949) 754-8000 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: LAURA B. HUNTER, ESQ. ALAN K. AUSTIN, ESQ. CHRISTINE P. LE, ESQ. BRIAN C. ERB, ESQ. BROBECK, PHLEGER & HARRISON LLP BRIAN M. MCDANIEL, ESQ. 38 TECHNOLOGY DRIVE WILSON SONSINI GOODRICH & ROSATI IRVINE, CALIFORNIA 92618 PROFESSIONAL CORPORATION (949) 790-6300 650 PAGE MILL ROAD PALO ALTO, CALIFORNIA 94304 (650) 493-9300
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. ------------------------ If the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended (the "Securities Act"), check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE(1) REGISTRATION FEE(2) - -------------------------------------------------------------------------------------------------------------------- Common stock, no par value.................................. $224,000,000 $59,136 - -------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------
(1) Includes 420,000 shares which the Underwriters have the option to purchase from certain selling shareholders and/or the Company to cover over-allotments, if any. (2) Estimated solely for the purpose of computing the registration fee pursuant to Rule 457(c) of the Securities Act of 1933, as amended, and based upon the average high and low prices on February 14, 2000, as reported on the Nasdaq National Market. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY CHANGE. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES, AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION, DATED FEBRUARY 22, 2000 [QUEST SOFTWARE LOGO] 2,800,000 SHARES COMMON STOCK ---------------------------------- Quest Software, Inc. is offering 1,000,000 shares of common stock. The selling shareholders identified in this prospectus are offering an additional 1,800,000 shares. We will not receive any proceeds from the shares of common stock sold by the selling shareholders. Our common stock is traded on the Nasdaq National Market under the symbol "QSFT." On February 16, 2000, the last reported sale price for our common stock on the Nasdaq National Market was $83.00 per share. ---------------------------------- INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 7. ----------------------------------
PER SHARE TOTAL --------- ------------ Public Offering Price....................................... $83.00 $232,400,000 Underwriting Discounts and Commissions...................... $ 3.74 $ 10,472,000 Proceeds to Quest Software, Inc............................. $79.26 $ 79,260,000 Proceeds to selling shareholders............................ $79.26 $142,668,000
---------------------------------- THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE NOT APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. We have granted the underwriters a 30-day option to purchase from certain selling shareholders and/or us up to an additional 420,000 shares of common stock to cover any over-allotments. FleetBoston Robertson Stephens Inc. expects to deliver the shares of common stock to purchasers on . ---------------------------------- ROBERTSON STEPHENS DONALDSON, LUFKIN & JENRETTE CIBC WORLD MARKETS FAC/EQUITIES CHASE H&Q WIT SOUNDVIEW THE DATE OF THIS PROSPECTUS IS FEBRUARY , 2000. 3 Inside Front Cover [QUEST SOFTWARE LOGO] The Quest Solution. Quest offers both application and information availability solutions that enhance the performance and reliability of e-business, enterprise and custom applications and facilitate the delivery of information across the entire enterprise. [Schematic depiction of enterprise software environment showing the functionality of and relationships among Quest's products and this underlying environment.] [Three columns of text at the bottom of the page. The first column is entitled "Development -- Deployment" and reads, "Integrated products that aid in the rapid development, testing and automated deployment of Internet software applications in quickly changing, mission-critical environments." The second column is entitled "Production Management" and reads, "Software solutions designed to maintain high performance and provide constant access to critical business applications, as well as monitoring these systems to detect and correct problems before they impact users." The third column is entitled "Information Delivery" and reads, "An output management system that captures and delivers reports and data from nearly any software application for immediate and secure distribution to information consumers within an organization or over the Internet."] 2 4 YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED. ------------------------ TABLE OF CONTENTS
PAGE ---- Summary..................................................... 4 Risk Factors................................................ 7 Information Regarding Forward-Looking Statements............ 15 Use of Proceeds............................................. 16 Dividend Policy............................................. 16 Price Range of Common Stock................................. 16 Capitalization.............................................. 17 Selected Consolidated Financial Data........................ 18 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 19 Business.................................................... 28 Management.................................................. 42 Certain Transactions........................................ 51 Principal and Selling Shareholders.......................... 53 Description of Capital Stock................................ 56 Shares Eligible for Future Sale............................. 58 Underwriting................................................ 60 Legal Matters............................................... 62 Experts..................................................... 62 Additional Information...................................... 62 Index to Financial Statements............................... F-1
3 5 SUMMARY You should read the following summary together with the more detailed information and consolidated financial statements and the notes to those statements appearing elsewhere in this prospectus. This prospectus contains forward looking statements that involve risks and uncertainties. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of the factors set forth under "Risk Factors" and elsewhere in this prospectus. QUEST SOFTWARE, INC. We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, enterprise and custom applications and enable the delivery of information across the entire enterprise. Organizations are constantly seeking ways to use information and technology to compete more effectively. Today, organizations must deliver relevant information and provide increasingly sophisticated and time-sensitive services to a rapidly expanding audience, including employees, customers, suppliers and partners both inside and outside the traditional enterprise. Many organizations are beginning to extend their business over the Internet to directly reach a large number of geographically dispersed end-users. These initiatives, commonly referred to as e-business, are raising the strategic importance of real-time information and are increasing the challenges of building and maintaining the systems to effectively manage and distribute information. As a result, organizations must assure that their systems provide: - Application availability -- uninterrupted and high performance access to applications under widely varying conditions; and - Information availability -- broad distribution of critical business information from underlying applications to decision-makers throughout the entire enterprise. We offer a family of products that provide both application and information availability solutions. Our products are designed to work individually and together to provide immediate and continuous availability of applications and information. Our application availability products are designed to help ensure uninterrupted and high performance access to software systems by utilizing a number of integrated products that tune the performance and monitor the operation of applications and the underlying database which stores an enterprise's critical information. Other primary components of our application availability solution include our database products that maintain a real-time copy of a database for offloading critical systems and assuring high availability, as well as our products that manage the complex and error-prone process of development and deployment of rapidly changing applications. Our information availability products deliver an enterprise, report-based information management solution that captures, stores, indexes, prints and archives report data or electronic documents from virtually any application for instant distribution over intranets or the Internet. The key elements of our strategy include extending our product leadership, continuing our focus on the e-business applications market, leveraging our significant installed base, expanding our sales force and international distribution channels and extending our existing strategic relationships and developing new partnerships with leading global systems integrators. We have thousands of customers across a range of industries including technology, financial services, manufacturing, healthcare, energy, insurance and telecommunications. We market and sell our software and services worldwide through a combination of direct sales and telesales in the United States, Canada, Australia, the United Kingdom and Germany, as well as through resellers and distributors. In August 1999, we completed an initial public offering of our common stock, raising net proceeds of approximately $64.9 million. In December 1999, we acquired MBR Technologies, Inc. In January 2000, we acquired Foglight Software, Inc. and in February 2000, we acquired QMaster Software Solutions, Inc. 4 6 THE OFFERING Common stock offered by Quest......... 1,000,000 shares Common stock offered by selling shareholders.......................... 1,800,000 shares Common stock to be outstanding after this offering......................... 39,905,344 shares Use of proceeds....................... We intend to use the net proceeds for general corporate purposes, including working capital, expanding our sales and marketing efforts, product development, expanding our customer support organization, possible acquisitions and capital expenditures. Nasdaq National Market symbol......... QSFT The number of shares of common stock to be outstanding after this offering is based on the actual number of shares outstanding as of December 31, 1999 which excludes: - 5,085,935 shares of common stock issuable upon exercise of stock options outstanding as of February 16, 2000, at a weighted average exercise price of $6.81 per share; - 190,974 shares of common stock issued upon the exercise of options in between January 1, 2000 and February 16, 2000; - 2,214,820 shares of common stock reserved for future issuance under our stock incentive plans; - 600,000 shares of common stock reserved for issuance under our employee stock purchase plan, of which 119,097 shares were issued in February 2000. See "Capitalization," "Management -- 1999 Stock Incentive Plan," "-- 1999 Employee Stock Purchase Plan" and Note 8 of the notes to our consolidated financial statements; and - 1,187,603 shares of common stock issued in connection with an acquisition in January 2000. CORPORATE INFORMATION We were incorporated in California in April 1987. Our principal executive offices are located at 8001 Irvine Center Drive, Irvine, CA 92618 and our telephone number is (949) 754-8000. Our Web site is located at www.quest.com. Information contained on our Web site does not constitute part of this prospectus. Except as otherwise noted, all information in this prospectus assumes that the underwriters' over-allotment option is not exercised. 5 7 SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The following table should be read with the consolidated financial statements and notes thereto appearing elsewhere in this prospectus. The as adjusted information reflects our receipt of the estimated net proceeds from the sale of 1,000,000 shares of our common stock offered by us hereby at a public offering price of $83.00 per share and the application of the estimated proceeds described in "Use of Proceeds."
YEAR ENDED DECEMBER 31, ---------------------------------------------- 1995 1996 1997 1998 1999 ------ ------- ------- ------- ------- CONSOLIDATED STATEMENT OF INCOME DATA: Total revenues................................ $9,524 $12,862 $18,315 $34,790 $70,868 Gross profit.................................. 8,284 10,445 15,036 28,850 63,675 Income (loss) from operations................. 2,335 (372) 1,448 3,689 4,468 Net income.................................... 2,358 16 289 2,346 3,397 Net income applicable to common shareholders................................ 2,807 Basic and diluted net income per share:....... $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.07 Weighted average common shares outstanding: Basic....................................... 19,500 38,350 40,373 44,261 37,677 Diluted..................................... 19,500 38,350 40,617 44,459 41,800
DECEMBER 31, 1999 --------------------- ACTUAL AS ADJUSTED ------- ----------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................... $39,643 $118,353 Short-term marketable securities............................ 11,000 11,000 Working capital............................................. 38,670 117,380 Total assets................................................ 99,149 177,859 Retained earnings........................................... 1,864 1,864 Total shareholders' equity.................................. 62,669 141,379
6 8 RISK FACTORS An investment in our shares involves risks and uncertainties. You should carefully consider the factors described below before making an investment decision in our securities. The risks described below are the risks that we currently believe are material risks of business, the industry in which we compete and this offering. Our business, financial condition and results of operations could be adversely affected by any of the following risks. If we are adversely affected by such risks, then the trading price of our common stock could decline, and you could lose all or part of your investment. 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; - 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. 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 large amount of our sales in the last month or weeks of each quarter and delays in the closing of sales near the end of a quarter could cause quarterly revenue 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 7 9 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 are 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 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. See "Business -- Competition." 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 MBR Technologies, Inc., Foglight Software, Inc., and QMaster Software Solutions, 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 type of relationships. There can be no 8 10 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 66 as of December 31, 1996 to 123 as of December 31, 1997, to 257 as of December 31, 1998, and to 654 as of December 31, 1999. 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 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: - 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 9 11 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 three wholly-owned subsidiaries in Australia, the United Kingdom and Germany. Revenues from licenses and services to customers outside of North America were $5.8 million in 1998, representing 16.7% of total revenues, and $15.3 million in the year ended December 31, 1999, representing 21.6% of total revenues. 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; - 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 conduct business in the currency of the country in which they operate, we are subject to currency fluctuations and currency transaction losses or gains which 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. 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 10 12 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 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. 11 13 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. 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: - 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. 12 14 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. RISKS RELATED TO THIS OFFERING OUR OFFICERS AND DIRECTORS WILL BE ABLE TO EXERT SIGNIFICANT CONTROL ON QUEST AFTER THIS OFFERING Executive officers, directors and persons and entities affiliated with them will, in the aggregate, own approximately 73.9% of our outstanding common stock following this offering. These shareholders, if acting together, would be able to determine all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combination transactions. WE EXPECT THE PRICE OF OUR COMMON STOCK TO BE VOLATILE The market price of the common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including: - quarterly variations in our operating results; - changes in financial estimates by securities analysts; - changes in market valuation of software and Internet companies; - announcements by us of significant contracts, acquisitions or capital commitments; - failure to complete significant license transactions; - additions or departures of key personnel; - any shortfall in revenue or net income or any increase in losses from levels expected by securities analysts; - future sales of common stock; and - stock market price and volume fluctuations, which are particularly common among highly volatile securities of Internet and software companies. YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION The public offering price is substantially higher than the net tangible book value per share of the outstanding common stock after this offering. Accordingly, if you purchase common stock in this offering at the offering price of $83.00 per share, you will incur immediate and substantial dilution of $79.76 in the net tangible book value per share of the common stock from the price you pay for the common stock in this offering. A LARGE NUMBER OF SHARES OF OUR COMMON STOCK WILL BE ELIGIBLE FOR SALE SHORTLY AFTER THE OFFERING, WHICH COULD RESULT IN A DECLINE IN OUR STOCK PRICE Sales in the market of a substantial number of shares of common stock after the offering could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. Based on the shares of common stock outstanding as of December 31, 1999, on completion of this offering, we will have 39,905,344 shares of common stock 13 15 outstanding (based on the assumptions on page 5), and up to 40,325,344 shares if the underwriters' option to purchase additional shares is exercised from existing shareholders and/or the Company in full. The 2,800,000 shares sold in this offering, which would be 3,220,000 shares if the underwriters' option to purchase additional shares is exercised in full, will be freely tradable without restriction or further registration under the Federal securities laws unless purchased by our "affiliates" as that term is defined in Rule 144. 32,104,783 of the remaining shares of common stock outstanding on completion of this offering will be "restricted securities" as that term is defined in Rule 144. Some of our stock and substantially all of our option holders are subject to agreements that limit their ability to sell common stock. These holders cannot sell or otherwise dispose of any shares of common stock for a period of at least 90 days after the date of this prospectus without the prior written approval of FleetBoston Robertson Stephens. When these agreements expire, these shares and the shares underlying the options will become eligible for sale, in some cases only pursuant to the volume, manner of sale and notice requirements of Rule 144. See "Shares Eligible for Future Sale" and "Underwriting." 14 16 INFORMATION REGARDING FORWARD-LOOKING STATEMENTS Some of the matters discussed under the captions "Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this prospectus include forward-looking statements. We have based these forward-looking statements on currently available information and our current beliefs, expectations and projections about future events, including, among other things, - successfully implementing our business strategy; - maintaining and expanding market acceptance of the products we offer; and - our ability to successfully compete in our marketplace. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "potential," "continue," "expects," "anticipates," "intends," "plans," "believes," "estimates" and similar expressions. All forward-looking statements contained herein are subject to numerous risks and uncertainties. Our actual results and events may vary significantly from those discussed in the forward-looking statements. In light of these assumptions, risks and uncertainties, the forward-looking events discussed in this prospectus might not occur. 15 17 USE OF PROCEEDS The net proceeds to us from the sale of the 2,800,000 shares of common stock offered hereby will be approximately $78,710,000 million to the Company and $142,668,000 to the selling shareholders based upon an estimated offering price per share of $83.00 and after conducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of the shares of our common stock being offered by the selling shareholders in this prospectus. We intend to use the net proceeds of this offering to the Company for general corporate purposes, including working capital, expanding our sales and marketing efforts, product development, expanding our customer support organization, possible acquisitions and capital expenditures. The other principal purposes of this offering are to increase our financial flexibility, facilitate our future access to public equity markets and increase our visibility in the marketplace. As of the date of this prospectus, we cannot specify with certainty the particular uses for the net proceeds to be received upon the closing of this offering. Pending other uses, the net proceeds of this offering will be invested in short-term, interest-bearing investment-grade instruments. From time to time, in the ordinary course of business, we evaluate possible acquisitions of, or investments in, businesses, products and technologies that are complementary to our business. A portion of the net proceeds may be used to fund acquisitions or investments. In January and February of 2000, we signed letters of intent to acquire two companies for a total purchase price in cash and stock of $25 million, plus in one instance, certain earnouts. Neither of the proposed acquisitions is a material transaction either individually or in the aggregate to us. There can be no assurance that we will close either or both acquisitions. DIVIDEND POLICY Prior to our conversion to a C corporation for tax purposes in January 1997, we paid distributions to our S corporation shareholders in amounts generally consistent with their tax liabilities arising from their allocable share of S corporation earnings. Since becoming a C corporation, we have not declared or paid any cash dividends on our common stock and do not expect to do so in the foreseeable future. We currently intend to retain all available funds for use in the operation and expansion of our business. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our results of operations, financial conditions, contractual and legal restrictions and other factors the board deems relevant. PRICE RANGE OF OUR COMMON STOCK Our common stock has been listed on the Nasdaq National Market since August 13, 1999 under the symbol "QSFT." The following table sets forth the high and low closing sale prices on the Nasdaq National Market for our common stock for the calendar periods indicated.
PRICE RANGE OF COMMON STOCK --------------------- HIGH LOW --------- -------- YEAR ENDED DECEMBER 31, 1999: Third Quarter (from August 13)...................... $ 52.3750 $32.5625 Fourth Quarter...................................... 116.5000 45.8750 YEAR ENDING DECEMBER 31, 2000: First Quarter (through February 16)................. $ 118.00 $ 74.50
On February 16, 2000, the last reported sale price of our common stock on the Nasdaq National Market was $83.00 per share. As of December 31, 1999, there were 59 holders of record of our common stock. 16 18 CAPITALIZATION The Actual column in the following table sets forth our actual capitalization as of December 31, 1999. The As Adjusted column in the following table gives effect to the sale of 1,000,000 shares of common stock in this offering by the Company at an estimated public offering price of $83.00 per share and the application of the estimated net proceeds therefrom. See "Use of Proceeds" and the notes to our consolidated financial statements. The As Adjusted information set forth below should be read in conjunction with our consolidated financial statements and the notes thereto.
DECEMBER 31, 1999 ----------------------- ACTUAL AS ADJUSTED -------- ----------- (DOLLARS IN THOUSANDS) Shareholders' equity: Preferred stock, no par value; 5,000,000 shares authorized; no shares issued or outstanding, actual and as adjusted... $ -- $ -- Common stock, no par value; 75,000,000 shares authorized; 38,905,344 and shares issued and outstanding, actual and as adjusted.................................... 94,010 172,720 Retained earnings........................................... 1,864 1,864 Accumulated other comprehensive income (loss)............... (26) (26) Notes receivable from sale of common stock.................. (3,115) (3,115) Capital distribution in excess of basis in common stock..... (30,064) (30,064) -------- --------- Total shareholders' equity................................ 62,669 141,379 -------- --------- Total capitalization...................................... $ 62,669 $ 141,379 ======== =========
The information in the table above excludes: - - 5,085,935 shares of common stock issuable upon exercise of stock options outstanding as of February 16, 2000, at a weighted average exercise price of $6.81 per share; - - 190,974 shares of common stock issued upon the exercise of options between January 1, 2000 and February 16, 2000; - - 2,214,820 shares of common stock reserved for future issuance under our stock incentive plans; - - 600,000 shares of common stock reserved for issuance under our employee stock purchase plan, of which 119,097 shares were issued in February 2000. See "Capitalization," "Management -- 1999 Stock Incentive Plan," "-- 1999 Employee Stock Purchase Plan" and Note 8 of the notes to our consolidated financial statements; and - - 1,187,603 shares of common stock issued in connection with an acquisition in January 2000. 17 19 SELECTED CONSOLIDATED FINANCIAL DATA You should read the following selected consolidated financial data in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus. The following selected consolidated statement of income data for the years ended December 31, 1997, 1998 and 1999, and the consolidated balance sheet data at December 31, 1998 and 1999, have been derived from audited consolidated financial statements included elsewhere in this prospectus. The consolidated data presented below for the years ended December 31, 1995 and 1996, and at December 31, 1995, 1996 and 1997, are derived from audited consolidated financial statements that are not included in this prospectus. The data presented below do not include pro forma adjustments to reflect the income tax provision as if we were a C corporation in fiscal years 1995 and 1996.
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1995 1996 1997 1998 1999 ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF INCOME DATA: Revenues: Licenses.................................. $ 7,219 $ 9,316 $12,158 $24,901 $54,269 Services.................................. 2,305 3,546 6,157 9,889 16,599 ------- ------- ------- ------- ------- Total revenues.................... 9,524 12,862 18,315 34,790 70,868 ------- ------- ------- ------- ------- Cost of revenues: Licenses.................................. 260 950 1,307 3,433 2,998 Services.................................. 980 1,467 1,972 2,507 4,195 ------- ------- ------- ------- ------- Total cost of revenues............ 1,240 2,417 3,279 5,940 7,193 ------- ------- ------- ------- ------- Gross profit................................ 8,284 10,445 15,036 28,850 63,675 Operating expenses: Sales and marketing....................... 2,179 4,328 5,845 11,836 32,078 Research and development.................. 1,134 2,995 4,293 8,047 15,980 General and administrative................ 2,636 3,494 3,450 5,278 9,906 Other compensation costs and goodwill amortization........................... -- -- -- -- 1,243 ------- ------- ------- ------- ------- Total operating expenses.......... 5,949 10,817 13,588 25,161 59,207 ------- ------- ------- ------- ------- Income (loss) from operations............... 2,335 (372) 1,448 3,689 4,468 Other income (expense), net................. 51 389 (137) 336 1,202 ------- ------- ------- ------- ------- Income before income tax provision.......... 2,386 17 1,311 4,025 5,670 Income tax provision........................ 28 1 1,022 1,679 2,273 ------- ------- ------- ------- ------- Net income.................................. $ 2,358 $ 16 $ 289 $ 2,346 3,397 ======= ======= ======= ======= ------- Preferred stock dividends................... 590 ------- Net income applicable to common shareholders.............................. $ 2,807 ======= Basic and diluted net income per share...... $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.07 Weighted average shares outstanding: Basic..................................... 19,500 38,350 40,373 44,261 37,677 Diluted................................... 19,500 38,350 40,617 44,459 41,800
DECEMBER 31, ---------------------------------------------- 1995 1996 1997 1998 1999 ------ ------- ------- ------- ------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents.................... $2,709 $ -- $ 2,096 $ 8,981 $39,643 Short-term marketable securities............. -- -- -- -- 11,000 Working capital.............................. 2,594 553 374 2,771 38,670 Total assets................................. 6,171 6,408 9,713 19,645 99,149 Total shareholders' equity................... 2,996 2,429 2,836 5,074 62,669
18 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations also should be read in conjunction with the consolidated financial statements and notes to those statements included elsewhere in this prospectus. 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 entire enterprise. We were incorporated in 1987. At our inception, we focused on developing and marketing software which supported developers and users of Hewlett Packard's HP 3000 proprietary operating system known as MPE. In 1995, Vincent C. Smith joined us as a director and in 1997, he became our chief executive officer. In 1995, we began to transition our focus from proprietary MPE technology to open system technology. Additionally, commencing in 1995, we began extending our Vista Plus product to open system architectures, and in 1998, we extended Vista Plus to support the Internet. In 1996, we acquired R*Tech which developed SQLab, our first product series for Oracle databases. In 1997, we made a number of additional acquisitions which augmented the product line for managing Oracle databases including our SQL Navigator, I/Watch and Schema Manager products. Beginning in late 1997, we also began a major expansion of our research and development, sales and marketing, and customer support organizations by adding personnel in all departments, and through an acquisition, the establishment of operations in Australia and the United Kingdom. Commencing in the second half of 1998, we also introduced several additional products including SharePlex and SQLab Xpert. In 1998, we also established a direct sales operation in Germany. In 1999, we introduced Instance Monitor and Data Manager. In December 1999, we acquired MBR Technologies, Inc. and its Stat! product for consideration consisting of 93,471 shares of our common stock valued at $9.3 million and a cash payment of $1.3 million, and the assumption of net liabilities of $340,000. Of the total purchase price, which included direct acquisition costs, $11.5 million was allocated to goodwill, which will be amortized over a five-year period, and $784,000 was allocated to assumed liabilities. In January 2000, we acquired Foglight Software, Inc. and its Foglight product for consideration consisting of 1,187,603 shares of our common stock valued at $104.2 million, cash payment of $0.4 million, the assumption of unvested Foglight stock options valued at $2.1 million and the assumption of net liabilities of $5.1 million. The total purchase price, which included direct acquisition costs, is estimated to be allocated primarily to goodwill and other intangible assets, which will be amortized primarily over a five-year period. In February 2000, we acquired QMaster Software Solutions, Inc. and the QMaster Output product for $15 million in cash. The total purchase price, which will include direct costs of the acquisition estimated to be $75,000, is estimated to be allocated primarily to goodwill, which will be amortized over a five-year period. We derive our revenues primarily from the sale of software licenses and related annual maintenance fees. Our total revenues have increased over each of the past five fiscal years, from $9.5 million in 1995 to $70.9 million in 1999. Pricing of our software licenses is based on the number of servers, workstations and/or users of our products. Annual maintenance contracts may be purchased separately by customers at their discretion. We recognize software license revenues when a non-cancellable 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. See Note 1 of the notes to our consolidated financial statements. 19 21 We market our software and services primarily through our direct sales organization in the United States, Australia, the United Kingdom and Germany. International revenues from licenses and services sold to customers outside of North America were $1.4 million in 1997, $5.8 million in 1998, and $15.3 million in 1999. 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 three wholly owned subsidiaries in Australia, the United Kingdom and Germany. 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 which 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. At the time of our incorporation, we elected to be treated as an S corporation under Subchapter S of the Internal Revenue Code. As an S corporation, our shareholders were liable for federal income tax liabilities resulting from our operations. Effective January 1, 1997, we terminated our status as an S corporation and for all periods thereafter, we have been liable for federal income taxes. Prior to the termination of our S corporation status, we declared distributions as dividends to shareholders payable in cash in an amount generally equal to the tax consequence created by our earnings up to the date of such termination. 20 22 RESULTS OF OPERATIONS The following table sets forth certain consolidated statement of income data as a percentage of total revenues for the periods indicated:
YEAR ENDED DECEMBER 31, ----------------------- 1997 1998 1999 ----- ----- ----- Revenues: Licenses.................................................. 66.4% 71.6% 76.6% Services.................................................. 33.6 28.4 23.4 ----- ----- ----- Total revenues.................................... 100.0 100.0 100.0 ----- ----- ----- Cost of revenues: Licenses.................................................. 7.1 9.9 4.2 Services.................................................. 10.8 7.2 5.9 ----- ----- ----- Total cost of revenues............................ 17.9 17.1 10.1 ----- ----- ----- Gross profit................................................ 82.1 82.9 89.9 Operating expenses: Sales and marketing....................................... 31.9 34.0 45.3 Research and development.................................. 23.5 23.1 22.6 General and administrative................................ 18.8 15.2 14.0 Other compensation costs and goodwill amortization........ -- -- 1.8 ----- ----- ----- Total operating expenses.......................... 74.2 72.3 83.7 ----- ----- ----- Income from operations...................................... 7.9 10.6 6.2 Other (expense) income, net................................. (0.7) 0.9 1.7 ----- ----- ----- Income before income tax provision.......................... 7.2 11.5 7.9 Income tax provision........................................ 5.6 4.8 3.2 ----- ----- ----- Net income.................................................. 1.6% 6.7% 4.7% ===== ===== =====
YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 REVENUES Revenues were $18.3 million, $34.8 million and $70.9 million for 1997, 1998 and 1999, respectively, representing increases of $16.5 million, or 90.2%, from 1997 to 1998, and $36.1 million, or 103.7% from 1998 to 1999. International revenues accounted for 7.4%, 16.7% and 21.6% of total revenues for 1997, 1998 and 1999, respectively. No customer accounted for more than 10.0% of total revenues in 1997, 1998 or 1999. Licenses -- Licenses were $12.2 million, $24.9 million and $54.3 million in 1997, 1998 and 1999, respectively, representing increases of $12.7 million, or 104.1%, from 1997 to 1998, and $29.4 million or 118.1% from 1998 to 1999. Licenses represented 66.4%, 71.6% and 76.6% of total revenues in 1997, 1998 and 1999, respectively. International licenses accounted for 8.2%, 18.6% and 23.4% of total licenses in 1997, 1998 and 1999, respectively. The increase in licenses from 1997 to 1998 was due to the expansion of our domestic sales organization of 67 people, a $3.6 million increase in international license revenue, greater market acceptance of our products for Oracle database market and the success of our Vista Plus product for the UNIX environment. The increase in licenses from 1998 to 1999 was due to both an increase in our worldwide sales force of 176 people, as well as the availability of new products for all of 1999 including Schema Manager, I/Watch and TOAD. Services -- Services were $6.2 million, $9.9 million and $16.6 million in 1997, 1998 and 1999, respectively, representing increases of $3.7 million, or 60.6%, from 1997 to 1998, and $6.7 million or 67.7% from 1998 to 1999. Services represented 33.6%, 28.4% and 23.4% of total revenues in 1997, 1998 and 1999, 21 23 respectively. The increases in services reflects the increase in the number of software licenses sold with maintenance agreements. International services accounted for 5.7%, 11.9% and 15.9% of total services in 1997, 1998 and 1999, respectively. COST OF REVENUES Cost of Licenses -- Cost of licenses was $1.3 million, $3.4 million and $3.0 million in 1997, 1998 and 1999, respectively, representing an increase of $2.1 million, or 161.5%, from 1997 to 1998, and a decrease of $.4 million or 11.8% from 1998 to 1999. Cost of licenses as a percentage of license revenue was 10.8%, 13.8% and 5.5% for 1997, 1998 and 1999, respectively. The increase in cost of licenses as a percentage of license revenue from 1997 to 1998 was attributable primarily to a $1.8 million increase in royalties and a $551,000 increase in amortization of purchased technology and software licenses. The decrease in cost of licenses from 1998 to 1999, was due to decreases for both royalties and amortization as a result of reaching several royalty maximums and completion of amortization of certain purchased technology. Cost of Services -- Cost of services was $2.0 million, $2.5 million and $4.2 million in 1997, 1998 and 1999, respectively, representing increases of $500,000, or 25.0%, from 1997 to 1998 and $1.7 million or 68.0% from 1998 and 1999. The increases over these periods were primarily due to an increase in the number of customer support personnel to service our growing customer and product base. Cost of services as a percentage of service revenues was 32.0%, 25.4% and 25.3% for 1997, 1998 and 1999, respectively. The decreases in cost of services as a percentage of services over these periods were primarily due to economies of scale realized as a result of our increasing service revenues. OPERATING EXPENSES Sales and Marketing -- Sales and marketing expenses were $5.8 million, $11.8 million and $32.1 million in 1997, 1998 and 1999, respectively, representing increases of $6.0 million, or 103.4%, from 1997 to 1998, and $20.3 million or 172.0% from 1998 to 1999. The increases reflect our increasing investment in our sales and marketing organization, which from 1997 to 1998 included a $3.6 million increase in salaries and related expenses, a $1.1 million increase in additional commissions, and a $353,000 increase in marketing communications expenses such as trade shows and advertising. The increases from 1998 to 1999 reflect an increase in salaries and related expenses of $8.9 million, a $4.3 million increase in commissions and a $627,000 increase in marketing communications expenses. Travel and entertainment expenses, and related costs of hiring sales and marketing management also increased for both periods. Research and Development -- Research and development expenses were $4.3 million, $8.0 million and $16.0 million in 1997, 1998 and 1999, respectively, representing increases of $3.7 million, or 86.0%, from 1997 to 1998, and $8.0 million or 100.0% from 1998 to 1999. The increases for these periods were primarily related to a 63 person increase from 1997 to 1998, and a 138 person increase from 1998 to 1999 in the number of software developers and quality assurance personnel and, to a lesser extent, an increase in the cost of hiring outside contractors to support product development activities. General and Administrative -- General and administrative expenses were $3.5 million, $5.3 million and $9.9 million in 1997, 1998 and 1999, respectively, representing an increase of $1.8 million, or 51.4%, from 1997 to 1998, and an increase of $4.6 million or 86.8% from 1998 to 1999. The most significant expense increases during both periods were for salaries and related expenses and rent. Other compensation costs and goodwill amortization -- Compensation costs and goodwill amortization was $1.2 million in 1999 and includes $715,000 related to the severance package provided to Doran Machin, one of our founders and a director, which will be paid out over a three-year period, $432,000 of compensation costs related to the grant of stock options at less than fair market value and $97,000 of goodwill amortization related to acquisitions. Other Income (Expense), net -- Other income (expense), net was $(137,000) in 1997, $336,000 in 1998, and $1.2 million in 1999, representing an increase of $473,000 from 1997 to 1998, and $864,000 22 24 from 1998 to 1999. The increases reflect increased interest income from higher cash and short-term investments which accelerated in 1999 after the receipt of the IPO proceeds. Provision for Income Taxes -- Provision for income taxes was $1.0 million, $1.7 million and $2.3 million in 1997, 1998 and 1999, respectively, representing increases of $700,000, or 70.0%, from 1997 to 1998, and an increase of $600,000 or 35.3% from 1998 to 1999. The effective income tax rate was 78.0%, 41.7% and 40.1% in 1997, 1998 and 1999, respectively. The high effective tax rate in 1997 is attributable to our election, effective January 1, 1997, to terminate our status as an S corporation under federal tax regulations which resulted in the establishment of deferred taxes. See Note 6 of the notes to our consolidated financial statements. INFLATION Inflation has not had a significant effect on our results of operations or financial position for the years ended December 31, 1997, 1998 and 1999. 23 25 QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited consolidated statement of operations data for the ten quarters in the period ended December 31, 1999, as well as such data expressed as a percentage of total revenues for the periods indicated. This data has been derived from our unaudited consolidated financial statements that have been prepared on the same basis as the audited consolidated financial statements included in this prospectus and, in the opinion of our management, include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information when read in conjunction with the consolidated financial statements and the notes thereto included in this prospectus. These quarterly results have been in the past and may in the future be subject to significant fluctuations. As a result, we believe that results of operations for interim periods should not be relied upon as any indication of the results to be expected in any future period.
THREE MONTHS ENDED --------------------------------------------------------------------------------------- SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, 1997 1997 1998 1998 1998 1998 1999 1999 --------- -------- -------- -------- --------- -------- -------- -------- (IN THOUSANDS) Revenues: Licenses............................ $3,066 $3,887 $4,840 $4,740 $6,190 $ 9,131 $ 9,540 $11,825 Services............................ 1,405 1,665 2,203 2,252 2,544 2,890 3,299 3,625 ------ ------ ------ ------ ------ ------- ------- ------- Total revenues.................... 4,471 5,552 7,043 6,992 8,734 12,021 12,839 15,450 ------ ------ ------ ------ ------ ------- ------- ------- Cost of revenues: Licenses............................ 179 730 557 947 1,081 848 684 720 Services............................ 500 578 521 523 609 854 904 834 ------ ------ ------ ------ ------ ------- ------- ------- Total cost of revenues............ 679 1,308 1,078 1,470 1,690 1,702 1,588 1,554 ------ ------ ------ ------ ------ ------- ------- ------- Gross profit.......................... 3,792 4,244 5,965 5,522 7,044 10,319 11,251 13,896 Operating expenses: Sales and marketing................. 1,461 1,874 1,923 2,448 3,169 4,296 5,036 7,122 Research and development............ 1,087 1,120 1,766 1,863 1,928 2,490 2,758 3,276 General and administrative.......... 900 978 841 1,229 980 2,228 1,938 2,051 Other compensation costs and goodwill amortization............. -- -- -- -- -- -- -- 775 ------ ------ ------ ------ ------ ------- ------- ------- Total operating expenses.......... 3,448 3,972 4,530 5,540 6,077 9,014 9,732 13,224 ------ ------ ------ ------ ------ ------- ------- ------- Income (loss) from operations......... 344 272 1,435 (18) 967 1,305 1,519 672 Other (expense) income, net........... (9) 18 48 71 106 111 113 (31) ------ ------ ------ ------ ------ ------- ------- ------- Income before income tax provision.... 335 290 1,483 53 1,073 1,416 1,632 641 Income tax provision.................. 262 227 615 22 446 596 689 270 ------ ------ ------ ------ ------ ------- ------- ------- Net income............................ $ 73 $ 63 $ 868 $ 31 $ 627 $ 820 $ 943 $ 371 ====== ====== ====== ====== ====== ======= ======= ======= Preferred stock dividends............. -- -- -- -- -- -- -- 340 ------ ------ ------ ------ ------ ------- ------- ------- Net income applicable to common shareholders........................ $ 73 $ 63 $ 868 $ 31 $ 627 $ 820 $ 943 $ 31 ====== ====== ====== ====== ====== ======= ======= ======= AS A PERCENTAGE OF TOTAL REVENUES Revenues: Licenses............................ 68.6% 70.0% 68.7% 67.8% 70.9% 76.0% 74.3% 76.5% Services............................ 31.4 30.0 31.3 32.2 29.1 24.0 25.7 23.5 ------ ------ ------ ------ ------ ------- ------- ------- Total revenues.................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ------ ------ ------ ------ ------ ------- ------- ------- Cost of revenues: Licenses............................ 4.0 13.2 7.9 13.5 12.3 7.1 5.3 4.7 Services............................ 11.2 10.4 7.4 7.5 7.0 7.1 7.1 5.4 ------ ------ ------ ------ ------ ------- ------- ------- Total cost of revenues............ 15.2 23.6 15.3 21.0 19.3 14.2 12.4 10.1 ------ ------ ------ ------ ------ ------- ------- ------- Gross profit.......................... 84.8 76.4 84.7 79.0 80.7 85.8 87.6 89.9 Operating expenses: Sales and marketing................. 32.7 33.8 27.3 35.1 36.3 35.8 39.2 46.1 Research and development............ 24.3 20.2 25.1 26.6 22.1 20.7 21.5 21.2 General and administrative.......... 20.1 17.5 11.9 17.6 11.2 18.5 15.1 13.3 Other compensation costs and goodwill amortization............. -- -- -- -- -- -- -- 5.0 ------ ------ ------ ------ ------ ------- ------- ------- Total operating expenses.......... 77.1 71.5 64.3 79.3 69.6 75.0 75.8 85.6 ------ ------ ------ ------ ------ ------- ------- ------- Income (loss) from operations......... 7.7 4.9 20.4 (0.3) 11.1 10.8 11.8 4.3 Other (expense) income, net........... (0.2) 0.3 0.6 1.0 1.2 0.9 0.9 (0.2) ------ ------ ------ ------ ------ ------- ------- ------- Income before for income tax provision........................... 7.5 5.2 21.0 0.7 12.3 11.7 12.7 4.1 Income tax provision.................. 5.9 4.1 8.7 0.3 5.1 5.0 5.4 1.7 ------ ------ ------ ------ ------ ------- ------- ------- Net income............................ 1.6% 1.1% 12.3% 0.4% 7.2% 6.7% 7.3% 2.4% ====== ====== ====== ====== ====== ======= ======= ======= Preferred stock dividends............. -- -- -- -- -- -- -- 2.2 ------ ------ ------ ------ ------ ------- ------- ------- Net income applicable to common shareholders........................ 1.6% 1.1% 12.3% 0.4% 7.2% 6.7% 7.3% 0.2% ====== ====== ====== ====== ====== ======= ======= ======= THREE MONTHS ENDED -------------------- SEPT. 30, DEC. 31, 1999 1999 --------- -------- (IN THOUSANDS) Revenues: Licenses............................ $13,995 $18,909 Services............................ 4,313 5,362 ------- ------- Total revenues.................... 18,308 24,271 ------- ------- Cost of revenues: Licenses............................ 734 860 Services............................ 1,154 1,303 ------- ------- Total cost of revenues............ 1,888 2,163 ------- ------- Gross profit.......................... 16,420 22,108 Operating expenses: Sales and marketing................. 8,321 11,599 Research and development............ 4,502 5,444 General and administrative.......... 2,787 3,130 Other compensation costs and goodwill amortization............. 186 282 ------- ------- Total operating expenses.......... 15,796 20,455 ------- ------- Income (loss) from operations......... 624 1,653 Other (expense) income, net........... 278 842 ------- ------- Income before income tax provision.... 902 2,495 Income tax provision.................. 380 934 ------- ------- Net income............................ $ 522 $ 1,561 ======= ======= Preferred stock dividends............. 250 -- ------- ------- Net income applicable to common shareholders........................ $ 272 $ 1,561 ======= ======= AS A PERCENTAGE OF TOTAL REVENUES Revenues: Licenses............................ 76.4% 77.9% Services............................ 23.6 22.1 ------- ------- Total revenues.................... 100.0 100.0 ------- ------- Cost of revenues: Licenses............................ 4.0 3.5 Services............................ 6.3 5.4 ------- ------- Total cost of revenues............ 10.3 8.9 ------- ------- Gross profit.......................... 89.7 91.1 Operating expenses: Sales and marketing................. 45.5 47.8 Research and development............ 24.6 22.4 General and administrative.......... 15.2 12.9 Other compensation costs and goodwill amortization............. 1.0 1.2 ------- ------- Total operating expenses.......... 86.3 84.3 ------- ------- Income (loss) from operations......... 3.4 6.8 Other (expense) income, net........... 1.5 3.5 ------- ------- Income before for income tax provision........................... 4.9 10.3 Income tax provision.................. 2.0 3.9 ------- ------- Net income............................ 2.9% 6.4% ======= ======= Preferred stock dividends............. 1.4 -- ------- ------- Net income applicable to common shareholders........................ 1.5% 6.4% ======= =======
24 26 Our total revenues have increased in each period presented, with the exception of the three months ended June 30, 1998. These increases have been generally due to increased acceptance of our products and the expansion of our sales force and increased service revenues as the installed customer base has grown. Total cost of revenues have also generally increased in absolute dollars over these periods presented due to increased amortization of purchased technology and software licenses, royalty costs, and an increase in the number of customer support personnel. Total operating expenses have increased in absolute dollars in each period presented as we have grown our infrastructure to support our expanding operations. While we have not experienced a significant amount of seasonality in the past, we expect that we will begin to experience seasonal customer buying patterns in the foreseeable future. Specifically, we would expect to experience relatively stronger demand for our products during the quarters ending December 31 and June 30, and relatively weaker demand in the quarters ending March 31 and September 30. In addition, to the extent international operations constitute a greater percentage of our revenues in future periods, we anticipate that demand for our products in Europe will decline during the summer vacation season. LIQUIDITY AND CAPITAL RESOURCES We have funded our business, to date, primarily from cash generated by our operations and net proceeds of $64.9 million from our initial public offering in August 1999. Our sources of liquidity as of December 31, 1999, consisted principally of cash and cash equivalents of $39.6 million and marketable securities of $15.5 million. Net cash provided by operating activities was $3.6 million, $8.2 million and $11.4 million in 1997, 1998 and 1999, respectively. The increases in 1997, 1998 and 1999, were primarily due to increases in net income, depreciation and amortization, deferred revenue resulting from additional service contracts and accrued expenses, offset by increases in accounts receivable resulting from increased sales. Net cash used in investing activities was $1.3 million, $1.3 million, and $24.1 million in 1997, 1998, and 1999, respectively. The increase in cash used in investing activities in 1999 was primarily related to capital expenditures of $7.1 million associated with company growth and net purchases of marketable securities totalling $15.5 million. Financing activities used $270,000 and $8,000 in 1997 and 1998, respectively, and generated $43.6 million in 1999. In April 1999, we raised $25.0 million through the sale of preferred stock and an additional $10.0 million in term debt from a commercial bank in order to purchase shares of common stock from a shareholder and founder for $35.0 million. See "Certain Transactions" and Note 4 of the notes to our consolidated financial statements. In August of 1999, we raised net proceeds of $64.9 million from our initial public offering. A portion of the proceeds was utilized to retire debt of $10.9 million and redeem the outstanding Series B Preferred Stock for $10.0 million. We believe that the net proceeds from this offering, 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, there can be no assurance that such financing will be available to us on commercially reasonable terms or at all. 25 27 YEAR 2000 Prior to January 1, 2000, there was a great deal of concern regarding the ability of computers to adequately distinguish 21st century dates from 20th century dates due to the two-digit date fields used by many systems. Most reports to date, however, are that computer systems are functioning normally and the compliance and remediation work accomplished leading up to the Year 2000 was effective to prevent any problems. Computer experts have warned that there may still be residual consequences of the change in centuries and any such difficulties could result in a decrease in sales of our products, an increase in allocation of resources to address Year 2000 problems of our customers without additional revenue commensurate with such dedication of resources, or an increase in litigation costs relating to losses suffered by our customers due to such Year 2000 problems. 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 position or results of operations. We will be required to implement SFAS No. 133 for the year ending December 31, 2001. In December 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions. SOP 98-9 amends SOP 97-2 and SOP 98-4, extending the deferral of the application of certain provisions of SOP 97-2 amended by SOP 98-4 through fiscal years beginning on or before March 15, 1999. All other provisions of SOP 98-9 are effective for transactions entered into in fiscal years beginning after March 15, 1999. We do not expect the adoption of SOP 98-9 to have a material effect on our results of operations or financial condition. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DERIVATIVES AND FINANCIAL INSTRUMENTS 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 Australia, the United Kingdom and Germany 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 The Company's exposure to market rate risk for changes in interest rates relates primarily to the Company's investment portfolio. The Company has not used derivative financial instruments in its investment portfolio. The Company places its investments with high-quality issuers and, by policy, limits the amount of credit exposure to any one issuer. The Company's 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. The Company classifies all of its 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 stockholders' equity. At December 31, 1999, the net loss on available-for-sale securities of $26 is comprised of five positions, all with unrealized losses. 26 28 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. 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. 27 29 BUSINESS This prospectus contains certain forward looking statements within the meaning of the federal securities laws. Actual results and the timing of certain events could differ materially from those projected in the forward looking statements due to a number of factors, including those set forth under "Risk Factors" and elsewhere in this prospectus. OVERVIEW We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, enterprise and custom applications and enable the delivery of information across the entire enterprise. Our application availability products are designed to help ensure uninterrupted and high performance access to software systems by utilizing a number of integrated products that enhance the performance of applications and the underlying database which stores an enterprise's critical information. Other primary components of our application availability solution include our database products that maintain a real-time copy of a database for offloading critical systems and assuring high availability, as well as our products that manage the complex and error-prone process of development and deployment of rapidly changing applications. Our information availability products deliver an enterprise, report-based information management solution that captures, manages and distributes report data or electronic documents from virtually any application for instant distribution over intranets or the Internet. INDUSTRY BACKGROUND Organizations are constantly seeking ways to use information and technology to gain competitive advantages. To compete more effectively, organizations must deliver relevant information and provide increasingly sophisticated and time-sensitive services to a rapidly expanding audience, including employees, customers, suppliers and partners both inside and outside of the traditional enterprise. Today, a growing number of organizations are using the Internet to conduct business electronically. In embracing this e-business model, enterprises are attempting to maximize the value of their information technology infrastructure as they extend their business over the Internet to directly reach a large number of geographically dispersed end-users. The fundamental changes brought on by the increasing reliance on information technology, including today's rapidly expanding e-business initiatives, are introducing new complexities and transforming business practices: - Decisions need to be made in real-time by personnel at all levels both inside and outside the enterprise; - Users demand relevant information immediately and without interruption, and have increasingly high expectations regarding response time; - New software applications must be developed, and existing applications need to be extended over the Internet; and - Organizations must deploy new applications and technologies at an increasingly rapid pace. Underlying each of these requirements is the importance of effective management and distribution of information. While raising the strategic importance of real-time, dynamic information, today's e-business initiatives have heightened the challenges of developing and managing the systems to deliver it. For example, if an electronic commerce application fails, the relationship between the organization and the customer is jeopardized, giving new meaning to the term "mission critical." As a result, organizations must assure that their systems provide: - Application availability -- uninterrupted and high performance access to applications under widely varying conditions; and - Information availability -- broad distribution of critical business information from underlying applications to decision makers throughout the entire enterprise. 28 30 Application Availability The challenge of today's competitive environment is to provide users with the ability to immediately execute transactions and access information, without regard to the underlying complexities inherent in the disparate systems that run business applications. Since the emergence of e-business has allowed consumers to directly communicate with an organization's systems, it is more important than ever before to maximize application performance and minimize downtime. Furthermore, as e-business, enterprise resource planning and other applications are deployed to a wider audience, rapid and unpredictable spikes in the number of users can dramatically increase the likelihood of performance degradation and system failure. Not only must organizations have adequate back-up systems in place, but they also need solutions that will enable them to proactively monitor, identify and resolve issues that can adversely affect application performance. Finally, to ensure true application availability, organizations need solutions that will enable them to quickly and accurately develop and deploy new applications and modifications to existing applications. Information Availability In addition to assuring the availability of applications, the imperatives of e-business require organizations to make the strategic information within these applications readily available to the users who need it. The Internet has created a platform for distributing critical, dynamic business information, such as inventory levels, requisitions, billing statements, manufacturing data and sales reports to a broad range of employees, partners and suppliers, many of whom may be located in geographically remote locations and connected through multiple, non-integrated systems. Organizations must be able to leverage this platform to reach customers and provide 24x7x365 access to valuable information, including customer support and current account information. The challenge, however, is effectively extracting, publishing and disseminating large volumes of information to thousands of employees, customers, partners and suppliers over the Internet without massive amounts of application reengineering. Need for a Comprehensive Solution The effectiveness of an organization's information delivery system is dependent on its application availability environment. A user's ability to access information is linked to the performance and reliability of the underlying application. Historically, organizations have relied on a combination of manual processes and a heterogeneous assortment of software tools to manage the performance and reliability of their application infrastructure and to enable the distribution of information throughout the enterprise. However, the requirements of today's e-business initiatives have stretched the capabilities of these traditional solutions. This dynamic environment has created the need for a comprehensive solution that will address the breadth of these application and information availability requirements: - Deliver data from multiple, heterogeneous sources, scale to thousands of users and deliver information across all environments, quickly and cost-effectively; - Provide high performance and reliability for 24x7x365 access, and minimize the strain on existing systems and personnel; - Be easy to use and deploy without requiring in-depth technical expertise; - Adapt to accommodate rapidly changing business needs; - Provide an architecture to realize immediate value for Web-based applications; and - Address these requirements across the entire Web, application and database environments. 29 31 THE QUEST SOLUTION Quest offers application and information availability software solutions that enhance the performance and reliability of e-business, enterprise and custom applications and enable the delivery of information across the entire enterprise. Key elements of our solution include: Assure Application Availability We offer a family of products that enhance the reliability and performance of software applications. Our application availability products enable the development of efficient and reliable Internet-enabled applications; accurately deploy database and application changes; provide replication solutions for fail-over capability, data distribution and distributing load across multiple systems; and proactively monitor, diagnose and resolve database and system performance issues before they are noticed by the end-user. Our products are designed to maintain the continuous availability of applications to the enterprise, not only in terms of uptime, but also in terms of providing adequate performance under a wide range of operating conditions. As a result, information technology personnel are able to efficiently and proactively enhance the performance and reliability of critical business applications. Extend the Reach of Information We enable enterprises to deliver information internally and externally via the Internet to reach employees, customers and partners throughout large and geographically dispersed organizations. Our Web-based information availability solutions enable access to a greater number of users, minimize the delay in publishing information and reduce manual printing and delivery costs associated with paper-based report distribution. For example, these solutions can integrate with corporate portals to allow for delivery of personalized information to a user's desktop through a Web browser. We optimize the storage and distribution of information by publishing information once from disparate applications to a centralized repository. This repository serves as a common platform to capture and distribute information without taxing the application systems or the network. Our solution is designed to empower decision-makers by providing relevant, dynamic information, more quickly and more cost-effectively than previously possible. Leverage the Web Our products allow organizations to leverage the functionality and flexibility of the Internet to address the high-performance demands of e-business environments. Specifically, our products are designed to adapt to the varying bandwidth and response times encountered on the Internet with efficient and fault-tolerant architectures; employ Java-based interfaces to deliver transparent Web access to business information; and ensure the security and integrity of Web-based access to applications. Maximize Investment in Existing Technology We enable organizations to enhance the capabilities and extend the benefits of their existing information technology infrastructure. Our products enable existing enterprise and custom applications to reach throughout and beyond the enterprise without requiring re-engineering. Additionally, we enable our customers to improve the reliability and performance of existing information technology infrastructure to cost-effectively and predictability support the increasing number of users and large volumes of transactions required by today's e-business applications. Easy to Deploy and Use Our products are easy to deploy and use, thereby minimizing implementation, training and support costs. We designed our products to be installed quickly by the customer, typically without the need for on-site assistance. Our products contain specific integration modules for SAP R/3, PeopleSoft and Oracle Financials, enabling rapid deployment in these environments, minimizing the need for customization and reducing ongoing maintenance requirements. 30 32 Architected to Scale Our products are well-suited for large, enterprise-wide deployments. We designed our products to effectively scale when implemented in large and rapidly expanding environments without compromising system performance. Our products support heterogeneous networks, manage large quantities of information and support thousands of users while at the same time minimizing the consumption of network and computing resources. Our Java user interfaces significantly reduce the need for client-side software management, effectively leveraging today's wide deployment of Internet browser technology. STRATEGY Our objective is to become the leading provider of application and information availability solutions to enable organizations to deliver relevant information and provide sophisticated services to employees, customers, suppliers and partners both inside and outside of the traditional enterprise. Key elements of our strategy include: Extend Product Leadership We offer a family of products that work together to provide application and information availability solutions capable of meeting today's performance requirements. We believe our family of application availability products provides the most thorough and efficient approach to optimizing the performance and availability of e-business, enterprise and custom applications. We also believe that we offer the leading Web-based information availability software solutions in terms of functionality and innovation. We intend to advance this product leadership by investing significantly in research and development and by acquiring and integrating complementary products and technologies. We intend to strengthen and expand our offerings of integration software for leading enterprise resource planning (ERP) applications. Our flexible and open architecture allows for the integration of new modules that enhance our current solutions and add new e-business functionality, such as electronic bill presentment. We plan to augment our existing application availability solutions with capabilities to monitor and maintain the underlying infrastructure of e-business applications. For example, we plan to introduce a product that manages and optimizes the performance of Web application servers. Focus on e-Business Applications Market We believe that both recent and expected growth in e-business applications have created strong demand for our application and information availability products. We intend to capitalize on this opportunity by actively marketing our products to companies with strong e-business initiatives. In addition to developing new e-business applications, organizations are attempting to improve the e-business functionality of their existing enterprise applications by extending them over the Internet. As a result, we believe a significant market opportunity exists to help organizations leverage these investments by incorporating new e-business functionality into these systems. We believe that our products will be used as a key component of the infrastructure for emerging e-business applications. Leverage our Significant Installed Base of Customers We have an installed base of thousands of customers that we believe provides us with a significant opportunity for additional sales of current and future products, as well as ongoing maintenance revenues. A majority of our customers have purchased only one or a few of our products or use our products in specific business-units or locations. We believe that we can sell more deeply into our installed customer base by expanding these departmental deployments into enterprise-wide implementations as well as by cross-selling additional products and services. Expand our Sales Force and Distribution Channels We market and sell our products worldwide primarily though a direct sales and telesales force. We believe that our direct sales approach allows us to achieve better control of the sales process and respond 31 33 more quickly to customer needs while maintaining an efficient sales model. We are continuing to expand our direct sales efforts both domestically and internationally. Sales outside of North America represented approximately 17% of total revenue in 1998 and 22% in 1999, and we believe that there is significant untapped demand for our software products internationally. We intend to continue to expand our direct sales staff and increase the number of sales offices internationally, and, to a lesser extent, develop alliances with international distributors. Extend Strategic Integrator Relationships We intend to increase the value of our solutions to customers by offering additional and improved consulting and implementation services for our enterprise-level software solutions. Specifically, we plan to extend our existing strategic relationships and develop new partnerships with leading global systems integrators who specialize in implementing software solutions that support e-business and enterprise application software. We believe that these relationships will both facilitate the successful enterprise deployment of our products and generate additional product sales opportunities. 32 34 PRODUCTS Our products are designed to work individually and together to provide immediate and continuous availability of applications and information, both of which are critical as enterprises rapidly extend their information technology infrastructure. Our products and their functionality are summarized below:
- ------------------------------------------------------------------------------------------------------------ INFORMATION AVAILABILITY - ------------------------------------------------------------------------------------------------------------ VISTA PLUS Captures, manages and distributes report-based information through an enterprise report and document repository. - ------------------------------------------------------------------------------------------------------------ VISTA PLUS E-PURPOSING MODULE Extends information delivery across the Internet by providing global delivery of time-sensitive documents, electronic bill and statement presentment without requiring application changes. - ------------------------------------------------------------------------------------------------------------ VISTA PLUS INTERFACE MODULES FOR SAP Provides rapid installation and continuous synchronization R/3, PEOPLESOFT, AND ORACLE of users, groups, authorization profiles and report APPLICATIONS information from ERP systems to Vista Plus. - ------------------------------------------------------------------------------------------------------------ QMASTER* A web-based, enterprise-wide solution for delivering, managing, and monitoring nearly all printed, faxed or emailed output throughout an organization. - ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------ APPLICATION AVAILABILITY - ------------------------------------------------------------------------------------------------------------ DATABASE REPLICATION - ------------------------------------------------------------------------------------------------------------ SHAREPLEX(R) REPLICATION Replicates high volumes of data from Oracle databases to improve performance and manage future growth. - ------------------------------------------------------------------------------------------------------------ ENTERPRISE MONITORING - ------------------------------------------------------------------------------------------------------------ FOGLIGHT* Monitors and resolves problems across the hardware and software components that comprise modern applications, including the network, application servers, database servers and web servers, from a Java-based centralized console. - ------------------------------------------------------------------------------------------------------------ I/WATCH Offers a centralized console for monitoring, alerting, diagnosing and resolving problems in Oracle-based applications. - ------------------------------------------------------------------------------------------------------------ DATABASE AND APPLICATION PERFORMANCE - ------------------------------------------------------------------------------------------------------------ INSTANCE MONITOR A real-time monitoring and diagnostic tool featuring visual representation of database process flows. - ------------------------------------------------------------------------------------------------------------ SQLAB XPERT Identifies and resolves database resource consumption problems caused by poorly performing application code by recommending optimal tuning scenarios. - ------------------------------------------------------------------------------------------------------------ SPACE MANAGER Reorganizes database objects and performs capacity planning to improve performance and manage future growth. - ------------------------------------------------------------------------------------------------------------ APPLICATION CHANGE MANAGEMENT - ------------------------------------------------------------------------------------------------------------ SCHEMA MANAGER Manages database change and migration from development through production by providing comprehensive version control, auditing and rollback capabilities. - ------------------------------------------------------------------------------------------------------------ DATA MANAGER Builds test databases, deploys reference data to production during software rollouts, extracts data for data warehouses or reporting databases, and purges or archives production data that is not needed on-line. - ------------------------------------------------------------------------------------------------------------ SQL IMPACT Manages interdependencies between database objects and application source code, providing detailed impact analysis, documentation and auditing. - ------------------------------------------------------------------------------------------------------------ SQL NAVIGATOR AND TOAD Server-side database development and management solutions with optional add-on modules available for debugging, SQL tuning with expert advice and integrated code libraries for rapid development. - ------------------------------------------------------------------------------------------------------------ STAT! Tracks and manages all customizations made by an organization to their PeopleSoft implementations. Changes can be unapplied or reapplied to new versions of PeopleSoft automatically, an otherwise highly complex and error prone process. - ------------------------------------------------------------------------------------------------------------
- ------------------------- * Products acquired after December 31, 1999 33 35 INFORMATION AVAILABILITY Vista Plus. Our Vista Plus products deliver the benefits of enabling Web-based access to existing information and applications without a complex development or deployment effort. Vista Plus is an enterprise, report-based information management solution that captures, stores, indexes, prints and archives report data or electronic documents from virtually any application. Vista Plus maintains a repository of this output for instant distribution over a heterogeneous, widely distributed network, including the Internet, with our sophisticated Java or Windows clients. By storing output from applications in its repository, Vista Plus also eliminates the processing needed to rerun reports, and its report mining capabilities provide users access to information without burdening the primary systems. Vista Plus enables real-time access to business-critical information at any time, even if the source application is not accessible. Vista Plus provides the ability to quickly navigate from summary to detailed information, data extraction, hyperlinks to navigate between related information and numerous print and electronic distribution functions with no application changes, delivering immediate benefits throughout the enterprise. The robust security model built into Vista ensures that only authorized users gain access to data. Vista Plus further extends information availability by transforming production reports into a series of personalized emails, PDF files or HTML pages for Internet distribution of statements such as invoices, purchase orders and financial statements. As a result, the data that is delivered to end users contains relevant information in a familiar and highly usable format. QMaster provides a scalable, open architecture solution which automates Output Delivery to printers, faxes, email, electronic documents and the scheduling and execution of Batch Processes in a heterogeneous environment of NT and UNIX platforms. QMaster supports a wide variety of incompatible operating systems and devices. Nearly any form of output can automatically be routed across a variety of high and low speed printers, securely, in order to optimize use of resources and ensure information is successfully delivered even if a device becomes unavailable. The web-based user interface allows the control of delivery of documents from anywhere over the Internet. APPLICATION AVAILABILITY We provide a broad range of products that together provide a comprehensive application availability solution. Our products provide a wide range of services that work together to maintain the high level of performance and continuous access required by today's demanding e-business environment. Integration between these components significantly enhances the value of each solution by increasing user productivity and delivering otherwise unavailable functionality. Database Replication SharePlex. SharePlex replicates high volumes of data from an Oracle database to one or more other databases. Replication is accomplished in real-time with very little overhead to critical application servers. Secondary systems can then be used for offloading non-critical processing, thus preserving desired user response times and Web server performance, as well as providing a back-up system for reporting and fail-over. SharePlex also supports wide-area networks without the need for expensive high bandwidth data links. Enterprise Monitoring Foglight. Foglight is a new generation Enterprise Monitoring solution that monitors all components of a modern application system, including web servers, application servers, and database servers. Applications being deployed today offer increasing complexity involving multiple systems and software packages that are interdependent. Understanding the relationship between these software and hardware components and how they interact and affect each other is often difficult. Foglight's correlation technology allows system administrators to determine where performance bottlenecks are occurring for rapid resolution. Foglight provides an extensible and scalable platform which can be used for end-to-end monitoring in the most demanding and dynamic environments. 34 36 I/Watch. I/Watch offers a central console for Oracle-based applications and alerts the operations staff of problems as they develop. I/Watch is easy to deploy and consumes relatively few system resources. I/Watch detects system and application failures, and allows operations staff to watch for developing problems over a large network of systems. I/Watch can alert and automatically respond with appropriate measures to resource problems. I/Watch provides an intuitive, graphical interface that clearly shows where problems are occurring and supports the ability to quickly navigate from summary to detailed information for diagnosing and resolving issues. I/Watch allows for the mining of previously monitored time periods to help pinpoint the root cause of problems. Database and Application Performance Instance Monitor. Instance Monitor is a real-time monitoring and diagnostic tool featuring visual representations of process flows within the database. Instance Monitor's unique user-interface design displays a comprehensive diagram of a database's internal workings and the flow of information within the database. Instance Monitor tracks database performance in real-time, identifies potential bottlenecks and provides detailed expert advice to help resolve problems as they occur. SQLab Xpert. SQLab Xpert automatically locates and highlights poorly written database application code. It provides expert advice to help both novice and seasoned developers and administrators quickly find solutions to difficult performance problems. Space Manager. Space Manager addresses the complex issues of physical data management to help keep application performance at peak levels. As database structures are modified to accommodate application changes and growth, performance begins to degrade due to poor physical organization of information within the database. Space Manager is designed to perform this necessary maintenance as well as assist in planning for future growth in storage requirements. Application Change Management SQL Impact. SQL Impact scans application code and stores it in its repository. If a change is needed to any object in a database, SQL Impact determines which programs and specific lines of code will be affected, reducing the likelihood of overlooking required application changes. Schema Manager. Schema Manager automatically determines the differences between a development and production database and can synchronize the databases automatically. Schema Manager packages all of the changes needed for a new application deployment, checks to make sure the changes will not fail in the production environment, and implements the changes. Its auditing capability documents all database changes, allowing the immediate rollback of a change if required. Data Manager. Data Manager deploys and transforms data when new applications are rolled out, for example, storing or changing reference data such as sales tax tables and control information. Data Manager also creates test databases for developers, eliminating the need to use a full copy of a production database which can be impractical due to its large size. Stat! Stat! provides users of the PeopleSoft ERP and Human Resources software with a method to track and preserve all changes and customizations made to a PeopleSoft implementation. Since modification of standard packaged software like PeopleSoft is often necessary, managing these changes becomes critical to preserving the customized software environment. With integrated workflow, Stat! is a centralized repository for documenting, tracking, migrating, supporting and delivering PeopleSoft application changes. Customizations are safeguarded and preserved without risk of losing them. By using Stat!, organizations can greatly reduce the effort required to implement upgraded versions of PeopleSoft's applications, a process that is otherwise highly resource intensive, time consuming and expensive. Database Programming SQL Navigator and TOAD enable development of server side code for databases, a key component of Internet-enabled application development. SQL Navigator and TOAD allow developers to rapidly and 35 37 accurately develop and enhance the performance of applications. Providing similar functionality, these two products incorporate different user interfaces that increase their appeal to a broader spectrum of developers and database administrators. They integrate with our other application availability products, enabling developers to check and correct the performance of their code before it is put into production. CUSTOMERS AND CASE STUDIES Our software products are licensed to customers worldwide to provide a wide range of application and availability solutions. Our products have been sold to thousands of corporations, governmental agencies and other organizations worldwide. In 1997, 1998 and 1999, no customer accounted for more than 10% of our total revenues. A representative sampling of customers who have purchased at least $100,000 of software licenses and support services includes: TECHNOLOGY FINANCIAL SERVICES MANUFACTURING Akamai ADP 3M Applied Materials AIG Marketing American Cyanamid Dell Computer American National Bank Avery Dennisson Earthlink Ceridian Tax Service Boeing Hewlett-Packard Chase Manhattan Mortgage Eaton Corp. Intuit Citibank General Electric Plastics Mail.com Credit Suisse/First Boston Honeywell Merisel Cyber Cash Imation Micro Warehouse DLJ Direct Johnson Controls Micron Electronics Fidelity Investments Koch Industries Motorola First National Bank Chicago Lockheed Martin Oracle FleetBoston Robertson Stephens Monsanto Priceline.com GE Capital Sara Lee Hosiery Sony Mercury Insurance Group Smuckers Sun Microsystems Nations Bank Toyota Motors Yahoo Wellington Management Weyerhaeuser HEALTHCARE/PHARMACEUTICAL Wells Fargo OTHER TELECOMMUNICATIONS 3M Health Information Systems American Home Shield Acuson Air Touch Communications Andersen Consulting Blue Cross-Blue Shield (FL) AT&T Aramark Bristol Meyers British Telecom Bausch & Lomb Worldwide Cardinal Health Lucent Technologies Carlson Companies GE Medical Systems MCI System House Circuit City Harvard Pilgrim Health Care Nextel ConAgra Hoechst Marion Roussel Southwestern Bell Mobile Dun & Bradstreet Info. Systems Hoffman LaRoche Communications Earth Tech Kaiser Permanente TCI Communications Hertz Merck Williams Information Services JC Penney US Surgical Musicland ENERGY Pepsi-Cola PriceWaterhouseCoopers Detroit Edison Purdue University FirstEnergy Corp. State of Georgia Pennsylvania Power & Light Time Inc. PG&E Texas Management United Space Alliance Shell Services International University of Michigan Sun Chemical Yamaha Valero Energy Wisconsin Power & Light
The following case studies illustrate how a selected group of representative customers are using a variety of Quest products to ensure high application and information availability across their increasingly 36 38 heterogeneous and distributed networks. We compiled this information in consultation with the companies listed below. Applied Materials Applied Materials is a leading semiconductor equipment manufacturer. To improve efficiency in its global operations, Applied Materials needed a Web-based enterprise-wide report management solution that could seamlessly integrate with their existing applications, automate their processes and provide instant access to corporate reports to thousands of employees worldwide. Such a solution would eliminate the need to prepare, compile and distribute thousands of corporate reports manually. Applied Materials selected and implemented Vista Plus as an enterprise-wide report warehouse and distribution solution for automated electronic delivery and archiving of application reports. We believe that Applied Materials was able to realize cost savings and productivity benefits immediately. Administrative overhead was reduced through lower paper and printing costs and reduced human resource expenses. Moreover, Applied Materials deployed Vista Plus without having to reconfigure its existing applications. After experiencing the benefits of Vista Plus, Applied Materials purchased I/Watch, for enterprise monitoring and SQLab Xpert for application turning, to improve the availability and performance of their Oracle database environment. EarthLink EarthLink is a leading Internet service provider, with a full range of innovative access and hosting solutions used by approximately 1.15 million individuals and businesses every day. Using Oracle databases, EarthLink needed a better way to diagnose and address day-to-day application availability and management issues. Due to the size and the dynamic nature of its business, downtime would be catastrophic. EarthLink selected our products to satisfy its requirements in this area. To manage its applications, EarthLink uses I/Watch and Instance Monitor for database monitoring, diagnostics and resolution. Based on our discussions with EarthLink, we believe that they particularly liked the user interfaces and integration of the products they purchased. We also believe that these products, along with SQLab Xpert, enable their database administrators to perform "targeted tuning" with intelligent tuning recommendations that improve the performance of the databases. Space Manager provides EarthLink with a comprehensive solution for database reorganization and capacity planning for application availability through preventive maintenance, problem detection and resolution across all databases. NCR NCR provides integrated software, consulting services and hardware solutions for businesses. NCR runs Oracle in a multi-platform environment with a combination of applications, including Oracle Financials, PeopleSoft and other internally developed solutions. NCR employs over 300 servers worldwide and executes mission-critical data transfers. This complexity required a controlled application development and deployment environment. Our change management products allow NCR to facilitate the identification, migration and deployment of critical database changes required to ensure that all databases have the same structure across the entire enterprise. NCR uses SQL Impact to identify the interdependencies between application source code and the database objects. NCR uses Schema Manager to synchronize and migrate database structural changes between development and production databases. In addition, they use SQLab Tuner to tune complex queries and SQL Navigator for server-side development and debugging. As a result of implementing our products, we believe that NCR was able to realize a reduction in processing time by improving code integrity and reducing development time. Priceline.com On April 6, 1998, priceline.com opened its virtual doors to pioneer a new level of service that allows online consumers to "name your price and save" on an array of goods and services from airline tickets to home mortgages. Because priceline.com's customers can only purchase product via the Internet, the Web site is the business and therefore depends on continuous availability. To ensure this availability, priceline.com turned to our SharePlex replication solution. SharePlex protects priceline.com from downtime by providing live, up-to-the-minute copies of their production databases to not only balance the workload of thousands of consumers, but also provide a backup in the event of a failure. SharePlex 37 39 was the only solution available that met the requirements of priceline.com's demanding environment. Creating the environment required for around the clock access poses one of the greatest challenges Internet companies face today. SharePlex not only solved this problem but also provided geographical redundancy to both priceline.com sites, located in Connecticut and New Jersey. SALES, MARKETING AND DISTRIBUTION We market and sell our products and services worldwide through a combination of direct sales and telesales forces and, to a lesser extent, resellers and distributors. Our domestic sales organization is headquartered in Irvine, California. We have additional sales offices located in the metropolitan areas of Atlanta, Boston, Chicago, Dallas, Detroit, New York, Raleigh, San Francisco and Washington D.C. We also have international sales offices in the metropolitan areas of Frankfurt, London and Melbourne. We are continuing to expand our sales organization and establish additional sales offices domestically and internationally. We also sell certain of our products through our Web site, which allows our customers to conveniently download our products for evaluation and direct purchase. Our sales and marketing approach is designed to help customers understand both the business and technical benefits of our products. Accordingly, we complement the efforts of our sales organization with a pre-sale customer support organization that is responsible for addressing technical questions related to our products. The sales team for each customer is responsible for maintaining appropriate contacts with key information technology personnel who have planning and purchasing responsibility within the customer's organization. Since a number of our products affect systems and employees throughout the enterprise, our sales effort typically involve technology presentations and pilot implementations, and many times involve numerous decision makers. As a result, a key feature of our sales efforts is to establish relationships at all appropriate levels in our customers' organizations. While the sales cycle varies substantially from customer to customer, the typical sales cycle for our Vista Plus and SharePlex products has ranged from three to six months. Focusing on our target markets, our marketing efforts are designed to create awareness for our products and generate sales leads. To achieve these goals, we engage in a variety of marketing activities, including seminars, trade shows, direct mailings and print and Web-based advertising. In addition, we have recently expanded our marketing staff and intend to commence an ongoing public relations program that will include establishing and maintaining relationships with key trade press, business press and industry analysts. We also intend to initiate a customer advisory council which will provide a communication channel for regular feedback from key customers to facilitate the design of products to meet the expanding requirements of our target market. CUSTOMER SERVICE AND SUPPORT A high level of customer service and support is critical to the successful marketing and sale of our products and the development of long-term customer relationships. Our customer support group provides technical support to our customers under support agreements entered into at the time of the initial sale. Our base level of e-mail-, Internet-, fax-, and telephone-based support includes assistance with installation, configuration and initial set-up of our products; ongoing support during normal business hours; and software maintenance and upgrade releases. For an additional fee, we provide support on a 24x7x365 basis as well as training and other services. Customer support is provided domestically through our offices in Irvine and internationally through our offices in Europe and Australia. We plan to hire additional support personnel and, as needed, establish additional support sites domestically and internationally to meet our customers' needs. Furthermore, we plan to extend our existing strategic partnerships and develop new partnerships with leading systems integrators to provide implementation guidance, assistance with configuration and initial set-up of applications. Our services contracts are generally of 12 months' duration and are renewable at the customer's option. Service contracts are generally priced at approximately 20% of the amount of licenses and the customer is invoiced annually in advance. 38 40 RESEARCH AND DEVELOPMENT We believe that strong research and product development capabilities are essential to enhancing our core technologies and developing additional products that offer maximum value and ease of use. We have invested significant time and resources in creating a structured process for undertaking product development projects. This process is designed to provide the proper framework for defining and addressing the steps, tasks and activities required to bring product concepts and development projects to market successfully. A significant portion of our development effort is conducted in Melbourne, Australia. We have actively recruited key software engineers and developers with expertise in the areas of Oracle technologies, SQL Server, Java, Microsoft development technologies, ERP systems, IBM database technologies and document management. Our engineers include several of the industry's leading database management authorities. Complementing these individuals, our senior management has extensive background in the database, network infrastructure and enterprise and system software industries. Our research and development efforts focus on designing and developing reliable, easy to install and use products that solve application and information availability problems for our customers. Since our inception in 1987, we have made substantial investments in research and development through both internal development and technology acquisitions. Our products utilize a number of advanced technologies including the log analysis component of SharePlex that allows quick and accurate determination of the database structural and data changes with minimal overhead. Another example is our Vista Plus product line which contains highly sophisticated postscript and PCL parsing technology that allows these products to understand complex output data streams, enabling search, transformation and extraction from graphics-intensive output. COMPETITION The market for application and information availability solutions is emerging rapidly, and, as a result, is intensely competitive and characterized by rapidly changing technology and evolving standards. We expect competition to continue to increase both from existing competitors and new market entrants. We believe that our ability to effectively compete depends on many factors, including: - the ease of use, performance, features, price and reliability of our products as compared to those of our competitors; - the timing and market acceptance of new products and enhancements to existing products developed by us and our competitors; - the quality of our customer support; and - the effectiveness of our sales and marketing efforts. Companies currently offering competitive products vary in the scope and breadth of the products and services offered and include: - providers of enterprise report management products such as Computer Associates, Mobius, Hewlett Packard and IBM; - providers of hardware and software replication tools such as EMC and Veritas; and - providers of database and database management products such as BMC, Compuware, Oracle, and Computer Associates. Many of our competitors and potential competitors have greater name recognition, a larger installed customer base company-wide and significantly greater financial, technical, marketing, and other resources than we do. Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. In addition, because there are relatively low barriers to entry in the software market, we may encounter additional competition as other established and emerging companies enter our field and introduce new products and technologies. 39 41 In addition, providers of database solutions such as Oracle, Microsoft and IBM currently produce database management tools and may in the future enhance their products to include functionality that is currently provided by our products. The inclusion of the functionality of our software as standard features of the underlying database solution or application supported by our products could render our products obsolete and unmarketable, particularly if the quality of such functionality were comparable to that of our products. Even if the functionality provided as standard features by these system providers is more limited than that of our software, there can be no assurance that a significant number of customers would not elect to accept more limited functionality in lieu of purchasing additional software. Moreover, there is substantial risk that the mere announcements of competing products by large competitors such as Oracle could result in the delay or cancellation of customer orders for our products in anticipation of the introduction of such new products. In addition to the competition that we may face because of the internal development efforts of our competitors, current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with third parties, thereby increasing their ability to address the needs of our current or prospective customers. Accordingly, it is possible that new competitors or alliances among current and new competitors may emerge and rapidly gain significant market share. Such competition could also materially adversely affect our ability to sell our products or to obtain maintenance and support renewals for existing licenses on terms favorable to us. There can be no assurance that we will be able to compete successfully against current and future competitors. Increased competition could result in price reductions, fewer customer orders, reduced gross margins and loss of market share, any of which could materially affect our business, operating results or financial condition. PROPRIETARY RIGHTS 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. We presently have no patents on our products. We currently hold several trademark registrations and have numerous trademark applications in the United States and certain foreign countries. Our trademark applications might not result in the issuance of any valid trademarks. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to signed or shrinkwrap license agreements, which impose restrictions on the licensee's ability to utilize the software. Finally, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code. 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. In addition, we sell our products internationally. The laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. 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 and would materially adversely affect our business, operating results and financial condition. We cannot assure you that our means of protecting our proprietary rights will be adequate or that competition will not independently develop similar or superior technology. 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. We are not aware that we are infringing any proprietary rights of third parties. There can be no assurance, however, that third parties will not claim we infringe their 40 42 intellectual property rights. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. 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, our business, operating results and financial condition could be materially adversely affected. We incorporate technology from third parties into our SQL Navigator, TOAD, Vista Plus and Foglight products. We currently have a material license agreement with Inso for the use of file viewing technology which is incorporated into an add-on module for our Vista Plus products. We currently pay Inso royalty fees based on sales of our Vista Plus product. This license agreement terminates on February 10, 2002. In addition, we currently have a material license agreement with Artifex for the use of technology which is incorporated into an add-on module for our Vista Plus products. We currently pay Artifex royalty fees based on sales of Vista Plus products incorporating the licensed software. The license for the technology from Artifex remains in effect for so long as any proprietary rights in the licensed technology are enforceable under the laws of any jurisdiction, unless earlier terminated by us upon 30 days written notice or by Artifex upon a material breach by us. We also have a material license agreement with Inxight which is incorporated into the Foglight product. We currently pay Inxight a license fee per year plus royalty fees equal to a percentage of the license fee. The license agreement terminates September 30, 2002. As we continue to introduce new products, we may be required to license additional technology from others. There can be no assurance that these third-party technology licenses will continue to be available to us on commercially reasonable terms, if at all. SharePlex is a registered trademark owned by us. This prospectus also makes reference to the other trademarks that we own, some of which we are seeking registration for, and to trademarks of other companies. EMPLOYEES As of December 31, 1999, we employed 654 full-time employees, including 299 in sales and marketing, 226 in research and development, 52 in customer service and support and 77 in general and administrative. We believe that our future success will depend in large part upon our continuing ability to attract and retain highly skilled managerial, sales, marketing, customer support and research and development personnel. Like other software companies, we face intense competition for such personnel, and we have at times experienced and continue to experience difficulty in recruiting qualified personnel. There can be no assurance that we will be successful in attracting, assimilating and retaining other qualified personnel in the future. We are not subject to any collective bargaining agreement and we believe that our relationships with our employees are good. FACILITIES Our principal administrative, sales, marketing, support and research and development facility is currently located in approximately 67,500 square feet of space in Irvine, California. This facility is under a six-year lease and we have an option to renew this lease for an additional five-year term. We also lease sales offices in the metropolitan areas of Atlanta, Boston, Calgary, Chicago, Dallas, Detroit, New York, Raleigh, San Francisco, and Washington, D.C. Our Chicago office is currently located in approximately 30,000 square feet in Warrenville, Illinois. This facility is under a 7-year lease. Our German subsidiary currently operates from two facilities in Frankfurt and Dusseldorf. Our Australian subsidiary operates from two leased facilities in Melbourne which total approximately 10,000 square feet. Our UK subsidiary leases a 5,300 square-foot office in the London metropolitan area. LEGAL PROCEEDINGS We are not currently a party to any material legal proceeding. 41 43 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information regarding our executive officers and directors as of February 1, 2000:
NAME AGE POSITION - ---- --- -------- Vincent C. Smith.............. 36 Chief Executive Officer and Chairman of the Board David M. Doyle(2)............. 39 President, Secretary and Director John J. Laskey................ 50 Chief Financial Officer and Vice President, Finance Eyal M. Aronoff............... 36 Vice President, Technology and Engineering Douglas F. Garn............... 41 Vice President, Worldwide Sales Doran G. Machin(1)(2)......... 45 Director Jerry Murdock, Jr.(1)(2)...... 41 Director
- ------------------------- (1) Member of Compensation Committee (2) Member of Audit Committee Set forth below is certain information regarding the business experience during the past five years of each of the above-named persons. Vincent C. Smith has served as our Chief Executive Officer since 1997 and a director since 1995. Mr. Smith became Chairman of the Board in 1998. In 1994, Mr. Smith was Director of Open Systems at BMC Software, where he managed its sales operations. From 1992 to 1994, Mr. Smith co-founded Patrol Software North America and served as its Vice President of Worldwide Sales and Marketing. Patrol Software merged with BMC in 1994. Mr. Smith worked at Oracle Corporation from 1987 to 1992 in a variety of sales management positions. Mr. Smith received his B.S. degree in Computer Science with a minor in Economics from University of Delaware. David M. Doyle is our President, Secretary, founder and a director. Mr. Doyle has been President and a director since the formation of Quest in 1987 and has been our Secretary since June 1999. Mr. Doyle was the primary designer and developer of our products during the initial four years after the founding of Quest. Prior to the founding of Quest, Mr. Doyle served as a consultant to a variety of industries, specializing in the areas of system design and application performance and co-founded American Data Industries. Mr. Doyle studied Information and Computer Sciences at University of California, Irvine. John J. Laskey is our Chief Financial Officer and Vice President, Finance. Mr. Laskey has held these positions since October 1998. From June 1995 to October 1998, Mr. Laskey served as the Chief Financial Officer and Vice President, Finance of Continuus Software Corporation, a provider of software change management solutions. From April to June 1995, Mr. Laskey was the Chief Financial Officer and Vice President, Finance of StarBase Corporation. From September 1986 to April 1995, Mr. Laskey worked at FileNet Corporation as Vice President, Finance and Principal Accounting Officer. Mr. Laskey received his B.S. degree in Electrical Engineering from University of Illinois and his M.B.A. from Loyola University of Chicago. Eyal M. Aronoff has been our Vice President of Technology and Engineering since March 1996, when we acquired R*Tech Systems, Inc., a database management company. Mr. Aronoff founded R*Tech Systems in 1992 and served as its President from 1992 to 1996. Prior to this, Mr. Aronoff worked for John Bryce Ltd., an Oracle distributor in Israel, attended school and served in the Israeli Defense Force. Mr. Aronoff received a B.A. degree in computer science and chemistry from Bar-Ilan University Ramat-Gan, Israel. Douglas F. Garn is the Vice President of Worldwide Sales. Mr. Garn has held this position since January 1998. From March 1996 to January 1998, Mr. Garn was Vice President of North American Sales for Peregrine Systems, Inc. From July 1995 until April 1996, Mr. Garn was Vice President of Sales with 42 44 Syntax, Inc., a networking software company. From November 1993 until July 1995, Mr. Garn was Regional Sales Manager with BMC. Mr. Garn holds a B.S. in Marketing from University of Southern California. Doran G. Machin has served as a director since 1987. Mr. Machin was also our Secretary and Executive Vice President from 1987 through April, 1999. Prior to 1987, Mr. Machin was employed as an independent computer consultant, worked for Hewlett-Packard and American Data Industries. Mr. Machin attended Cerritos College and California State University, Fullerton. Jerry Murdock, Jr. has served as a member of our board since April 1999. Since 1995, Mr. Murdock has been employed by InSight Capital Partners, an investment firm which he co-founded in that year. From 1987 to 1995, Mr. Murdock was President of Aspen Technology Group, a consulting firm which he founded in 1987. Mr. Murdock has a degree in Political Science from San Diego State University. Mr. Murdock is a member of the boards of directors of several private technology companies. KEY EMPLOYEES Kimberly A. Kinnison has been our Vice President of Technical Support since January 1999. As such, Ms. Kinnison oversees our management information systems department and our worldwide technical support staff. From January 1998 to January 1999, Ms. Kinnison was our Director of Technical Support and from June 1995 to December 1997, she was our Support Manager. Ms. Kinnison joined Quest in November 1991 as a technical support engineer. Prior to joining Quest, Ms. Kinnison held positions as a systems programmer at Hughes Aircraft and instructor/consultant at Hewlett Packard. Ms. Kinnison received her B.S. in Computer Information Systems from California State Polytechnic University, Pomona. Terence J. Mullin has been our Vice President of the Output Management Business Unit since April 1998. From November 1997 to April 1998, Mr. Mullin was the Vice President of Marketing and Business Development of Clarion Corporation of America's Advanced Technology Division. From April 1997 to November 1997, Mr. Mullin was the Vice President of Marketing and Business Development for NetSoft/NetManage. From April 1995 to April 1997, Mr. Mullin held the position of Strategic Planner of Internet Strategy and Marketing at FileNet Corporation. Mr. Mullin studied Computer Science at California State University, Fullerton and completed the Advanced Management Development in Business Administration program offered by the University of Southern California. Charles C. Ramsey has been our Vice President of International Sales since January 1999. In this position, Mr. Ramsey heads up the expansion of our international direct-sales and support teams and will complete the development of a worldwide channel organization. From April 1998 to January 1999, Mr. Ramsey was a Regional Field Sales Manager. From May 1989 to April 1998, Mr. Ramsey was employed with Ziff Davis Market Intelligence, where he was most recently the Vice President of Sales. Prior to working at Ziff Davis, Mr. Ramsey worked for IBM Corporation for five years. Mr. Ramsey received a B.S. in Communications from University of California, San Diego and an M.I.M. from American Graduate School of International Management. BOARD OF DIRECTORS AND COMMITTEES We have established an audit committee composed of Messrs. Doyle, Machin and Murdock. Messrs. Machin and Murdock are independent directors. This committee reviews and supervises our financial controls, including the selection of our auditors, reviews the books and accounts, meets with our officers regarding our financial controls, acts upon recommendations of auditors and takes further actions as the audit committee deems necessary to complete an audit of our books and accounts, as well as other matters which may come before it or as directed by the board. We have established a compensation committee, which reviews and approves the compensation and benefits for our executive officers, administers our stock plans and performs other duties as may from time 43 45 to time be determined by the board. The compensation committee is currently comprised of Messrs. Murdock and Machin. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION We did not have a Compensation Committee for 1998. In 1998, all decisions regarding executive compensation were made by our board of directors. We created our compensation committee in June 1999. In October 1997, we sold to Mr. Smith, our Chief Executive Officer and Chairman of the Board, 3,900,000 shares of common stock for aggregate consideration of $2.2 million. Mr. Smith executed a promissory note for the purchase price. This note is due and payable on April 1, 2002 and bears interest at a rate of 6.2%. The accrued interest on this note at 1999 fiscal year end was $326,251. As of the date of this prospectus, the entire principal amount of this note is outstanding. This note is also secured in part by the 3,900,000 shares of common stock. In April 1999, we purchased an aggregate of 14,820,000 shares of our common stock for a total purchase price of $35.0 million from trusts established by Mr. Machin, one of the founders and a director of Quest. In addition, we entered into a severance agreement with Mr. Machin pursuant to which we agreed to pay him an annual fee of $200,000 per year from 1999 to 2001, pay him medical benefits and provide for his use of a company car and related car expenses. Mr. Machin currently owns no shares of our capital stock. In April 1999, we sold an aggregate of 1,688,889 shares of our Series A Preferred Stock at a price of $5.625 per share to investors affiliated with InSight Capital Partners. The shares of Series A Preferred Stock converted into 2,533,333 shares of common stock immediately after our initial public offering. Mr. Murdock, a director of Quest, is a General Partner of InSight Capital Partners. Mr. Murdock has not been an officer or employee of ours at any time since our formation. No interlocking relationship exists between any of our executive officers or any member of our compensation committee and any member of any other company's board of directors or compensation committee. DIRECTOR COMPENSATION AND OTHER ARRANGEMENTS Directors receive no cash remuneration for serving on the board of directors or any committee thereof. Non-employee directors are reimbursed for reasonable expenses incurred by them in attending board and committee meetings. Non-employee board members are also eligible for option grants pursuant to the provisions of the automatic option grant program under our 1999 Stock Incentive Plan. See "-- 1999 Stock Incentive Plan." 44 46 SUMMARY COMPENSATION TABLE The following table sets forth for the year ended December 31, 1997, 1998 and 1999, all compensation received for services rendered to Quest in all capacities by our chief executive officer and each of the other four most highly compensated executive officers whose salary and bonus exceeded $100,000 in 1999. These officers are referred to in this prospectus as the "Named Executive Officers." Does not include those individuals who would otherwise have been includable in such table on the basis of salary and bonus earned during 1997, 1998 and 1999 who have resigned or otherwise terminated his employment during 1997, 1998 and 1999. The compensation table excludes other compensation in the form of perquisites and other personal benefits that constitutes the lesser of $50,000 or 10% of the total annual salary and bonus earned by each of the Named Executive Officers in 1997, 1998 and 1999. The amount set forth in the "All Other Compensation" column includes matching contributions under our 401(k) Plan and expenses paid by us for car and the automobile insurance thereon.
LONG-TERM COMPENSATION ANNUAL COMPENSATION ------------------ --------------------- SECURITIES ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) UNDERLYING OPTIONS COMPENSATION($) - --------------------------- ---- --------- -------- ------------------ --------------- Vincent C. Smith................. 1999 $246,875 -- -- -- Chief Executive Officer 1998 191,666 $175,000 -- -- 1997 275,000 -- -- -- David M. Doyle................... 1999 246,875 -- -- $25,700 President 1998 200,000 175,000 -- -- 1997 273,854 -- -- -- John J. Laskey................... 1999 155,000 15,000 22,500 -- Chief Financial Officer 1998 -- -- 180,000 -- 1997 -- -- -- -- Eyal M. Aronoff.................. 1999 212,946 -- -- -- Vice President, Technology 1998 195,445 -- 39,000 -- and Engineering 1997 176,322 39,518 -- 44,137 Douglas F. Garn.................. 1999 194,500 125,000 -- -- Vice President, Worldwide Sales 1998 184,510 125,000 576,000 -- 1997 -- -- -- --
OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth certain information with respect to stock options granted to each of the Named Executive Officers in 1999, including the potential realizable value over the ten-year term of the options, based on assumed rates of stock appreciation of 5% and 10%, compounded annually. These assumed rates of appreciation comply with the rules of the Commission and do not represent our estimate of future stock price. Actual gains, if any, on stock option exercises will be dependent on the future performance of our common stock. No stock appreciation rights were granted to the Named Executive Officers during 1999.
OPTIONS GRANTS IN 1999 ----------------------------------------------------- POTENTIAL REALIZABLE PERCENT OF VALUE AT ASSUMED ANNUAL NUMBER OF TOTAL RATES OF STOCK PRICE SECURITIES OPTIONS EXERCISE APPRECIATION FOR UNDERLYING GRANTED TO PRICE OPTION TERM($) OPTIONS EMPLOYEES IN PER-SHARE EXPIRATION ------------------------- NAME GRANTED(#) 1999(%) ($) DATE 5% 10% ---- ---------- ------------ --------- ---------- ---------- ----------- John J. Laskey....... 22,500 * $80.50 12/01/09 $1,884,238 $ 4,049,358
- ------------------------- * Less than one percent. The option listed in the table was granted under our 1999 Stock Incentive Plan, and represents the right to purchase one share of common stock. Except for 902 of Mr. Laskey's options, the options shown in this table are all nonqualified stock options. These options vest in full upon the one year anniversary of the grant date. 45 47 To the extent not already exercisable, all of these options will become exercisable in the event of a merger in which more than 50% of our outstanding securities are transferred to persons different from those persons who are our shareholders prior to the merger or upon the sale of substantially all our assets in complete liquidation or dissolution. This acceleration feature does not apply in the event that the options are assumed by the successor corporation in the merger or are replaced with a cash incentive program. During 1999 we granted options to purchase up to an aggregate of 2,391,125 shares of common stock. All options were granted at an exercise price equal to the fair market value of our common stock on the date of grant, as determined by our board of directors. The potential realizable value is calculated based on the ten year term of the option at its time of grant. It is calculated based on the assumption that the public offering price of $ per share appreciates at the indicated annual rate compounded annually for the entire term of the option and that the option is exercised and sold on the last day of its term for the appreciated stock price. Actual gains, if any, on stock option exercises are dependent on the future performance of the common stock and overall stock market conditions. The amounts reflected in the table may not necessarily be achieved. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES The following table sets forth the number and value of shares of common stock underlying the unexercised options held by the Named Executive Officers. No options were exercised during 1999.
NUMBER OF VALUE OF UNEXERCISED SECURITIES UNDERLYING IN-THE-MONEY UNEXERCISED OPTIONS AT OPTIONS AT DECEMBER 31, 1999 DECEMBER 31, 1999 ---------------------------- ---------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- Vincent C. Smith........................ -- -- -- -- David M. Doyle.......................... -- -- -- -- John J. Laskey.......................... 36,000 166,500 $ 3,629,880 $15,003,270 Eyal M. Aronoff......................... 10,920 28,080 $ 1,102,410 $ 2,834,040 Douglas F. Garn......................... 173,700 402,300 $17,543,700 $40,632,300
These values have been calculated on the basis of the fair market value of our common stock on December 31, 1999, less the applicable exercise price per share, multiplied by the number of shares underlying such options. 1999 STOCK INCENTIVE PLAN Introduction. Our 1999 Stock Incentive Plan is intended to serve as the successor equity incentive program to our 1998 Stock Option/Stock Issuance Plan. The 1999 Stock Incentive Plan was adopted by the board and subsequently approved by the shareholders in June 1999. The 1999 Stock Incentive Plan became effective upon its adoption by the board. On August 12, 1999, all outstanding options under our predecessor plan were incorporated into the 1999 Stock Incentive Plan, and no further option grants were made under the predecessor plan. The incorporated options will continue to be governed by their existing terms, unless the plan administrator elects to extend one or more features of the 1999 Incentive Plan to those options. Except as otherwise noted below, the incorporated options have substantially the same terms as will be in effect for grants made under the Discretionary Option Grant Program of the 1999 Stock Incentive Plan. Share Reserve. 7,493,400 shares of common stock have been authorized for issuance under the 1999 Stock Incentive Plan. This share reserve which was 2,214,820 at December 31, 1999 consists of the number of shares that remain available for issuance under the predecessor plan and shares of common stock subject to outstanding options thereunder. No participant in the 1999 Stock Incentive Plan may be granted stock options, separately exercisable stock appreciation rights and direct stock issuances for more than 500,000 shares of common stock in total per calendar year. 46 48 Programs. The 1999 Stock Incentive Plan is divided into five separate programs: - the discretionary option grant program under which eligible individuals in Quest's employ may be granted options to purchase shares of common stock at an exercise price determined by the plan administrator; - the stock issuance program under which such individuals may be issued shares of common stock directly, through the purchase of such shares at a price determined by the plan administrator or as a bonus tied to the performance of services; - the salary investment option grant program which may, at the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow executive officers and other highly compensated employees the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants; - the automatic option grant program under which option grants will automatically be made at periodic intervals to eligible non-employee board members to purchase shares of common stock at an exercise price equal to 100% of the fair market value of those shares on the grant date; and - the director fee option grant program which may, in the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow non-employee board members the opportunity to apply a portion of the annual retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants. Administration. The discretionary option grant program and the stock issuance program will be administered by the compensation committee of the board of directors. This committee will determine which eligible individuals are to receive option grants or stock issuances under those programs, the time or times when such option grants or stock issuances are to be made, the number of shares subject to each such grant or issuance, the status of any granted option as either an incentive stock option or a non-statutory stock option under the Federal tax laws, the vesting schedule to be in effect for the option grant or stock issuance and the maximum term for which any granted option is to remain outstanding. The compensation committee will also have the authority to select the executive officers and other highly compensated employees who may participate in the salary investment option grant program in the event that program is activated for one or more calendar years. Plan Features. Our 1999 Stock Incentive Plan includes the following features: - The exercise price for any options granted under the plan may be paid in cash or in shares of common stock valued at fair market value on the exercise date. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. - The compensation committee will have the authority to cancel outstanding options under the discretionary option grant program in return for the grant of new options for the same or different number of option shares with an exercise price per share based upon the fair market value of our common stock on the new grant date. - Stock appreciation rights may be issued under the discretionary option grant program. Such rights will provide the holders with the election to surrender their outstanding options for an appreciation distribution from us equal to the fair market value of the vested shares of common stock subject to the surrendered option less the exercise price payable for those shares. We may make the payment in cash or in shares of common stock. Change in Control. The 1999 Stock Incentive Plan includes the following change in control provisions which may result in the accelerated vesting of outstanding option grants and stock issuances: - In the event that Quest is acquired by merger or asset sale or a board-approved sale of more than fifty percent of the outstanding stock by our shareholders, each outstanding option under the discretionary option grant program which is not assumed or continued by the successor corporation will immediately become exercisable for all the option shares, and all unvested shares will 47 49 immediately vest, except to the extent we repurchase rights with respect to those shares are to be assigned to the successor corporation. - The plan administrator will have complete discretion to grant one or more options which will become exercisable for all the option shares in the event those options are assumed in the acquisition but the optionee's service with us or the acquiring entity is subsequently terminated. The vesting of outstanding shares under the 1999 Stock Incentive Plan may be accelerated upon similar terms and conditions. - The plan administrator may also grant options which will immediately vest upon our acquisition by another entity, whether or not those options are assumed by the successor corporation. - The plan administrator may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful tender offer for more than fifty percent (50%) of the outstanding voting stock or a change in the majority of our board of directors through one or more contested elections. Such accelerated vesting may occur either at the time of such transaction or upon the subsequent termination of the individual's service. Salary Investment Option Grant Program. In the event the compensation committee decides to put this program into effect for one or more calendar years, each of our executive officers and other highly compensated employees selected for participation may elect to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10,000 nor more than $75,000. Each selected individual who makes such an election will automatically be granted, on the first trading day in January of the calendar year for which that salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of common stock on the grant date. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. A compensation expense will be recorded for the amount of the salary reduction. As a result, the total spread on the option shares at the time of grant will be equal to the amount of salary invested in that option. The option will vest and become exercisable in a series of twelve (12) equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting upon certain changes in the ownership or control of Quest. Automatic Option Grant Program. Each individual who first becomes a non-employee board member at any time after the completion of this offering will automatically receive an option grant for 25,000 shares on the date such individual joins the board, provided such individual has not been in the prior employ of Quest. In addition, on the date of each annual shareholders meeting beginning with the 2001 annual shareholders meeting, each non-employee board member who has served as a non-employee board member since the date of the last annual shareholders meeting will automatically be granted an option to purchase 7,500 shares of common stock. Each automatic grant will have a term of ten years, subject to earlier termination following the optionee's cessation of board service. The initial 25,000 share option will be immediately exercisable for all of the option shares; however, any unvested shares purchased under the option will be subject to repurchase by us, at the exercise price paid per share, should the optionee cease board service prior to vesting in those shares. The shares subject to each 25,000 share automatic option grant will vest over a four (4) year period in successive equal annual installments upon the individual's completion of each year of board service over the four (4) year period measured from the option grant date. However, the shares subject to each such automatic grant will immediately vest in full upon certain changes in control or ownership of Quest or upon the optionee's death or disability while a board member. Each 7,500 share automatic option grant will be immediately exercisable and fully vested on the option grant date. Director Fee Option Grant Program. If this program is put into effect in the future, then each non-employee board member may elect to apply all or a portion of any annual retainer fee otherwise payable in cash to the acquisition of a below-market option grant. The option grant will automatically be 48 50 made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the retainer fee applied to the program by two-thirds of the fair market value per share of common stock on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the aggregate exercise price payable for those shares will be equal to the portion of the retainer fee invested in that option. The option will become exercisable in a series of twelve (12) equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares upon certain changes in the ownership or control of Quest or the death or disability of the optionee while serving as a board member. Limited Stock Appreciation Rights. Limited stock appreciation rights will automatically be included as part of each grant made under the automatic option grant, salary investment option grant and director fee option grant programs and may be granted to one or more of our officers as part of their option grants under the discretionary option grant program. Options with such a limited stock appreciation right may be surrendered to Quest upon the successful completion of a hostile tender offer for more than 50% of the Quest outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from us in an amount per surrendered option share based on the highest price per share of common stock paid in connection with the tender offer. Amendment. The board may amend or modify the 1999 Stock Incentive Plan at any time, subject to any required shareholder approval. The 1999 Stock Incentive Plan will terminate no later than June 8, 2009. 1999 EMPLOYEE STOCK PURCHASE PLAN Introduction. The 1999 Employee Stock Purchase Plan was adopted by the board and approved by the shareholders in June 1999 and became effective on August 12, 1999. The 1999 Employee Stock Purchase Plan is designed to allow our eligible employees and the employees of our participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through their periodic payroll deductions under the 1999 Employee Stock Purchase Plan. Share Reserve. 600,000 shares of common stock have been reserved for issuance, of which 119,097 shares have been issued as of February 2, 2000. Purchase Periods. The plan has a series of successive purchase periods, each with a maximum duration of six months. The initial purchase period began on August 12, 1999 and ended on the last business day in January 2000. Thereafter, purchase periods run from the first business day in February to the last business day in July each year, and from the first business day in August to the last business day in January of the following year. Eligible Employees. Individuals who are scheduled to work more than 20 hours per week for more than 5 calendar months per year on the start date of any purchase period may join the plan on such start date. Payroll Deductions. A participant may contribute up to 15% of his or her cash earnings, and the accumulated payroll deductions will be applied to the purchase of shares on each semi-annual purchase date. The purchase price per share will be equal to 85% of the fair market value of the common stock on the start date of the purchase period or, if lower, the fair market value on the semi-annual purchase date. Semi-annual purchase dates will occur on the last business day of January and July each year. In no event, however, may any participant purchase more than 600 shares on any semi-annual purchase date. Change in Control. In the event Quest is acquired by merger or asset sale, all outstanding purchase rights will automatically be exercised immediately prior to the effective date of the acquisition. The purchase price will be equal to 85% of the fair market value per share of common stock on the 49 51 participant's entry date into the offering period in which such acquisition occurs or, if lower, the fair market value per share of common stock immediately prior to such acquisition. Termination/Amendment. The 1999 Employee Stock Purchase Plan will terminate on the last business day of July 2009. The board may at any time alter, suspend or discontinue the plan. However, certain amendments to the plan may require shareholder approval. Registration Statement on Form S-8. On November 22, 1999, we filed a registration statement on Form S-8 with the Commission pursuant to which we registered 7,493,400 shares of common stock issued or issuable upon exercise of options granted under the 1999 Stock Incentive Plan, 500,000 shares of common stock issuable under the 1999 Employee Stock Purchase Plan and 100,000 shares of common stock issuable under the International Employee Stock Purchase Plan. This registration statement became effective immediately upon filing. The possible sale of a significant number of such shares by the holders thereof may have an adverse effect on the price of our common stock. FOGLIGHT SOFTWARE, INC. 1998 STOCK OPTION PLAN In connection with the Foglight merger, we assumed the outstanding options issued under the Foglight Software, Inc. 1998 Stock Option Plan and reserved 25,602 shares of our common stock for issuance upon exercise of these assumed options. On February 4, 2000, we filed a registration statement on Form S-8 with the Commission pursuant to which we registered 25,602 shares of common stock issuable upon exercise of these assumed options. This registration statement became effective immediately upon filing. LIMITATION OF LIABILITY AND INDEMNIFICATION Our Amended and Restated Articles of Incorporation limit the personal liability of our directors for monetary damages to the fullest extent permitted by the California General Corporation Law. Under California law, a director's liability to a company or its shareholders may not be limited: - for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law; - for acts or omissions that a director believes to be contrary to the best interests of the company or its shareholders or that involve the absence of good faith on the part of the director; - for any transaction from which a director derived an improper personal benefit; - for acts or omissions that show a reckless disregard for the director's duty to the company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing the director's duties, of a risk of serious injury to the company or its shareholders; - for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the company or its shareholders; - under Section 310 of the California General Corporation Law concerning contacts or transactions between the company and a director; or - under Section 316 of the California General Corporation Law concerning directors' liability for improper dividends, loans and guarantees. The limitation of liability does not affect the availability of injunctions and other equitable remedies available to our shareholders for any violation by a director of the director's fiduciary duty to us or our shareholders. Our Articles of Incorporation also include an authorization for us to indemnify our "agents," as defined in Section 317 of the California General Corporation Law, through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, our Amended and Restated Bylaws provide for indemnification of our directors, officers and employees. In addition, we may, at our 50 52 discretion, provide indemnification to persons whom we are not obligated to indemnify. The Amended and Restated Bylaws also allow us to enter into indemnity agreements with individual directors, officers, employees and other agents. Indemnity agreements have been entered into with all directors and certain executive officers and provide the maximum indemnification permitted by law. We also currently maintain directors' and officers' liability insurance. These agreements, together with our Amended and Restated Bylaws and Amended and Restated Articles of Incorporation, may require us, among other things, to indemnify our directors and executive officers, other than for liability resulting from willful misconduct of a culpable nature, and to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification. Section 317 of the California General Corporation Law and our Amended and Restated Bylaws and our indemnification agreements make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities, including reimbursement of expenses incurred, arising under the Securities Act. We are not currently aware of any pending litigation or proceeding involving any of our directors, officers, employees or agents in which indemnification will be required or permitted. Moreover, we are not currently aware of any threatened litigation or proceeding that might result in a claim for such indemnification. We believe that the foregoing indemnification provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. CERTAIN TRANSACTIONS SALES OF PREFERRED STOCK In April 1999, we sold an aggregate of 1,688,889 shares of our Series A Preferred Stock at a price of $5.625 per share to investors affiliated with InSight Capital Partners. Mr. Murdock, a director of Quest, is a General Partner of InSight Capital Partners. In April 1999 we also sold 977,778 shares of Series A Preferred Stock and 1,777,778 shares of our Series B Redeemable Preferred Stock to UBS Capital LLC at a price of $5.625 per share. The proceeds from the issuance of the Series A and Series B Preferred Stock was used to repurchase shares of our common stock held by Mr. Machin, one of our co-founders and directors. See "-- Repurchase of Shares from and Severance Arrangement with Director." Immediately after our initial public offering, all of the 2,666,667 shares of Series A Preferred Stock were converted into 4,000,000 shares of common stock. Such holders of shares of common stock issued upon the conversion of the Series A Preferred Stock are entitled to certain registration rights with respect to the common stock issued upon conversion thereof. See "Description of Capital Stock -- Registration Rights." We used approximately $10.6 million of the net proceeds of our initial public offering to redeem the Series B Redeemable Preferred Stock, including all accrued, cumulative dividends thereon. The following table summarizes the shares of preferred stock purchased by our executive officers, directors and five percent shareholders and persons associated with them since January 1996. The number of total shares on an as-converted basis reflects the 1-for-1.5 conversion ratio for each share of Series A Preferred Stock. The entities affiliated with InSight Capital Partners consist of InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P. and WI Software Investors LLC.
SERIES B SERIES A REDEEMABLE TOTAL SHARES ON AN PREFERRED PREFERRED AS-CONVERTED AGGREGATE INVESTOR STOCK STOCK BASIS CONSIDERATION - -------- --------- ---------- ------------------ ------------- Entities affiliated with InSight Capital Partners.................... 1,688,889 -- 2,533,333 $ 9,500,000 UBS Capital LLC....................... 977,778 1,777,778 1,466,667 15,500,000
51 53 REPURCHASE OF SHARES FROM AND SEVERANCE ARRANGEMENT WITH DIRECTOR In April 1999 we purchased an aggregate of 14,820,000 shares of our common stock for a total purchase price of $35.0 million from trusts established by Mr. Machin, one of the founders and a director of Quest. During late 1998, Mr. Machin sought to sell his stock and liquidate his position in Quest. Mr. Machin and the Company negotiated at arms-length to determine the pricing of the repurchase and Mr. Machin ultimately agreed upon a price based on the fact that he could obtain cash immediately. In addition, we entered into a severance agreement with Mr. Machin to pay him an annual fee of $200,000 per year from 1999 to 2001 and to provide for his use of a company car, related car expenses and medical benefits. There was no prior agreement that obligated us to consummate the repurchase transaction with Mr. Machin. Currently, Mr. Machin does not own any shares of our capital stock. ACQUISITION OF R*TECH SYSTEMS, INC. AND SALE OF STOCK TO OFFICER In March 1996, we acquired R*Tech Systems, Inc., the sole shareholder of which was Mr. Aronoff, our current Vice President, Engineering and Technology, through a merger of R*Tech with and into Quest. In the merger Quest issued 1,950,000 shares of common stock to Mr. Aronoff. Mr. Aronoff also entered into an employment agreement with us for a term of 24 months, under which he received an annual salary of $85,000, the right to receive commissions on the sale of certain products, the right to receive bonus payments of up to $400,000 upon the achievement of specified performance milestones, and an option to purchase up to 2.5% of our outstanding capital stock. In April 1998, Mr. Aronoff purchased 975,000 shares of common stock under the option for a per share purchase price of $.769 and a total purchase price of $750,000, for which Mr. Aronoff executed a promissory note. The note has a term of four years, bears interest at the rate of 5.7% per annum, and up to 25% of the original principal amount of the note may be prepaid in each year of the four-year term. The entire amount due under the note may be prepaid upon a sale or merger of Quest or at any time Mr. Smith no longer serves as our chief executive officer. During the year ended December 31, 1999, Mr. Aronoff made principal payments on the note of $230,000. The accrued interest on this note at 1999 fiscal year end was $68,984. Mr. Aronoff's two-year employment agreement expired in March 1998. SALE OF COMMON STOCK TO MR. SMITH In October 1997, we sold to Mr. Smith, our Chief Executive Officer, 3,900,000 shares of common stock for aggregate consideration of $2.2 million. Mr. Smith executed a promissory note for the purchase price. See "Management -- Compensation Committee Interlocks and Insider Participation." TRANSACTIONS WITH DIRECTORS AND OFFICERS In June 1998, we granted options to two of our officers, Eyal Aronoff and Douglas Garn, to purchase 24,000 and 450,000 shares of our common stock, respectively, at an exercise price of $1.00 per share. In July 1998, we granted options to Mr. Garn and Terence Mullin and Charles Ramsey, officers, to purchase 126,000, 75,000 and 150,000 shares of our common stock, respectively, at an exercise price of $1.00. In September 1998, we granted options to Mr. Aronoff and to John Laskey, an officer, to purchase 15,000 and 180,000 shares of our common stock, respectively, at an exercise price of $1.17 per share. In January 1999, we granted options to purchase 120,000 shares of our common stock at an exercise price of $2.37 per share to Carla Fitzgerald, an officer. In January 1999, we granted options to purchase 30,000 and 15,000 shares of our common stock at an exercise price of $2.37 per share to Mr. Mullin and Mr. Ramsey, respectively. In December 1999, we granted options to purchase 22,500 shares of our common stock at an exercise price of $80.50 per share to Mr. Laskey. 52 54 OTHER RELATED PARTY TRANSACTIONS We have entered into an indemnification agreement with certain of our executive officers and our directors containing provisions that may require us, among other things, to indemnify our officers and our directors against certain liabilities that may arise by reason of their status or service as officers or directors, other than liabilities arising from willful misconduct of a culpable nature, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. See "Management -- Limitation of Liability and Indemnification." We believe that all of the transactions set forth above were made on terms no less favorable to us than could have been otherwise obtained from unaffiliated third parties. All future transactions, including loans, if any, between us and our officers, directors and principal shareholders and their affiliates and any transactions between us and any entity with which our officers, directors or principal shareholders are affiliated will be approved by a majority of the board of directors, including a majority of the independent and disinterested outside directors of the board of directors and will be on terms no less favorable to us than could be obtained from unaffiliated third parties. PRINCIPAL AND SELLING SHAREHOLDERS The table below sets forth information regarding the beneficial ownership of our common stock as of February 16, 2000 by the following individuals or groups: - each person or entity who is known by Quest to own beneficially more than five percent of our outstanding common stock; - each of the Named Executive Officers; - each director; - all directors and executive officers as a group, which for us is seven persons; and - the selling shareholders. Applicable percentage ownership in the following table is based on the number of shares of common stock outstanding as of February 16, 2000. In addition, information presented in the table below assumes no exercise of the underwriters' over-allotment option. Beneficial ownership is determined in accordance with the rules of the Commission and generally includes voting or investment power with respect to securities. The number of shares beneficially owned and the percentage of shares beneficially owned are based on 40,283,920 shares of common stock outstanding as of February 16, 2000 and 41,407,720 shares of common stock outstanding upon consummation of this offering. Shares of common stock subject to options currently exercisable or exercisable within 60 days of February 16, 2000 are deemed to be outstanding and to be beneficially owned by the person holding these options for the purpose of computing the number of shares beneficially owned and the percentage of the person or entity holding these securities, but are not deemed outstanding for the purpose of computing the percentage ownership of any other person or entity. Unless otherwise indicated, the principal address of each of the shareholders below is c/o Quest Software, Inc., 8001 Irvine Center Drive, Irvine, California 92618.
NUMBER OF SHARES NUMBER OF SHARES BENEFICIALLY OWNED BENEFICIALLY OWNED PRIOR TO THIS OFFERING AFTER THIS OFFERING ----------------------- SHARES TO ------------------------ NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE BE SOLD NUMBER PERCENTAGE ------------------------ ---------- ---------- --------- ---------- ---------- Vincent C. Smith(1)................. 18,084,174 44.9% 0 18,084,174 43.7% David M. Doyle...................... 7,250,657 18.0 250,000 7,000,657 16.9 Eyal M. Aronoff(2).................. 2,940,990 7.3 250,000 2,690,990 6.5 Jerry Murdock(3).................... 2,785,201 6.9 0 2,785,201 6.7 John J. Laskey(4)................... 59,400 * 18,000 41,400 *
53 55
NUMBER OF SHARES NUMBER OF SHARES BENEFICIALLY OWNED BENEFICIALLY OWNED PRIOR TO THIS OFFERING AFTER THIS OFFERING ----------------------- SHARES TO ------------------------ NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE BE SOLD NUMBER PERCENTAGE ------------------------ ---------- ---------- --------- ---------- ---------- Douglas F. Garn(5).................. 248,580 * 20,000 228,580 * Doran G. Machin..................... InSight Capital Partners(7)......... 2,520,001 6.3 0 2,520,001 6.1 UBS Capital LLC(8).................. 1,466,667 3.6 170,000 1,296,667 3.1 WI Software Investors, LLC.......... 1,200,000 3.0 600,000 600,000 1.4 Mohr Davidow Ventures IV, L.P....... 253,728 * 126,864 126,864 * Daniel Benveniste(9)................ 155,168 * 3,800 151,368 * Gal Bar-Or.......................... 145,471 * 2,900 142,571 * Robert Fanini....................... 143,762 * 43,129 100,633 * James Jordan........................ 104,539 * 41,816 62,723 * Daniel Callahan..................... 88,274 * 17,655 70,619 * Weiss Peck & Greer Venture 38,546 Associates IV, L.L.C.............. 77,091 * 38,545 * WPG Enterprise Fund III, L.L.C...... 68,195 * 34,097 34,098 * Westpool Investment Trust........... 44,540 * 22,270 22,270 * Lion Investments Limited............ 44,094 * 22,047 22,047 * Dennis Blay(10)..................... 16,942 * 930 16,012 * MDV IV Entrepreneurs' Network Fund, 6,675 L.P............................... 13,350 * 6,675 * Weiss Peck & Greer Venture 4,920 Associates IV, Cayman, L.P........ 9,839 * 4,919 * Roger Tharp(11)..................... 7,636 * 500 7,136 * WPG Information Sciences 1,531 Enterpreneur Fund, L.P............ 3,062 * 1,531 * Joseph Hnilo(12).................... 1,504 * 300 1,204 * Weber Family Trust.................. 445 * 223 223 * All other selling shareholders together beneficially own less than 1% of the total outstanding shares prior to this offering ( persons)(13)................... 123,800 All executive officers and directors 30,831,002 as a group (7 persons)(6)......... 31,369,002 77.5 538,000 73.9
- ------------------------- * Less than 1%. (1) Includes 38,100 shares held in the name of McNair Smith and 38,100 shares held in the name of McKenzie Smith, Mr. Smith's minor children. (2) Includes 4,224 shares held in the name of Aely Sollie Aronoff and 17,223 shares held in the name of Leya Jullie Aronoff, Mr. Aronoff's minor children. Also includes 15,990 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. (3) Includes 265,200 shares of common stock owned directly by Mr. Murdock. Also includes 1,188,000 shares of common stock held by InSight Capital Partners II, L.P., 132,001 shares of common stock held by InSight Capital Partners (Cayman) II, L.P., and 1,200,000 shares of common stock held by WI Software Investors LLC. Mr. Murdock is a General Partner of InSight Capital Partners and a director of Quest. Mr. Murdock disclaims beneficial ownership of the shares held by InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., and WI Software Investors LLC, except to the extent of his indirect pecuniary interests therein. (4) Consists of 59,400 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. 54 56 (5) Consists of 248,580 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. (6) Consists of 323,970 shares issuable upon the exercise of stock options that are exercisable within 60 days of February 16, 2000. See Notes 2, 4 and 5. See also Notes 1 and 3. (7) Includes 132,001 shares of common stock held by InSight Capital Partners (Cayman) II, L.P., 1,188,000 shares of common stock held by InSight Capital Partners II, L.P., and 1,200,000 shares of common stock held by WI Software Investors LLC. InSight Capital Partners II, L.P. is a limited partnership controlled by its general partner, InSight Venture Associates II, LLC, which has voting and dispositive powers over its shares of Series A Preferred Stock. InSight Capital Partners (Cayman) II, L.P. is a limited partnership controlled by its general partner, InSight Venture Associates (Cayman) II, a Cayman Island company, which has voting and dispositive powers over its shares of Series A Preferred Stock. The managing members of InSight Venture Associates II, LLC and InSight Venture Associates (Cayman) II are Jeff Horing, Jerry Murdock and Ramanan Raghavendran. (8) UBS is a limited liability company controlled by a board of managers who have voting and dispositive powers over UBS' shares of common stock. The board of managers consists of Justin Maccarone, Michael Green and Marc Unger. (9) Includes 1,071 shares of common stock which are subject to our right of repurchase which lapses on April 28, 2003. Also includes 15,517 shares of common stock which are subject to an escrow which expires of October 7, 2000. (10) Includes 7,875 shares of common stock which are subject to our right of repurchase which lapses on June 24, 2003. Also includes 1,694 shares of common stock which are subject to an escrow which expires on October 7, 2000. (11) Includes 3,056 shares of common stock which are subject to our right of repurchase which lapses on April 28, 2003. Also includes 764 shares of common stock which are subject to an escrow which expires on October 7, 2000. (12) Includes 11,282 shares of common stock which are subject to our right of repurchase which lapses on May 13, 2003. Also includes 1,504 shares of common stock which are subject to an escrow which expires on October 7, 2000. (13) We will sell any shares not sold by this group of selling shareholders. 55 57 DESCRIPTION OF CAPITAL STOCK Our authorized capital stock consists of 75,000,000 shares of common stock and 5,000,000 shares of undesignated preferred stock. The following description of our capital stock is subject to and qualified by our Amended and Restated Articles of Incorporation and Bylaws and by the provisions of applicable California law. COMMON STOCK As of December 31, 1999, there were 38,905,344 shares of common stock outstanding held of record by 59 shareholders, and options to purchase an aggregate of 5,251,307 shares of common stock were also outstanding. There will be 39,905,344 shares of common stock outstanding, assuming no exercise of the underwriters' option to purchase additional shares, additional issuances of shares of common stock in connection with acquisitions after December 31, 1999, exercise of outstanding options under the stock plans after December 31, 1999 or exercise of warrants outstanding after the closing of this offering, after giving effect to the sale of the shares of common stock to the public offered in this prospectus. The holders of common stock are entitled to one vote per share on all matters to be voted upon by the shareholders. Subject to preferences that may be applicable to any outstanding preferred stock that may come into existence, the holders of common stock are entitled to receive ratably those dividends, if any, as may be declared from time to time by the board of directors out of funds legally available for dividends. See "Dividend Policy." In the event of our liquidation, dissolution or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock then outstanding, if any. The common stock has no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and nonassessable, and the shares of common stock to be outstanding upon completion of this offering will be fully paid and nonassessable. PREFERRED STOCK Our board of directors is authorized, without further shareholder approval, to issue from time to time up to an aggregate of 5,000,000 shares of preferred stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption price or prices, liquidation preferences and the number of shares constituting any series or designations of such series. We have no present plans to issue any shares of preferred stock. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. Any series of preferred stock may possess voting, dividend, liquidation and redemption rights superior to that of the common stock. Issuance of a new series of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of entrenching our board of directors and making it more difficult for a third party to acquire, or discourage a third party from acquiring, a majority of our outstanding voting stock. We have no present plans to issue any shares of or designate any series of preferred stock. We believe that the ability to issue preferred stock without the expense and delay of a special shareholders' meeting will provide us with increased flexibility in structuring possible future financings and acquisitions, and in meeting other corporate needs that might arise. This also permits the board of directors to issue preferred stock containing terms which could impede the completion of a takeover attempt, subject to certain limitations imposed by the securities laws. The board of directors will make any determination to issue such shares based on its judgment as to the best interests of Quest and our shareholders at the time of issuance. This could discourage an acquisition attempt or other transaction which shareholders might believe to be in their best interests or in which they might receive a premium for their stock over the then market price of the stock. 56 58 REGISTRATION RIGHTS The holders of an aggregate of 4,000,000 shares of common stock are entitled to certain rights with respect to the registration of such shares under the Securities Act. Under the terms of the registration rights agreements, if we propose to register any of our securities under the Securities Act, either for our own account or for the account of other security holders exercising registration rights, these holders are entitled to notice of such registration and are entitled to include shares of common stock in the registration. The rights are subject to conditions and limitations, among them the right of the underwriters of an offering subject to the registration to limit the number of shares included in such registration. Holders of these rights may also require us to file a registration statement under the Securities Act at our expense with respect to their shares of common stock, and we are required to use our best efforts to effect such registration, subject to certain conditions and limitations. Furthermore, shareholders with registration rights may require us to file additional registration statements on Form S-3, subject to conditions and limitations. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the common stock is U.S. Stock Transfer Corporation. LISTING Our common stock is quoted on the Nasdaq National Market under the trading symbol "QSFT." 57 59 SHARES ELIGIBLE FOR FUTURE SALE Future sales of substantial amounts of common stock, including shares issued upon exercise of outstanding options or warrants, in the public market could adversely affect prevailing market prices from time to time. Furthermore, since only a limited number of shares will be available for sale shortly after this offering because of certain contractual and legal restrictions on resale, as described below, sales of substantial amount of common stock in the public market after the restrictions lapse could adversely affect the prevailing market price and our ability to raise equity capital in the future. Upon completion of this offering, we will have 39,905,344 shares of common stock outstanding assuming the issuance of 1,000,000 shares of common stock offered, no exercise of the underwriters' over-allotment option, no exercise of outstanding stock options after December 31, 1999 and no issuances of additional shares of common stock in connection with acquisitions after December 31, 1999. Of the total outstanding shares of common stock, the 2,800,000 shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act, except that any shares purchased by our "affiliates," as that term is defined in Rule 144 under the Securities Act, may generally only be sold pursuant to an effective registration statement under the Securities Act or in compliance with the limitations of Rule 144 as described below. In addition, the 5,060,000 shares of common stock that we sold in our initial public offering are freely tradeable. 32,104,783 shares of common stock are "restricted securities" as that term is defined in Rule 144, 54,900 shares are freely tradeable under Rule 144(k) 5,085,935 shares may be freely sold pursuant to Registration Statements on Form S-8, and 27,810 shares may be sold pursuant to Rule 701. All of these restricted securities, 144(k) shares, S-8 shares and Rule 701 shares will be available for sale in the public market following the expiration of the 90 day lock-up agreement further described below. If the underwriter elects to waive the lock-up period for any reason, these shares will be available for sale under Rule 144, Rule 144(k), Rule 701 or pursuant to Form S-8 prior to that time. The holders of 4,000,000 restricted shares are entitled to certain rights with respect to registration of these shares for sale in the public market. Registration of such shares under the Securities Act would result in such shares becoming freely tradeable without restriction under the Securities Act, except for shares purchased by our affiliates. If these holders sell in the public market these sales would have a material adverse effect on the market price of the common stock. Certain of these shares will be sold in this offering. Quest, our officers, directors, shareholders, and most of our optionholders have entered into contractual "lock-up" agreements generally providing that, subject to certain limited exceptions, they will not offer, pledge, sell, offer to sell, contract to sell, sell any option or contract to purchase, purchase any option to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any of the shares of common stock or any securities convertible into, or exercisable or exchangeable for, common stock owned by them, or enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the common stock, for a period of 90 days after the date of this prospectus, without the prior written consent of FleetBoston Robertson Stephens, except that we may, without such consent, grant options and sell shares pursuant to our stock plans. FleetBoston Robertson Stephens may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements. FleetBoston Robertson Stephens currently has no plans to release any portion of the securities subject to lock-up agreements. When determining whether or not to release shares from the lock-up agreements, FleetBoston Robertson Stephens will consider, among other factors, the shareholder's reasons for requesting the release, the number of shares for which the release is being requested and market conditions at the time. Following the expiration of the 90-day lock-up period, the restricted securities will be available for sale in the public market subject to compliance with Rule 144 or Rule 701. 58 60 In general, under Rule 144 as currently in effect, any affiliate of ours or a person, or persons whose shares are aggregated, who has beneficially owned restricted shares for at least one year, including the holding period of any prior owner other than a person who may be deemed an affiliate of ours, is entitled to sell within any three-month period a number of shares of common stock that does not exceed the greater of: - one percent of the then-outstanding shares of common stock (approximately 399,053 shares after giving effect to this offering); and - the average weekly trading volume of the common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a Form 144 notice with respect to this sale. Sales under Rule 144 of the Securities Act are subject to certain restrictions relating to manner of sale, notice and the availability of current public information about us. Under Rule 144(k), a person who is not an affiliate of ours at any time during the 90 days preceding a sale, and who has beneficially owned shares for at least two years, including the holding period of any prior owner other than a person who may be deemed an affiliate of ours, would be entitled to sell these shares immediately following this offering without regard to the volume limitations, manner of sale provisions or notice or other requirements of Rule 144 of the Securities Act. However, the transfer agent may require an opinion of counsel that a proposed sale of shares comes within the terms of Rule 144 of the Securities Act prior to effecting a transfer of these shares. We are unable to estimate the number of shares that will be sold under Rule 144, as this will depend on the market price for our common stock, the personal circumstances of the sellers and other factors. There can be no assurance that a significant public market for our common stock will develop or be sustained after this offering. Any future sale of substantial amounts of common stock in the open market may adversely affect the market price of the common stock offered hereby. On November 22, 1999, we filed a Form S-8 registration statement under the Securities Act registering all shares of common stock issuable under the 1999 Stock Incentive Plan and the Employee Stock Purchase Plan. On February 4, 2000, we filed a Form S-8 registration statement registering all shares of common stock issuable upon exercise of outstanding options which we assumed in connection with the Foglight merger. Such registration statements became effective immediately upon filing, and shares covered by the registration statements are eligible for sale in the public markets, subject to any lock-up agreements applicable thereto and Rule 144 limitations applicable to affiliates. See "Management -- 1999 Employee Stock Purchase Plan," "Management -- Foglight Software, Inc. 1998 Stock Option Plan," "Description of Capital Stock -- Registration Rights" and "Underwriting." 59 61 UNDERWRITING The underwriters named below, acting through their representatives, FleetBoston Robertson Stephens Inc., Donaldson, Lufkin & Jenrette Securities Corporation, CIBC World Markets Corp., FAC/Equities, a division of First Albany Corporation, Chase Securities Inc. and SoundView Technology Group, Inc. (the "Representatives"), have severally agreed with us, subject to the terms and conditions set forth in the underwriting agreement, to purchase from us the number of shares of common stock set forth opposite their names below. The underwriters are committed to purchase and pay for all such shares if any are purchased.
NUMBER OF UNDERWRITER SHARES - ----------- --------- FleetBoston Robertson Stephens Inc. ........................ Donaldson, Lufkin & Jenrette Securities Corporation ........ CIBC World Markets Corp. ................................... First Albany Corporation.................................... Chase Securities, Inc....................................... SoundView Technology Group, Inc. ........................... --------- Total............................................. 2,800,000 =========
We have been advised by the Representatives that the underwriters propose to offer the shares of common stock to the public at the initial public offering price set forth on the cover page of this prospectus and to certain dealers at such price less a concession of not in excess of $ per share, of which $ may be reallowed to other dealers. After the initial public offering, the initial public offering price, concession and reallowance to dealers may be reduced by the Representatives. No such reduction shall change the amount of proceeds to be received by us as set forth on the cover page of this prospectus. The common stock is offered by the underwriters as stated herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. Over-Allotment Option Certain selling shareholders and/or we have granted to the underwriters an option, exercisable during the 30-day period after the date of this prospectus, to purchase up to 420,000 additional shares of common stock at the same price per share as we will receive for the 2,800,000 shares that the underwriters have agreed to purchase. To the extent that the underwriters exercise this option, each of the underwriters will have a firm commitment to purchase approximately the same percentage of such additional shares that the number of shares of common stock to be purchased by it shown in the above table represents as a percentage of the 2,800,000 shares offered hereby. If purchased, such additional shares will be sold by the underwriters on the same terms as those on which the 2,800,000 shares are being sold. We will be obligated, pursuant to the option, to sell shares to the extent the option is exercised. The underwriters may exercise such option only to cover over-allotments made in connection with the sale of the shares of common stock offered hereby. If such option is exercised in full, the total public offering price, underwriting discounts and commissions and proceeds to us will be $267,260,000, $12,042,800 and $79,260,000, respectively. Indemnity The underwriting agreement contains covenants of indemnity among the underwriters and us against certain civil liabilities, including liabilities under the Securities Act and liabilities arising from breaches of representations and warranties contained in the underwriting agreement. 60 62 Lock-Up Agreements Each of our executive officers, directors and shareholders and substantially all of our optionholders have agreed with the Representatives, for a period of 90 days after the date of this prospectus, subject to certain exceptions, not to offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to any shares of common stock, any options or warrants to purchase any shares of common stock, or any securities convertible into or exchangeable for shares of common stock owned as of the date of this prospectus or, with certain exceptions, thereafter acquired directly by such holders or with respect to which they have or hereafter acquire the power of disposition, without the prior written consent of FleetBoston Robertson Stephens. However, FleetBoston Robertson Stephens may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to the lock-up agreements. There are no agreements between the Representatives and any of our shareholders providing consent by the Representatives to the sale of shares prior to the expiration of the period of 90 days after this prospectus. Future Sales In addition, we have agreed that during the period of 90 days after this prospectus, we will not, subject to certain exceptions, without the prior written consent of FleetBoston Robertson Stephens: - Consent to the disposition of any shares held by shareholders prior to the expiration of the period of 90 days after this prospectus; or - Issue, sell, contract to sell or otherwise dispose of, any shares of common stock, any options or warrants to purchase any shares of common stock or any securities convertible into, exercisable for or exchangeable for shares of common stock. Electronic Prospectus A prospectus in electronic format is being made available on an Internet web site maintained by Wit Capital Corporation, an affiliate of SoundView Technology Group, Inc. Other than the prospectus in electronic format, the information on Wit Capital Corporation's web site and any information contained on any other web site maintained by any dealer is not part of this prospectus or the registration statement of which this prospectus forms a part, has not been approved and/or endorsed by us or any underwriter in its capacity as underwriter and should not be relied upon by investors. Stabilization The Representatives have advised us that, pursuant to Regulation M under the Securities Act, certain persons participating in this offering may engage in transactions, including stabilizing bids, syndicate covering transactions or the imposition of penalty bids, that may have the effect of stabilizing or maintaining the market price of the common stock at a level above that which might otherwise prevail in the open market. A "stabilizing bid" is a bid for or the purchase of the common stock on behalf of the underwriters for the purpose of fixing or maintaining the price of the common stock. A "syndicate covering transaction" is the bid for or the purchase of the common stock on behalf of the underwriters to reduce a short position incurred by the underwriters in connection with this offering. A "penalty bid" is an arrangement permitting the Representatives to reclaim the selling concession otherwise accruing to an underwriter or syndicate member in connection with this offering if the common stock originally sold by such underwriter or syndicate member is purchased by the Representatives in a syndicate covering transaction and has therefore not been effectively placed by such underwriter or syndicate member. The Representatives have advised us that such transactions may be effected on the Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. 61 63 LEGAL MATTERS The validity of the common stock offered will be passed upon for us by Brobeck, Phleger & Harrison LLP, Irvine, California. Certain legal matters in connection with the offering will be passed upon for the underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. EXPERTS The Consolidated Financial Statements of Quest Software, Inc. as of December 31, 1998 and 1999 and for each of the three years in the period ended December 31, 1999 included in this prospectus and the related financial statement schedule included elsewhere in the registration statement have been audited by Deloitte & Touche LLP, independent auditors, as stated in their reports appearing herein and elsewhere in the registration statement, and have been so included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing. The financial statements of MBR Technologies, Inc. as of March 31, 1999 and for the period from April 23, 1998 (inception) to March 31, 1999 included in this prospectus and registration statement have been audited by Swenson Advisors, LLP, independent auditors, as stated in their report, which we have included in this prospectus and registration statement and is given upon the authority of Swenson Advisors, LLP, as experts in accounting and auditing. The financial statements of Foglight Software, Inc. as of December 31, 1998 and for the period from November 10, 1997 (inception) to December 31, 1998 included in this prospectus and registration statement have been audited by PriceWaterhouseCoopers LLP, independent auditors, as stated in their report, which we have included in this prospectus and registration statement and is given upon the authority of PriceWaterhouseCoopers LLP, as experts in accounting and auditing. ADDITIONAL INFORMATION We have filed with the Securities and Exchange Commission, Washington, D.C. 20549 (the "Commission"), under the Securities Act, as amended, a registration statement on Form S-1 relating to the common stock offered. This prospectus does not contain all of the information set forth in the registration statement and its exhibits and schedules. For further information with respect to us and the shares we are offering pursuant to this prospectus you should refer to the registration statement, including its exhibits and schedules. Statements contained in this prospectus as to the contents of any contract, agreement or other document referred to are materially complete, and you should refer to the copy of that contract or other document filed as an exhibit to the registration statement or any other document. You may inspect a copy of the registration statement without charge at the Public Reference Section of the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 or at the Commission's regional offices at 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036. The Commission maintains an Internet site that contains reports, proxy information statements and other information regarding registrants that file electronically with the Commission. The Commission's World Wide Web address is www.sec.gov. We intend to furnish holders of our common stock with annual reports containing, among other information, audited consolidated financial statements certified by an independent public accounting firm and quarterly reports containing unaudited condensed financial information for the first three quarters of each fiscal year. We intend to furnish these other reports as we may determine or as may be required by law. 62 64 INDEX TO FINANCIAL STATEMENTS
PAGE ---- QUEST SOFTWARE, INC. Independent Auditors' Report.............................. F-2 Consolidated Balance Sheets as of December 31, 1998 and 1999................................................... F-3 Consolidated Statements of Income for the Years Ended December 31, 1997, 1998 and 1999....................... F-4 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1997, 1998 and 1999........... F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and 1999....................... F-6 Notes to Consolidated Financial Statements................ F-7 MBR TECHNOLOGIES, INC. Report of Independent Auditors............................ F-24 Balance Sheets as of March 31, 1999 and December 17, 1999 (Unaudited)............................................ F-25 Statements of Operations From Inception (April 23, 1998) Through March 31, 1999 and for the Period From January 1, 1999 to December 17, 1999 (Unaudited)............... F-26 Statements of Shareholders' Equity From Inception (April 23, 1998) Through March 31, 1999 and the Period From April 1, 1999 to December 17, 1999 (Unaudited)......... F-27 Statements of Cash Flows From Inception (April 23, 1998) Through March 31, 1999 and the Period From January 1, 1999 to December 17, 1999 (Unaudited).................. F-28 Notes to Financial Statements............................. F-29 FOGLIGHT SOFTWARE, INC. Report of Independent Accountants......................... F-32 Balance Sheet as of December 31, 1998..................... F-33 Statement of Operations for the Period November 10, 1997 (Date of Inception) to December 31, 1998...................................... F-34 Statement of Stockholders' Deficit for the Period November 10, 1997 (Date of Inception) to December 31, 1998...... F-35 Statement of Cash Flows for the Period November 10, 1997 (Date of Inception) to December 31, 1998............... F-36 Notes to Financial Statements............................. F-37 Balance Sheet as of September 30, 1999 (Unaudited)........ F-47 Statements of Operations for the Nine Months Ended September 30, 1998 and 1999 (Unaudited)................ F-48 Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1999 (Unaudited)................ F-49 Notes to Unaudited Financial Statements................... F-50 UNAUDITED PRO FORMA INFORMATION Unaudited Pro Forma Information........................... F-52 Balance Sheet as of December 31, 1999..................... F-53 Statements of Operations for the Year Ended December 31, 1999................................................... F-54 Notes to Pro Forma Financial Statements................... F-55
F-1 65 INDEPENDENT AUDITORS' REPORT The Shareholders and Board of Directors Quest Software, Inc. We have audited the accompanying consolidated balance sheets of Quest Software, Inc. and subsidiaries (the Company) as of December 31, 1998 and 1999, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial position of Quest Software, Inc. and its subsidiaries at December 31, 1998 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California February 1, 2000 (except for Note 12 as to which the date is February 11, 2000) F-2 66 QUEST SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, ------------------- 1998 1999 ------- -------- ASSETS Current assets: Cash and cash equivalents................................. $ 8,981 $ 39,643 Short-term marketable securities, available for sale...... -- 11,000 Accounts receivable, net of allowance for doubtful accounts and sales returns of $1,052 (1998) and $3,239 (1999)................................................. 7,443 18,771 Prepaid expenses and other current assets................. 720 3,244 Deferred income taxes..................................... 198 2,089 ------- -------- Total current assets................................. 17,342 74,747 Property and equipment, net................................. 1,388 7,179 Long-term marketable securities, available for sale......... -- 4,484 Purchased technology and software licenses, net............. 527 441 Goodwill, net............................................... -- 11,452 Deferred income taxes....................................... 267 415 Other assets................................................ 121 431 ------- -------- $19,645 $ 99,149 ======= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 1,468 $ 3,436 Accrued compensation...................................... 1,937 4,966 Other accrued expenses.................................... 2,243 7,062 Income taxes payable...................................... -- 2,030 Deferred support revenue.................................. 7,298 13,932 Deferred license revenue.................................. 1,625 4,651 ------- -------- Total current liabilities............................ 14,571 36,077 Long-term liabilities....................................... -- 403 Commitments and contingencies (Note 9) Shareholders' equity: Preferred stock, no par value, 5,000 shares authorized; no shares issued or outstanding........................... -- -- Common stock, no par value, 75,000 shares authorized; 44,538 and 38,905 shares issued and outstanding at December 31, 1998 and 1999............................. 4,241 94,010 Retained earnings........................................... 3,991 1,864 Accumulated other comprehensive income (loss)............... -- (26) Notes receivable from sale of common stock.................. (3,158) (3,115) Capital distribution in excess of basis in common stock..... -- (30,064) ------- -------- Total shareholders' equity........................... 5,074 62,669 ------- -------- $19,645 $ 99,149 ======= ========
See accompanying notes to consolidated financial statements. F-3 67 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, ----------------------------------------- 1997 1998 1999 ----------- ----------- ----------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Revenues: Licenses.................................................. $12,158 $24,901 $54,269 Services.................................................. 6,157 9,889 16,599 ------- ------- ------- Total revenues....................................... 18,315 34,790 70,868 Cost of revenues: Licenses.................................................. 1,307 3,433 2,998 Services.................................................. 1,972 2,507 4,195 ------- ------- ------- Total cost of revenues............................... 3,279 5,940 7,193 ------- ------- ------- Gross profit................................................ 15,036 28,850 63,675 Operating expenses: Sales and marketing....................................... 5,845 11,836 32,078 Research and development.................................. 4,293 8,047 15,980 General and administrative................................ 3,450 5,278 9,906 Other compensation costs and goodwill amortization........ -- -- 1,243 ------- ------- ------- Total operating expenses............................. 13,588 25,161 59,207 ------- ------- ------- Income from operations...................................... 1,448 3,689 4,468 Other (expense) income, net................................. (137) 336 1,202 ------- ------- ------- Income before income tax provision.......................... 1,311 4,025 5,670 Income tax provision........................................ 1,022 1,679 2,273 ------- ------- ------- Net income.................................................. $ 289 $ 2,346 3,397 ======= ======= Preferred stock dividends................................... 590 ------- Net income applicable to common shareholders................ $ 2,807 ======= Basic and diluted net income per share...................... $ 0.01 $ 0.05 $ 0.07 Weighted average shares: Basic..................................................... 40,373 44,261 37,677 Diluted................................................... 40,617 44,459 41,800
See accompanying notes to consolidated financial statements. F-4 68 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
CAPITAL DISTRIBUTION ACCUMULATED NOTES IN EXCESS OF COMMON STOCK OTHER RECEIVABLE BASIS IN TOTAL ------------------ RETAINED COMPREHENSIVE FROM COMMON SHAREHOLDERS' SHARES AMOUNT EARNINGS INCOME (LOSS) SHAREHOLDERS STOCK EQUITY -------- ------- -------- ------------- ------------ ------------ ------------- BALANCE, January 1, 1997..... 39,000 $ 812 $ 1,617 $ -- $ -- $ -- $ 2,429 Issuance of common stock..... 597 413 -- -- -- -- 413 Note receivable from shareholder for purchase of common stock............... 3,900 2,200 -- -- (2,200) -- -- Accrued interest receivable from shareholder........... -- -- -- -- (34) -- (34) Net income................... -- -- 289 -- -- -- 289 Distributions paid........... -- -- (261) -- -- -- (261) -------- ------- ------- ---- ------- -------- -------- BALANCE, December 31, 1997... 43,497 3,425 1,645 -- (2,234) -- 2,836 Issuance of common stock..... 66 66 -- -- -- -- 66 Note receivable from shareholder for purchase of common stock............... 975 750 -- -- (750) -- -- Accrued interest receivable from shareholders.......... -- -- -- -- (174) -- (174) Net income................... -- -- 2,346 -- -- -- 2,346 -------- ------- ------- ---- ------- -------- -------- BALANCE, December 31, 1998... 44,538 4,241 3,991 -- (3,158) -- 5,074 -------- ------- ------- ---- ------- -------- -------- Exercise of stock options, including tax benefit...... 34 201 -- -- -- -- 201 Payment on notes receivable from shareholders for purchase of common stock... -- -- -- -- 230 -- 230 Accrued interest receivable from shareholders.......... -- -- -- -- (187) -- (187) Repurchase of common stock... (14,820) (2) (4,934) -- -- (30,064) (35,000) Conversion of Series A Redeemable Preferred Stock to common stock............ 4,000 15,000 -- -- -- -- 15,000 Issuance of common stock in the initial public offering, net.............. 5,060 64,856 -- -- -- -- 64,856 Compensation expense associated with stock option grants.............. -- 432 -- -- -- -- 432 Common stock issued for an acquisition, net (Note 2)......................... 93 9,282 -- -- -- -- 9,282 Dividends on Series B Redeemable Preferred Stock...................... -- -- (590) -- -- -- (590) Unrealized loss on available-for-sale securities................. -- -- -- (26) -- -- (26) Net income................... -- -- 3,397 -- -- -- 3,397 -------- Comprehensive income......... -- -- -- -- -- -- 3,371 -------- ------- ------- ---- ------- -------- -------- BALANCE, December 31, 1999... 38,905 $94,010 $ 1,864 $(26) $(3,115) $(30,064) $ 62,669 ======== ======= ======= ==== ======= ======== ========
See accompanying notes to consolidated financial statements. F-5 69 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1998 1999 ------- -------- -------- Cash flows from operating activities: Net income................................................ $ 289 $ 2,346 $ 3,397 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization......................... 964 1,893 2,107 Compensation expense associated with stock option grants............................................... -- -- 432 Loss from disposal of property and equipment.......... 52 -- -- Accrued interest receivable from shareholders......... (34) (174) (187) Deferred income taxes................................. 178 (643) (1,667) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable................................ (683) (2,628) (11,441) Income taxes receivable............................ (122) 122 -- Prepaid expenses and other current assets.......... 282 (620) (2,527) Other assets....................................... 38 5 (288) Accounts payable................................... 113 941 1,974 Bank overdraft..................................... (393) -- -- Accrued compensation............................... 108 1,162 2,544 Other accrued expenses............................. 881 1,141 5,366 Income taxes payable............................... -- -- 2,218 Deferred revenue................................... 1,960 4,636 9,449 ------- -------- -------- Net cash provided by operating activities.......... 3,633 8,181 11,377 Cash flows from investing activities: Purchases of property and equipment....................... (536) (1,231) (7,143) Purchases of software licenses............................ (831) (57) (350) Cash received (paid) for acquisitions, net of cash acquired................................................ 100 -- (1,094) Purchases of marketable securities........................ -- -- (15,510) Sales and maturities of marketable securities............. -- -- -- ------- -------- -------- Net cash used in investing activities.............. (1,267) (1,288) (24,097) Cash flows from financing activities: Distributions to shareholders............................. (261) -- -- Proceeds from note payable................................ -- -- 10,000 Repayment of notes payable................................ -- -- (10,918) Repayment of capital lease obligations.................... -- -- (36) Proceeds from issuance of preferred stock................. -- -- 25,000 Redemption of Series B Preferred Stock.................... -- -- (10,000) Repurchase of common stock................................ -- -- (35,000) Net proceeds from the sale of common stock................ -- -- 64,856 Proceeds from the exercise of stock options............... -- -- 33 Repayment of note payable to related party................ (9) (8) (8) Payment on notes receivable from shareholders for purchase of common stock......................................... -- -- 230 Cash dividends paid on Series B Redeemable Preferred Stock................................................... -- -- (590) ------- -------- -------- Net cash (used in) provided by financing activities........................................ (270) (8) 43,567 Effect of exchange rate changes on cash and cash equivalents............................................... -- -- (185) ------- -------- -------- Net increase in cash and cash equivalents................... $ 2,096 $ 6,885 $ 30,662 Cash and cash equivalents, beginning of period.............. -- 2,096 8,981 ------- -------- -------- Cash and cash equivalents, end of period.................... $ 2,096 $ 8,981 $ 39,643 ======= ======== ======== Supplemental disclosures of consolidated cash flow information: Cash paid during the year for: Interest................................................ $ 8 $ 5 $ 240 ======= ======== ======== Income taxes............................................ $ 938 $ 2,054 $ 1,874 ======= ======== ======== Supplemental schedule of noncash investing and financing activities: Note receivable from shareholders for purchase of common stock................................................... $ 2,200 $ 750 ======= ======== Conversion of Series A Redeemable Preferred Stock to Common Stock............................................ $ 15,000 ======== Tax benefit related to stock option exercises............. $ 168 ======== Unrealized loss on available-for-sale securities.......... $ 26 ========
See Note 2 for details of assets acquired and liabilities assumed in purchase transactions. See accompanying notes to consolidated financial statements. F-6 70 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Nature of Operations -- Quest Software, Inc., a California corporation, (the Parent) and its subsidiaries (collectively the Company) 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 entire enterprise. The Company also provides consulting, training, and support services to its customers. The accompanying consolidated financial statements include the accounts of the Parent and its wholly owned subsidiaries in Australia, the United Kingdom, Germany, Israel, and Ireland. All significant intercompany transactions and balances have been eliminated in consolidation. Stock Split -- On June 23, 1998, the Company's Board of Directors approved and effected a 1,300-for-1 stock split of the Company's common stock, and on March 10, 1999, the Company's Board of Directors approved and effected a 2-for-1 stock split. On June 4, 1999, in connection with the public offering of the Company's common stock, the Company's Board of Directors approved and effected a 3-for-2 stock split of the Company's common stock. All share, per share and conversion amounts relating to common stock, preferred stock, and stock options included in the accompanying consolidated financial statements and footnotes have been restated to reflect the stock splits and for all periods presented. Foreign Currency Translation -- In accordance with Statement of Financial Accounting Standards (SFAS) No. 52, Foreign Currency Translation, the United States dollar is considered to be the functional currency for the Company's foreign subsidiaries, as such subsidiaries act as sales offices for the Parent. Therefore, gains or losses from translation adjustments are included in other income in the Company's consolidated statements of operations. Translation adjustments were not material for the years ended December 31, 1997, 1998 and 1999. However, due to the increase in international operations, the Company's results of operations could be impacted in the future. Fair Value of Financial Instruments -- The Company's consolidated balance sheets include the following financial instruments: cash, accounts receivable, notes receivable, accounts payable, and accrued liabilities. The Company considers the carrying value of cash, accounts receivable, accounts payable, and accrued liabilities in the consolidated financial statements to approximate fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. Based on borrowing rates currently available, the fair value of the notes receivable from the sale of common stock at December 31, 1999, was approximately $3,669. Cash and Cash Equivalents -- Cash equivalents include short-term, highly liquid investments with original maturities of three months or less. Interest income, included in other income (expense) in the accompanying consolidated statements of operations, was, $72, $372, and $1,514 for the years ended December 31, 1997, 1998 and 1999, respectively. Accounts Receivable -- The Company sells and/or licenses its products and services to various companies across several industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and sales returns. Investments -- The Company has classified all debt securities with original maturities of greater than three months as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders' equity net of applicable income taxes. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in other income. The cost basis for realized gains and losses on available-for-sale securities is determined on a specific identification basis. The Company has classified available-for-sale securities as current or long-term based primarily on the maturity date of the related securities. F-7 71 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 1999, the Company had available-for-sale debt securities with a fair market value of $15,484 and a cost basis of $15,510. The unrealized loss of $26 has been recorded as a separate component of stockholders' equity, and consisted of five positions, all with unrealized losses. Property and Equipment -- Property and equipment are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives ranging from three to seven years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the improvements or the term of the related lease. Repair and maintenance costs are expensed as incurred. Long-Lived Assets -- The Company accounts for the impairment and disposition of long-lived assets in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. In accordance with SFAS No. 121, long-lived assets to be held are reviewed for events or changes in circumstances which indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of long-lived assets to determine whether or not an impairment to such value has occurred. At December 31, 1998 and 1999, there was no impairment of long-lived assets. Purchased Technology and Software Licenses -- Purchased technology is recorded either at cost or, for amounts related to acquisitions, at appraised value and amortized using the straight-line method over estimated useful lives of three years to five years. Accumulated amortization was $1,483, $1,638 and $1,777 at December 31, 1997, 1998, and 1999, respectively. Software licenses are recorded at cost and are amortized over the shorter of the estimated useful lives of the related products or the term of the license. Accumulated amortization was $644, $871 and $1,027 at December 31, 1997, 1998 and 1999, respectively. The net carrying amount of purchased technology and software licenses was considered recoverable at December 31, 1998 and 1999, based on the undiscounted future cash flows expected to be realized from continued sales of the related software products. Other Assets -- Other assets include amounts receivable related to a settlement agreement the Company entered into with a former employee. Under the terms of the settlement agreement, the Company received a lump-sum payment totaling $220 in January 1997, and a promissory note providing for 40 monthly payments of $4 each commencing March 1, 1997. Approximately $63 and $25 of the settlement receivable is recorded in other current assets in the accompanying consolidated financial statements at December 31, 1998 and 1999, respectively. Goodwill -- Goodwill arising from acquisitions (Note 2) is amortized on a straight-line basis over five years. The Company will annually evaluate the carrying value of goodwill for impairment of value based on undiscounted future cash flows. Capital Distribution in Excess of Basis in Common Stock -- In connection with the repurchase of common stock in April 1999 from a major stockholder (Note 4) the excess of the repurchase price over the original cost of the shares has been recorded as a capital distribution in excess of the basis of the common stock in the accompanying consolidated financial statements. Revenue Recognition -- During October 1997, the Financial Accounting Standards Board (FASB) issued Statement of Position (SOP) 97-2, Software Revenue Recognition, which provides guidance in recognizing revenue on software transactions. SOP 97-2 is effective for transactions entered into in fiscal years beginning after December 15, 1997, and supersedes SOP 91-1. The Company adopted this statement, as amended, for the year ended December 31, 1998, and such adoption did not have any impact on the Company's results of operations. Software Licenses, Services, and Post-Contract Customer Support -- Revenues from sales of software licenses, which generally do not contain multiple elements, are recognized upon shipment of the related product if the requirements of SOP 97-2, as amended, are met. If the requirements of SOP 97-2, F-8 72 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS including evidence of an arrangement, customer acceptance, a fixed or determinable fee, collectibility or vendor-specific objective evidence about the value of an element are not met at the date of shipment, revenue recognition is deferred until such items are known or resolved. Amounts recorded at December 31, 1998 and 1999 for deferred license revenue represent sales in which the Company has received some payments, but all of the requirements of SOP 97-2 have not been met. Revenue from service and post-contract customer support is deferred and recognized ratably over the term of the contract. Software Development Costs -- Costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established, any additional costs are capitalized in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed. Because the Company believes that its current process for developing software is essentially completed concurrently with the establishment of technical feasibility, no software development costs have been capitalized as of December 31, 1998 and 1999. Advertising Expenses -- Advertising expenses were $300, $594 and $998 for the years ended December 31, 1997, 1998 and 1999, respectively. Income Taxes -- The Company accounts for its income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Deferred taxes on income result from temporary differences between the reporting of income for financial statements and tax reporting purposes. Measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and tax bases of the Company's assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Stock-Based Compensation -- The Company accounts for stock-based awards to employees, using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Net Income Per Share -- The Company computes net income per share in accordance with SFAS No. 128, Earnings per Share. Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted 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. For the year ended December 31, 1999, net income applicable to common shareholders was $2,807 representing net income for the year of $3,397 less Preferred Stock dividends of $590 associated with the Series B Redeemable Preferred Stock (Note 7). The table below sets forth the reconciliation of the denominator of the earnings per share calculation:
YEAR ENDED DECEMBER 31, --------------------------- 1997 1998 1999 ------- ------- ------- Shares used in computing basic net income per share..... 40,373 44,261 37,677 Conversion of Series A Preferred Stock.................. -- -- 1,238 Dilutive effect of stock options........................ 244 198 2,885 ------- ------- ------- Shares used in computing diluted net income per share... 40,617 44,459 41,800 ======= ======= =======
The conversion of the Series A Preferred Stock into common stock reflects the weighted average of such shares per SFAS No. 128. F-9 73 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Comprehensive Income -- For the year ended December 31, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income. There was no difference between the net income and the comprehensive net income for the years ended December 31, 1997 and 1998. For the year ended December 31, 1999, the difference between net income and comprehensive net income was an unrealized loss for available-for-sale securities of $26. Use of Estimates -- The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Risks and Uncertainties -- The Company is subject to risks and uncertainties in the normal course of business, including customer acceptance of its products, rapid technological changes, delays in introducing and market acceptance of new products, competition, e-business developments, the impact of the Year 2000, international expansion, ability to attract and retain qualified personnel, ability to protect its intellectual property, and other matters inherent in the software industry. NEW ACCOUNTING PRONOUNCEMENTS: The Company has adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. In accordance with SFAS No. 131, the Company has disclosed in Note 10 certain information about operating segments and certain information about the Company's revenue types, geographic areas to which the Company sells its products, and major customers. 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. 2. ACQUISITIONS On April 12, 1996, through a majority-owned subsidiary in the United Kingdom, the Company acquired certain net assets of System Software International Limited (SSI). The acquisition was accounted for under the purchase method of accounting, and the purchase price of approximately $119 was allocated to net assets of $30 and goodwill of $89. At December 31, 1996, expected future undiscounted cash flows from SSI did not support the recoverability of the goodwill resulting in the write-off of the remaining unamortized balance. In March 1997, the Company elected to discontinue funding the subsidiary, and in July 1997 commenced liquidation proceedings. During the year ended December 31, 1999, the liquidation was completed without a material loss to the Company. On May 1, 1997, the Company entered into an agreement to acquire the net assets of Common Sense Computing Pty. Ltd. (CSC) for 663 shares of the Company's common stock. At the closing date, 597 shares valued at $413 were issued to the seller, with the remaining 66 shares to be issued in June 1998, provided that the seller performed certain obligations under the indemnification provisions in the agreement. The acquisition was accounted for under the purchase method of accounting and the purchase price was allocated $320 to technology rights based upon the estimated fair value at the date of acquisition, $53 to property, plant and equipment, $100 to cash, and $60 to liabilities assumed. CSC's operating results have been included in the Company's financial statements from the date of acquisition. On June 15, 1998, the remaining 66 shares of common stock were issued resulting in an allocation of an additional $66 to technology rights, based on the fair market value of the Company's common stock at the time of issuance. F-10 74 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On July 1, 1999, the Company, through its wholly owned subsidiaries in Israel and Ireland, acquired certain assets of Neptune Software Ltd. for a cash payment of $484. The acquisition was accounted for under the purchase method of accounting and the purchase price was allocated to net assets of $474 and goodwill of $10. On December 17, 1999, the Company, through a majority owned subsidiary, acquired all of the outstanding common stock and stock options of MBR Technologies, Inc. (MBR) in exchange for 93 shares of the Company's common stock valued at $9,324, a cash payment of $1,314, and the assumption of net liabilities of $340, including a note payable to Quest of $507. The acquisition was accounted for as a purchase and the purchase price of $10,750, which included $112 of direct acquisition costs, was allocated as follows: Current assets.............................................. $ 308 Deferred taxes.............................................. 339 Fixed assets................................................ 123 Goodwill.................................................... 11,534 Liabilities assumed......................................... (1,110) Acquisition liabilities..................................... (444) ------- Total purchase price................................... $10,750 =======
The acquisition liabilities consist of $36 related to the buyout of an operating lease and $408 related to the cost of an abandoned lease on MBR's facility reduced by the monthly lease costs up to the date of abandonment. MBR's operating results have been included in the Company's financial statements from the date of acquisition. Goodwill will be amortized on a straight-line basis over five years. The following unaudited pro forma condensed consolidated results of operations assumes that the MBR acquisition had occurred on the first day of the Company's fiscal year ended December 31, 1998. The pro forma condensed consolidated results of operations, presented for information purposes only, is based on historical information and does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of the combined enterprise.
YEARS ENDED DECEMBER 31, ------------------- 1998 1999 ------- ------- Net revenues................................................ $35,058 $71,438 Net loss.................................................... $ (512) $ (72) Net loss per share: Basic and diluted......................................... $ (0.01) $ (0.00)
In connection with the employment agreements of certain of the MBR shareholders by Quest, bonus payments of up to $6,000 could be earned over a two-year period ending in 2002 if certain sales of MBR products, based on a formula, exceed $4,000 and $8,000. Such bonus payments, if any, will be recorded as compensation expense when and if such bonuses are earned. On January 7, 2000, the Company, through a majority owned subsidiary, acquired all of the outstanding common stock of Foglight Software, Inc. in exchange for 1,188 shares of the Company's common stock valued at $104,168, cash payments estimated to be $424, the assumption of unvested Foglight stock options valued at $2,088 and the assumption of net liabilities estimated to be $5.1 million. The acquisition will be accounted for as a purchase and the purchase price, including $193 of direct acquisition costs will be allocated primarily to goodwill and intangible assets which will generally be amortized over five years. Quest also had notes receivable from Foglight of $1,308 at December 31, 1999. F-11 75 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On February 1, 2000, the Company, through a wholly owned subsidiary, acquired all of the outstanding common stock of QMaster Software Solutions (QMaster) for a cash payment of $15,000 including an estimated $75 in direct acquisition costs. The acquisition was accounted for as a purchase and the purchase price is expected to be allocated primarily to goodwill and other intangible assets. 3. PROPERTY AND EQUIPMENT Net property and equipment consist of the following at December 31:
1998 1999 ------- ------- Furniture and fixtures...................................... $ 596 $ 2,262 Machinery and equipment..................................... 270 758 Computer equipment.......................................... 1,711 5,311 Computer software........................................... 315 692 Leasehold improvements...................................... 109 407 ------- ------- 3,001 9,430 Less accumulated depreciation and amortization.............. (1,613) (2,251) ------- ------- Property and equipment, net................................. $ 1,388 $ 7,179 ======= =======
4. RELATED-PARTY TRANSACTIONS In 1994, the Company borrowed $32 from a shareholder for the purchase of certain fixed assets. The note payable bears interest at 8.5% per annum, payable monthly, and requires monthly principal and interest payments of $1 through December 31, 1999. Approximately $8 was included in other accrued expenses in the accompanying consolidated financial statements representing the remaining outstanding note payable balance at December 31, 1998. The remaining note payable balance was repaid during 1999. During 1997, the Company received a note receivable from an officer of the Company for the purchase of 3,900 shares of the Company's common stock at $0.56 per share. The note receivable plus accrued interest is due April 2002 and bears interest at 6.2%. The note receivable and accrued interest is secured by the common stock. During 1998, the Company received a note receivable from another officer of the Company for the purchase of 975 shares of the Company's common stock at $0.77 per share. The note receivable plus accrued interest is due April 2003 and bears interest at 5.7%. Up to 25% of the unpaid principal and accrued interest may be repaid in each year during the four-year term of the note. The Company has the option to repurchase any shares at the original issuance price associated with the unpaid principal balance if the officer ceases to be employed by the Company. All of the outstanding unpaid principal and interest may be prepaid at any time when the current Chief Executive Officer of the Company ceases to be employed or immediately prior to a sale of substantially all of the assets of the Company or a merger in which the Company is not the surviving entity. The note receivable and accrued interest is secured by the common stock. In April 1999, the Company repurchased and cancelled 14,820 shares of common stock from a shareholder of the Company at a price of $2.36 per share. The Company also entered into a severance agreement with the shareholder whereby the shareholder will receive $200 per year through 2001 and provides for use of a company car and related expenses and medical benefits. The Company recorded approximately $715 of expense related to the agreement in April 1999, which is included in compensation and other costs in the accompanying consolidated financial statements. F-12 76 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. TERM NOTE In connection with the repurchase of common stock from a shareholder in April 1999 (Note 4), the Company borrowed $10,000 under a term note with a bank. The borrowings under the term note were secured by substantially all assets of the Company, bore interest, at the Company's option, at either the bank's prime rate or at the LIBOR rate plus a maximum of 2.75% per annum, required monthly interest payments commencing June 1, 1999, and the principal was payable in 24 monthly installments of $417 commencing June 1, 2000. All unpaid principal and interest was due on May 1, 2002. The loan contained covenants relating to certain financial statement amounts related to tangible net worth, cash flow from operations, and a debt to cash flow from operations and quick ratios. The Company repaid the note after its initial public offering in August, 1999. 6. INCOME TAXES The provision for income taxes consists of the following for the years ended December 31:
1997 1998 1999 ------ ------ ------- Current: Federal....................................... $1,359 $1,819 $ 2,763 State......................................... 102 425 402 Foreign....................................... -- 78 808 ------ ------ ------- 1,461 2,322 3,973 Deferred: Federal....................................... (360) (568) (1,391) State......................................... (79) (75) (309) Foreign....................................... (85) (165) (122) ------ ------ ------- (524) (808) (1,822) Change in valuation allowance................... 85 165 122 ------ ------ ------- Total income tax provision............ $1,022 $1,679 $ 2,273 ====== ====== =======
The reconciliation of income tax expense computed at U.S. federal statutory rates to income tax expense for the years ended December 31, 1997, 1998 and 1999, is as follows:
1997 1998 1999 ----- ---- ---- Tax at U.S. federal statutory rates............... 35.0% 35.0% 35.0% State taxes....................................... 2.0 5.7 1.1 Recording of deferred income tax liabilities in connection with the conversion to a C corporation..................................... 45.2 -- -- Foreign taxes..................................... 6.2 6.0 8.3 Research and development credits.................. (10.4) (4.6) (4.7) Other............................................. -- (0.4) 0.4 ----- ---- ---- 78.0% 41.7% 40.1% ===== ==== ====
F-13 77 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred taxes as of December 31, 1998 and 1999, are as follows:
1998 1999 ----- ------- Deferred tax assets: Accounts receivable and sales returns reserves.......... $ 313 $ 871 Accrued liabilities..................................... 165 892 Foreign net operating loss carryforwards................ 250 127 U.S. net operating loss carryforwards................... -- 339 Intangible assets....................................... 264 453 Stock compensation...................................... -- 184 Other................................................... 56 -- ----- ------- Total gross deferred assets............................... 1,048 2,866 Deferred tax liabilities: Cash to accrual adjustment.............................. (301) (150) State taxes............................................. (32) (47) Fixed assets............................................ -- (38) ----- ------- Total gross deferred liabilities.......................... (333) (235) Valuation allowance....................................... (250) (127) ----- ------- Net deferred income taxes................................. $ 465 $ 2,504 ===== ======= Less current portion...................................... (198) (2,089) ----- ------- $ 267 $ 415 ===== =======
The Company has U.S. net operating loss carryforwards of $889 that are subject to limitation by Internal Revenue Code Section 382 and begin to expire in 2018. The Company has foreign net operating loss carryforwards of $425 that can be carried forward indefinitely. Effective January 1, 1997, the Company converted to a C corporation and became subject to regular federal and state income taxes on an ongoing basis. As a result, the Company recorded $617 of net deferred income tax liabilities on January 1, 1997. Total cash distributions charged against retained earnings include payments of $261 in 1997, made to the Company's shareholders. 7. SHAREHOLDERS' EQUITY In April 1999, the Company issued 2,667 shares of Series A Preferred Stock (Series A) for $15,000 and 1,778 shares of Series B Redeemable Preferred stock (Series B) for $10,000. Series A shares were convertible at the holder's option into shares of common stock, based on the conversion ratio defined in the agreement. The conversion ratio could be adjusted, from time to time, in the event of certain diluting events, as defined. Conversion was automatic in the event of a public offering of the Company's common stock, that met certain specified criteria initially at a rate of 1.5 shares of common stock for each share of preferred stock. Additionally, the holders of not less than a majority of the Series A shares had the right to redeem the Series A shares for cash in two equal installments due on April 30, 2006 and 2007, respectively. The redemption price would be determined on each date by the then applicable liquidation preference. Upon the election of not less than a majority of the Series A holders to redeem the Series A shares, all Series A shares would be redeemed. Dividends on Series A F-14 78 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS were cumulative on a "when and as if declared" basis at a rate of 8% per share per annum. Series A shareholders had the right to elect one director and have veto rights over certain management decisions. In the event of liquidation, dissolution or winding up of the Company, each Series A shareholder had a liquidation preference equal to $5.625 per share, plus an amount equal to all accrued but unpaid dividends, with respect to such shares plus an amount equal to a prorated dividend from the last dividend payment date to the date fixed for liquidation, dissolution, or winding up. In connection with the Company's initial public offering in August 1999, all outstanding shares of Series A Preferred Stock were converted into 4,000 shares of common stock. Series B shares were convertible into shares of Series A shares one year after the issuance of the Series B shares at the holder's option based on the ratio defined in the agreement. If the Series A shares were not converted into common stock, Series B shares were convertible into shares of Series A preferred stock at the Company's option prior to the one year anniversary of the date of issuance of the Series B shares. The conversion ratio could be adjusted, from time to time, in the event of certain diluting events, as defined. Dividends on Series B were cumulative and could be declared at the discretion of the Board of Directors. The dividend rate was 18% per share per annum. Series B shareholders did not have voting rights with the exception of the redemption provisions discussed below. In the event of liquidation, dissolution or winding up of the Company, each Series B shareholder had a liquidation preference equal to $5.625 per share, plus an amount equal to all accrued but unpaid dividends, with respect to such shares plus an amount equal to a prorated dividend from the last dividend payment date to the date fixed for liquidation, dissolution, or winding up. Additionally, the holders of the Series B shares and the Company had the right to redeem the Series B shares for cash at any time one year following the issuance of the Series B shares, or, if earlier, upon consummation of an initial public offering. The redemption price was determined on the redemption date by the then applicable liquidation preference. In connection with the Company's initial public offering in August 1999, the Series B shares were redeemed for $10,000 plus dividends of $590. 8. STOCK OPTION PLANS In connection with a prior acquisition, the Company entered into an employment agreement with the president of the acquired company under which options to purchase up to 2.5% of the Company's outstanding common stock at $0.77 per share were granted. The agreement provided for issuance of additional common shares to the individual in the event the Company issued common shares to employees, subject to limitations as defined in the agreement. In connection with the issuance of 975 shares of common stock to this individual in 1998 (Note 4), the option was cancelled. In May 1998, the Company adopted the 1998 Stock Option/Stock Issuance Plan (the Plan). Under the terms of the Plan, options to purchase 7,500 shares of the Company's common stock were reserved for issuance to employees, directors, and consultants. 1999 STOCK INCENTIVE PLAN The 1999 Stock Incentive Plan is intended to serve as the successor equity incentive program to the 1998 Stock Option/Stock Issuance Plan. The 1999 Stock Incentive Plan was adopted by the Board and subsequently approved by the shareholders on June 9, 1999. The 1999 Stock Incentive Plan became effective upon its adoption by the Board. On the date of the Company's initial public offering, all outstanding options under the 1998 plan were incorporated into the 1999 Stock Incentive Plan, and no further option grants will thereafter be made under the 1998 plan. The incorporated options will continue to be governed by their existing terms, unless the plan administrator elects to extend one or more features of the 1999 Incentive Plan to those options. Except as otherwise noted below, the incorporated options F-15 79 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS have substantially the same terms as will be in effect for grants made under the Discretionary Option Grant Program of the 1999 Stock Incentive Plan. Share Reserve -- At December 31, 1999, 7,493 shares of common stock have been authorized for issuance under the 1999 Stock Incentive Plan of which 2,215 shares are available for issuance. The share reserve consists of the number of shares that remain available for issuance under the 1998 plan and shares of common stock subject to outstanding options thereunder. No participant in the 1999 Stock Incentive Plan may be granted stock options, separately exercisable stock appreciation rights and direct stock issuances for more than 500 shares of common stock in total per calendar year. Programs -- The 1999 Stock Incentive Plan is divided into five separate programs: - The discretionary option grant program under which eligible individuals may be granted options to purchase shares of common stock at an exercise price determined by the plan administrator; - The stock issuance program under which individuals may be issued shares of common stock directly, through the purchase of such shares at a price determined by the plan administrator or as a bonus tied to the performance of services; - The salary investment option grant program which may, at the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow executive officers and other highly compensated employees the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants; - The automatic option grant program under which option grants will automatically be made at periodic intervals to eligible non-employee Board members to purchase shares of common stock at an exercise price equal to 100% of the fair market value of those shares on the grant date; and - The director fee option grant program which may, in the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow non-employee Board members the opportunity to apply a portion of the annual retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants. Administration -- The discretionary option grant program and the stock issuance program will be administered by the compensation committee of the Board of Directors. Plan Features -- The 1999 Stock Incentive Plan includes the following features: - The exercise price for any options granted under the plan may be paid in cash or in shares of common stock valued at fair market value on the exercise date. The option may also be exercised through a same-day sale program without any cash outlay by the optionee. - The compensation committee will have the authority to cancel outstanding options under the discretionary option grant program in return for the grant of new options for the same or different number of option shares with an exercise price per share based upon the fair market value of our common stock on the new grant date. - Stock appreciation rights may be issued under the discretionary option grant program. Such rights will provide the holders with the election to surrender their outstanding options for an appreciation distribution from the Company equal to the fair market value of the vested shares of common stock subject to the surrendered option less the exercise price payable for those shares. Payment can be made in cash or in shares of common stock. F-16 80 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Change in Control -- The 1999 Stock Incentive Plan includes the following change in control provisions, which may result in the accelerated vesting of outstanding option grants and stock issuances: - In the event that the Company is acquired by merger or asset sale or a Board-approved sale of more than fifty percent of the then outstanding stock, each outstanding option under the discretionary option grant program which is not assumed or continued by the successor corporation will immediately become exercisable for all the option shares, and all unvested shares will immediately vest, except to the extent the Company's repurchase rights with respect to those shares are assigned to the successor corporation. - The plan administrator will have complete discretion to grant one or more options which will become exercisable for all the option shares in the event those options are assumed in an acquisition, but the optionee's service with the Company or the acquiring entity is subsequently terminated. The vesting of outstanding shares under the 1999 Stock Incentive Plan may be accelerated upon similar terms and conditions. - The plan administrator may also grant options which will immediately vest upon our acquisition by another entity, whether or not those options are assumed by the successor corporation. - The plan administrator may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful tender offer for more than 50% of the outstanding voting stock or a change in the majority of our board of directors through one or more contested elections. Such accelerated vesting may occur either at the time of such transaction or upon the subsequent termination of the individual's service. Salary Investment Option Grant Program -- In the event the compensation committee decides to put this program into effect for one or more calendar years, each of the Company's executive officers and other highly compensated employees selected for participation may elect to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10 nor more than $75. Each selected individual who makes such an election will automatically be granted, on the first trading day in January of the calendar year for which that salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of common stock on the grant date. Compensation expense will be recorded for the amount of the salary reduction. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. As a result, the total spread on the option shares at the time of grant will be equal to the amount of salary invested in that option. The option will vest and become exercisable in a series of twelve equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting upon certain changes in the ownership or control. Automatic Option Grant Program -- Each individual who first becomes a non-employee Board member at any time after the completion of this offering will automatically receive an option grant for 25 shares on the date such individual joins the Board, provided such individual has not been in the prior employ of the Company. In addition, on the date of each annual shareholders meeting, beginning with the 2001 annual shareholders meeting, each non-employee board member who has served as a non-employee Board member since the date of the last annual shareholders meeting will automatically be granted an option to purchase 8 shares of common stock. Each automatic grant will have a term of ten years, subject to earlier termination following the optionee's cessation of Board service. The initial 25-shares option will be immediately exercisable for all of the option shares; however, any unvested shares purchased under the option will be subject to repurchase by us, at the exercise price paid per share, should the optionee cease Board service prior to vesting in those shares. The shares subject to each 25 share automatic option grant will vest over a four-year period in F-17 81 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS successive equal annual installments upon the individual's completion of each year of board service over the four-year period measured from the option grant date. However, the shares subject to each such automatic grant will immediately vest in full upon certain changes in control or ownership of the Company or upon the optionee's death or disability while a Board member. Each 8 share automatic option grant will be immediately exercisable and fully vested on the option grant date. Director Fee Option Grant Program -- If this program is put into effect, each non-employee Board member may elect to apply all or a portion of any annual retainer fee otherwise payable in cash to the acquisition of a below-market option grant. The option grant will automatically be made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the retainer fee applied to the program by two-thirds of the fair market value per share of common stock on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the aggregate exercise price payable for those shares will be equal to the portion of the retainer fee invested in that option. The option will become exercisable in a series of twelve equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares upon certain changes in the ownership or control or the death or disability of the optionee while serving as a Board member. Limited Stock Appreciation Rights -- Limited stock appreciation rights will automatically be included as part of each grant made under the automatic option grant, salary investment option grant and director fee option grant programs and may be granted to one or more of the Company's officers as part of their option grants under the discretionary option grant program. Options with such a limited stock appreciation right may be surrendered to the Company upon the successful completion of a hostile tender offer for more than 50% of the Company's outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from the Company in an amount per surrendered option share based on the highest price per share of common stock paid in connection with the tender offer. Amendment -- The board may amend or modify the 1999 Stock Incentive Plan at any time, subject to any required shareholder approval. The 1999 Stock Incentive Plan will terminate no later than June 8, 2009. 1999 EMPLOYEE STOCK PURCHASE PLAN Introduction -- The 1999 Employee Stock Purchase Plan was adopted by the Board and approved by the shareholders in June 1999 and will become effective immediately upon the effective date of the Company's initial public offering. The 1999 Employee Stock Purchase Plan is designed to allow eligible employees and the employees of participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through their periodic payroll deductions. Share Reserve -- At December 31, 1999, 600 shares of common stock were reserved for issuance. In February, 2000, 119 shares of common stock were purchased under the plan. At December 31, 1999, $1,269 was recorded in accrued liabilities that employees had deposited for purchases of common stock under the plan. Purchase Periods -- The plan has a series of successive purchase periods, each with a maximum duration of six months. The initial purchase period began on August 12, 1999 and ended on the last business day in January 2000. Thereafter, purchase periods run from the first business day in February to the last business day in July of each year, and from the first business day in August to the last business day in January of the following year. F-18 82 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Eligible Employees -- Individuals who are scheduled to work more than 20 hours per week for more than five calendar months per year on the start date of any purchase period may join the plan on such start date. Payroll Deductions -- A participant may contribute up to 15% of their cash earnings, and the accumulated payroll deductions will be applied to the purchase of shares on each semi-annual purchase date. The purchase price per share will be equal to 85% the fair market value of the common stock on the start date of the purchase period or, if lower, the fair market value on the semi-annual purchase date. Semi-annual purchase dates will occur on the last business day of January and July each year. In no event, however, may any participant purchase more than .6 shares on any semi-annual purchase date. Change in Control -- In the event the Company is acquired by merger or asset sale, all outstanding purchase rights will automatically be exercised immediately prior to the effective date of the acquisition. The purchase price will be equal to 85% of the fair market value per share of common stock on the participant's entry date into the offering period in which such acquisition occurs or, if lower, the fair market value per share of common stock immediately prior to such acquisition. Termination/Amendment -- The 1999 Employee Stock Purchase Plan will terminate on the last business day of July 2009. The Board may at any time alter, suspend or discontinue the plan. However, certain amendments to the plan may require shareholder approval. As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the Company has chosen to continue to account for its stock-based compensation plans under APB Opinion No. 25 and provide the expanded disclosures specified in SFAS No. 123. Compensation costs would not have significantly changed net income or net income per share in fiscal 1997. Had compensation cost been determined using the provisions of SFAS No. 123, the Company's net income available to common shareholders would have been decreased to the pro forma amounts indicated below:
DECEMBER 31, DECEMBER 31, 1998 1999 ------------ ------------ Net income available to common shareholders: As reported............................................... $2,346 $2,807 ====== ====== Pro forma................................................. $2,177 $ 204 ====== ====== Basic net income per share: As reported............................................... $ 0.05 $ 0.07 ====== ====== Pro forma................................................. $ 0.05 $ 0.01 ====== ====== Diluted net income per share: As reported............................................... $ 0.05 $ 0.07 ====== ====== Pro forma................................................. $ 0.05 $ 0.00 ====== ======
For purposes of estimating the compensation cost of the Company's option grants in accordance with SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted average assumptions used for grants in the years 1997 and 1998, as a private company: expected volatility of zero; risk-free interest rates of 6%; and expected lives of ten years. Weighted average assumptions for 1999 were: expected volatility of 221%; risk-free interest rates of 6%; and expected lives of five years. F-19 83 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes activity under all of the Company's stock option plans:
DECEMBER 31, --------------------------------------------------------- 1997 1998 1999 ----------------- ----------------- ----------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------ -------- ------ -------- ------ -------- Outstanding, beginning of period........ 1,531 $0.64 975 $0.77 3,367 $ 1.19 Granted................................. -- $ -- 3,383 $1.19 2,391 $14.05 Exercised............................... -- $ -- -- $ -- (34) $ 1.00 Canceled................................ (556) $0.40 (991) $0.77 (473) $ 3.25 ----- ----- ----- ------ Balance, end of period.................. 975 $0.77 3,367 $1.19 5,251 $ 6.86 Weighted average fair value of options granted during the year............... -- $0.53 $13.42 ===== ===== ======
The Company will record compensation expense of approximately $2,978 relating to options granted during the year ended December 31, 1999, to purchase 530 shares of common stock. The expense equals the difference between the fair market value of the Company's common stock on the grant date and the exercise price of the stock options and will be recognized ratably over the four-year vesting period of the stock options. The Company recorded $432 of expense associated with such option grants during the year ended December 31, 1999 which is included in compensation and other costs in the accompanying consolidated financial statements.
DECEMBER 31, 1999 ------------------------------------------------------------- OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------ ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE --------------- ----------- ----------- -------- ----------- -------- $ 1.00 -- 1.00......................... 2,161 8.49 $ 1.00 578 $1.00 $ 1.17 -- 3.77......................... 2,166 9.00 $ 2.33 125 $1.17 $ 6.00 -- 12.00......................... 468 9.53 $10.39 -- -- $37.00 -- 45.00......................... 192 9.74 $41.03 -- -- $50.75 -- 64.13......................... 198 9.90 $54.34 -- -- $80.50 -- 80.50......................... 66 9.92 $80.50 -- -- ----- --- 5,251 703 $1.03 ===== === =====
Options to purchase 47 shares of common stock at exercise prices of $1.00 to $1.17 per share were exercised in January 2000. 9. COMMITMENTS AND CONTINGENCIES The Company leases its office facilities and certain equipment under various operating leases. The majority of these leases are non-cancelable and obligate the Company to pay costs of maintenance, utilities, and applicable taxes. The leases on most of the office facilities contain escalation clauses and renewal options. Total rent expense was $732, $1,038 and $2,593, for the years ended December 31, 1997, 1998, and 1999. F-20 84 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Minimum lease commitments under noncancelable operating leases at December 31, 1999, are as follows: Year ending December 31: 2000............................................. $ 3,457 2001............................................. 3,353 2002............................................. 3,245 2003............................................. 2,739 2004............................................. 2,656 Thereafter....................................... 4,652 ------- $20,102 =======
As a result of the acquisition of MBR (Note 2), the Company is obligated under capital lease agreements for certain property and equipment requiring monthly installments of principal and interest (at 10%) through 2004. The present value of the remaining capital lease payments is $114 at December 31, 1999. The Company maintains a profit-sharing plan covering substantially all employees. Quarterly contributions may be made by the Company based upon employee salaries. Effective January 1, 1997, the Company amended and restated the profit sharing plan to include a 401(k) plan. The Company contributed $134, $466 and $929 to the amended plan for the years ended December 31, 1997, 1998 and 1999, respectively. On May 25, 1999, Mobius Management Systems, Inc., filed a complaint in the United States District Court for the District of New Jersey (Mobius Management Systems, Inc. v. Quest Software, Inc., Case No. 99-2337). The complaint alleged that the Company published three advertisements that were false and misleading and, therefore, in violation of the Lanham Act and common law, and that the Company misappropriated unspecified trade secrets belonging to Mobius. The advertisements that Mobius alleged in its complaint are false and misleading were two e-mails intended for internal use, a comparison chart believed to have been prepared by a former Company employee in 1997 for internal purposes, and a statement made regarding the Company's Vista Plus Java client which had been posted on the Internet. The case was settled in late 1999, with both sides agreeing to pay their own legal fees. No other expenses were incurred by the Company in connection with this matter. The Company is involved in various claims and legal actions arising in the ordinary course of business. The litigation process is inherently uncertain, and it is possible that the resolution of such claims and legal actions may adversely affect the Company. However, it is the opinion of management that the ultimate disposition of these matters will not materially affect the Company's results of operations or financial position. 10. GEOGRAPHIC INFORMATION AND CONCENTRATION OF CREDIT RISK 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 Software Licenses operating 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. F-21 85 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 sales 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 years in the period ended December 31, 1999, was as follows:
LICENSES SERVICES TOTAL -------- -------- ------- Year ended December 31, 1997: Revenues.................................................. $12,158 $ 6,157 $18,315 Cost of revenues.......................................... 1,307 1,972 3,279 ------- ------- ------- Gross profit........................................... $10,851 $ 4,185 $15,036 ======= ======= ======= Year ended December 31, 1998: Revenues.................................................. $24,901 $ 9,889 $34,790 Cost of revenues.......................................... 3,433 2,507 5,940 ------- ------- ------- Gross profit........................................... $21,468 $ 7,382 $28,850 ======= ======= ======= Year ended December 31, 1999: Revenues.................................................. $54,269 $16,599 $70,868 Cost of revenues.......................................... 2,998 4,195 7,193 ------- ------- ------- Gross profit........................................... $51,271 $12,404 $63,675 ======= ======= =======
Revenues are attributed to geographic areas based on the location of the entity to which the products or services were sold. Revenues, gross profit, income (loss) from operations and long-lived assets concerning principal geographic areas in which the Company operates are as follows:
UNITED STATES INTERNATIONAL ELIMINATIONS TOTAL ------- ------------- ------------ ------- Year ended December 31, 1997: Revenues..................................... $17,511 $ 1,261 $ (457) $18,315 Gross profit................................. 14,413 1,075 (452) 15,036 Income (loss) from operations................ 1,533 (339) 254 1,448 Long-lived assets............................ 2,336 118 -- 2,454 Year ended December 31, 1998: Revenues..................................... $32,189 $ 4,172 $(1,571) $34,790 Gross profit................................. 26,594 3,840 (1,584) 28,850 Income (loss) from operations................ 3,839 (252) 102 3,689 Long-lived assets............................ 1,600 315 -- 1,915 Year ended December 31, 1999: Revenues..................................... $55,532 $19,736 $(4,400) $70,868 Gross profit................................. 55,389 8,701 (415) 63,675 Income from operations....................... 3,270 693 505 4,468 Long-lived assets............................ 17,839 1,233 -- 19,072
In fiscal 1997, 1998 and 1999, no single customer accounted for 10% or more of total revenue. No single international location accounted for more than 5% of total revenues for any of the periods indicated. F-22 86 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH FISCAL QUARTER QUARTER QUARTER QUARTER YEAR -------- -------- -------- -------- -------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31, 1999 Revenue.................................... $12,839 $15,450 $18,308 $24,271 $70,868 Gross profit............................... 11,251 13,896 16,420 22,108 63,675 Income before income taxes................. 1,632 641 902 2,495 5,670 Net income applicable to common shareholders............................ 943 31 272 1,561 2,807 Basic earnings per share................... 0.02 0.00 0.01 0.04 0.07 Diluted earnings per share................. 0.02 0.00 0.01 0.04 0.07 YEAR ENDED DECEMBER 31, 1998 Revenue.................................... $ 7,043 $ 6,992 $ 8,734 $12,021 $34,790 Gross profit............................... 5,965 5,522 7,044 10,319 28,850 Income before income taxes................. 1,483 53 1,073 1,416 4,025 Net income applicable to common shareholders............................ 868 31 627 820 2,346 Basic earnings per share................... 0.02 0.00 0.01 0.02 0.05 Diluted earnings per share................. 0.02 0.00 0.01 0.02 0.05
12. SUBSEQUENT EVENTS On January 31 and February 11, 2000, the Company entered into two non-binding letters of intent to acquire two companies for an aggregate purchase price of $25 million. F-23 87 REPORT OF INDEPENDENT AUDITORS To the Shareholders and Directors of MBR Technologies, Inc. We have audited the accompanying balance sheet of MBR Technologies, Inc., a California Corporation, as of March 31, 1999, the related statements of operations, shareholders' equity and cash flows from inception (April 23, 1998) through March 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based upon our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MBR Technologies Inc. as of March 31, 1999, and the results of its operations and cash flows from inception (April 23, 1998) through March 31, 1999, in conformity with generally accepted accounting principles. /s/ SWENSON ADVISORS, LLP Temecula, California September 29, 1999 F-24 88 MBR TECHNOLOGIES, INC. BALANCE SHEETS
MARCH 31, DECEMBER 17, 1999 1999 ---------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 63,055 $ 229,011 Accounts receivable....................................... 94,918 94,785 Deposits and prepaid assets............................... 21,831 23,737 ---------- ----------- Total current assets................................. 179,804 347,533 ---------- ----------- Property, equipment and software: Software.................................................. 262,722 13,548 Furniture and fixtures.................................... 55,722 79,235 Computers and equipment................................... 114,868 186,287 Leasehold improvements.................................... 9,772 9,772 ---------- ----------- 443,084 288,842 Less: accumulated depreciation.............................. (17,118) (63,131) ---------- ----------- Net property and equipment................................ 425,966 225,711 ---------- ----------- Other assets.............................................. 4,044 3,458 ---------- ----------- Total assets......................................... $ 609,814 $ 576,702 ========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities.................. $ 45,553 30,204 Other current liabilities................................. 13,001 -- Notes payable to Quest Software........................... -- 506,454 Current portion of notes payable to related parties....... 299,136 411,020 Current portion of capital lease obligations.............. 30,342 42,585 Deferred revenue.......................................... 22,912 48,540 ---------- ----------- Total current liabilities............................ 410,944 1,038,803 ---------- ----------- Long term liabilities: Capital lease obligations, net of current portion......... 52,443 70,872 ---------- ----------- Total liabilities.................................... 463,387 1,109,675 ---------- ----------- Shareholders' equity (deficit): Common stock, no par value; authorized 10,000,000 shares; Issued and outstanding 1,020,000 shares................ 1,020,000 1,020,000 Accumulated deficit....................................... (873,573) (1,552,973) ---------- ----------- Total shareholders' equity (deficit)................. 146,427 (532,973) ---------- ----------- Total liabilities and shareholders' equity........... $ 609,814 $ 576,702 ========== ===========
See Accompanying Notes to Financial Statements. F-25 89 MBR TECHNOLOGIES, INC. STATEMENTS OF OPERATIONS
FROM INCEPTION PERIOD FROM (APRIL 23, 1998) JANUARY 1, 1999 THROUGH TO MARCH 31, 1999 DECEMBER 17, 1999 ---------------- ----------------- (UNAUDITED) Revenue..................................................... $ 267,825 $ 569,958 Operating expenses: Salary expenses and related employee benefits............. 248,859 497,291 Research and development.................................. 300,873 208,660 Amortization of software costs............................ 337,278 346,452 Selling, general and administrative....................... 137,087 226,833 Professional fees and outside services.................... 92,710 87,657 Amortization and depreciation............................. 17,568 56,134 ---------- --------- Total operating expenses............................. 1,134,375 1,423,027 ---------- --------- Operating loss.............................................. (866,550) (853,069) Interest income............................................. 278 467 ---------- --------- Loss before interest and taxes.............................. (866,272) (852,602) Interest expense............................................ 6,501 31,007 Income tax provision........................................ 800 1,395 ---------- --------- Net loss.................................................... $ (873,573) $(885,004) ========== =========
See Accompanying Notes to Financial Statements. F-26 90 MBR TECHNOLOGIES, INC. STATEMENT OF SHAREHOLDERS' EQUITY FROM INCEPTION (APRIL 23, 1998) THROUGH MARCH 31, 1999 AND THE PERIOD FROM JANUARY 1, 1999 TO DECEMBER 17, 1999 (UNAUDITED)
COMMON RETAINED STOCK DEFICIT ---------- ---------- BALANCE, April 23, 1998..................................... $ -- $ -- Net loss.................................................... -- (873,573) Sale of common stock........................................ 1,020,000 -- ---------- ---------- BALANCE, March 31, 1999..................................... 1,020,000 (873,573) Unaudited: Net loss.................................................... -- (679,400) ---------- ---------- BALANCE, December 17, 1999.................................. $1,020,000 $1,552,973 ========== ==========
See Accompanying Notes to Financial Statements. F-27 91 MBR TECHNOLOGIES, INC. STATEMENTS OF CASH FLOWS
FROM INCEPTION PERIOD FROM (APRIL 23, 1998) JANUARY 1, 1999 THROUGH TO MARCH 31, 1999 DECEMBER 17, 1999 ---------------- ----------------- (UNAUDITED) Cash flows from operating activities: Net loss.................................................. $(873,573) $(885,004) Adjustments used in operating activities: Depreciation and amortization.......................... 17,568 56,234 Amortization of software costs......................... 337,278 346,452 Related party equity exchanges......................... 237,040 -- Change in notes payable to related parties............. 4,136 21,420 Changes in assets and liabilities: Increase in accounts receivable...................... (94,918) 74,660 Increase in deposits and prepaid expenses............ (21,831) 2,374 Increase in organization costs....................... (4,494) -- Increase in accounts payable and accrued liabilities....................................... 45,553 (11,127) Increase in other current liabilities................ 13,001 7,071 Increase in deferred revenue......................... 22,912 (48,540) --------- --------- Net cash used in operating activities............. (317,328) (436,460) Cash flows from investing activities: Purchase of property and equipment........................ (82,472) (51,732) --------- --------- Net cash used in investing activities............. (82,472) (51,732) Cash flows from financing activities: Proceeds from common stock................................ 173,501 22,717 Borrowings from related parties........................... 295,000 155,000 Borrowings from Quest Software............................ -- 500,000 Payments on capital lease obligations..................... (5,646) (29,933) --------- --------- Net cash provided by financing activities......... 462,855 647,784 --------- --------- Increase in cash............................................ 63,055 159,592 Cash, beginning of period................................... -- 69,419 --------- --------- Cash, end of period......................................... $ 63,055 $ 229,011 ========= ========= Supplemental Disclosure of Cash flow Information: Cash paid for interest.................................... $ 2,364 $ 31,007 ========= =========
See Notes 4 and 6 for supplemental cash flow disclosures. See Accompanying Notes to Financial Statements. F-28 92 MBR TECHNOLOGIES, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 -- ORGANIZATION MBR Technologies, Inc. (the "Company") was incorporated in California on April 23, 1998. The Company develops, publishes, markets, and distributes middleware solutions for enterprise software platforms. The Company's products are designed to reduce the cost of ownership and maintenance of the PeopleSoft and CSS/Horizon (ADP) environments. In addition to product sales the Company also provides annual maintenance for their software and related consulting services. The Company markets its software through several channels, including: direct sales, software showcase conferences, joint marketing relationships and value added resellers (VARs). Unaudited Information -- The accompanying statement of operations and cash flows for the period January 1, 1999 to December 17, 1999, have been prepared by the Company without audit in accordance with Generally Accepted Accounting Principles for interim financial information and, in the opinion of management, contain all adjustments consisting only of normal recurring accruals necessary for a fair presentation of such information. Such information has been prepared for use in the proforma financial statements required by Quest Software, Inc. (Quest) in connection with its acquisition in December, 1999 by Quest. NOTE 2 -- LIQUIDITY AND BUSINESS RISK The accompanying financial statements have been prepared assuming the Company will continue as a going concern. The Company has an accumulated deficit of $873,573 and negative working capital of $231,140 as of March 31, 1999. The Company's ability to continue business in its present form is subject to a variety of factors, which include, among other things, the Company's ability to raise working capital and to generate profitable operations. In the opinion of management, the Company will be able to improve its profitability and raise adequate capital to meet its current working capital requirements. The Company is subject to a number of risks associated with companies at a similar stage of development including; the need for funding its operations and growth, marketplace acceptance, competition, technological obsolescence, and the retention and reliance on key personnel. On February 17, 1999, the Company was sold to Quest Software, Inc. for $10,638 which consisted of 93,471 shares of Quest's common stock valued at $9,323,732 and cash of $1,313,853. NOTE 3 -- SIGNIFICANT ACCOUNTING POLICIES Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents -- The Company considers all unrestricted highly liquid investments purchased with maturity of three months or less to be cash equivalents. The carrying value of cash equivalents approximates fair value. Revenue Recognition -- Revenue from training and consulting fees is recognized when earned. Revenues from product sales and support fees are recognized in accordance with the provisions outlined in the AICPA SOP 97-2. Deferred revenue represents certain post contract customer support recognized on a monthly basis. Property and Equipment -- Property and equipment is stated at cost, less accumulated depreciation and amortization. Depreciation is determined using the straight line method for all assets based on F-29 93 MBR TECHNOLOGIES, INC. NOTES TO FINANCIAL STATEMENTS estimated useful lives of the assets, which range from three to seven years for furniture and equipment, and fifteen years for leasehold improvements. Software Costs -- Software costs related to the acquisition of the Stat! software have been capitalized and amortized over the useful life of the software, estimated to be twenty months. For the year ended March 31, 1999, $337,278 of these costs have been amortized. For the period January 1, 1999 to December 17, 1999, $346,452 of these costs have been amortized. Income Taxes -- For the year ended March 31, 1999 and the period from January 1, 1999 to December 17, 1999, there was no federal tax liability for financial statement or tax bases. The minimum franchise tax of $800 has been accrued. NOTE 4 -- RELATED PARTIES During the year ended March 31, 1999, the Secretary and Chief Financial Officer of the Company loaned $195,000 and $100,000, respectively, to the Company to be used for operating and investing activities. The loans are due and payable no later than September 30, 1999, and interest accrues at a rate of 5% per annum. The Company has obtained a waiver until December 31, 1999. For the year ended March 31, 1999, $4,136 of interest was accrued on these notes. During the year ended March 31, 1999, certain related parties received stock in exchange for goods and services. The Chief Executive Officer and Chief Operations Officer of the Company received 350,000 and 300,000 shares, respectively, in exchange for rights to software and related consulting for the product. The Chief Financial Officer received approximately 118,100 shares for consulting and certain equipment. NOTE 5 -- COMMON STOCK AND CAPITAL FUNDING The Company has one class of common stock. There are no preferences related to dividends, voting rights or dissolution. During the year ended March 31, 1999, $173,501 new cash was received for common stock sold to related and unrelated parties. (See Note 4) NOTE 6 -- COMMITMENTS AND CONTINGENCIES Operating Leases -- The Company leases office space under an operating lease agreement with monthly rent of $8,192; which increases to a maximum of $9,558 in 2003. Rent expense under this lease totaled $24,685 for the year ended March 31, 1999 and $81,511 for the period from January 1, 1999 to December 17, 1999. The Company also entered into an operating equipment lease at March 31 that expires in December 2001. Future minimum lease payments under these operating leases are as follows: 2000...................................................... $104,294 2001...................................................... 108,390 2002...................................................... 112,487 2003...................................................... 116,583 -------- $441,754 ========
Capital Leases -- The Company has entered into certain capital leases. Interest accrues on each of these leases at a rate of 10% annually. Lease terms range from 36 to 48 months. F-30 94 MBR TECHNOLOGIES, INC. NOTES TO FINANCIAL STATEMENTS Future lease payments under capital leases are as follows: 2000...................................................... $ 41,160 2001...................................................... 41,160 2002...................................................... 38,476 2003...................................................... 8,293 -------- $129,089 ========
NOTE 7 -- 401(K)PLAN The Company provides a tax qualified section 401(k) plan for the benefit of eligible employees. In accordance with Plan guidelines, contributions by the employer are discretionary. During the year ended March 31, 1999, the Company contributed $8,546 to the Plan. No contributions were payable at the end of the fiscal year. The Company paid $1,700 in administrative costs for the Plan. Contributions made by the Company vest based on the employee's years of service. Vesting begins after two years of service in 20% annual increments until the employee is 100% vested after six years. NOTE 8 -- STOCK OPTION PLAN In June 1999, the Company adopted the Fiscal Year 2000 Equity Incentive Plan (2000 Plan.) Under the 1999 Plan, a maximum of 200,000 shares of Common Stock have been reserved for issuance of options. Options under the 1999 Plan may be granted at exercise prices determined by the Board of Directors, provided that the exercise prices shall not be less than 85% of the fair market of the common stock. The options vest over three years at 33.3% a year commencing on the grant date. The term of the options are not to exceed 10 years. There were no options granted under this Plan as of March 31, 1999. Approximately 11,500 options were granted after March 31, 1999 through September 29, 1999. NOTE 9 -- YEAR 2000 ISSUE (UNAUDITED) Like other organizations and individuals around the world, the Company could be adversely affected if the computer systems it uses and those used by the Company's major customers and vendors do not properly process and calculate date-related information and data from and after January 1, 2000. This is commonly known as the "Year 2000 Issue." Management is assessing its computer systems and the systems compliance issues of its major service providers. Based on information available to management, the Company's major customers and vendors are taking steps that they believe are reasonably designed to address the Year 2000 Issue with respect to computer systems that they use. At this time, however, there can be no assurance that these steps will be sufficient, and the failure of a timely completion of all necessary procedures could have a material adverse effect on the Company's operations. Management will continue to monitor the status of, and its exposure to, this issue. NOTE 10 -- NOTES PAYABLE TO QUEST SOFTWARE (UNAUDITED) Included in the accompanying financial statements at December 17, 1999 are notes and accrued interest at 7% payable to Quest Software of $506,454, which Quest Software assumed in the acquisition of the Company in December, 1999. F-31 95 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Foglight Software, Inc. (a company in the development stage) In our opinion, the accompanying balance sheet and the related statements of operations, of stockholders' deficit and of cash flows present fairly, in all material respects, the financial position of Foglight Software, Inc. at December 31, 1998 and the results of its operations and its cash flows for the period from November 10, 1997 (date of inception) to December 31, 1998 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred losses and negative cash flows from operations since inception that raise substantial doubt about its ability to continue as a going concern. The Company's ability to continue as a going concern is dependent, among other factors, on its ability to obtain sufficient financing to complete the development and commercialization of its products and to obtain adequate customers for its product. Management's plans with regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ PRICEWATERHOUSECOOPERS LLP September 13, 1999, except for Note 10, for which it is October 29, 1999 F-32 96 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) BALANCE SHEETS
DECEMBER 31, 1998 ------------ ASSETS Current assets: Cash and cash equivalents................................. $ 2,164,741 Restricted cash........................................... 76,423 Accounts receivable....................................... -- Inventory................................................. -- Prepaid expenses and other current assets................. 189,632 ----------- Total current assets................................. 2,430,796 Property and equipment, net................................. 1,016,124 Other assets................................................ 34,344 ----------- Total assets......................................... $ 3,481,264 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable, current portion............................ $ 3,303,137 Accounts payable.......................................... 229,971 Accrued liabilities....................................... 235,214 Deferred revenue.......................................... 126,134 Capital lease obligations, current portion................ 155,980 ----------- Total current liabilities............................ 4,050,436 Notes payable, net of current portion....................... 4,063,139 Capital lease obligations, net of current portion........... 539,311 ----------- 8,652,886 ----------- Commitments (Note 6) Stockholders' equity: Series A Convertible Preferred Stock: $0.001 per value; 710,029 shares authorized; 618,680 shares issued and outstanding............................................ 612 Series B Convertible Preferred Stock: $0.001 par value; 1,700,000 shares authorized; 1,238,390 shares issued and outstanding........................................ 1,238 Series C Convertible Preferred Stock: $0.001 par value; 2,500,000 shares authorized; no shares issued and outstanding....................... -- Unearned compensation..................................... (271,780) Common Stock: $0.001 par value; 15,000,000 shares authorized; 5,244,274 shares issued and outstanding.... 5,244 Additional paid-in capital................................ 1,404,036 Deficit accumulated during the development stage.......... (6,310,972) ----------- Total stockholders' deficit.......................... (5,171,622) ----------- Total liabilities and stockholders' deficit.......... $ 3,481,264 ===========
The accompanying notes are an integral part of these financial statements. F-33 97 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) STATEMENTS OF OPERATIONS
PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998 ------------------- Net revenues................................................ $ 296,514 Cost of net revenues........................................ (16,501) ----------- Gross profit................................................ 280,013 Operating expenses: Research and development.................................. (3,116,105) Sales and marketing....................................... (1,767,442) General and administrative................................ (1,116,259) ----------- Total operating expenses............................. (5,999,806) ----------- Loss from operations........................................ (5,719,793) Interest income............................................. 36,487 Interest expense............................................ (310,488) Other income (expense), net................................. (316,378) ----------- Loss before provision for income tax........................ (6,310,172) Provision for income tax.................................... (800) ----------- Net loss.................................................... $(6,310,972) ===========
The accompanying notes are an integral part of these financial statements. F-34 98 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) STATEMENTS OF STOCKHOLDERS' DEFICIT PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998
CONVERTIBLE PREFERRED STOCK DEFICIT ------------------------------------- ACCUMULATED SERIES A SERIES B COMMON STOCK ADDITIONAL DURING THE ---------------- ------------------ ------------------ PAID-IN UNEARNED DEVELOPMENT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION STAGE ------- ------ --------- ------ --------- ------ ---------- ------------ ----------- Issuance of Series A Preferred Stock, Series B Preferred Stock and Common Stock in exchange for assets in March 1998............... 691,205 $691 1,238,390 $1,238 3,745,153 $3,745 $ 731,005 $ -- $ -- Exercise of Common Stock Options at $0.01 per share from March to July 1998............... -- -- -- -- 1,509,020 1,509 13,581 -- -- Repurchase of Preferred in April 1998............... (79,585) (79) -- -- -- -- (90,948) -- -- Repurchase of common stock at $0.01 per share from August to December 1998... -- -- -- -- (16,149) (16) (145) -- Unearned compensation....... -- -- -- -- -- -- 455,861 (455,861) -- Amortization of unearned compensation....... -- -- -- -- -- -- -- 184,081 -- Issuance of Series C Preferred Stock warrants in conjunction with the Comdisco loan (Note 5)........... -- -- -- -- -- -- 282,188 -- -- Exercise of Series A warrants at $0.00 per share in October 1998....... 7,060 -- -- -- -- -- -- -- -- Issuance of Common Stock at $2.00 per share in exchange for consulting services in November 1998...... -- -- -- -- 6,250 6 12,494 -- -- Net loss............. -- -- -- -- -- -- -- -- (6,310,972) ------- ---- --------- ------ --------- ------ ---------- --------- ----------- Balance at December 31, 1998........... 618,680 $612 1,238,390 $1,238 5,244,274 $5,244 $1,404,036 $(271,780) $(6,310,972) ======= ==== ========= ====== ========= ====== ========== ========= =========== TOTAL SHAREHOLDERS' DEFICIT ------------- Issuance of Series A Preferred Stock, Series B Preferred Stock and Common Stock in exchange for assets in March 1998............... $ 736,679 Exercise of Common Stock Options at $0.01 per share from March to July 1998............... 15,090 Repurchase of Preferred in April 1998............... (91,027) Repurchase of common stock at $0.01 per share from August to December 1998... (161) Unearned compensation....... -- Amortization of unearned compensation....... 184,081 Issuance of Series C Preferred Stock warrants in conjunction with the Comdisco loan (Note 5)........... 282,188 Exercise of Series A warrants at $0.00 per share in October 1998....... -- Issuance of Common Stock at $2.00 per share in exchange for consulting services in November 1998...... 12,500 Net loss............. (6,310,972) ----------- Balance at December 31, 1998........... $(5,171,622) ===========
The accompanying notes are an integral part of these financial statements. F-35 99 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) STATEMENTS OF CASH FLOWS
PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998 ------------------- Cash flows from operating activities: Net loss.................................................. $(6,310,972) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Accretion on warrants................................ 23,777 Depreciation and amortization........................ 244,839 Amortization of stock-based compensation............. 184,081 Issuance of common stock for consulting services..... 12,500 Changes in current assets and liabilities: Prepaid expenses and other current assets......... 68,948 Accounts payable.................................. 229,971 Accrued liabilities............................... 305,233 Deferred revenue.................................. 126,134 ----------- Net cash used in operating activities........... (5,115,489) ----------- Cash flows from financing activities: Proceeds from issuance of common stock.................... 15,090 Cost of repurchase of common stock........................ (91,188) Principal payments on capital lease obligations........... (67,249) Proceeds from notes payable............................... 7,500,000 Increase in restricted cash............................... (76,423) ----------- Net cash provided by financing activities....... 7,280,230 ----------- Net increase in cash and cash equivalents................... 2,164,741 Cash and cash equivalents at beginning of period............ -- ----------- Cash and cash equivalents at end of period.................. $ 2,164,741 =========== Supplemental cash flow information: Cash paid for income taxes................................ $ 800 =========== Cash paid for interest.................................... $ 81,786 =========== Supplemental non-cash investing and financing activity: Property and equipment acquired under capital leases...... $ 755,802 =========== Issuance of common stock for consulting services.......... $ 12,500 ===========
Assets and liabilities transferred from Capital Technology, Inc. (see Note 2). The accompanying notes are an integral part of these financial statements. F-36 100 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY Foglight Software, Inc. (the "Company"), was incorporated in November 1997 in the state of Delaware to develop, market and sell software tools that are used by network professionals to diagram, document and manage network environments. Products are sold directly to end users in North America, primarily through its sales organization. Since its formation the Company has been in the development stage with its principal activities consisting of recruiting personnel, developing its initial technology and raising capital. In March 1999, the Company changes its name from Resolute Software to Foglight Software Inc. BASIS OF PRESENTATION The financial statements have been prepared assuming the Company will continue as a going concern. The Company has sustained losses from operations since the Company's inception in November 1997, related primarily to the development of its products. In 1999, the Company's management plans to fund working capital requirements through additional financing, which the Company is seeking. The Company's continued existence is dependent on obtaining this financing or achieving profitable operations. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE RECOGNITION Under SOP 97-2, product license revenue is recognized upon shipment, if a signed contract exists, the fee if fixed and determinable, collection of resulting receivable is probable and product returns are reasonably estimable. For contracts with multiple elements (e.g. product licenses maintenance, and other services), in which the Company does not have objective evidence of fair value for each component, the Company must recognize revenue ratably over the period of the contract for which services will be provided. Service revenue consists primarily of maintenance, training and consulting services. Maintenance revenues are recognized ratably over the maintenance period, which is generally one year. Revenue for training and consulting services are recognized as the services are performed. CERTAIN RISKS AND CONCENTRATIONS Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, and accounts receivable. The Company performs limited credit evaluations of its customers' financial condition and, generally, requires no collateral from its customers. For the period from November 10, 1997 (date of inception) to December 31, 1998, two customers accounted for 61.7% and 11.8% respectively of the Company's revenues. F-37 101 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS The Company's products are concentrated in a single segment in the software industry which is characterized by rapid technological advances, changes in customer requirements and evolving industry standards. The success of the Company depends on management's ability to anticipate and respond quickly and adequately to technological developments in the industry, changes in customer requirements or changes in industry standards. Any significant delays in the development or introduction of products or services could have a material adverse effect on the Company's business and operating results. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, accounts payable and other accrued liabilities approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company for leases and notes payable with similar terms, the carrying value of its lease and notes payable obligations approximates fair value. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company's cash and cash equivalents are maintained in accounts with one U.S. financial institution. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from three to seven years. RESEARCH AND DEVELOPMENT Research and development costs are expensed as incurred. Software development costs are capitalized beginning when a product's technological feasibility has been established and ending when a product is available for general release to customers. The Company has not capitalized any software development costs to date as such costs have not been material. INCOME TAXES Income taxes are recorded under the liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. COMPREHENSIVE INCOME The Company has adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement requires the disclosure of comprehensive income and its components in a full set of general purpose financial statements or on the statement of operations. Comprehensive income is defined as net income plus revenues, expenses, gains and losses that, under generally accepted accounting principles, are excluded from net income. For the period ended December 31, 1998, there are no material differences between comprehensive income and net income. F-38 102 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB No. 25") and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). The new standard requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives should be reported in the statement of operations or as a deferred item, depending on the use of derivatives and whether they qualify for hedge accounting. The key criterion for hedge accounting is that the derivative must be highly effective in achieving offsetting changes in fair value of cash flows of the hedged items during the term of the hedge. SFAS No. 133 will be effective for fiscal years beginning after June 15, 2000. Currently, the Company does not hold derivative instruments or engage in hedging activities. 2. INITIAL FUNDING FROM CAPITAL TECHNOLOGIES INTEGRATION, INC. On March 16, 1998 the Company received certain assets and liabilities from Capital Technologies Integration, Inc. in exchange for an issuance of stock to Capital Technologies Integration, Inc. The exchange was recorded at historical cost since there was no change in ownership. The historical cost of the net assets received are as follows: Accounts receivable......................................... $259,721 Other current assets........................................ 33,203 -------- 292,924 Property and equipment...................................... 505,161 -------- Total assets......................................... 798,085 Accrued liabilities......................................... 61,406 -------- Net assets........................................... $736,679 ========
In addition, Capital Technologies Integration, Inc. loaned $1,500,000 to the Company (see Note 5). 3. BALANCE SHEET COMPONENTS
DECEMBER 31, 1998 ------------ Property and equipment, net: Computer equipment........................................ $1,080,343 Furniture and fixtures.................................... 180,620 ---------- 1,260,963 Less: Accumulated depreciation and amortization........... (244,839) ---------- $1,016,124 ==========
F-39 103 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS Property and equipment includes $755,802 of computer equipment and internal-use software under capital leases at December 31, 1998. Accumulated depreciation and amortization of assets under capital leases totaled $94,660 at December 31, 1998.
DECEMBER 31, 1998 -------------- Accrued liabilities: Payroll and related expenses.............................. $122,379 Accrued interest expense.................................. 73,500 Other..................................................... 39,335 -------- $235,214 ========
4. INCOME TAXES The provision for income taxes consists of the following:
PERIOD FROM NOVEMBER 10, 1997 (DATE OF INCEPTION) TO DECEMBER 31, 1998 ------------------- Current: State and local........................................... $800 ---- $800 ====
Deferred tax assets and liabilities consist of the following:
DECEMBER 31, 1998 ------------ Deferred tax assets: Net operating loss carryforwards.......................... $ 2,118,855 Accruals and reserves..................................... 82,855 Capitalized start up costs................................ 199,905 Depreciation and amortization............................. 2,601 Deferred revenue.......................................... 33,859 ----------- 2,438,075 ----------- Net deferred tax assets..................................... 2,438,075 Valuation allowance......................................... (2,438,075) ----------- $ -- ===========
Management believes that, based on cumulative losses, it is more likely than not that the deferred tax assets will not be utilized, such that a full valuation allowance has been recorded. At December 31, 1998, the Company had approximately $5,319,000 of federal and state net operating loss carryforwards available to offset future taxable income which expire in varying amounts beginning in 2018 and 2006, respectively. The Company's net operating loss carryforwards may be subject to certain limitations on annual utilization attributable to equity transactions that result in changes in ownership, as defined by the Tax Reform Act of 1986. F-40 104 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS 5. BORROWINGS EQUIPMENT LEASE LINE At December 31, 1998, the Company had $695,291 outstanding and due under equipment lease financing lines with the leasing companies Phoenix Leasing and Comdisco Inc. The equipment lease lines provide for borrowings of up to $1,250,552 which are collateralized by the leased equipment. The financing lines expire in September 2001 and December 2002, respectively, and charges interest at rates of 18.13% and 18.59% per annum, respectively. In conjunction with the Comdisco lease line, the Company issued warrants to purchase 1,750 shares of Series C preferred stock at a price of $2.00 per share, exercisable until September 2008 or five years after an initial public offering by the Company, whichever is earlier. The leases contain various covenants which the Company has not fully complied with but which have been waived by the leasing companies. NOTES PAYABLE Notes payable consists of the following:
DECEMBER 31, 1998 ------------ 5.88% Convertible notes: matures July 24, 2008..................................... $ 3,000,000 10.50% Captech note: matures March 16, 2008.................................... 1,624,687 11.50% Comdisco note; matures September 30, 2001................................ 2,741,589 ----------- 7,366,276 Less: Current portion....................................... (3,303,137) ----------- $ 4,063,139 ===========
CONVERTIBLE NOTE The entire principal and accrued interest on the convertible notes are convertible into 1,500,000 shares of Series C preferred stock of the Company at the option of the holder in a ten day period following the closing of the next sale of the Company's equity. The notes were converted into Series C preferred stock in May 1999. There is interest in arrears on the notes of $73,500. CAPTECH NOTE Under an agreement signed with Capital Technologies Integration, Inc. on March 16, 1998, the $1,500,000 Promissory Note shall terminate, and the obligation of the Company to make payment on the unpaid principal and accrued interest due shall be forgiven in full, on the date of the earlier to occur of (i) the consummation of the Company's initial sale of its Common Stock in a bona fide commitment underwriting pursuant to a registration statement on Form S-1 (or successor form) under the Securities Act (other than a registration statement relating either to the sale of securities to the Company's employees pursuant to a stock option, stock purchase or similar plan or a SEC Rule 145 transaction) provided that such public offering establishes a valuation for the Company of at least $75,000,000, or F-41 105 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS (ii) upon a change of control, provided such a change of control establishes a valuation for the Company of at least $75,000,000. For the purposes of this note, a "change of control" means to sell, convey, or otherwise dispose of or encumber all or substantially all of its property, or business or consolidate with any other corporation or effect any transactions or series of related transactions which dispose of more than 50% of the voting power of the Company. There is interest in arrears of $124,687. COMDISCO NOTE In conjunction with the Comdisco note the Company issued warrants to purchase 187,500 shares of Series C preferred stock at a price of $2.00 per share, exercisable until September 2008 or five years after an initial public offering by the Company, whichever is earlier. The warrants issued have a fair value of 1.55 per warrant, at the time of issuance, using the Black-Scholes pricing model. The aggregate fair value of these warrants of approximately $282,188 has been, recorded as a discount on the debt and will be amortized to interest expense over the life of the note which is three years. The amortization for the period from November 10, 1997 (date of inception) to December 31, 1998 is $23,777. The Loan is collateralized by substantially all the assets of the Company not collateralized by the lease lines. The notes are subject to certain covenants that the Company is not currently in compliance with, however, the lender has currently waived its covenants. Principal payments under notes payable are as follows: Year Ending December 31, 1999...................................................... $ 397,200 2000...................................................... 1,286,704 2001...................................................... 1,316,096 2002...................................................... -- 2003...................................................... -- Thereafter................................................ 4,500,000 ---------- $7,500,000 ==========
6. COMMITMENTS PURCHASE COMMITMENTS At December 31, 1998, the Company had approximately $72,000 in noncancelable purchase commitments with suppliers. The Company expects to sell all products which it has committed to purchase from suppliers. LEASES The Company leases office space and equipment under noncancelable operating and capital leases with various expiration dates through 2002. Rent expense for the period from November 10, 1997 (date of inception) to December 31, 1998 was $179,869. The Company recognizes rent expense on a straight-line basis over the lease period, and has accrued for rent expense incurred but not paid. F-42 106 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS Future minimum lease payments under noncancelable operating and capital leases, including lease commitments entered into subsequent to December 31, 1998 are as follows:
CAPITAL OPERATING LEASES LEASES -------- ---------- Year Ending December 31, 1999...................................................... $253,888 $ 306,510 2000...................................................... 284,430 310,116 2001...................................................... 297,745 313,722 2002...................................................... 52,013 158,664 -------- ---------- Total minimum lease payments................................ 888,076 $1,089,012 ========== Less: Amount representing interest.......................... 192,785 -------- Present value of capital lease obligations.................. 695,291 Less: Current portion....................................... 155,980 -------- Long-term portion of capital lease obligations......... $539,311 ========
7. CONVERTIBLE PREFERRED STOCK Convertible Preferred Stock at December 31, 1998 consists of the following:
SHARES ------------------------- PROCEEDS NET OF SERIES AUTHORIZED OUTSTANDING ISSUANCE COSTS ------ ---------- ----------- --------------- A............................................. 710,029 618,680 $ 612 B............................................. 1,700,000 1,238,390 1,238 C............................................. 2,500,000 -- -- --------- --------- ------ 4,910,029 1,857,070 $1,850 ========= ========= ======
The holders of Convertible Preferred Stock have various rights and preferences as follows: VOTING Each holder of shares of Preferred Stock shall be entitled to the number of votes equal to an equivalent number of shares of Common Stock into which it is convertible and votes together as one class with the Common Stock. As long as at least 47,058 shares of Convertible Preferred Stock remain outstanding, the Company must obtain approval from a majority of the holders of Convertible Preferred Stock in order to alter the Articles of Incorporation as related to Convertible Preferred Stock, increase the authorized number of shares of Convertible Preferred Stock, authorize or issue any other equity security senior to or on a parity with the Series A, B or C preferred stock, repurchase any shares of Common Stock other than shares subject to the right of repurchase by the Company, sell all or substantially all the Company's assets in a single transaction or series of related transactions, authorize a dividend for any class or series other than Convertible Preferred Stock or effect a merger, consolidation or sale of assets where the existing shareholders retain less than 50% of the voting stock of the surviving entity. DIVIDENDS Holders of Series A, B and C Convertible Preferred Stock are entitled to receive noncumulative dividends at the per annum rate of $0.083215, $0.19125 and $0.16 per share, respectively, when and if F-43 107 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS declared by the Board of Directors. The holders of Series A, B and C Convertible Preferred Stock will also be entitled to participate in dividends on Common Stock, when and if declared by the Board of Directors, based on the number of shares of Common Stock held on an as-if converted basis. No dividends on Convertible Preferred Stock or Common Stock have been declared by the Board from inception through December 31, 1998. LIQUIDATION In the event of any liquidation, dissolution or winding up of the Company, including a merger, or acquisition that results in the transfer of 50% or more of the outstanding voting power of the Company or a sale of substantially all of the assets of the Company, the holders of Series A, B and C Convertible Preferred Stock are entitled to receive an amount per share equal to (i) the applicable Original Issue Price for such series of Convertible Preferred Stock, plus (ii) all declared but unpaid dividends thereon, plus (iii) for the Series B Convertible Preferred Stock only, an additional amount per share equal to $0.8075 (as adjusted for any stock splits, stock dividends, recapitalizations or the like) and (iv) for the Series C Convertible Preferred Stock only, an additional amount per share equal to $0.6667 (as adjusted for any stock splits, stock dividends, recapitalizations or the like). The remaining assets, if any, shall be distributed among the holders of the then outstanding Common Stock pro rata, according to the number of shares of Common Stock held by each holder thereof. Should the Company's legally available assets be insufficient to satisfy the liquidation preferences, the funds will be distributed ratably among holders of the Series A, B and C Convertible Preferred Stock preferences, so that each holder receives the same percentage of the applicable preferential amount. CONVERSION Each share of Series A, B and C Convertible Preferred Stock is convertible, at the option of the holder, according to a conversion ratio, subject to adjustment for dilution. Each share of Series A, B and C Convertible Preferred Stock automatically converts into the number of shares of Common Stock into which such shares are convertible at the then effective conversion ratio upon: (1) immediately prior to the closing of a public offering of Common Stock with the aggregate public offering price of at least $8.00 per share and with gross proceeds of at least $10,000,000 and (2) upon the Company's receipt of the written consent of the holders of not less than a majority of outstanding Convertible Preferred Stock. WARRANTS FOR CONVERTIBLE PREFERRED STOCK There is a further commitment to issue 11,763 shares of Series A Convertible Preferred Stock for no consideration per share upon the exercise of a warrant to purchase stock of Capital Technologies Integration, Inc. which shares are issuable as dividend on the Capital Technologies Integration, Inc. stock underlying the warrant. 8. COMMON STOCK The Company's Articles of Incorporation, as amended, authorize the Company to issue 15,000,000 shares of $0.01 par value Common Stock. A portion of the shares sold are subject to a right of repurchase by the Company subject to vesting, which is generally over a four year period from the earlier of grant date or employee hire date, as applicable, until vesting is complete. At December 31, 1998, there were 1,378,623 shares subject to repurchase. F-44 108 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS 9. STOCK OPTION PLANS In March 13, 1998, the Company adopted the 1998 Stock Option Plan (the "Plan"). The Plan provides for the granting of stock options to employees and consultants of the Company. Options granted under the Plan may be either incentive stock options or nonqualified stock options. Incentive stock options ("ISO") may be granted only to Company employees (including officers and directors who are also employees). Nonqualified stock options ("NSO") may be granted to Company employees and consultants. The Company has reserved 1,735,000 shares of Common Stock for issuance under the Plan. Options under the Plan may be granted for periods of up to ten years and at prices no less than 85% of the estimated fair value of the shares on the date of grant as determined by the Board of Directors, provided, however, that (i) the exercise price of an ISO and NSO shall not be less than 100% and 85% of the estimated fair value of the shares on the date of grant, respectively, and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the estimated fair value of the shares on the date of grant, respectively. Options are exercisable immediately subject to repurchase options held by the Company which lapse over a maximum period of four years at such times and under such conditions as determined by the Board of Directors. To date, options granted generally vest over four years.
SHARES NUMBER WEIGHTED AVAILABLE OF OPTIONS AVERAGE FOR GRANT OUTSTANDING PRICE TOTAL ---------- ----------- -------- -------- Initial shares reserved........................ 1,735,000 -- $ -- $ -- Options granted.............................. (1,914,743) 1,914,743 0.02 43,182 Shares issued from option pool............... (6,250) -- -- -- Options exercised............................ -- (1,509,020) 0.01 (15,090) Options canceled............................. 201,299 (201,299) 0.02 (4,008) ---------- ---------- -------- Balances at December 31, 1998.................. 15,306 204,424 $0.12 $ 24,084 ========== ========== ========
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation ("SFAS No. 123")." The Company however, continues to apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for the Plan. Accordingly, no compensation cost has been recognized for the Plan. Determination of compensation cost for the Plan based on the fair value at the grant date for awards in 1998 consistent with the provisions of SFAS No. 123, would not result in a significant difference from the reported net loss for the period from November 10, 1997 (date of inception) to December 31, 1998. The fair value of each option grant is estimated on the date of grant using the minimum value method assuming an expected life of four years and a risk-free interest rate of 4.62% to 5.89%. The weighted average expected life was calculated based on the vesting period and the expected exercise behavior of options granted. The risk-free interest rate was calculated in accordance with the grant date and expected life calculated of options granted. In connection with certain stock option grants during the year ended December 31, 1998, the Company recorded stock-based compensation totaling $455,861, which is being amortized in accordance with FASB Interpretation No. 28 over the vesting periods of the related options, which is generally four years. Stock-based compensation amortization recognized during the year ended December 31, 1998 totaled $184,081. F-45 109 FOGLIGHT SOFTWARE, INC. (A COMPANY IN THE DEVELOPMENT STAGE) NOTES TO FINANCIAL STATEMENTS The weighted average fair value of the options granted was $0.02 in the period from November 10, 1997 (date of inception) to December 31, 1998.
DECEMBER 31, 1998 ------------------------------------------------------------- OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------ ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE EXERCISE PRICE OUTSTANDING LIFE PRICE OUTSTANDING PRICE -------------- ----------- ----------- -------- ----------- -------- $0.01 -- 0.20.................................... 204,424 9.6 $0.12 204,424 $0.12
10. SUBSEQUENT EVENTS On January 13, 1999, the Company increased the shares reserved under the 1998 plan to a total of 2,000,000 shares. On April 28, 1999 the Company increased the shares reserved under the 1998 plan to a total of 2,500,000 shares. In February 1999, the Company instituted a change of control agreement whereby in the event of a change of control unvested employee stock options vest, and repurchase rights lapse, by 25%. If after a change of control the individual is involuntarily terminated the stock options vest, and repurchase rights lapse, by an additional 25%. On March 31, 1999, the Board authorized that shares of Series C Convertible Preferred Stock increase to a total of 3,189,250. On April 28, 1999, the Board authorized that the shares of Series C Convertible Preferred Stock and Common Stock increase to a total of 4,789,250 and 16,600,000, respectively. In April 1999, the Company issued 1,000,000 shares of Series C Convertible Preferred Stock, along with warrants for 499,995 shares of Series C Convertible Preferred Stock, for $2,000,000. In July 1999 and October 1999, the Company issued an aggregate of $1,000,000 of promissory notes convertible into shares of Series C Convertible Preferred Stock along with warrants for 249,994 shares of Series C Convertible Preferred Stock. The warrants terminate upon the earliest of September 30, 2004 or the sale of the business and have an exercise price of $2.00. F-46 110 FOGLIGHT SOFTWARE, INC. UNAUDITED BALANCE SHEET
SEPTEMBER 30, 1999 ------------- ASSETS Current assets: Cash and cash equivalents................................. $ 604,429 Restricted cash........................................... 50,207 Accounts receivable, net.................................. 1,004,988 Prepaid expenses and other current assets................. 222,217 ------------ Total current assets................................. 1,881,841 Property and equipment, net................................. 945,265 Other assets................................................ 34,344 ------------ Total assets......................................... $ 2,861,450 ============ LIABILITIES AND CAPITAL DEFICIENCY Current liabilities: Notes payable, current portion............................ $ 1,760,310 Accounts payable.......................................... 242,854 Accrued liabilities....................................... 630,441 Deferred revenue.......................................... 344,612 Capital lease obligations, current portion................ 353,020 ------------ Total current liabilities............................ 3,331,237 Notes payable, net of current portion..................... 3,094,384 Capital lease obligations, net of current portion......... 511,948 Commitments and contingencies (Note 6) Stockholders' equity (deficiency): Convertible Preferred Stock: $0.001 par value, 4,910,029 shares authorized; 4,357,070 shares issued and outstanding............................................ 4,350 Unearned compensation..................................... (1,293,511) Common stock: $0.001 par value; 15,000,000 shares authorized; 4,997,123 shares issued and outstanding................ 4,997 Additional paid-in-capital................................ 8,787,451 Accumulated deficit....................................... (11,579,406) ------------ Total stockholders' deficiency....................... (4,076,119) ------------ Total liabilities and stockholders' deficit................. $ 2,861,450 ============
The accompanying notes are an integral part of these financial statements. F-47 111 FOGLIGHT SOFTWARE, INC. UNAUDITED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, -------------------------- 1998 1999 ----------- ----------- Net revenues................................................ $ 237,037 $ 2,704,063 Cost of net revenues........................................ 13,425 105,752 ----------- ----------- Gross profit................................................ 223,612 2,598,311 Operating expenses: Research and development.................................. 1,941,436 2,897,829 Sales and marketing....................................... 1,254,168 2,839,268 General and administrative................................ 541,832 903,136 ----------- ----------- Total operating expenses............................. 3,737,436 6,640,233 ----------- ----------- Loss from operations........................................ (3,513,824) (4,041,922) Other expense, net.......................................... (446,575) (566,012) ----------- ----------- Loss before provision for income taxes...................... (3,960,399) (4,607,934) Provision for income taxes.................................. 800 500 ----------- ----------- Net loss.................................................... (3,961,199) (4,608,434) ----------- ----------- Value of beneficial conversion feature...................... -- (660,000) ----------- ----------- Net loss applicable to common shareholders.................. $(3,961,199) $(5,268,434) =========== ===========
The accompanying notes are an integral part of these financial statements. F-48 112 FOGLIGHT SOFTWARE, INC. STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, -------------------------- 1998 1999 ----------- ----------- Cash flows from operating activities: Net loss.................................................. $(3,961,199) $(4,608,434) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of debt discount........................ -- 106,669 Depreciation and amortization........................ 138,484 357,198 Amortization of stock-based compensation............. 92,986 280,295 Changes in current assets and liabilities: Accounts receivable............................... 89,106 (1,004,988) Prepaid expenses and other current assets......... (161,971) (32,585) Other assets...................................... (26,444) -- Accounts payable.................................. 250,066 12,883 Accrued liabilities............................... 299,668 395,227 Deferred revenue.................................. 34,334 218,478 ----------- ----------- Net cash used in operating activities........... (3,244,970) (4,275,257) ----------- ----------- Cash flows from investing activities: Purchases of property and equipment....................... (26,159) (53,290) ----------- ----------- Net cash used in investing activities (26,159) (53,290) Cash flows from financing activities: Proceeds from issuance of common stock.................... 15,090 6,019 Proceeds from issuance of preferred stock................. -- 1,981,897 Cost of repurchase of common stock........................ (161) (4,887) Cost of repurchase of preferred stock..................... (91,027) -- Principal payments on capital lease obligations and notes payable................................................ -- (274,176) Proceeds from notes payable............................... 4,482,732 1,033,166 Decrease (increase) in restricted cash.................... (75,730) 26,216 ----------- ----------- Net cash provided by financing activities....... 4,330,904 2,768,235 ----------- ----------- Net increase (decrease) in cash and cash equivalents........ 1,059,775 (1,560,312) Cash and cash equivalents at beginning of period............ -- 2,164,741 ----------- ----------- Cash and cash equivalents at end of period.................. $ 1,059,775 $ 604,429 =========== =========== Supplemental cash flow information: Cash paid for income taxes................................ $ 800 $ 800 =========== =========== Cash paid for interest.................................... $ 81,786 $ 316,634 =========== =========== Supplemental non-cash investing and financing activity: Property and equipment acquired under capital leases...... $ 471,603 $ 233,049 =========== =========== Conversion of notes payable to preferred stock............ $ 3,117,600 =========== Recognition of beneficial conversion feature associated with preferred stock issuance.......................... $ 660,000 ===========
The accompanying notes are an integral part of these financial statements. F-49 113 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited interim financial statements at September 30, 1999 and, for the nine months ended September 30, 1998 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 periods presented and do not include all of the information and footnotes required by generally accepted accounting principles for annual financial statements. These financial statements should be read in conjunction with the Company's annual audited financial statements for the period from November 10, 1997 (date of inception) to December 31, 1998. The Company emerged from the development stage during the nine months ended September 30, 1999. The Company's Independent accountants report for the period from November 10, 1997 (date of inception) to December 31, 1998 contained an explanatory paragraph regarding the Company's continuation as a going concern. On January 7, 2000, the Company was purchased by Quest Software, Inc. (Quest) in exchange for 1,187,603 shares of Quest's common stock valued at $104,167,628, estimated cash payments of $424,182, the assumption of unvested stock option valued at $2,088,000 and the assumption of the net liabilities at the date of purchase estimated to be $5,106,000. 2. 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. 3. NOTES PAYABLE In April 1999, in connection with the issuance of 1,000,000 shares of Series C Convertible Preferred stock (Series C) (Note 4), $3,000,000 in previously outstanding convertible notes were converted into 1,500,000 shares of Series C Stock. In July 1999, the Company received $500,000 from a third party which is payable, plus interest at 5.32%, in June 2000. In connection with this note, the Company issued warrants to purchase 124,997 shares of Series C Stock at a price of $2.00 per share. The Company has determined the relative fair value of the note and warrants to be $325,000 and $175,000, respectively. The fair value of the warrants has been recorded as a discount on the debt and will be amortized over the one-year term of the note. During August and September of 1999, the Company received approximately $423,000 from the same third party noted above as an advance on an additional financing arrangement completed in October 1999. The additional financing provided for a loan of $500,000 under similar terms noted above, and included the issuance of 124,997 warrants to purchase Series C Stock at a price of $2.00 per share. The warrants were not issued until subsequent to September 30, 1999. However, shareholders received the right to the warrants when the funds were advanced to the Company in August and September of 1999. Approximately $148,000 has been ascribed to these rights as of September 30, 1999. During the nine-months ended September 30, 1999, the Company made principal and interest payments totalling approximately $390,000 to Comdisco, Inc. under the original terms of the note. 4. STOCKHOLDER'S EQUITY In April 1999, the Company issued 1,500,000 of Series C Stock at $2.00 per share upon the conversion of $3,000,000 in previously outstanding convertible notes. F-50 114 FOGLIGHT SOFTWARE, INC. NOTES TO FINANCIAL STATEMENTS In April 1999, the Company issued 1,000,000 shares of Series C Stock for $2,000,000. In connection with this issuance, the Company issued warrants to purchase 499,995 shares of Series C Stock for $2.00 per share. The Company ascribed $660,000 to these warrants, based on the relative fair value at the date of issuance and recorded the $660,000 as the value of the beneficial conversion feature because of the Series C Stock being immediately convertible. The beneficial conversion feature has been shown as an increase to the net loss available to common shareholders in the accompanying financial statements. 5. STOCK OPTION PLANS The following table summarizes information about stock options outstanding as of September 30, 1999:
NUMBER OF OPTIONS EXERCISABLE AS OF NUMBER OF SEPTEMBER 30, SHARES PRICE PER SHARE 1999 --------- --------------- ------------- Balance at January 1, 1999....................... 204,424 $0.01-$0.20 Granted........................................ 744,122 0.20- 0.20 Exercised...................................... (184,533) 0.01- 0.20 Canceled....................................... (131,565) 0.01- 0.20 --------- Balance at September 30, 1999.................... 632,448 $0.01-$0.20 632,448 =========
In connection with certain stock option grants during the nine months ended September 30, 1999, the Company recorded stock based compensation totalling $1.3 million, which is being amortized over the vesting periods of the related options. Stock based compensation recognized during the nine months ended September 30, 1999 totaled approximately $280,000. 6. INITIAL FUNDING FROM CAPITAL TECHNOLOGIES INTEGRATION, INC. On March 16, 1998 the Company received certain assets and liabilities from Capital Technologies Integration, Inc. in exchange for an issuance of stock to Capital Technologies Integration, Inc. The exchange was recorded at historical cost since there was no change in ownership. The historical cost of the net assets received are as follows: Accounts receivable......................................... $259,721 Other current assets........................................ 33,203 -------- 292,924 Property and equipment...................................... 505,161 -------- Total assets......................................... 798,085 Accrued liabilities......................................... 61,406 -------- Net assets........................................... $736,679 ========
7. COMMITMENTS AND CONTINGENCIES The Company is involved in various claims and legal actions arising in the ordinary course of business. The litigation process is inherently uncertain, and it is possible that the resolution of such claims and legal actions may adversely affect the Company. However, it is the opinion of management that the ultimate disposition of these matters will not materially affect the Company's results of operations or financial position. F-51 115 QUEST SOFTWARE, INC. UNAUDITED PRO FORMA INFORMATION On December 17, 1999 the Company, through a wholly owned subsidiary, acquired all of the outstanding common stock and stock options of MBR Technologies, Inc. (MBR) in exchange for 93,471 shares of Quest Common Stock valued at $9,323,732, a cash payment of $1,313,583 and the assumption of net liabilities of $340,000. The acquisition was accounted for as a purchase and the results of MBR's operations were included in the Company's statement of operations from the date of acquisition. On January 7, 2000 the Company, through a wholly owned subsidiary, acquired all of the outstanding common stock of Foglight Software, Inc. (Foglight) in exchange for 1,187,603 shares of Quest Common Stock valued at $104,167,628, estimated cash payments of $424,182, the assumption of unvested Foglight stock options valued at $2,088,000 and the assumption of net liabilities estimated to be $5,106,000. The acquisition will be accounted for as a purchase. The following unaudited pro forma balance sheet as of December 31, 1999 assumes that the acquisition of Foglight had occurred on December 31, 1999. The unaudited statement of operations includes the unaudited statement of operations of MBR for the period from January 1, 1999 to December 17, 1999 and the unaudited statement of operations of Foglight for the year ended December 31, 1999 and assumes that the acquisition of MBR and Foglight had occurred on January 1, 1999. The pro forma combined results of operations is presented for information purposes only, is based on historical information, and does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results of the combined enterprise. F-52 116 QUEST SOFTWARE, INC. UNAUDITED PRO FORMA BALANCE SHEET (IN THOUSANDS)
QUEST FOGLIGHT COMBINED SOFTWARE SOFTWARE TOTAL PRO FORMA DECEMBER 31, DECEMBER 31, DECEMBER 31, PRO FORMA DECEMBER 31, 1999 1999 1999 ADJUSTMENTS 1999 ------------ ------------ ------------ ----------- ------------ ASSETS Current assets: Cash and cash equivalents.................. $ 39,643 $ 32 $ 39,675 $ (424)(1) $ 39,251 Restricted cash............................ -- 51 51 -- 51 Short-term marketable securities........... 11,000 -- 11,000 -- 11,000 Accounts receivable, net................... 18,771 107 18,878 -- 18,878 Prepaid expenses and other current assets................................... 5,333 196 5,529 (1,308)(3) 4,221 -------- -------- -------- -------- -------- Total current assets................... 74,747 386 75,133 (1,732) 73,401 Property and equipment, net................ 7,179 866 8,045 -- 8,045 Long-term marketable securities............ 4,484 -- 4,484 -- 4,484 Purchased technology and software licenses, net...................................... 441 -- 441 4,700(1) 5,141 Goodwill and other intangibles............. 11,452 -- 11,452 104,236(1) 115,688 Deferred income taxes...................... 415 -- 415 2,850(1) 3,265 Other assets............................... 431 34 465 -- 465 -------- -------- -------- -------- -------- Total assets........................... $ 99,149 $ 1,286 $100,435 $110,054 $210,489 ======== ======== ======== ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Notes payable, current portion............. $ -- $ 4,747 $ 4,747 $ (2,808)(3) $ 1,939 Accounts payable........................... 3,436 80 3,516 -- 3,516 Accrued compensation....................... 4,966 -- 4,966 -- 4,966 Other accrued expenses..................... 7,062 780 7,842 -- 7,842 Income taxes payable....................... 2,030 -- 2,030 -- 2,030 Deferred support revenue................... 13,932 226 14,158 -- 14,158 Deferred license revenue................... 4,651 -- 4,651 -- 4,651 Capital lease obligations, current portion.................................. -- 361 361 -- 361 -------- -------- -------- -------- -------- Total current liabilities.............. 36,077 6,194 42,271 (2,808) 39,463 -------- -------- -------- -------- -------- Notes payable, net of current portion...... -- 1,279 1,279 -- 1,279 Long-term liabilities...................... 403 419 822 -- 822 Shareholders' equity: Preferred stock............................ -- 5 5 (5)(2) -- Common stock and additional paid in capital.................................. 94,010 9,164 103,174 97,092(1)(2)(3) 200,266 Retained earnings (deficit)................ 1,864 (14,381) (12,517) 14,381(1) 1,864 Accumulated other comprehensive income (loss)................................... (26) -- (26) -- (26) Unearned compensation costs................ -- (1,394) (1,394) 1,394(1) -- Notes receivable from sale of common stock.................................... (3,115) -- (3,115) -- (3,115) Capital distribution in excess of basis in common stock............................. (30,064) -- (30,064) -- (30,064) -------- -------- -------- -------- -------- Total shareholders' equity (deficit)... 62,669 (6,606) 56,063 112,862 168,925 -------- -------- -------- -------- -------- Total liabilities and shareholders' equity.............................. $ 99,149 $ 1,286 $100,435 $110,054 $210,489 ======== ======== ======== ======== ========
F-53 117 QUEST SOFTWARE, INC. UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999 (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
MBR TECHNOLOGIES FOR THE QUEST PERIOD FOGLIGHT COMBINED SOFTWARE JANUARY 1, SOFTWARE TOTAL PRO FORMA YEAR ENDED 1999 TO YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 17, DECEMBER 31, DECEMBER 31, PRO FORMA DECEMBER 31, 1999 1999 1999 1999 ADJUSTMENTS 1999 ------------ ------------ ------------ ------------ ----------- ------------ Revenues: Licenses............... $54,269 $ 380 $ 2,449 $57,098 $ -- $ 57,098 Services............... 16,599 190 377 17,166 -- 17,166 ------- ----- ------- ------- -------- -------- Total revenues.... 70,868 570 2,826 74,264 -- 74,264 Cost of Revenues: Licenses............... 2,998 346 133 3,477 1,567(4) 5,044 Services............... 4,195 195 187 4,577 -- 4,577 ------- ----- ------- ------- -------- -------- Total cost of revenues....... 7,193 541 320 8,054 1,567 9,621 ------- ----- ------- ------- -------- -------- Gross profit............. 63,675 29 2,506 66,210 (1,567) 64,643 Operating expenses: Sales and marketing.... 32,078 149 3,734 35,961 -- 35,961 Research and development......... 15,980 209 3,680 19,869 -- 19,869 General and administrative...... 9,906 524 1,261 11,691 -- 11,691 Other compensation costs and goodwill amortization........ 1,243 -- 403 1,646 23,139(4) 24,785 ------- ----- ------- ------- -------- -------- Total operating expenses....... 59,207 882 9,078 69,167 23,139 92,306 ------- ----- ------- ------- -------- -------- Income (loss) from operations............. 4,468 (853) (6,572) (2,957) (24,706) (27,663) Other income (expense), net.................... 1,202 (31) (837) 334 (87)(5) 247 ------- ----- ------- ------- -------- -------- Income (loss) before income tax provision... 5,670 (884) (7,409) (2,623) (24,793) (27,416) Income tax provision (benefit).............. 2,273 1 1 2,275 (3,327)(6) (1,052) ------- ----- ------- ------- -------- -------- Net income (loss)........ 3,397 (885) (7,410) (4,898) (21,466) (26,364) Preferred stock dividends and value of beneficial conversion feature..... 590 -- 660 1,250 -- 1,250 ------- ----- ------- ------- -------- -------- Net income (loss) applicable to common shareholders........... $ 2,807 $(885) $(8,070) $(6,148) $(21,466) $(27,614) ======= ===== ======= ======= ======== ======== Basic and diluted net income (loss) per share.................. $ 0.07 $ (0.71) ======= ======== Weighted average shares: Basic.................. 37,677 1,281(7) 38,958 Diluted................ 41,800 (2,847)(7) 38,958
F-54 118 NOTES TO PRO FORMA FINANCIAL STATEMENTS (1) To reflect the elimination of Foglight's equity accounts and the allocation of the purchase price of $111,785,810 as follows: Goodwill................................................... $103,785,810 Deferred tax asset, net.................................... 2,850,000 Purchased technology....................................... 4,700,000 Workforce.................................................. 500,000
The allocation may change once the audit of Foglight's closing balance sheet is completed and other valuation information is received. (2) To reflect the conversion of all outstanding shares of Preferred Stock to Common Stock prior to the close of the Foglight acquisition. (3) To eliminate the note payable to Quest of $1,308,000 and the forgiveness of the Cap Tech note payable of $1,500,000. (4) To reflect the amortization of goodwill over five years on a straight-line basis, and workforce over three years on a straight-line basis ($20,913,829) and the amortization of purchased technology over three years on a straight-line basis ($1,566,667)for the Foglight transaction. Also includes the amortization of goodwill related to the MBR purchase for the period January 1, 1999 to December 17, 1999 of $2,225,000. (5) To reflect the decrease in interest income due to the use of cash in the acquisitions at a 5% annual yield. (6) To reflect the establishment of a deferred tax asset anticipated from the utilization of the operating loss of Foglight for the year and to adjust the income tax provision to reflect the estimated income tax benefit on a combined basis. (7) To adjust for the 1,187,719 and 93,471 shares of Quest common stock issued in the acquisitions of Foglight and MBR, respectively, in the basic net income per share calculation and reduce the number of weighted average shares for the diluted net loss per share calculation. F-55 119 Inside Back Cover [QUEST SOFTWARE LOGO] [Background consists of the names of certain Quest customers] Quest Software products have been sold to thousands of corporations, governmental agencies and other organizations worldwide. The companies listed here are a representative sampling of customers who have purchased at least $100,000 of software licenses since January 1996. 120 [QUEST SOFTWARE LOGO] 121 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable in connection with the sale and distribution of the securities being registered. All amounts are estimates except the SEC registration fee and the NASD filing fees. SEC Registration Fee........................................ $ 59,136 NASD Filing Fee............................................. 25,760 Nasdaq National Market Listing Fee.......................... 0 Printing and Engraving Expenses............................. 100,000 Legal Fees and Expenses..................................... 100,000 Accounting Fees and Expenses................................ 225,000 Blue Sky Fees and Expenses.................................. 2,500 Transfer Agent Fees......................................... 10,000 Directors' & Officers' Liability Insurance.................. 0 Miscellaneous............................................... 27,604 -------- Total............................................. $550,000 ========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Registrant's Amended and Restated Articles of Incorporation limit the personal liability of its directors for monetary damages to the fullest extent permitted by the California General Corporation Law (the "California Law"). Under the California Law, a director's liability to a company or its shareholders may not be limited (1) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (2) for acts or omissions that a director believes to be contrary to the best interest of the Registrant or its shareholders or that involve the absence of good faith on the part of the director, (3) for any transaction from which a director derived an improper personal benefit, (4) for acts or omissions that show a reckless disregard for the director's duty to the Registrant or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of a serious injury to the Registrant or its shareholders, (5) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Registrant or its shareholders, (6) under Section 310 of the California Law concerning contacts or transactions between the Registrant and a director, or (7) under Section 316 of the California Law concerning directors' liability for improper dividends, loans and guarantees. The limitation of liability does not affect the availability of injunctions and other equitable remedies available to the Registrant's shareholders for any violation by a director of the director's fiduciary duty to the Registrant or its shareholders. The Registrant's Articles of Incorporation also include an authorization for the Registrant to indemnify its "agents" (as defined in Section 317 of the California Law), through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, the Registrant's Bylaws provide for indemnification of the Registrant's directors, officers and employees. In addition, the Registrant, at its discretion, may provide indemnification to persons whom the Registrant is not obligated to indemnify. The Bylaws also allow the Registrant to enter into indemnity agreements with individual directors, officers, employees and other agents. These indemnity agreements have been entered into with all directors and executive officers and provide the maximum indemnification permitted by law. These agreements, together with the Registrant's Bylaws and Articles of Incorporation, may require the Registrant, among other things, to indemnify these directors or executive officers (other than for liability resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification, and to obtain directors' and officers' insurance if available on II-1 122 reasonable terms. Section 317 of the California Law and the Registrant's Bylaws make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expense incurred) arising under the Securities Act. The Registrant currently maintains directors' and officers' liability insurance. There is no pending litigation or proceeding involving any director, officer, employee or agent of the Registrant in which indemnification will be required or permitted. Moreover, the Registrant is not aware of any threatened litigation or proceeding that might result in a claim for such indemnification. The Registrant believes that the foregoing indemnification provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. The Underwriting Agreement (the form of which is filed as Exhibit 1.1 hereto) provides for indemnification by the Underwriters of the Registrant and its officers and directors, and by the Registrant of the Underwriters, for certain liabilities arising under the Securities Act or otherwise. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES During the past three years, the Registrant has issued unregistered securities to a limited number of persons as described below: 1. In March 1996, the Registrant issued 1,950,000 shares of common stock to Eyal M. Aronoff in connection with the Registrant's purchase of R*Tech Systems, Inc. 2. In May 1997, the Registrant issued 663,000 shares of common stock to the former shareholders of Common Sense Computing Pty. Ltd. in connection with the Registrant's acquisition of Common Sense Computing. 3. In October 1997, the Registrant sold to Vincent C. Smith, the Registrant's Chief Executive Officer, 3,900,000 shares of common stock for aggregate consideration of $2,200,000. Mr. Smith executed a promissory note for the purchase price. This note has a term of five years and bears interest at 6.2%. This note is also secured, in part, by the 3,900,000 shares of common stock purchased from the Registrant. 4. In April 1998, the Registrant sold an aggregate of 975,000 shares of common stock for an aggregate purchase price of $750,000, for which Mr. Aronoff executed a promissory note and agreed to cancel an option to purchase up to 2.5% of the outstanding capital stock of the Registrant. The note has a term of four years, bears interest at the rate of 5.7% per annum, and up to 25% of the original principal amount of the note may be prepaid in each year of the four-year term. 5. In April 1999, the Registrant sold an aggregate of 888,889 shares of its Series A Preferred Stock at a price of $5.625 per share to InSight Capital Partners II, L.P. and InSight Capital Partners (Cayman) II, L.P. Each share of Series A Preferred Stock will convert into one and one-half shares of common stock upon the closing of this offering. 6. In April 1999, the Registrant sold an aggregate of 800,000 shares of its Series A Preferred Stock at a price of $5.625 per share to WI Software Investors LLC. Each share of Series A Preferred Stock will convert into one and one-half shares of common stock upon the closing of this offering. 7. In April 1999, the Registrant sold an aggregate of 977,778 shares of its Series A Preferred Stock and 1,777,778 shares of its Series B Redeemable Preferred Stock, each at a price of $5.625 per share, to UBS Capital LLC. Each share of Series A Preferred Stock will convert into one and one-half shares of common stock and each share of Series B Preferred Stock will be redeemed upon the closing of this offering. II-2 123 8. Since June, 1998, the Registrant has granted stock options to purchase common stock under individual stock option agreements and the 1998 Stock Option/Stock Issuance Plan to eligible officers, directors, consultants and employees of the Registrant as described in the prospectus. 9. Since June, 1999, the Registrant has granted stock options to purchase common stock under the 1999 Stock Incentive Plan to eligible officers, directors, consultants and employees of the Registrant as described in the prospectus. 10. In December 1999, the Registrant issued an aggregate of 93,471 shares of its common stock to the former shareholders of MBR Technologies, Inc. in connection with the Registrant's acquisition of MBR Technologies, Inc. 11. In January 2000, the Registrant issued an aggregate of 1,187,603 shares of its common stock to the former shareholders of Foglight Software, Inc. in connection with the Registrant's acquisition of Foglight Software, Inc. None of the foregoing transactions involved any underwriters, underwriting discounts or commissions, or any public offering, and the Registrant believes that each transaction was exempt from the registration requirements of the Securities Act by virtue of Sections 3(a)(10) or 4(2) thereof, Regulation D promulgated thereunder or Rule 701 pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701. The recipients in such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the share certificates and instruments issued in such transactions. All recipients had adequate access, through their relationships with the Registrant, to information about the Registrant. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (A) EXHIBITS
EXHIBIT NUMBER EXHIBIT TITLE - -------- ------------- 1.1* Form of Underwriting Agreement. 2.1*** Agreement and Plan of Merger dated as of November 2, 1999, as amended, by and among Quest, Quest Merger Corporation, MBR Technologies, Inc., and certain shareholders of MBR Technologies, Inc. 2.2**** Agreement and Plan of Merger dated as of November 10, 1999, by and among Quest, Quest Acquisition Corporation II, Inc., and Foglight Software, Inc. 3.1** Second Amended and Restated Articles of Incorporation. 3.2 Second Amended and Restated Bylaws, as amended. 4.1** Form of Registrant's Specimen Common Stock Certificate. 5.1* Opinion of Brobeck, Phleger & Harrison LLP. 10.1** Registrant's 1998 Stock Option/Stock Issuance Plan. 10.2** Registrant's 1999 Stock Incentive Plan. 10.3** Registrant's 1999 Employee Stock Purchase Plan. 10.4** Form of Directors' and Officers' Indemnification Agreement. 10.5** Securities Purchase Agreement, dated as of April 21, 1999, by and among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.6** Investors' Rights Agreement dated as of April 21, 1999 among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC.
II-3 124
EXHIBIT NUMBER EXHIBIT TITLE - -------- ------------- 10.7+** Agreement, dated February 19, 1999, between Quest Software, Inc. and INSO Chicago Corporation, dba INSO Corporation. 10.8+** OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 10.9** Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest Software, Inc. 10.10 Office Lease between The Northwestern Mutual Life Insurance Company (Landlord) and Quest Software, Inc. (Tenant) dated as of September 30, 1999. 10.11* Inxight/Resolute Software: Software Distribution and License Agreement -- Inxight Technology dated September 30, 1998 between Resolute Software, Inc. and Inxight Software, Inc. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of Swenson Advisors LLP. 23.3 Consent of PricewaterhouseCoopers LLP. 23.4* Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1 Power of Attorney (Included on signature page hereto). 27.1 Financial Data Schedule (In EDGAR format only).
- ------------------------- * To be filed by amendment. ** Incorporated by reference herein to the Registration Statement of Form S-1 and all amendments thereto filed with the Securities and Exchange Commission on June 11, 1999 and declared effective August 12, 1999. *** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on December 29, 1999. **** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on January 21, 2000. + Confidential treatment requested and received as to certain portions of this agreement. II-4 125 (B) FINANCIAL STATEMENT SCHEDULE SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNT
BALANCE AT CHARGES, BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD ----------- ---------- --------- ---------- ---------- Year ended December 31, 1997: Allowance for doubtful accounts and sales returns......................................... $ 546 $ 584 $ (347) $ 783 Year ended December 31, 1998: Allowance for doubtful accounts and sales returns......................................... $ 783 $1,116 $ (847) $1,052 Year ended December 31, 1999: Allowance for doubtful accounts and sales returns......................................... $1,052 $5,451 $(3,264) $3,239
ITEM 17. UNDERTAKINGS The Registrant hereby undertakes to provide to the underwriters at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the California General Corporation Law, the Amended and Restated Articles of Incorporation or the Amended and Restated Bylaws of the Registrant, Indemnification Agreements entered into between the Registrant and its officers and directors, the Underwriting Agreement, or otherwise, the Registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective; (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 126 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on this 18th day of February, 2000. QUEST SOFTWARE, INC. By: /s/ DAVID M. DOYLE ------------------------------------ David M. Doyle President and Secretary POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints, jointly and severally, Vincent C. Smith, David M. Doyle and John J. Laskey, and each one of them, his true and lawful attorneys-in-fact and agents, each with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, and to sign any registration statement for the same offering covered by this Registration Statement that is to be effective upon filing pursuant to Rule 462(b) promulgated under the Securities Act of 1933, as amended, and all post-effective amendments thereto, and to file the same, with all exhibits thereto and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming that each of said attorneys-in-fact and agents or any of them, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. IN WITNESS WHEREOF, each of the undersigned has executed this Power of Attorney as of the date indicated. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed by the persons whose signatures appear below, which persons have signed such Registration Statement in the capacities and on the dates indicated:
SIGNATURE TITLE DATE - --------- ----- ---- /s/ VINCENT C. SMITH Chief Executive Officer February 18, 2000 - --------------------------------------------------- (principal executive Vincent C. Smith officer) and Chairman of the Board /s/ DAVID M. DOYLE President, Secretary and February 18, 2000 - --------------------------------------------------- Director David M. Doyle /s/ JOHN J. LASKEY Chief Financial Officer February 18, 2000 - --------------------------------------------------- (principal financial and John J. Laskey accounting officer) and Vice President, Finance /s/ DORAN G. MACHIN Director February 18, 2000 - --------------------------------------------------- Doran G. Machin /s/ JERRY MURDOCK, JR. Director February 18, 2000 - --------------------------------------------------- Jerry Murdock, Jr.
II-6 127 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT TITLE - -------- ------------- 1.1* Form of Underwriting Agreement. 2.1*** Agreement and Plan of Merger dated as of November 2, 1999, as amended, by and among Quest, Quest Merger Corporation, MBR Technologies, Inc., and certain shareholders of MBR Technologies, Inc. 2.2**** Agreement and Plan of Merger dated as of November 10, 1999, by and among Quest, Quest Acquisition Corporation II, Inc., and Foglight Software, Inc. 3.1** Second Amended and Restated Articles of Incorporation. 3.2 Second Amended and Restated Bylaws, as amended. 4.1** Form of Registrant's Specimen Common Stock Certificate. 5.1* Opinion of Brobeck, Phleger & Harrison LLP. 10.1** Registrant's 1998 Stock Option/Stock Issuance Plan. 10.2** Registrant's 1999 Stock Incentive Plan. 10.3** Registrant's 1999 Employee Stock Purchase Plan. 10.4** Form of Directors' and Officers' Indemnification Agreement. 10.5** Securities Purchase Agreement, dated as of April 21, 1999, by and among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.6** Investors' Rights Agreement dated as of April 21, 1999 among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.7+** Agreement, dated February 19, 1999, between Quest Software, Inc. and INSO Chicago Corporation, dba INSO Corporation. 10.8+** OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 10.9** Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest Software, Inc. 10.10 Office Lease between The Northwestern Mutual Life Insurance Company (Landlord) and Quest Software, Inc. (Tenant) dated as of September 30, 1999. 10.11* Inxight/Resolute Software: Software Distribution and License Agreement -- Inxight Technology dated September 30, 1998 between Resolute Software, Inc. and Inxight Software, Inc. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP. 23.2 Consent of Swenson Advisors LLP. 23.3 Consent of PricewaterhouseCoopers LLP. 23.4* Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1 Power of Attorney (Included on signature page hereto). 27.1 Financial Data Schedule (In EDGAR format only).
- ------------------------- * To be filed by amendment. ** Incorporated by reference herein to the Registration Statement of Form S-1 and all amendments thereto filed with the Securities and Exchange Commission on June 11, 1999 and declared effective August 12, 1999. *** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on December 29, 1999. **** Incorporated by reference herein to the Form 8-K and all amendments thereto filed with the Securities and Exchange Commission on January 21, 2000. + Confidential treatment requested and received as to certain portions of this agreement. EX-3.2 2 SECOND AMENDED AND RESTATED BYLAWS, AS AMENDED. 1 EXHIBIT 3.2 SECOND AMENDED AND RESTATED BYLAWS OF QUEST SOFTWARE, INC. ARTICLE I CORPORATE OFFICES 1.1 Principal Office. The Board of Directors shall fix the location of the principal executive office of the corporation at any place within or outside the State of California. If the principal executive office is located outside California and the corporation has one or more business offices in California, then the Board of Directors shall fix and designate a principal business office in California. 1.2 Other Offices. The Board of Directors may at any time establish branch or subordinate offices at any place or places. ARTICLE II MEETINGS OF SHAREHOLDERS 2.1 Place of Meetings. Meetings of shareholders shall be held at any place within or outside the State of California designated by the Board of Directors. In the absence of any such designation, shareholders' meetings shall be held at the principal executive office of the corporation or any place consented to in writing by all persons entitled to vote at such meeting, given before or after the meeting and filed with the Secretary of the corporation. 2.2 Annual Meeting. An annual meeting of shareholders shall be held each year on a date and at a time designated by the Board of Directors. At that meeting, directors shall be elected. Any other proper business may be transacted at the annual meeting of shareholders. 2.3 Special Meetings. Special meetings of the shareholders may be called at any time, subject to the provisions of Sections 2.4 and 2.5 of these Bylaws, by the Board of Directors, the Chairman of the Board, the President or the holders of shares entitled to cast not less than twenty percent (20%) of the votes at that meeting. If a special meeting is called by anyone other than the Board of Directors or the President or the Chairman of the Board, then the request shall be in writing, specifying the time of such meeting and the general nature of the business proposed to be transacted, and shall be delivered personally or sent by registered mail or by other written communication to the Chairman of the Board, the President, any Vice President or the Secretary of the corporation. The officer receiving the request shall cause notice to be given to the shareholders entitled to vote, in accordance with the provisions of Sections 2.4 and 2.5 of these Bylaws, that a meeting will be held at the time requested by the person or persons calling the meeting, so long as that time is not less than thirty-five (35) nor more than sixty (60) days after the receipt of the request. If the notice is not given within twenty (20) days after receipt of the request, then the person or persons requesting the meeting may give the notice. Nothing contained in this paragraph of this Section 2.3 shall be construed as limiting, fixing or affecting the time when a meeting of shareholders called by action of the Board of Directors may be held. 2 2.4 Notice of Shareholders' meetings. All notices of meetings of shareholders shall be sent or otherwise given in accordance with Section 2.5 of these Bylaws not less than ten (10) (or, if sent by third-class mail pursuant to Section 2.5 of these Bylaws, not less than thirty (30)) nor more than sixty (60) days before the date of the meeting to each shareholder entitled to vote thereat. Such notice shall state the place, date, and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted, and no business other than that specified in the notice may be transacted, or (ii) in the case of the annual meeting, those matters which the Board of Directors, at the time of the mailing of the notice, intends to present for action by the shareholders, but, subject to the provisions of the next paragraph of this Section 2.4, any proper matter may be presented at the meeting for such action. The notice of any meeting at which directors are to be elected shall include the names of nominees intended at the time of the notice to be presented by the Board for election. If action is proposed to be taken at any meeting for approval of (i) a contract or transaction in which a director has a direct or indirect financial interest, pursuant to Section 310 of the California Corporations Code (the "Code"), (ii) an amendment of the Articles of Incorporation, pursuant to Section 902 of the Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of the Code, (iv) a voluntary dissolution of the corporation, pursuant to Section 1900 of the Code, or (v) a distribution in dissolution other than in accordance with the rights of any outstanding preferred shares, pursuant to Section 2007 of the Code, then the notice shall also state the general nature of that proposal. 2.5 Manner of Giving Notice; Affidavit of Notice. Notice of a shareholders' meeting shall be given either personally or by first-class mail, or, if the corporation has outstanding shares held of record by five hundred (500) or more persons (determined as provided in Section 605 of the Code) on the record date for the shareholders' meeting, notice may be sent by third-class mail, or other means of written communication, addressed to the shareholder at the address of the shareholder appearing on the books of the corporation or given by the shareholder to the corporation for the purpose of notice; or if no such address appears or is given, at the place where the principal executive office of the corporation is located or by publication at least once in a newspaper of general circulation in the county in which the principal executive office is located. The notice shall be deemed to have been given at the time when delivered personally or deposited in the mail or sent by other means of written communication. If any notice (or any report referenced in Article VII of these Bylaws) addressed to a shareholder at the address of such shareholder appearing on the books of the corporation is returned to the corporation by the United States Postal Service marked to indicate that the United States Postal Service is unable to deliver the notice to the shareholder at that address, all future notices or reports shall be deemed to have been duly given without further mailing if the same shall be available to the shareholder upon written demand of the shareholder at the principal executive office of the corporation for a period of one (1) year from the date of the giving of the notice. An affidavit of mailing of any notice or report in accordance with the provisions of this Section 2.5, executed by the Secretary, Assistant Secretary or any transfer agent, shall be prima facie evidence of the giving of the notice or report. 2 3 2.6 Quorum. Unless otherwise provided in the Articles of Incorporation of the corporation, shares entitled to vote and holding a majority of the voting power, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders. The shareholders present at a duly called or held meeting at which a quorum is present may continue to transact business until adjournment notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by shares holding at least a majority of the voting power required to constitute a quorum. In the absence of a quorum, any meeting of shareholders may be adjourned from time to time by the vote of a majority of the shares represented either in person or by proxy, but no their business may be transacted, except as provided in the last sentence of the preceding paragraph. 2.7 Adjourned Meeting Notice. Any shareholders' meeting, annual or special, whether or not a quorum is present, may be adjourned from time to time by the shares entitled to vote and holding a majority of the voting power, represented in person or by proxy, at that meeting. When any meeting of shareholders, either annual or special, is adjourned to another time or place, notice need not be given of the adjourned meeting if its time and place are announced at the meeting at which the adjournment is taken. However, if the adjournment is for more than forty-five (45) days from the date set for the original meeting or if a new record date for the adjourned meeting is fixed, a notice of the adjourned meeting shall be given to each shareholder of record entitled to vote at the adjourned meeting in accordance with the provisions of Sections 2.4 and 2.5 of these Bylaws. At any adjourned meeting the corporation may transact any business which might have been transacted at the original meeting. 2.8 Voting. The shareholders entitled to vote at any meeting of shareholders shall be determined in accordance with the provisions of Section 2.11 of these Bylaws, subject to the provisions of Sections 702 through 704 of the Code (relating to voting shares held by a fiduciary, in the name of a corporation, or in joint ownership). Elections for directors and voting on any other matter at a shareholders' meeting need not be by ballot unless a shareholder demands election by ballot at the meeting and before the voting begins. Except as provided in the last paragraph of this Section 2.8, or as may be otherwise provided in the Articles of Incorporation, each outstanding share, regardless of class, shall be entitled to one (1) vote on each matter submitted to a vote of the shareholders. Any holder of shares entitled to vote on any matter may vote part of the shares in favor of the proposal and refrain from voting the remaining shares or may vote them against the proposal other than elections to office, but, if the shareholder fails to specify the number of shares such shareholder is voting affirmatively, it will be conclusively presumed that the shareholder's approving vote is with respect to all shares which the shareholder is entitled to vote. The affirmative vote of shares holding a majority of the voting power, represented and voting at a duly held meeting at which a quorum is present (which shares voting 3 4 affirmatively also constitute at least a majority of the voting power required to constitute a quorum), shall be the act of the shareholders, unless the vote of a greater number of voting by classes is required by the Code or by the Articles of Incorporation. At a shareholders' meeting at which directors are to be elected, a shareholder shall be entitled to cumulate votes either (i) by giving one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which that shareholder's shares are normally entitled or (ii) by distributing the shareholder's votes on the same principle among as many candidates as the shareholder thinks fit, if the candidate or candidates' names have been placed in nomination prior to the voting and the shareholder has given notice prior to the voting of the shareholder's intention to cumulate the shareholder's votes. If any one shareholder has given such a notice, then every shareholder entitled to vote may cumulate votes for candidates in nomination. The candidates receiving the highest number of affirmative votes, up to the number of directors to be elected, shall be elected; votes against any candidate and votes withheld shall have no legal effect. Notwithstanding the foregoing, at such time as the corporation becomes a listed corporation (as such term is defined in Section 301.5 of the California Corporations Code), shareholders shall no longer be entitled to cumulate their votes for candidates in an election of directors. 2.9 Validation of Meetings; Waiver of Notice; Consent. The transactions of any meeting of shareholders, either annual or special, however called and noticed, and wherever held, are as valid as though they had been taken at a meeting duly held after regular call and notice, if a quorum be present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by proxy, signs a written waiver of notice or a consent to the holding of the meeting or an approval of the minutes thereof. Neither the business to be transacted at nor the purpose of any annual or special meeting of shareholders need be specified in any written waiver of notice or consent to the holding of the meeting or approval of the minutes thereof, except that if action is taken or proposed to be taken for approval of any of those matters specified in the second paragraph of Section 2.4 of these Bylaws, the waiver of notice or consent or approval shall state the general nature of the proposal. All such waivers, consents, and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance of a person at a meeting shall constitute a waiver of notice of and presence at that meeting, except when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened and except that attendance at a meeting is not a waiver of any right to object to the consideration of matters required by the Code to be included in the notice of such meeting but not so included, if such objection is expressly made at the meeting. 2.10 Shareholder Action By Written Consent Without A Meeting. Any action which may be taken at any annual or special meeting of shareholders may be taken without a meeting and without prior notice, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. 4 5 Directors may not be elected by written consent except by unanimous written consent of all shares entitled to vote for the election of directors. However, a director may be elected at any time to fill any vacancy on the Board of Directors (so long as such vacancy has not been filled by the directors) by the written consent of shares holding a majority of the voting power that are entitled to vote for the election of directors. All such consents shall be maintained in the corporate records. Any shareholder giving a written consent, or the shareholder's proxy holders, or a transferee of the shares, or a personal representative of the shareholder, or their respective proxy holders, may revoke the consent by a writing received by the Secretary of the corporation before written consents of the number of shares required to authorize the proposed action have been filed with the Secretary. If the consents of all shareholders entitled to vote have not been solicited in writing, the Secretary shall give prompt notice of any corporate action approved by the shareholders without a meeting by less than unanimous written consent to those shareholders entitled to vote who have not consented in writing. Such notice shall be given in the manner specified in Section 2.5 of these Bylaws. In the case of approval of (i) a contract or transaction ins which a director has a direct or indirect financial interest, pursuant to Section 310 of the Code, (ii) indemnification of a corporate "agent," pursuant to Section 317 of the Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of the Code, and (iv) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares, pursuant to Section 2007 of the Code, the notice shall be given at least ten (10) days before the consummation of any action authorized by that approval, unless the consents of all shareholders entitled to vote have been solicited in writing. 2.11 Record Date For Shareholder Notice; Voting; Given Consents. In order that the corporation may determine the shareholders entitled to notice of any meeting or to vote, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) days nor less than ten (10) days prior to the date of such meeting nor more than sixty (60) days before any other action. Shareholders at the close of business on the record date are entitled to notice and to vote, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date, except as otherwise provided in the Articles of Incorporation or the Code. A determination of shareholders of record entitled to notice of or to vote at a meeting of shareholders shall apply to any adjournment of the meeting unless the Board of Directors fixes a new record date for the adjourned meeting, but the Board of Directors shall fix a new record date if the meeting is adjourned for more than forty-five (45) days from the date set for the original meeting. If the Board of Directors does not so fix a record date: (a) The record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the 5 6 day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. (b) The record date for determining shareholders entitled to give consent to corporate action in writing without a meeting, (i) when no prior action by the Board of Directors has been taken, shall be the day on which the first written consent is given, or (ii) when prior action by the Board of Directors has been taken, shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such other action, whichever is later. The record date for any other purpose shall be as provided in Section 8.1 of these Bylaws. 2.12 Proxies. Every person entitled to vote for directors, or on any other matter, shall have the right to do so either in person or by one or more agents authorized by a written proxy signed by the person and filed with the Secretary of the corporation. A proxy shall be deemed signed if the shareholder's name or other authorization is placed on the proxy (whether by manual signature, typewriting, telegraphic or electronic transmission or otherwise) by the shareholder or the shareholder's attorney-in-fact. A validly executed proxy which does not state that it is irrevocable shall continue in full force and effect unless (i) the person who executed the proxy revokes it prior to the time of voting by delivering a writing to the corporation stating that the proxy is revoked or by executing a subsequent proxy and presenting it to the meeting or by attendance at such meeting and voting in person, or (ii) written notice of the death or incapacity of the maker of that proxy is received by the corporation before the vote pursuant to that proxy is counted; provided, however, that no proxy shall be valid after the expiration of eleven (11) months from the date thereof, unless otherwise provided in the proxy. The dates contained on the forms of proxy presumptively determine the order of execution, regardless of the postmark dates on the envelopes in which they are mailed. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Sections 705(e) and 705(f) of the Code. 2.13 Inspectors of Election. In advance of any meeting of shareholders, the Board of Directors may appoint inspectors of election to act at the meeting and any adjournment thereof. If inspectors of election are not so appointed or designed or if any persons so appointed fail to appear or refuse to act, then the Chairman of the meeting may, and on the request of any shareholder or a shareholder's proxy shall, appoint inspectors of election (or persons to replace those who so fail to appear) at the meeting. The number of inspectors shall be either one (1) or three (3). If appointed at a meeting on the request of one (1) or more shareholders or proxies, shares holding a majority of the voting power, represented in person or by proxy, shall determine whether one (1) or three (3) inspectors are to be appointed. The inspectors of election shall (a) determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, and the authenticity, validity, and effect of proxies, (b) receive totes, ballots or consents, (c) bear and determine all challenges and questions in any way arising in connection with the right to vote, (d) count and tabulate all votes or consents, (e) determine when the polls shall close, (f) 6 7 determine the result and (g) do any other acts that may be proper to conduct the election or vote with fairness to all shareholders. ARTICLE III DIRECTORS 3.1 Powers. Subject to the provisions of the Code, any limitations in the Articles of Incorporation, and these Bylaws, relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the Board of Directors. The Board of Directors may delegate the management of the day-to-day operation of the business of the corporation to a management company or other person provided that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the Board of Directors. 3.2 Number of Directors. The authorized number of directors of the corporation shall be not less than three (3) nor more than seven (7) and the exact number of directors shall be set by a resolution duly adopted by the Board of Directors or by the shareholders. The minimum and maximum number of directors may be changed, or a definite number may be fixed without provision for an indefinite number, by a duly adopted amendment to the Articles of Incorporation or by an amendment to this Bylaw duly adopted by vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that an amendment reducing the fixed number or minimum number of directors to a number less than five (5) cannot be adopted if the votes cast against its adoption at a meeting, or the shares not consenting in the case of an action by written consent, are equal to more than sixteen and two-thirds percent (16-2/3%) of the outstanding shares entitled to vote thereon. No reduction of the authorized number of directors shall have the effect of removing any director before that director's term of office expires. 3.3 Election and Term of Office of Directors. At each annual meeting of shareholders, directors shall be elected to hold office until the next annual meeting. Each director, including a director elected to fill a vacancy, shall hold office until the expiration of the term for which elected and until a successor has been elected and qualified, except in the case of the death, resignation, or removal of such a director. 3.4 Resignation and Vacancies. Any director may resign effective upon giving oral or written notice to the Chairman of the Board, the President, the Secretary, or the Board of Directors, unless the notice specifies a later time for the effectiveness of such resignation. If the resignation of a director is effective at a future time, the Board of Directors may elect a successor to take office when the resignation becomes effective. All vacancies on the Board of Directors, whether caused by removal, resignation, death or otherwise, may be filled by a majority of the remaining directors or, if the number of directors then in office is less than a quorum, by (a) the unanimous written consent of the directors then in office, (b) the affirmative vote of a majority of the directors then in office at a meeting held pursuant to notice or waivers of notice complying with California Corporations 7 8 Code Section 307, or (c) a sole remaining director. Each director so elected shall hold office until his successor is elected at an annual, regular or special meeting of the shareholders. The shareholders may elect a director at any time to fill any vacancy not filled by the directors. Any such election by written consent requires the consent of a majority of the outstanding shares entitled to vote. A vacancy or vacancies in the Board of Directors shall be deemed to exist (i) in the event of the death, resignation or removal of any director, (ii) if the Board of Directors resolution declares vacant the office of a director who has been declared of unsound mind by an order of court or who has been convicted of a felony, (iii) if the authorized number of directors is increased, or (iv) if the shareholders fail, at any meeting of shareholders at which any director or directors are elected, to elect the full number of directors to be elected at that meeting. The shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors, but any such election by written consent shall require the consent of shares holding a majority of the voting power that are entitled to vote thereon. 3.5 Place of Meetings; Meetings By Telephone. Regular meetings of the Board of Directors may be held at any place within or outside the State of California that has been designated from time to time by resolution of the Board of Directors. In the absence of such a designation, regular meetings shall be held at the principal executive office of the corporation. Special meetings of the Board of Directors may be held at any place within or outside the State of California that has been designated in the notice of the meeting or, if not stated in the notice or if there is no notice, at the principal executive office of the corporation. Members of the Board of Directors may participate in a meeting through use of conference telephone, electronic video screen communication, or other communications equipment. Participation in a meeting through use of conference telephone constitutes presence in person at the meeting as long as all members participating in such meeting can hear one another. Participation in a meeting through the use of electronic video screen communication or other communications equipment (other than conference telephone) constitutes presence in person at that meeting if all of the following apply: (a) each member participating in the meeting can communicate with all of the other members concurrently, (b) each member is provided the means of participating in all matters before the Board of Directors, including, without limitation, the capacity to propose, or to interpose an objection to, a specific action to be taken by the corporation, and (c) the corporation adopts and implements some means of verifying that (i) a person participating in the meeting is a director or other person entitled to participate in the Board of Directors' meeting, and (ii) all actions of, or votes by, the Board of Directors are taken or cast only by the directors and not by persons who are not directors. 3.6 Regular Meetings. Regular meetings of the Board of Directors may be held without notice if the time and place of such meetings are fixed by the Board of Directors. 3.7 Special Meetings; Notice. Subject to the provisions of the following paragraph, special meetings of the Board of Directors for any purpose or purposes may be called at any time by the Chairman of the Board, the President, any Vice President, the Secretary or any two (2) directors. 8 9 Notice of the time and place of special meetings shall be delivered personally or by telephone (including a voice messaging system or other system or technology designed to record and communicate messages, telegraph, facsimile, electronic mail or other electronic means) to each director or sent by first class mail, addressed to each director at the director's address as it is shown on the records of the corporation. If the notice is mailed, it shall be deposited in the United States mail at least four (4) days before the time of the holding of the meeting. If the notice is delivered personally or by telephone, telecopier, telegram or any electronic means, it shall be delivered at least forty-eight (48) hours before the time of the holding of the meeting. An oral notice given personally or by telephone may be communicated either to the director or to the person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. The notice need not specify the purpose of the meeting. 3.8 Quorum. A majority of the authorized number of directors shall constitute a quorum of the Board of Directors for the transaction of business, except to adjourn as provided in Section 3.10 of these Bylaws. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present is the act of the Board of Directors, subject to the provisions of Section 310 of the Code (as to the approval of contracts or transactions in which a director has a direct or indirect material financial interest), Section 311 of the Code (as to the appointment of committees), Section 317(e) of the Code (as to the indemnification of directors), the Articles of Incorporation, and other applicable law. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for such meeting. 3.9 Waiver of Notice. Notice of a meeting need not be given to any director who signs a waiver of notice or a consent to holding the meeting or an approval of the minutes thereof, whether before or after the meeting, or who attends the meeting without protesting, prior thereto or at its commencement, the lack of notice to such director. All such waivers, consents, and approvals shall be filed with the corporate records or be made a part of the minutes of the meeting. A waiver of notice need not specify the purpose of any regular or special meeting of the Board of Directors. 3.10 Adjournment. A majority of the directors present, whether or not a quorum is present, may adjourn any meeting to another time and place. 3.11 Notice of Adjournment. If the meeting is adjourned for more than twenty-four (24) hours, notice of any adjournment to another time and place shall be given prior to the time of the adjourned meeting to the directors who were not present at the time of the adjournment. 3.12 Board Action By Written Consent Without A Meeting. Any action required or permitted to be taken by the Board of Directors may be taken without a meeting, if all members of the Board of Directors individually or collectively consent in writing to such action. Such written consent or consents shall be filed with the minutes of the proceedings of the Board of Directors. Such action by written consent shall have the same force and effect as a unanimous vote of the Board of Directors. 9 10 3.13 Fees and Compensation of Directors. Directors and members of committees may receive such compensation, if any, for their services and such reimbursement of expenses as may be fixed or determined by resolution of the Board of Directors. This Section 3.13 shall not be construed to preclude any director from serving the corporation in any other capacity as an officer, agent, employee, or otherwise, and receiving compensation for those services. 3.14 Approval of Loans to Officers. If these Bylaws have been approved by the corporation's shareholders in accordance with the Code, the corporation may, upon the approval of the Board of Directors alone, make loans of money or property to, or guarantee the obligations of, any officer of the corporation or of its parent, if any, whether or not a director, or adopt an employee benefit plan or plans authorizing such loans or guaranties provided that (i) the Board of Directors determines that such a loan or guaranty or plan may reasonably be expected to benefit the corporation, (ii) the corporation has outstanding shares held of record by 100 or more persons (determined as provided in Section 605 of the Code) on the date of approval by the Board of Directors, and (iii) the approval of the Board of Directors is by a vote sufficient without counting the vote of any interested director or directors. Notwithstanding the foregoing, the corporation shall have the power to make loans permitted by the Code. ARTICLE IV COMMITTEES 4.1 Committees of Directors. The Board of Directors may, by resolution adopted by a majority of the authorized number of directors, designate one or more committees, each consisting of two (2) or more directors, to serve at the pleasure of the Board of Directors. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent member at any meeting of the committee. The appointment of members or alternate members of a committee requires the vote of a majority of the authorized number of the directors. Any such committee shall have authority to act in the manner and to the extent provided in the resolution of the Board of Directors and may have all the authority of the Board of Directors, except with respect to: (a) The approval of any action which, under the Code, also requires shareholders' approval or approval of the outstanding shares. (b) The filling of vacancies on the Board of Directors or on any committee. (c) The fixing of compensation of the directors for serving on the Board of Directors or on any committee. (d) The amendment or repeal of these Bylaws or the adoption of new Bylaws. (e) The amendment or repeal of any resolution of the Board of Directors which by its express terms is not so amendable or repealable. (f) A distribution to the shareholders of the corporation, except at a rate, in a periodic amount or within a price range set forth in the Articles of Incorporation or determined by the Board of Directors. 10 11 (g) The appointment of any other committee of the Board of Directors or the members thereof. 4.2 Meetings and Actions of Committees. Meetings and actions of committee shall be governed by, and held and taken in accordance with, the provisions of Article III of these Bylaws, Section 3.5 (place of meetings), Section 3.6 (regular meetings), Section 3.7 (special meetings and notice), Section 3.8 (quorum), Section 3.9 (waiver of notice), Section 3.10 (adjournment), Section 3.11 (notice of adjournment), and Section 3.12 (action without meeting), with such changes in the context of those Bylaws as are necessary to substitute the committee and its members for the Board of Directors and its members; provided, however, that the time of regular meetings of committees may be determined either by resolution of the Board of Directors or by resolution of the committee, that special meetings of the Committees may also be called by resolution of the Board of Directors, and that notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The Board of Directors may adopt rules for the government of any committee not inconsistent with the provisions of these Bylaws. ARTICLE V OFFICERS 5.1 Officers. The officers of the corporation shall be a President, a Secretary, and a Chief Financial Officer. The corporation may also have, at the discretion of the Board of Directors, a Chairman of the Board, one or more Vice Presidents, one or more Assistant Secretaries, one or more Assistant Treasurers, and such other officers as may be appointed in accordance with the provisions of Section 5.3 of these Bylaws. Any number of offices may be held by the same person. 5.2 Appointment of Officers. The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 5.3 of these Bylaws, shall be chosen by the Board of Directors and serve at the pleasure of the Board of Directors, subject to the rights, if any, of an officer under any contract of employment. 5.3 Subordinate Officers. The Board of Directors may appoint, or may empower the Chairman of the Board or the President to appoint, such other officers as the business of the corporation may require, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in these Bylaws or as the Board of Directors may from time to time determine. 5.4 Removal or Resignation of Officers. Subject to the rights, if any, of an officer under any contract of employment, all officers serve at the pleasure of the Board of Directors and any officer may be removed, either with or without cause, by the Board of Directors at any regular or special meeting of the Board of Directors or, except in case of an officer chosen by the Board of Directors, by any officer upon whom such power of removal may be conferred by the Board of Directors. Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time 11 12 specified in that notice; and, unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. 5.5 Vacancy In Offices. A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed by these Bylaws for regular appointments to that office. 5.6 Chairman of the Board. The Chairman of the Board, if such an officer be elected, shall, if present, preside at meetings of the Board of Directors and exercise and perform such other powers and duties as may from time to time be assigned by the Board of Directors or as may be prescribed by these Bylaws. If there is no President, then the Chairman of the Board shall also be the chief executive officer of the corporation and shall have the powers and duties prescribed in Section 5.7 of these Bylaws. 5.7 President. The President shall be the general manager and chief executive officer of the corporation unless such title is assigned to another officer of the corporation; in the absence of a Chairman and Vice Chairman of the Board, the President shall preside as the chairman of meetings of the shareholders and the Board of Directors; and the President shall have general and active management of the business of the corporation and shall see that all orders and resolutions of the Board of Directors are carried into effect. The President or any Vice President shall execute bonds, mortgages and other contracts requiring a seal, under the seal of the corporation (if the corporation has adopted a seal), except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other officer or agent of the corporation. The President shall perform all such other duties as are incident to such office or are properly required by the Board of Directors. 5.8 Vice Presidents. In the absence or disability of the President, the Vice Presidents, if any, in order of their rank as fixed by the Board of Directors or, if not ranked, a Vice President designated by the Board of Directors, shall perform all the duties of the President and when so acting shall have all the powers of, and be subject to all the restrictions upon, the President. The Vice Presidents shall have such other powers and perform such other duties as from time to time may be prescribed for them respectively by the Board of Directors, these Bylaws, the President or the Chairman of the Board. 5.9 Secretary. The Secretary shall keep or cause to be kept, at the principal executive office of the corporation or other such place as the Board of Directors may direct, a book of minutes of all meetings and actions of directors, committees of directors and shareholders. The minutes shall show the time and place of each meeting, whether regular or special (and, if special, how authorized and the notice given), the names of those present at directors' meetings or committee meetings, the number of shares present or represented at shareholders' meetings, and the proceedings thereof. The Secretary shall keep, or cause to be kept, at the principal executive office of the corporation or at the office of the corporation's transfer agent or registrar, as determined by resolution of the Board of Directors, a share register, or a duplicate share register, showing the 12 13 names of all shareholders and their addresses, the number and classes of shares held by each, the number and dates of certificates evidencing such shares, and the number and date of cancellation of every certificate surrendered for cancellation. The Secretary shall give, or cause to be given, notice of all meetings of shareholders and of the Board of Directors required to be given by law or by these Bylaws. The Secretary shall keep the seal of the corporation, if one be adopted, in safe custody and shall have such other powers and perform other such duties as may be prescribed by the Board of Directors or by these Bylaws. 5.10 Chief Financial Officer. The Chief Financial Officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, retained earnings, and shares. The books of account shall at all reasonable times be open to inspection by any director. ARTICLE VI INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND OTHER AGENTS 6.1 Indemnification of Directors. The corporation shall, to the maximum extent and in the manner permitted by the Code, indemnify each of its directors against expenses (as defined in Section 317(a) of the Code), judgment, fines, settlements, and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was a director of the corporation. For purposes of this Article VI, a "director" of the corporation includes any person (i) who is or was a director of the corporation, (ii) who is or was serving at the request of the corporation as a director of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or (iii) who was a director of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. 6.2 Indemnification of Others. The corporation shall have the power, to the extent and in the manner permitted by the Code, to indemnify each of its employees, officers, and agents (other than directors) against expenses (as defined in Section 317(a) of the Code), judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceeding (as defined in Section 317(a) of the Code), arising by reason of the fact that such person is or was an employee, officer, or agent of the corporation. For purposes of this Article VI, an "employee" or "officer" or "agent" of the corporation (other than a director) includes any person (i) who is or was an employee, officer, or agent of the corporation, (ii) who is or was serving at the request of the corporation as an employee, officer, or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or (iii) who was an employee, officer, or agent of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation. 6.3 Payment of Expenses In Advance. Expenses and attorneys' fees incurred in defending any civil or criminal action or other proceeding for which indemnification is required pursuant to Section 6.1, or if otherwise authorized by the Board of Directors, shall be paid by the 13 14 corporation in advance of the final disposition of such action or proceeding upon receipt of an undertaking by or on behalf of the indemnified party to repay such an amount if it shall ultimately be determined that the indemnified party is not entitled to be indemnified as authorized in this Article VI. 6.4 Indemnity Not Exclusive. The indemnification provided by this Article VI shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled under any Bylaw, agreement, vote of shareholders or directors or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office. The rights to indemnity hereunder shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors, and administrators of the person. 6.5 Insurance Indemnification. The corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation against any liability asserted against or incurred by such person in such capacity or arising out of that person's status as such, whether or not the corporation would have the power to indemnify that person against such liability under the provisions of this Article VI. 6.6 Conflicts. No indemnification or advance shall be made under this Article VI, except where such indemnification or advance is mandated by law or the order, judgment or decree of any court of competent jurisdiction, in any circumstance where it appears: (1) that it would be inconsistent with the provisions of the Articles of Incorporation, these Bylaws, a resolution of the shareholders or an agreement in effect at the time of the accrual of the alleged cause of the action asserted in the proceeding in which the expenses were incurred or other amounts were paid, which prohibits or otherwise limits indemnification; or (2) that it would be inconsistent with any condition expressly imposed by a court in approving a settlement. 6.7 Right to Bring Suit. If a claim under this Article VI is not paid in full by the corporation within ninety (90) days after a written claim has been received by the corporation (either because the claim is denied or because no determination is made), the claimant may at any time thereafter bring suit against the corporation to recover the unpaid amount of the claim and, if successful in whole or in part, the claimant shall also be entitled to be paid the expenses of prosecuting such claim. The corporation shall be entitled to raise as a defense to any such action that the claimant has not met the standards of conduct that make it permissible under the Code for the corporation to indemnify the claimant for the claim. Neither the failure of the corporation (including its Board of Directors, independent legal counsel, or its shareholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is permissible in the circumstances because he or she has met the applicable standard of conduct, if any, nor an actual determination by the corporation (including the Board of Directors, independent legal counsel, or its shareholders) that the claimant has not met the applicable standard of conduct, shall be a defense to such action or create a presumption for the purposes of such action that the claimant has not met the applicable standard of conduct. 14 15 6.8 Indemnity Agreements. The Board of Directors is authorized to enter into a contract with any director, officer, employee or agent of the corporation, or any person who is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, including employee benefit plans, or any person who was a director, officer, employee or agent of a corporation which was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation, providing for indemnification rights equivalent to or, if the Board of Directors so determines and to the extent permitted by applicable law, greater than, those provided for in this Article VI. 6.9 Amendment, Repeal or Modification. Any amendment, repeal or modification of any provision of this Article VI shall not adversely affect any right or protection of a director, employee, officer or agent of the corporation existing at the time of such amendment, repeal or modification. ARTICLE VII RECORDS AND REPORTS 7.1 Maintenance and Inspection of Share Register. The corporation shall keep either at its principal executive office or at the office of its transfer agent or registrar (if either be appointed), as determined by resolution of the Board of Directors, a record of its shareholders listing the names and addresses of all shareholders and the number and class of shares held by each shareholder. A shareholder or shareholders of the corporation holding at least five percent (5%) in the aggregate of the outstanding voting shares of the corporation who held at least one percent (1%) of such voting shares and have filed a Schedule 14B with the United States Securities and Exchange Commission relating to the election of directors, shall have an absolute right to do either or both of the following (i) inspect and copy the record of shareholders' names, addresses, and shareholdings during usual business hours upon five (5) days' prior written demand upon the corporation, or (ii) obtain from the transfer agent of the corporation, upon written demand and upon the tender of such transfer agent's usual charges for such list (the amount of which charges shall be stated to the shareholder by the transfer agent upon request), a list of the shareholders' names and addresses who are entitled to vote for the election of the directors, and their shareholdings, as of the most recent record date for which it has been compiled or as of the date specified by the shareholder subsequent to the date of demand. The list shall be made available on or before the later of five (5) business days after the demand is received or the date specified therein as the date as of which the list is to be compiled. The record of shareholders shall also be open to inspection or copying by any shareholder or holder of a voting trust certificate at any time during usual business hours upon written demand on the corporation, for a purpose reasonably related to the holder's interests as a shareholder or holder of a voting trust certificate. Any inspection and copying under this Section 7.1 may be made in person or by an agent or attorney of the shareholder or holder of a voting trust certificate making the demand. 15 16 7.2 Maintenance and Inspection of Bylaws. The corporation shall keep at its principal executive office or, if its principal executive office is not in the State of California, at its principal business office in California, the original or a copy of these Bylaws as amended to date, which shall be open to inspection by the shareholders at all reasonable times during business hours. If the principal executive office is outside the State of California and the corporation has no principal business office in such state, then it shall, upon the written request of any shareholder, furnish to such shareholder a copy of these Bylaws as amended to date. 7.3 Maintenance and Inspection of Other Corporate Records. The accounting books and records and the minutes of proceedings of the shareholders and the Board of Directors, and committees of the Board of Directors shall be kept at such place or places as are designated by the Board of Directors or, in absence of such designation, at the principal executive office of the corporation. The minutes shall be kept in written form or in any other form capable of being converted into written form. The minutes and accounting books and records shall be open to inspection upon the written demand on the corporation of any shareholder or holder of a voting trust certificate at any reasonable time during usual business hours, for a purpose reasonably related to such holder's interests as a shareholder or as a holder of a voting trust certificate. Such inspection by a shareholder or a holder of a voting trust certificate may be made in person or by an agent or attorney and the right of inspection includes the right to copy and make extracts. Such rights of inspections shall extend to the records of each subsidiary corporation of the corporation. 7.4 Inspection By Directors. Every director shall have the absolute right at any reasonable time to inspect and copy all books, records, and documents of every kind and to inspect the physical properties of the corporation and each of its subsidiary corporations, domestic or foreign. Such inspection by a director may be made in person or by an agent or attorney and the right of inspection includes the right to copy and make extracts. 7.5 Annual Report to Shareholders; Waiver. The Board of Directors shall cause an annual report to be sent to the shareholders not later than one hundred twenty (120) days after the close of the fiscal year adopted by the corporation. Such report shall be sent to the shareholders at least fifteen (15) (or, if sent by third class mail, thirty-five (35)) days prior to the annual meeting of shareholders to be held in the next fiscal year and in the manner specified in Section 2.5 of these Bylaws for giving notice to shareholders of the corporation. The annual report shall contain a balance sheet as of the end of the fiscal year and an income statement and statement of changes in financial position for the fiscal year, accompanied by any report thereon of independent accountants or, if there is no such report, the certificate of an authorized officer of the corporation that the statements were prepared without audit from the books and records of the corporation. The foregoing requirement of an annual report shall be waived so long as the shares of the corporation are held by fewer than one hundred (100) holders of record. 7.6 Financial Statements. If no annual report for the fiscal year has been sent to shareholders, then the corporation shall, upon the written request of any shareholder made more 16 17 than one hundred twenty (120) days after the close of such fiscal year, deliver or mail to the person making the request, within thirty (30) days thereafter, a copy of a balance sheet as of the end of such fiscal year and an income statement and statement of changes in financial position for such fiscal year. A shareholder or shareholders holding at least five percent (5%) of the outstanding shares of any class of the corporation may make a written request to the corporation for an income statement of the corporation for the three-month, six-month or nine-month period of the current fiscal year ended more than thirty (30) days prior to the date of the request and a balance sheet of the corporation as of the end of that period. The statements shall be delivered or mailed to the person making the request within thirty (30) days thereafter. A copy of the statements shall be kept on file in the principal office of the corporation for twelve (12) months and it shall be exhibited at all reasonable times to any shareholder demanding an examination of the statements or a copy shall be mailed to the shareholder. If the corporation has not sent to the shareholders its annual report for the last fiscal year, the statements referred to in the first paragraph of this Section 7.6 shall likewise be delivered or mailed to the shareholder or shareholders within thirty (30) days after the request. The quarterly income statements and balance sheets referred to in this section shall be accompanied by the report thereon, if any, of any independent accountants engaged by the corporation or the certificate of an authorized officer of the corporation that the financial statements were prepared without audit from the books and records of the corporation. 7.7 Representation of Shares of Other Corporations. The Chairman of the Board, the President, any Vice President, the Chief Financial Officer, the Secretary or Assistant Secretary of this corporation, or any other person authorized by the Board of Directors or the President or a Vice President, is authorized to vote, represent, and exercise on behalf of this corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority herein granted may be exercised either by such person directly or by any other person authorized to do so by proxy or by power of attorney duly executed by such person having the authority. ARTICLE VIII GENERAL MATTERS 8.1 Record Date for Purpose Other Than Notice and Voting. For purposes of determining the shareholders entitled to receive payment of any dividend or other distribution or allotment of any rights or entitled to exercise any rights in respect of any other lawful action (other than with respect to notice or voting at a shareholders' meeting or action by shareholders by written consent without a meeting), the Board of Directors may fix, in advance, a record date, which shall not be more than sixty (60) days prior to any such action. Only shareholders of record at the close of business on the record date are entitled to receive the dividend, distribution or allotment of rights, or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date, except as otherwise provided for in the Articles of Incorporation or the Code. 17 18 If the Board of Directors does not so fix a record date, then the record date for determining shareholders for any such purpose shall be at the close of business on the day on which the Board adopts the resolution relating thereto or the sixtieth (60th) day prior to the date of that action, whichever is later. 8.2 Checks; Drafts; Evidence of Indebtedness. From time to time, the Board of Directors shall determine by resolution which person or persons may sign or endorse all checks, drafts, other orders for payment of money, notes or other evidences of indebtedness that are issued in the name of or payable to the corporation, and only the persons so authorized shall sign or endorse those instruments. 8.3 Corporate Contracts and Instruments; How Executed. The Board of Directors, except as otherwise provided in these Bylaws, may authorize any officer or officers, or agent or agents, to enter into any contract or execute any instrument in the name of or on behalf of the corporation; such authority may be general or confined to specific instances. Unless so authorized or ratified by the Board of Directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. 8.4 Certificate For Shares. A certificate or certificates for shares of the corporation shall be issued to each shareholder when any such shares are fully paid. The Board of Directors may authorize the issuance of certificates for shares partly paid provided that these certificates shall state the total amount of the consideration to be paid for them and the amount actually paid. All certificates shall be signed in the name of the corporation by the Chairman of the Board or the Vice Chairman of the Board or the President or a Vice President and by the Chief Financial Officer or an Assistant Treasurer or the Secretary or an Assistant Secretary, certifying the number of shares and the class and series of shares owned by the shareholder. Any or all of the signatures on the certificates may be by facsimile. In case any officer, transfer agent or registrar has signed or whose facsimile signature has been placed on a certificate has ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if that person were an officer, transfer agent or registrar at the date of issue. 8.5 Lost Certificates. Except as provided in this Section 8.5, no new certificate for shares shall be issued to replace a previously issued certificate unless the later is surrendered to the corporation or its transfer agent or registrar and cancelled at the same time. The Board of Directors may, in case any share certificate or certificate for any other security is lost, stolen or destroyed (as evidenced by a written affidavit or affirmation of such fact), authorize the issuance of replacement certificates on such terms and conditions as the Board of Directors may require; the Board of Directors may require indemnification of the corporation secured by a bond or other adequate security sufficient to protect the corporation against any claim that may be made against it, including any expense or liability, on account of the alleged loss, theft or destruction of the certificate or the issuance of the replacement certificate. 18 19 8.6 Construction; Definitions. Unless the context requires otherwise, the general provisions, rules of construction, and definitions in the Code shall govern the construction of these Bylaws. Without limiting generality of the provision, the singular number includes the plural, the plural number includes the singular, and the term "person" includes both a corporation and a natural person. ARTICLE IX AMENDMENTS 9.1 Amendment By Shareholders. New Bylaws may be adopted or these Bylaws may be amended or repealed by the vote or written consent of holders of a majority of outstanding shares entitled to vote; provided, however, that if the Articles of Incorporation of the corporation set forth the number of authorized directors of the corporation, then the authorized number of directors may be changed only by an amendment of the Articles of Incorporation. 9.2 Amendment By Directors. Subject to the rights of the shareholders as provided by Section 9.1 of these Bylaws, Bylaws, other than a Bylaw or an amendment of a Bylaw changing the authorized number of directors (except to fix the authorized number of directors pursuant to a Bylaw providing for a variable number of directors), may be adopted, amended or repealed by the Board of Directors. 9.3 Record of Amendments. Whenever an amendment or new Bylaw is adopted, it shall be copied in the book of minutes with the original Bylaws. If any Bylaw is repealed, the face of repeal, with the date of the meeting at which the repeal was enacted or written consent was filed, shall be stated in said book of minutes. ARTICLE X INTERPRETATION Reference in the Bylaws to any provision of the California Corporations Code shall be deemed to include all amendments thereof. 19 20 FIRST AMENDMENT TO SECOND AMENDED AND RESTATED BYLAWS OF QUEST SOFTWARE, INC. a California corporation Certificate of Secretary The undersigned does hereby certify that: I am the duly qualified and acting Secretary of Quest Software, Inc., a duly organized and existing California corporation. The following is a true copy of the resolutions duly adopted by the Board of Directors by unanimous written consent effective December 20, 1999, which appears in the minute book of Quest Software, Inc. SPECIAL MEETINGS NOW, THEREFORE, BE IT RESOLVED, that the first paragraph of Section 2.3 of Article II of the Second Amended and Restated Bylaws of Quest Software, Inc. be, and it hereby is, deleted in its entirety and replaced with the following in lieu thereof, effective immediately: Special Meetings. Special meetings of the shareholders may be called at any time, subject to the provisions of Sections 2.4 and 2.5 of these Bylaws, by the Board of Directors, the Chairman of the Board, the President or the holders of shares entitled to cast not less than ten percent (10%) of the votes at that meeting. The foregoing resolution is in conformity with the Second Amended and Restated Articles of Incorporation and Second Amended and Restated Bylaws of Quest Software, Inc., has never been modified or repealed, and is now in full force and effect. IN WITNESS WHEREOF, I have executed this Amendment to Second Amended and Restated Bylaws on the 20th day of December, 1999. /s/ David M. Doyle -------------------------------------- David M. Doyle Secretary EX-10.10 3 OFFICE LEASE BETWEEN DATED 9/30/99. 1 EXHIBIT 10.10 OFFICE LEASE BETWEEN THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY (LANDLORD) AND QUEST SOFTWARE, INC. (TENANT) CORNERSTONE AT CANTERA OFFICE BUILDING 4320 WINFIELD ROAD WARRENVILLE, IL 60555 2 TABLE OF CONTENTS
ARTICLE PAGE - ------- ---- Article 1. BASIC LEASE INFORMATION............................................1 1.1 Basic Lease Information..................................1 1.2 Exhibits.................................................3 Article 2. AGREEMENT..........................................................3 2.1 Lease Grant, Term and Use................................3 2.2 Termination Right........................................3 Article 3. DELIVERY OF PREMISES...............................................4 3.1 Delivery of Possession...................................4 3.2 Early Entry..............................................4 3.3 Right of First Offer.....................................4 Article 4. MONTHLY RENT.......................................................6 4.1 Monthly Rent.............................................6 4.2 .........................................................6 Article 5. OPERATING EXPENSES..................................................7 5.1 General..................................................7 5.2 Estimated Payments.......................................8 5.3 Annual Settlement........................................8 5.4 Final Proration..........................................9 5.5 Occupancy Variance.......................................9 5.6 Other Taxes..............................................9 5.7 Additional Rent..........................................9 Article 6. INSURANCE ........................................................10 6.1 Landlord's Insurance....................................10 6.2 Tenant's Insurance......................................10 6.3 Forms of Policies.......................................10 6.4 Waiver of Subrogation...................................10 6.5 Adequacy of Coverage....................................10 6.6 Certain Insurance Risks.................................11 Article 7. USE...............................................................11 Article 8. COMPLIANCE WITH LAWS..............................................11 Article 9. HAZARDOUS MATERIALS...............................................11 Article 10. ASSIGNMENT AND SUBLETTING........................................12 10.1 General.................................................12
2 3 Page ---- 10.2 Recapture...............................................12 10.3 Submission of Information...............................13 10.4 Payments to Landlord....................................14 10.5 Prohibited Transfers....................................14 10.6 Permitted Transfer......................................14 10.7 Condition...............................................14 10.8 Remedies................................................14 Article 11. RULES AND REGULATIONS............................................14 Article 12. COMMON AREAS.....................................................15 Article 13. LANDLORD'S SERVICES..............................................15 13.1 Landlord's Repair and Maintenance.......................15 13.2 Landlord's Other Services...............................15 13.3 Tenant's Costs..........................................16 13.4 Limitation on Liability.................................16 Article 14. TENANT'S CARE OF THE PREMISES....................................17 Article 15. ALTERATIONS......................................................17 15.1 General.................................................17 15.2 Free-Standing Partitions................................17 15.3 Removal.................................................17 15.4 ADA Compliance..........................................18 Article 16. MECHANICS' LIENS.................................................18 Article 17. END OF TERM......................................................18 Article 18. EMINENT DOMAIN...................................................19 Article 19. DAMAGE AND DESTRUCTION...........................................19 Article 20. SUBORDINATION....................................................20 20.1 General.................................................20 20.2 Attornment..............................................20 Article 21. ENTRY BY LANDLORD................................................21 Article 22. INDEMNIFICATION, WAIVER AND RELEASE..............................21 22.1 Tenant's Indemnification ...............................21 22.2 Waiver and Release......................................21 Article 23. QUIET ENJOYMENT..................................................22 Article 24. EFFECT OF SALE...................................................22 Article 25. DEFAULT ........................................................22 25.1 Events of Default by Tenant.............................22 25.2 Landlord's Remedies.....................................23 25.3 Damages; no Termination.................................23 3 4 Page ---- 25.4 Damages upon Termination................................23 25.5 Cumulative Remedies.....................................24 25.6 ........................................................24 Article 26. INTENTIONALLY OMITTED.............................................24 Article 27. PARKING ........................................................24 Article 28. MISCELLANEOUS.....................................................25 28.1 Intentionally Omitted...................................25 28.2 Security Deposit........................................25 28.3 Signs...................................................25 28.4 No Offer................................................25 28.5 Joint and Several Liability.............................25 28.6 No Construction Against Drafting Party..................26 28.7 Time of the Essence.....................................26 28.8 No Recordation..........................................26 28.9 No Waiver...............................................26 28.10 Limitation on Recourse..................................26 28.11 Estoppel Certificates...................................26 28.12 Waiver of Jury Trial....................................26 28.13 No Merger...............................................26 28.14 Holding Over............................................27 28.15 Notices.................................................27 28.16 Severability............................................27 28.17 Written Amendment Required..............................27 28.18 Captions................................................27 28.19 Authority...............................................27 28.20 Brokers.................................................27 28.21 Governing Law...........................................27 28.22 No Easements for Air or Light...........................27 28.23 Tax Credits.............................................28 28.24 Intentionally Omitted...................................28 28.25 Landlord's Fees.........................................28 28.26 Non-waiver..............................................28 28.27 Presumption.............................................28 28.28 Waiver of Technical Defects in Notices..................28 28.29 No Right to Terminate...................................28 28.30 No Liability for Crimes.................................28 28.31 Binding Effect..........................................28 28.32 Confidentiality.........................................28 28.33 Force Majeure...........................................29 28.34 Interest................................................29 28.35 Entire Agreement........................................29 EXHIBITS Exhibit A -- Layout Of The Premises Exhibit B -- Work Letter Exhibit C -- Commencement Date Certificate Exhibit D -- Rules and Regulations Exhibit E -- Tenant Estoppel Certificate Exhibit F -- Option to Renew Exhibit G - Janitorial Specifications 4 5 OFFICE LEASE BETWEEN THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY ("LANDLORD") AND QUEST SOFTWARE, INC. ("TENANT") THIS OFFICE LEASE ("Lease") is entered into by Landlord and Tenant on the date set forth in the following Basic Lease Information. Landlord and Tenant hereby agree as follows: ARTICLE 1. BASIC LEASE INFORMATION. - ------------------------------------ 1.1 BASIC LEASE INFORMATION. In addition to the Terms that are defined elsewhere in this Lease, the following terms shall have the following meaning as set forth in this Lease: (a) LEASE DATE: September 30, 1999 (b) LANDLORD: The Northwestern Mutual Life Insurance Company TYPE OF LEGAL ENTITY AND STATE OF FORMATION: a Wisconsin Corporation (c) LANDLORD'S ADDRESS FOR RECEIPT OF NOTICE: The Northwestern Mutual Life Insurance Company c/o Northwestern Investment Management Company 10 South Wacker Drive, Suite 3400 Chicago, IL 60606 Attn: Regional Manager (Fax: 312/559-0198) with a copy to: Northwestern Investment Management Company 720 East Wisconsin Avenue Milwaukee, WI 53202 Attn: Managing Director-Asset Management (Fax: 414/299-7016) (d) TENANT: Quest Software, Inc. TYPE OF LEGAL ENTITY AND STATE OF FORMATION: a California corporation (e) TENANT'S ADDRESS FOR RECEIPT OF NOTICE: at the following address until the Commencement Date, and thereafter at the Premises: Quest Software, Inc. 610 Newport Center Drive; Suite 1400 Newport Beach, CA 92660 Attn: Susan Twellman (Fax: 949-720-0426) with a copy to: Pinto & Dubia, LLP 2 Park Plaza, Suite 300 Irvine, CA 92614-8513 Attn: Tracy D. Johnson (Fax: 949-833-2067) 1 6 (f) LAND: The parcel of land located at the Building Address upon which the Building is situated. (g) PROJECT: The development commonly known as Cornerstone At Cantera consisting of the Land and all Improvements built on the Land, including without limitation, the Building, Common Areas, parking lot or parking structure, if any, walkways, driveways, fences and landscaping. (h) BUILDING: The building located on the Land of which the Premises are a part. (i) BUILDING ADDRESS: 4320 Winfield Road, Warrenville, Illinois 60555. (j) PREMISES: The Premises located at Suite 500 on the fifth floor of the Building, as further shown on Exhibit A to this Lease. (k) RENTABLE AREA OF THE PREMISES: 15,633 square feet, which Landlord and Tenant hereby conclusively agree shall be the Rentable Area of the Premises for all purposes of this Lease. (l) TERM: 84 months, beginning on the Commencement Date and ending on the Expiration Date. (m) COMMENCEMENT DATE: November 1, 1999 or as extended pursuant to Article 3.1 of this Lease. (n) EXPIRATION DATE: October 31, 2006, or as extended pursuant to Article 3.1 of this Lease. (o) SECURITY DEPOSIT: $32,347.50, subject to the provisions of Article 28.2. (p) MONTHLY RENT: [see Section 4] ($______________________________________) (q) ADDITIONAL RENT: Any amounts that this Lease requires Tenant to pay in addition to Monthly Rent. (r) RENT: Collectively, the Monthly Rent and Additional Rent. (s) TENANT'S PROPORTIONATE SHARE: 10.4744%, which is the ratio of the rentable square footage of the Premises (15,633 square feet) to the rentable square footage of the Building (149,250 rentable square feet). (t) [Intentionally omitted.] (u) [Intentionally omitted.] (v) LANDLORD'S BROKER: Jones Lang LaSalle Americas (Illinois), L.P. (w) TENANT'S BROKER: CB RICHARD ELLIS (x) PRIME RATE: The rate of interest from time to time published in the "Money Rates" section of the Wall Street Journal on the date such calculation is to be made or if not published on such date, the date of publication immediately preceding such calculation date. 2 7 (y) USE: The permitted use of the Premises shall be used for general office use. (z) LEASE YEAR: A period of twelve (12) consecutive calendar months with the first full Lease Year commencing on the Commencement Date (unless the Commencement Date is not the first day of a calendar month, in which case the first Lease Year will commence on the first day of the calendar month following the Commencement Date) and each succeeding Lease Year commencing on the anniversary of the commencement of the first Lease Year. (aa) CALENDAR YEAR: Each year in which any part of the Term falls through and including the year in which the Term expires. If any other provision of this Lease conflicts with anything set forth in this Article 1.1, such other provision will prevail. 1.2 EXHIBITS. The following exhibits are attached to this Lease and are made part hereof: Exhibit A -- Layout Of The Premises Exhibit B -- The Work Letter Exhibit C -- Commencement Date Certificate Exhibit D -- Rules and Regulations Exhibit E -- Tenant Estoppel Certificate Exhibit F -- Option to Renew Exhibit G -- Janitorial Specifications ARTICLE 2. AGREEMENT. - ---------------------- 2.1 LEASE GRANT, TERM AND USE. Landlord leases the Premises to Tenant, and Tenant leases the Premises from Landlord, pursuant to the terms and conditions of this Lease. The duration of this Lease shall be the Term. The Term shall commence on the Commencement Date and shall expire on the Expiration Date, except as may be otherwise set forth in this Lease. Landlord also grants to Tenant the rights under this Lease to use in common with Landlord and other tenants, occupants and visitors to the Building, the common areas, as hereinafter defined, including the common walkways and sidewalks of the Property, the Building lobby (but not for advertising or promotional purposes), entrances, stairs and elevators, and, if the Premises include less than an entire floor of the Building, the common lobbies, hallways and toilets and other common facilities of such floor. Landlord reserves the right to increase, reduce or change the size, layout or location of the Common Areas and facilities (as long as access to the Premises is not materially impaired). No easement, license or other right to light, air or view is created by this Lease. For the purpose of calculating the amounts due from Tenant as Rent and other charges, the First Lease Year shall include the period of time beginning on the Commencement Date to the first day of the calendar month following the Commencement Date. 2.2 TERMINATION RIGHT. Provided no Event of Default exists, and no condition exists which, with the giving of notice or the passing of time or both would result in an Event of Default, Tenant will have the right to terminate this Lease at the expiration of the fifth Lease Year. Tenant will exercise the right granted herein by delivering written notice to Landlord on or prior to February 1, 2004 exercising this termination right. Failure by Tenant to deliver such written notice within the time period stipulated herein will constitute a waiver of Tenant's right of termination. If Tenant elects to terminate this Lease as provided herein, Tenant must pay to Landlord an early termination fee in an amount equal to the sum of the following (the "TERMINATION FEE"): (i) $251,835.00 (which was calculated as the unamortized cost (as of the expiration of the fifth Lease Year) of the Work described in the Work Letter and of leasing commissions paid by Landlord in connection with this Lease, such costs being 3 8 amortized at 11% per annum over the period beginning on the Commencement Date and ending on the scheduled expiration of the initial Lease Term as set forth in Article 1.1(n)), plus any applicable sales tax, plus (ii) if Tenant has exercised its right of first offer under Article 3.3, the unamortized cost of any tenant improvement allowance or similar economic concession given to Tenant with respect to the Additional Premises and of any leasing commissions paid by Landlord in connection with the Additional Premises, such costs being amortized at 11% per annum over the period beginning on the date of the commencement of Tenant's lease of such Additional Premises and ending on the scheduled expiration of the initial Lease Term as set forth in Article 1.1(n) (as the same may have been extended under Article 3.1). Tenant must pay the entire Termination Fee at the time Tenant delivers its notice exercising its right to terminate. If the Termination Fee is not paid to Landlord when due, Tenant's right to terminate under this Article 2.2 will be deemed void and inoperable. If this Lease is terminated as provided herein, the parties agree to execute an instrument which confirms and effects a release and surrender of all right, title and interest in and to the Premises pursuant to the terms of this Lease and otherwise. ARTICLE 3. DELIVERY OF PREMISES. - --------------------------------- 3.1 DELIVERY OF POSSESSION. Landlord shall construct or install in the Premises any improvements to be constructed or installed by Landlord according to the Work Letter attached to this Lease as Exhibit B (such improvements described herein and in the Work Letter as the "Work" or "Tenant Improvements"). If Landlord is unable to deliver possession of the Premises or substantial completion of the Work is delayed due to any circumstances besides a Tenant Delay (as defined in the Work Letter), this Lease shall not be void or voidable and Landlord shall not be liable to Tenant for any resultant loss or damage; however, in such event the Commencement Date will be deferred until the Work is substantially complete and Landlord is able to deliver possession of the Premises to Tenant and the Expiration Date will be deferred for an equal amount of time. Substantial completion of the Work will include a final inspection by the City of Warrenville and the oral or written approval by such City for occupancy of the Premises. However, if the Expiration Date, as so extended, falls on other than the last day of a month, then the Expiration Date will be further extended to fall on the last day of such month. If Landlord's delay in delivering possession of the Premises or substantial completion of the Work is the result of a Tenant Delay, this Lease and Tenant's obligations hereunder shall be deemed to have become effective as of the scheduled Commencement Date, and there will be no deferral of the Commencement Date or Expiration Date. The Work shall be deemed substantially complete when the Work is completed except for Punch List items, as that term is defined in the Work Letter. Tenant and Landlord shall execute the Commencement Date Certificate attached to this Lease as Exhibit C within fifteen (15) days of Landlord's request. Tenant acknowledges that neither Landlord nor its agents or employees have made any representations or warranties as to the suitability or fitness of the Premises for the conduct of Tenant's business or for any other purpose, nor has Landlord or its agents or employees agreed to undertake any alterations or construct any tenant improvements to the Premises except as expressly provided in this Lease and the Work Letter. 3.2 EARLY ENTRY. Tenant shall have the right to enter the Premises 5 days prior to the Commencement Date for the purpose of installing fixtures, furniture, equipment and telephone systems permitted by Landlord and for any other purpose permitted by Landlord. Such entry prior to the Commencement Date shall be at Tenant's sole risk and subject to all the terms and provisions of this Lease as though the Commencement Date had occurred, except for the payment of Rent. Tenant, its agents or employees shall not interfere with or delay Landlord's completion of construction of the Tenant Improvements set forth in the Work Letter. All rights of Tenant under this Article 3.2 shall be subject to the requirements of all applicable building codes, zoning requirements, and federal, state, and local laws, rules, and regulations, so as not to interfere with Landlord's compliance with all laws, including the obtaining of a certificate of occupancy for the Premises. Landlord has the right to impose additional conditions on Tenant's early entry that Landlord, in its reasonable discretion, deems appropriate, including without limitation, an indemnification of Landlord and proof of insurance, and Landlord shall further have the right to require that Tenant execute an early entry agreement containing such conditions prior to Tenant's early entry. 3.3 RIGHT OF FIRST OFFER. During the initial Term of this Lease (but excluding the Renewal Term) and subject to the provisions set forth hereinafter and provided Tenant has not exercised its right to terminate this Lease as set forth in Article 2.2 herein, Tenant will have a continuing right of first offer to lease from Landlord all or any of the remainder of the fifth floor of the Building (the "ADDITIONAL PREMISES"). 4 9 If Tenant's Exercise Notice (defined below) is received before the end of the first Lease Year and the scheduled commencement of Tenant's lease of the Additional Premises (or such portion) occurs during the first 15 full calendar months of the Term, then Tenant's lease of such space will be on the same terms as contained in this Lease for the initial Premises, excluding the Work Letter, and except that (a) the Monthly Rent for the Additional Premises will be at a rate equal to the Monthly Rent per rentable square foot per annum then applicable to the Premises, increasing as and when the Monthly Rent increases under this Lease; and (b) Landlord will cause such space to be improved at Tenant's cost, in accordance with Landlord's then standard-form work letter for "allowance" buildouts, except that Landlord will provide an allowance (which may be applied to hard and soft construction costs only) calculated as follows: $35.00 multiplied by the number of rentable square feet in the subject portion of the Additional Premises to be leased by Tenant, divided by 84, and multiplied by the number of full calendar months in the period beginning on the date of commencement of the term of Tenant's lease of such portion of the Additional Premises through the Expiration Date. If Tenant's Exercise Notice (defined below) is received after the end of the first Lease Year or the scheduled commencement of Tenant's lease of the Additional Premises (or such portion) occurs after the first 15 full calendar months of the Term, then Tenant's lease of such space will be on the same terms as contained in this Lease for the initial Premises, excluding the Work Letter, and except that (A) the Monthly Rent for the Additional Premises will be at a rate equal to the then prevailing market rate as reasonably determined by Landlord for fully credit worthy tenants for comparable space in the Building and other first class office buildings which have comparable tenant improvements in the vicinity of the Building, for a term equal or comparable to the then-remaining initial Term of this Lease, with increases in fixed amounts based on prevailing-market Monthly Rent increases; and (B) Tenant will lease the Additional Premises in "as-is" condition, except that if in the prevailing market, as reasonably determined by Landlord, the rental rate determined in clause (A) above includes an allowance for leasehold improvements, then Landlord will grant to Tenant such prevailing market allowance (which may be applied to hard and soft construction costs only) to improve such space in accordance with Landlord's then standard-form work letter for "allowance" buildouts. The provisions of this Article will apply to all or any of the Additional Premises as all or any of the Additional Premises may become available for lease at any time from and after the date hereof, subject to any expansion and renewal options of any current tenant or tenants, their successors or assigns in the Building, and any extensions or renewals of existing leases for the Additional Premises. While Tenant's right of first offer is in effect, if Landlord sends to a prospective tenant a lease proposal for the Additional Premises, Landlord will contemporaneously deliver to Tenant a written notice stating that Landlord has delivered or is delivering such proposal to a prospective tenant, identifying the Additional Premises or portion thereof that is the subject of the proposal, and offering such space to Tenant on the terms set forth in this Section 3.3. Tenant must exercise its right of first offer by written notice to Landlord ("TENANT'S EXERCISE NOTICE") within 15 days following receipt of any such notice from Landlord. If Tenant exercises the right granted herein, Landlord and Tenant will enter into an amendment to this Lease to incorporate the respective portion of the Additional Premises and to make necessary adjustments to the Base Rental and similar provisions of this Lease. If Tenant declines to exercise its right as above provided for, or fails to deliver notice thereof within the time period stipulated above, or fails to execute the requisite amendment to this Lease, this right of first offer will lapse as to the subject proposal, and Landlord may lease the Additional Premises to the prospective tenant named in such proposal, or such prospective tenant's affiliates or designees, free of Tenant's rights under this Section but, after Landlord enters into any such lease of the Additional Premises with a third party(ies), if the subject portion of the Additional Premises again become available for lease (subject to any expansion and renewal options of any tenant or tenants at such time, their successors or assigns in the Building, and any extensions or renewals of such lease to such third party(ies) for the Additional Premises), Tenant will again have a right of first offer for the subject portion of the Additional Premises as set forth in this Section 3.3. However, if Landlord does not lease such space to such prospective tenant or its affiliates or designees, Landlord will continue to deliver to notify Tenant of Landlord's delivery of lease proposals to other prospective tenants of the Additional Premises, and Tenant's rights under this Section 3.3 will continue. The foregoing right of first offer may not be severed from this Lease or separately sold, assigned or transferred and is subject to the following additional conditions, namely: (a) that no less than 24 months remain on the current Term; (b) that the Term for any Additional Premises will run concurrently with this Lease; (c) that, at the time that Tenant exercises this right of first offer for any Additional Premises, no Event of Default exists, and no condition exists which, with the giving of notice or the passage of time, or both, would constitute an Event of 5 10 Default; (d) that, at the time Tenant exercises this right of first offer, Tenant occupies and is in possession of the Premises and has not assigned the Lease or sublet the Premises; and (e) that Tenant enters into an amendment to this Lease to incorporate the Additional Premises and make corresponding modifications to the provisions of this Lease. ARTICLE 4. MONTHLY RENT. - ------------------------- 4.1 MONTHLY RENT. Throughout the Term, and any renewal term which may be duly exercised by Tenant, Tenant shall pay Monthly Rent to Landlord in the amounts and for the time periods described as follows:
PERIOD ANNUAL MONTHLY RENT MONTHLY INSTALLMENTS ------ ------------------- -------------------- Commencement Date through the last day $265,761.00 $22,146.75 of the first Lease Year ($17.00 x 15,633 rsf / 12) First day of the second Lease Year $273,733.80 $22,811.15 through the last day of the second ($17.51 x 15,633 rsf / 12) Lease Year First day of the third Lease Year $282,019.32 $23,501.61 through the last day of the third ($18.04 x 15,633 rsf / 12) Lease Year First day of the fourth Lease Year $290,461.20 $24,205.10 through the last day of the fourth ($18.58 x 15,633 rsf / 12) Lease Year First day of the fifth Lease Year $299,059.32 $24,921.61 through the last day of the fifth ($19.13 x 15,633 rsf / 12) Lease Year First day of the sixth Lease Year $308,126.40 $25,677.20 through the last day of the sixth ($19.71 x 15,633 rsf / 12) Lease Year First day of the seventh Lease Year $317,349.96 $26,445.83 through the last day of the Lease Term ($20.30 x 15,633 rsf / 12)
Monthly Rent shall be paid in advance on or before the first day of each calendar month of the Term, and shall be accompanied by any applicable rent, sales, use or other tax which is based on the amount and/or payment of Rent payable pursuant to this Lease. If the Term commences on a day other than the first day of a calendar month or ends on a day other than the last day of a calendar month, then Monthly Rent will be appropriately prorated based on the actual number of calendar days in such month. If the Term commences on a day other than the first day of a calendar month, then the prorated Monthly Rent for such month will be paid on or before the first day of the Term. Monthly Rent shall be paid to Landlord, without written notice or demand and without deduction or offset (except as may be otherwise expressly provided in this Lease), as an independent covenant of Tenant, in lawful money of the United States of America at Landlord's address set forth in Article 1.1 herein or to such other address as Landlord may from time to time designate in writing. After the service of more than one notice on Tenant for overdue Rent or if more than one check is returned unpaid during any twelve month period during the Term, then Rent for the remainder of the Term shall be paid by cashier's check. 4.2 If Tenant fails to pay any Rent when due, the unpaid amounts will be subject to a late payment charge equal to three percent (3%) of the unpaid amounts. This late payment charge is intended to compensate Landlord for its additional administrative costs resulting from Tenant's failure, and has been agreed upon by Landlord and Tenant as a reasonable estimate of the additional administrative costs that will be incurred by Landlord as a result of Tenant's failure. The actual cost in each instance is extremely difficult, if not impossible, to determine. This late payment charge will constitute liquidated damages and will be paid to Landlord together with such unpaid amounts and interest pursuant to Article 28.34. The payment of this late payment charge will not constitute a waiver by Landlord of any default by Tenant under this Lease. 6 11 ARTICLE 5. OPERATING EXPENSES. - ------------------------------- 5.1 GENERAL. (a) In addition to Monthly Rent, beginning on the Commencement Date, Tenant shall pay Tenant's Proportionate Share of the Operating Expenses of the Project defined below, paid, payable or incurred by Landlord in each calendar year or partial calendar year during the Term. If Operating Expenses are calculated for a partial calendar year, an appropriate proration shall be made. (b) As used in this Lease, the term "Operating Expenses" means: (1) All costs of management, operation, and maintenance of the Project, including without limitation real and personal property taxes and assessments (and any tax levied in whole or in part in lieu of or in addition to real property taxes); wages, salaries, and compensation of employees engaged in the repair, operation, maintenance, leasing (but excluding third party leasing commissions), or security of the Project; consulting, accounting, legal, janitorial, maintenance, guard, and other services; management fees and costs (charged by Landlord, any affiliate of Landlord, or any other entity managing the Project and determined at a rate consistent with prevailing market rates for comparable services and Projects); that part of office rent or rental value of space in the Project used or furnished by Landlord to enhance, manage, operate, and maintain the Project; electricity, water, waste disposal, and other utilities; materials and supplies; maintenance and repairs; insurance obtained with respect to the Project; depreciation on personal property and equipment, except as set forth in Article 5.1(c), below, which is or should be capitalized on the books of Landlord; and any other costs, charges, and expenses that under generally accepted accounting principles would be regarded as management, maintenance, and/or Operating Expenses; and (2) The cost (amortized on a straight line basis over the reasonable useful life as determined by Landlord) together with interest at the lesser of the Prime Rate plus two percent (2%) or Landlord's borrowing rate for such capital improvements (including the rental of equipment which would be a substitute for a capital expense that the Landlord would otherwise incur), on the unamortized balance of any capital improvements that are made to the Project by Landlord (i) for the purpose of reducing Operating Expenses, or (ii) required under any law or regulation that was not applicable to the Project at or prior to the Commencement Date. (c) The Operating Expenses will not include: (1) depreciation on the Project (other than depreciation on personal property, equipment, window coverings on exterior windows provided by Landlord and carpeting and wall covering in public corridors and Common Areas); (2) advertising costs, finders' fees and real estate brokers' commissions; (3) ground lease or mortgage payments; (4) costs of replacements to personal property and equipment for which depreciation costs are included as an operating expense; (5) the cost of repairs due to casualty or condemnation that are reimbursed by third parties; (6) any income, estate, inheritance, or other land transfer or mortgage tax and any excess profit, franchise, or similar taxes on Landlord's business provided, however, that if a tax or excise on Rent or other amounts payable by Tenant to Landlord is levied or assessed against Landlord on account of Rent, such tax shall not be excluded from Operating Expenses; (7) The cost of correcting defects in construction of the Building or in the Building systems or equipment (as opposed to the cost of normal repair, materials and equipment installed in the Building in light of their specifications); (8) All expenses for which Landlord has received any reimbursement to the extent of such reimbursement including, without limitation, reimbursements from Tenant or other tenant (such as reimbursement for repairs) or pursuant to contractor's or other warranties or condemnation, but excluding matters paid as additional rent or rent adjustment or other tax or expense pass-through or escalation expressly provided for in a tenant lease; (9) Any interest or penalty charges or attorneys' fees incurred by Landlord due to the violation of any law or failure to pay obligations of the Landlord before they become delinquent (whether or not the payment of such obligations is reimbursed through Operating Expenses); 7 12 (10) Costs (including, without limitation, permit, license and inspection fees) of any alterations, renovations or improvements of, or decorating in, the Premises or any other tenant's premises in the Building; (11) Expenses incurred in connection with services (including special service from Landlord's employees) or other benefits of a type which are not available or provided to Tenant (regardless of whether Landlord is prepared to perform such services for Tenant) but which are available to or provided to another tenant or occupant of the Building; (12) Attorneys' fees, costs and disbursements and other expenses incurred in connection with any matters related to Landlord which are not related to the maintenance, operation or repairing of the Project including, without limitation, any matter related to (i) the formation and continued existence of Landlord, (ii) any loans to Landlord relating to the Building, (iii) tenant leases, including, without limitation, negotiations with prospective tenants or disputes with or enforcement actions against any tenant, and (iv) the defense of Landlord's title to or interest in the Building; (13) The cost of any repairs, alterations, additions, charges, replacements and other items not specifically permitted to be included under this Article 5 and which, under generally accepted accounting principles, are properly classified as capital expenditures; (14) Any on-site management or other fees paid to an agent which is related to Landlord to the extent such fees are in excess of the then current market rate for customary management fees for projects similar to the Building; (15) Payments in respect of profit to parties related to Landlord for supplies or materials to the extent that the cost of such supplies or materials exceeds the cost that would have been paid had such supplies or materials been provided by parties unaffiliated with the Landlord on a competitive basis; and (16) Costs incurred by Landlord in connection with the removal, abatement, containment or remediation of asbestos, asbestos containing material, volatile organic compounds or other hazardous materials (if and to the extent that such other hazardous materials are classified as such under applicable hazardous materials laws as in effect as of the date of this Lease) from or with respect to the Project. 5.2 ESTIMATED PAYMENTS. During each calendar year or partial calendar year in the Term beginning as of the Commencement Date, in addition to Monthly Rent, Tenant shall pay to Landlord on the first day of each month an amount equal to 1/12 of the product of Tenant's Proportionate Share multiplied by the Estimated Operating Expenses, defined below, for such calendar year. Estimated Operating Expenses for any calendar year means Landlord's reasonable estimate of Operating Expenses for such calendar year and will be subject to revision according to the further provisions of this Article 5.2 and Article 5.3. During any partial calendar year during the Term, Estimated Operating Expenses will be estimated on a full-year basis. During each December during the Term, or as soon after each December as practicable, Landlord will give Tenant written notice of Estimated Operating Expenses for the ensuing calendar year. On or before the first day of each month during the ensuing calendar year (or each month of the Term, if a partial calendar year), Tenant shall pay to Landlord 1/12 of the product of Tenant's Proportionate Share multiplied by the Estimated Operating Expenses for such calendar year; however, if such written notice is not given in December, Tenant shall continue to make monthly payments on the basis of the prior year's Estimated Operating Expenses until the month after such written notice is given, at which time Tenant shall commence making monthly payments based upon the revised Estimated Operating Expenses. In the month Tenant first makes a payment based upon the revised Estimated Operating Expenses, Tenant shall pay to Landlord for each month which has elapsed since December the difference between the amount payable based upon the revised Estimated Operating Expenses and the amount payable based upon the prior year's Estimated Operating Expenses. If at any time or times it reasonably appears to Landlord that the actual Operating Expenses for any calendar year will vary from the Estimated Operating Expenses for such calendar year, Landlord may, by written notice to Tenant, revise the Estimated Operating Expenses for such calendar year, and subsequent payments by Tenant in such calendar year will be based upon such revised Estimated Operating Expenses. 5.3 ANNUAL SETTLEMENT. Within one hundred twenty (120) days after the end of each calendar year during the Term or as soon after such one hundred twenty (120-day) period as practicable, Landlord shall deliver to Tenant a statement of amounts payable under Article 5.1 for such calendar year prepared and certified by Landlord 8 13 or its agents. Such certified statement shall be final and binding upon Tenant unless Tenant objects to it in writing to Landlord within thirty (30) days after it is given to Tenant. If such statement shows an amount owing by Tenant that is less than the estimated payments previously made by Tenant for such calendar year, the excess shall be held by Landlord and credited against the next payment of Rent; however, if the Term has ended and Tenant was not in default at its end, Landlord shall refund the excess to Tenant. If such statement shows an amount owing by Tenant that is more than the estimated payments previously made by Tenant for such calendar year, Tenant shall pay the deficiency to Landlord within thirty (30) days after the delivery of such statement. Provided no Event of Default exists under this Lease, Tenant shall have ninety (90) days after receipt of the statement to have an independent certified public accountant which is either (i) a "big-six" accounting firm or (ii) is not working for Tenant on a contingency fee basis, complete an audit of Landlord's books and records on Operating Expenses, during normal business hours upon reasonable advance written notice at Landlord's local office. Tenant shall deliver to Landlord a copy of the results of such audit within ten (10) days of receipt by Tenant. The cost of such audit will be borne solely by Tenant unless, in connection with the audit, it is demonstrated that Landlord overstated Operating Expenses by 5% or more in the aggregate (after netting any understated line items against overstated line items), in which case Landlord will bear the reasonable cost of such audit. 5.4 FINAL PRORATION. If the Term ends on a day other than the last day of a calendar year, the amount of increase (if any) in the Operating Expenses payable by Tenant applicable to the calendar year in which this Lease ends shall be calculated on the basis of the number of days of the Term falling within such calendar year, and Tenant's obligation to pay any increase, or Landlord's obligation to refund any overage, shall survive the expiration or other termination of this Lease. 5.5 OCCUPANCY VARIANCE. Operating Expenses which vary with occupancy and are attributable to any part of the Term in which less than 95% of the rentable area of the Building is occupied by tenants shall be adjusted by Landlord proportionally to the amount that they would have been if 95% of the rentable area of the Building had been occupied. 5.6 OTHER TAXES. (a) Tenant shall reimburse Landlord within 30 days after demand for any and all taxes payable by Landlord (other than as set forth in Article 5.6(b) below), whether or not now customary or within the contemplation of Landlord and Tenant: (1) upon or measured by rent, including without limitation, any gross revenue tax, excise tax, or value added tax levied by the federal government or any other governmental body with respect to the receipt of rent; (2) upon this transaction or any document to which Tenant is a party creating or transferring an interest or an estate in the Premises; and (3) upon a reassessment of the Project or Building by a taxing authority having jurisdiction over the same. (b) Tenant will not be obligated to pay any inheritance tax, gift tax, transfer tax, franchise tax, income tax (based on net income), profit tax, or capital levy imposed upon Landlord; provided, however, that Tenant shall pay any tax or excise on Rent or other amounts payable by Tenant to Landlord levied or assessed against Landlord on account of Rent. (c) Tenant shall pay promptly when due all personal property taxes on Tenant's personal property in the Premises and any other taxes payable by Tenant that if not paid might give rise to a lien on the Premises or Tenant's interest in the Premises. 5.7 ADDITIONAL RENT. Amounts payable by Tenant pursuant to this Article 5 shall be payable as Rent, without deduction or offset (except as may be otherwise expressly provided in this Lease). If Tenant fails to pay any amounts due according to this Article 5, Landlord shall have all the rights and remedies available to it under this Lease and/or applicable law. 9 14 ARTICLE 6. INSURANCE. - ---------------------- 6.1 LANDLORD'S INSURANCE. At all times during the Term, Landlord shall procure and keep in full force and effect the following insurance: (a) All-risk Property Insurance insuring the Building, its equipment, common area furnishings, and the Tenant Improvements (as that term is defined in the Work Letter) at full replacement cost (excluding foundations), with such deductibles as Landlord considers appropriate; (b) Commercial General Liability Insurance insuring its interest in the Project in such amounts as Landlord deems reasonably appropriate for the Project in the geographical area in which it is located; (c) Such other insurance as Landlord reasonably determines from time to time and is commercially reasonable and customary for the Project in the geographical area in which it is located. 6.2 TENANT'S INSURANCE. Tenant shall, at its sole cost and expense, keep in full force and effect the following insurance: (i) All-Risk Property Insurance on "Tenant's Property" for the full replacement value. Such policy shall contain an Agreed Amount endorsement in lieu of a coinsurance clause. "Tenant's Property" is defined to be all improvements, betterments and personal property of Tenant located in or on the Premises, Common Areas or Building, excluding that which is insured by Landlord's all-risk Property Insurance, as set forth in Article 6.1(a) herein. (ii) Commercial General Liability Insurance insuring Tenant against any liability arising out of its use, occupancy or maintenance of the Premises or the business operated by Tenant pursuant to the Lease. Such insurance shall be in the amount of at least $2,000,000 per occurrence. Such policy shall name Landlord, Landlord's wholly owned subsidiaries and agents and any Mortgagees of Landlord as additional insureds. (iii) Workers' Compensation insurance as required by state law. (iv) Any other form or forms of insurance or increased amounts of insurance as Landlord or any Mortgagees of Landlord may reasonably require from time to time. All such policies shall be written in a form and with an insurance company satisfactory to Landlord and any mortgagees of Landlord, and shall provide that Landlord, and any mortgagees of Landlord, receive not less than thirty (30) days prior written notice of any cancellation. Prior to or at the time that Tenant takes possession of the Premises, Tenant shall deliver to Landlord copies of policies or certificates evidencing the existence of the amounts and forms of coverage satisfactory to Landlord. Tenant shall, within ten (10) days prior to the expiration of such policies, furnish Landlord with renewals or "binders" thereof, or Landlord may order such insurance and charge the cost thereof to Tenant as Additional Rent. 6.3 FORMS OF POLICIES. All policies maintained by Tenant will provide that they may not be terminated nor may coverage be reduced except after thirty (30) days' prior written notice to Landlord. All Commercial General Liability and All-Risk property policies maintained by Tenant shall be written as primary policies, not contributing with and not supplemental to the coverage that Landlord may carry. 6.4 WAIVER OF SUBROGATION. Notwithstanding that any loss or damage may be due to or result from the negligence of either of the parties hereto, Landlord and Tenant, for themselves and their respective insurers, each waive any and all rights to recover against the other, against any subsidiary or joint venture of such other party or against any other occupant of the Project, or against the officers, directors, shareholders, partners, joint ventures, employees, agents, customers, invitees, or business visitors of such other party or of such other tenant or occupant of the Project, for any loss or damage to the property of such such waiving party arising from any cause. 6.5 ADEQUACY OF COVERAGE. Landlord, its agents and employees make no representation that the limits of liability specified to be carried by Tenant pursuant to this Article 6, are adequate to protect Tenant. If Tenant believes that any of such insurance coverage is inadequate, Tenant will obtain such additional insurance coverage as Tenant deems adequate, at Tenant's sole expense. 10 15 6.6 CERTAIN INSURANCE RISKS. Tenant shall not do or permit to be done any act or thing upon the Premises or the Project which would (a) jeopardize or be in conflict with fire insurance policies covering the Project or fixtures and property in the Project; (b) increase the rate of fire insurance applicable to the Project to an amount higher than it otherwise would be for general office use of the Project; or (c) subject Landlord to any liability or responsibility for injury to any person or persons or to property by reason of any business or operation being carried on upon the Premises. ARTICLE 7. USE. - ---------------- The Premises shall be used only for the purposes designated in Article 1.1(y) and purposes incidental to that use, and for no other purpose without the prior written consent of Landlord, which consent shall not be unreasonably withheld or delayed. Tenant shall use the Premises in a careful, safe, and proper manner. Tenant shall not use or permit the Premises to be used or occupied for any purpose or in any manner prohibited by any applicable laws, for the use or purposes of demonstrations or picketing, or for any improper, immoral, unlawful, pornographic, sexually explicit, or objectionable use or purpose. Tenant shall not cause, maintain, or permit any nuisance in, on, or about the Premises. Tenant shall not commit waste or suffer or permit waste to be committed in, on, or about the Premises. Tenant shall conduct its business and control its employees, and agents in such a manner as not to create any nuisance or interfere with, annoy, or disturb any other Tenant or occupant of the Project or Landlord in its operation of the Project. ARTICLE 8. COMPLIANCE WITH LAWS. - --------------------------------- Tenant, at its sole cost and expense, shall promptly comply with all laws, including building and zoning laws, the ADA, statutes, ordinances, and governmental rules and regulations with respect, related or applicable to Tenant's use or occupancy of the Premises. Tenant shall also comply with the requirements of any board of fire underwriters or other similar body constituted after the Lease Date, with any direction or occupancy certificate issued pursuant to any law by any public officer or officers, and with the provisions of all recorded documents affecting the Premises, insofar as they relate to the condition, use, or occupancy of the Premises, or improvements or alterations made by or for the Tenant after the Lease Date, excluding requirements of structural changes to the Premises or the Building, unless required by negligence or willful acts of the Tenant or by the unique nature of Tenant's use or occupancy of the Premises. Landlord represents and warrants to Tenant that as of the date of this Lease, Landlord has received no written notice from any governmental entity that the Project is in violation of any law applicable to the Project, which violation has not been corrected to the satisfaction of the governmental entity giving such notice. ARTICLE 9. HAZARDOUS MATERIALS. - -------------------------------- (a) For purposes of this Lease, "hazardous materials" means any explosives, radioactive materials, petroleum products, hazardous wastes, or hazardous substances, including without limitation substances defined as "hazardous substances" in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601-9657; the Hazardous Materials Transportation Act of 1975, 49 U.S.C. Section 1801-1812; the Resource Conservation and Recovery Act of 1976, 42 U.S.C. Section 6901-6987; or any other federal, state, or local statute, law, ordinance, code, rule, regulation, order, or decree regulating, relating to, or imposing liability or standards of conduct concerning hazardous materials, waste, or substances now or at any time hereafter in effect (collectively, "hazardous materials laws"). (b) Tenant shall not cause or permit the storage, use, generation, or disposition of any hazardous materials in, on, or about the Premises or the Project by Tenant, its agents, employees, or contractors or invitees except to use in the ordinary course of Tenant's business in customary quantities for office tenants and in compliance with hazardous materials laws. Tenant shall not permit the Premises to be used or operated in a manner that may cause the Premises or the Project to be contaminated by any hazardous materials in violation of any hazardous materials laws or result in the diminution of the value of the Building or Project or degradation of structural materials of the Premises. Tenant shall immediately advise Landlord in writing of (1) any and all 11 16 enforcement, cleanup, remedial, removal, or other governmental or regulatory actions instituted, completed, or threatened pursuant to any hazardous materials laws relating to any hazardous materials affecting the Premises; and (2) all claims made or threatened by any third party against Tenant, Landlord, or the Premises relating to damage, contribution, cost recovery, compensation, loss, or injury resulting from any hazardous materials on or about the Premises. Without Landlord's prior written consent, Tenant shall not take any remedial action or enter into any agreements or settlements in response to the presence of any hazardous materials in, on, or about the Premises. (c) Tenant shall be solely responsible for and will defend, indemnify and hold Landlord, its agents, and employees harmless from and against all claims, costs, and liabilities, including attorneys' fees and costs, arising out of or in connection with Tenant's breach of its obligations in this Article 9. Tenant will be solely responsible for and will defend, indemnify, and hold Landlord, its agents, and employees harmless from and against any and all claims, costs, and liabilities, including attorneys' fees and costs, arising out of or in connection with the removal, cleanup, and restoration work and materials necessary to return the Premises and any other property of whatever nature located on the Project to their condition existing prior to the default. Tenant's obligations under this Article 9 will survive the expiration or other termination of this Lease. ARTICLE 10. ASSIGNMENT AND SUBLETTING. - --------------------------------------- 10.1 GENERAL. Tenant, for itself, its heirs, distributees, executors, administrators, legal representatives, successors, and assigns, covenants that it shall not assign, mortgage, or encumber this Lease, nor sublease, nor permit the Premises or any part of the Premises to be used or occupied by others, without the prior written consent of Landlord in each instance, which consent shall not be unreasonably withheld or delayed. Any assignment or sublease in violation of this Article 10 will be void. If this Lease is assigned, or if the Premises or any part of the Premises are subleased or occupied by anyone other than Tenant, Landlord may, after default by Tenant, collect rent from the assignee, subtenant, or occupant, and apply the net amount collected to Rent. No assignment, sublease, occupancy, or collection shall be deemed (a) a waiver of the provisions of this Article 10; (b) the acceptance of the assignee, subtenant, or occupant as Tenant; or (c) a release of Tenant from the further performance by Tenant of covenants on the part of Tenant contained in this Lease including, without limitation, the covenant to pay Rent. The consent by Landlord to an assignment or sublease will not be construed to relieve Tenant from obtaining Landlord's prior written consent in writing to any further assignment or sublease. No assignment or subletting shall relieve Tenant from its obligations hereunder, and Tenant shall continue to be liable as a principal and not as a guarantor or surety to the same extent as though no assignment or sublease has been made. No permitted subtenant may assign or encumber its sublease or further sublease all or any portion of its subleased space, or otherwise permit the subleased space or any part of its subleased space to be used or occupied by others, without Landlord's prior written consent in each instance. Notwithstanding anything to the contrary contained herein, Landlord may withhold consent to a sublease or assignment unless Landlord is provided with waivers from any brokers involved in such subleasing or assignment of all lien rights of any such brokers under Illinois law, including but not limited to the Commercial Real Estate Broker Lien Act. Landlord also may withhold consent to a sublease or assignment if the proposed assignee or sublessee or its business is subject to compliance with additional requirements of the ADA, including related regulations as hereinafter defined, beyond those requirements which are applicable to Tenant unless Tenant, its assignee or subtenant at Landlord's request agree to make such alterations to the Premises and the Project that may be necessary in order to comply with the ADA as it applies to the use, occupancy, or alteration of the Premises, and to deposit with Landlord 100% of Landlord's reasonable estimate of the cost of such alterations. Notwithstanding anything in this Lease to the contrary, Tenant shall not assign this Lease or sublet all or any part of the Premises to a proposed assignee or sublessee whose use, occupancy, or tenancy of the Premises is prohibited by the terms of a lease between Landlord and any other tenant in: (i) the Building or (ii) any other building owned, developed, or constructed by or at the direction of Landlord on land adjacent to the Project. ("Prohibited Tenant.") Prohibited Tenant shall include, but not be limited to, BURGER KING, CHECKERS, HARDEE'S, WHITE CASTLE, WENDY'S, CARL'S JUNIOR, JACK IN THE BOX, AND RALLY'S. 10.2 RECAPTURE. Landlord shall have the additional right to terminate this Lease as to that portion of the Premises which the Tenant seeks to assign, or in the case of a sublease, to suspend this Lease as to that portion of the Premises and for that portion of the Term which the Tenant seeks to sublet. The Landlord may exercise such right to terminate or suspend by giving written notice to Tenant at any time on or before the date by which the Landlord notifies Tenant whether it consents to a proposed assignment or sublease. If the Landlord exercises such right to terminate or suspend, such termination or suspension shall become effective on the date set forth in the Landlord's written notice, which shall in no event be sooner than fifteen (15) days prior to, or later than fifteen (15) 12 17 days following, the effective date of the proposed assignment or sublease as set forth in the Tenant's request for the Landlord's consent; provided that if the Tenant has failed to request such consent, then the effective date of any termination or suspension by the Landlord pursuant to this Article 10.2 shall be on any date specified by the Landlord which is reasonably determined to be the date which would have been necessary to get the space ready for possession by the Tenant's proposed subtenant or assignee. Upon any termination of this Lease pursuant to this Article 10.2, whether with respect to all or any portion of the Premises, Tenant shall have no further obligation under this Lease with respect to all or such portion of the Premises, as the case may be, for the period following the termination; provided that the Tenant shall remain liable to the Landlord for obligations which arose prior to the termination. Upon any suspension of this Lease pursuant to this Article 10.2, whether with respect to all or any portion of the Premises, Tenant shall have no obligations to Landlord with respect to all or such portion of the Premises, as the case may be, for the period of such suspension but shall remain liable for all obligations which arose prior to the effective date of the suspension, and shall again become liable for all obligations arising after the expiration of the suspension. Notwithstanding the foregoing, if Landlord shall exercise its right to terminate or suspend this Lease by giving written notice pursuant to this Article 10.2, the Tenant may rescind its request for an assignment, or subletting, by giving the Landlord written notice of such decision within fifteen (15) days of the Landlord's written notice of termination or suspension, and upon such rescission the termination or suspension of this Lease by the Landlord shall be null and void. The recapture right set forth in this Article 10.2 will not apply to any sublease that will, by its terms, (i) expire at least 12 months before the expiration of the Lease Term, with the subtenant having no right to renew or extend the sublease term into such 12-month period, AND (ii) grant to the subtenant the right to use no more than 3,500 rentable square feet. Prior to seeking Landlord's consent to a specific sublease or assignment, Tenant may elect to notify Landlord of Tenant's intention to sublease a portion of the Premises or to assign this Lease, and to request Landlord to state whether Landlord would exercise its right of recapture in connection therewith. Tenant's notice need not be accompanied by a copy of the sublease or assignment, but must contain in reasonable detail the name of the proposed subtenant or assignee, a description of the space to be subleased (including the number of rentable square feet and a depiction), the proposed commencement and expiration dates of the sublease or the commencement of the assignment, a summary of the key economic terms and any material nonmonetary terms of the proposed transaction, and must request Landlord to notify Tenant whether Landlord will exercise its recapture right under this Section 10.2 in connection therewith. If Landlord receives such a notice, Landlord will notify Tenant whether Landlord elects to exercise its recapture right under this Section 10.2 with respect to such proposal. If Tenant's notice (requesting Landlord's notice of whether Landlord will exercise its recapture right) contains the following phrase in bold capital letters, then Landlord's right to exercise its recapture right with respect to such proposal will expire at the end of the 15th day after Landlord's receipt of such notice if it is not exercised within such time: "LANDLORD'S FAILURE TO EXERCISE ITS RECAPTURE RIGHT WITHIN 15 DAYS AFTER RECEIPT OF THIS NOTICE WILL RESULT IN EXPIRATION OF SUCH RECAPTURE RIGHT, AS SET FORTH IN SECTION 10.2 OF THE LEASE." If Landlord notifies Tenant that Landlord elects to recapture, then Tenant may, within 15 days after Landlord's notice, notify Landlord that Tenant elects not to proceed with the subject sublease or assignment and desires to keep this Lease in full force and effect, in which case Landlord's exercise of its recapture right will be rescinded. If, in response to Tenant's initial notice, Landlord notifies Tenant that Landlord elects not to recapture, then if Landlord receives from Tenant within 90 days after Landlord's notice of election a written request for Landlord's consent to a sublease or assignment conforming in all material respects (including, without limitation, commencement and expiration dates) to the proposal with respect to which Landlord elected not to recapture, then Landlord will not exercise its recapture right with respect to such sublease or assignment. Landlord's election not to recapture will not constitute Landlord's consent to the proposed transaction. 10.3 SUBMISSION OF INFORMATION. If Tenant requests Landlord's consent to a specific assignment or subletting, Tenant shall submit in writing to Landlord at least thirty (30) business days prior to the effective date of the proposed assignment or sublease (a) the name and address of the proposed assignee or subtenant; (b) the business terms of the proposed assignment or sublease; (c) reasonably satisfactory information as to the nature and character of the business of the proposed assignee or subtenant, and as to the nature of its proposed use of the space; (d) banking, financial, or other credit information reasonably sufficient to enable Landlord to determine the financial responsibility and character of the proposed assignee or subtenant; (e) the proposed form of assignment or sublease for Landlord's reasonable approval and any other information which Landlord may reasonably deem relevant. 13 18 10.4 PAYMENTS TO LANDLORD. If Landlord consents to a proposed assignment or sublease, then Landlord shall have the right to require Tenant to pay to Landlord (I) 50% of the total amount of (a) any rent or other consideration paid to Tenant by any proposed transferee that (after deducting the costs of Tenant, if any, in effecting the assignment or sublease, including reasonable alterations costs, commissions and legal fees) is in excess of the Rent allocable to the transferred space then being paid by Tenant to Landlord pursuant to this Lease; and (b) any other profit or gain (after deducting any necessary expenses incurred) realized by Tenant from any such sublease or assignment; plus (II) 100% of Landlord's reasonable attorneys' fees and costs incurred in connection with negotiation, review, and processing of the transfer. All such sums payable will be payable to Landlord at the time the next payment of Monthly Rent is due. 10.5 PROHIBITED TRANSFERS. The transfer of a majority of the issued and outstanding capital stock of any corporate tenant or subtenant of this Lease, or a majority of the total interest in any partnership tenant or subtenant, however accomplished, and whether in a single transaction or in a series of related or unrelated transactions, will be deemed an assignment of this Lease or of such sublease requiring Landlord's consent in each instance. For purposes of this Article 10, the transfer of outstanding capital stock of any corporate tenant will not include any sale of such stock by persons other than those deemed "insiders" within the meaning of the Securities Exchange Act of 1934, as amended, effected through the "over-the-counter market" or through any recognized stock exchange. 10.6 PERMITTED TRANSFER. Notwithstanding anything to the contrary contained in this Article, Landlord's consent shall not be required for an assignment or other transfer of Tenant's interest under this Lease or a sublease of the entire Premises to an affiliate of Tenant or to an entity resulting from a merger with Tenant or to an entity purchasing substantially all of the assets or capital stock of Tenant provided that (i) Tenant shall notify Landlord in writing of the proposed transaction and the identity of the proposed assignee or sublessee, (ii) at the time of such proposed assignment, transfer or sublease, Tenant shall not be in default of any of the terms of this Lease, (iii) any proposed assignee or transferee shall agree in a writing reasonably acceptable to Landlord that it will assume and be bound by the terms of this Lease, (iv) there shall be no change in use of the Premises, (v) any proposed assignee or transferee shall have a net worth no less than the net worth of Tenant as of the date of execution of this Lease, and (vi) that Tenant agrees to make such alterations to the Premises and the Project that may be necessary in order to comply with the ADA as it applies to the use, occupancy, or alteration of the Premises by the assignee or subtenant. As used herein, an "affiliate" shall mean an entity which directly or indirectly controls or is controlled by or is under common control with Tenant. "Controls," "controlled by" or "under common control" means with regard to a corporation ownership of at least 50% of the issued and outstanding stock or with regard to a corporation and any other entity, ownership of at least 50% of the equity, interests, voting or other decision making power. 10.7 CONDITION. It is an express condition of any permitted assignment or sublease that Tenant not be in default of any of the terms of this Lease at the time Tenant provides Landlord its request for written consent to such assignment or sublease. 10.8 REMEDIES. If Tenant believes that Landlord has unreasonably withheld or delayed its consent pursuant to this Article 10, Tenant's sole remedy will be to seek a declaratory judgment that Landlord has unreasonably withheld or delayed its consent or an order of specific performance or mandatory injunction of the Landlord's agreement to not unreasonably withhold or delay its consent. ARTICLE 11. RULES AND REGULATIONS. - ----------------------------------- Tenant and its employees, agents, licensees, and visitors shall at all times observe faithfully, and comply strictly with, the Rules and Regulations set forth in Exhibit D. Landlord may from time to time reasonably amend, delete, or modify existing rules and regulations, or adopt reasonable new rules and regulations for the use, safety, cleanliness, and care of the Premises, the Building, and the Project, and the comfort, quiet, and convenience of occupants of the Project. Modifications or additions to the Rules and Regulations will be effective upon thirty (30) days' prior written notice to Tenant from Landlord. In the event of any breach of any of the Rules or Regulations or any amendments or additions thereto, Landlord shall have all remedies that this Lease provides for default by Tenant, and shall in addition have any remedies available at law or in equity, including the right to enjoin any breach of such Rules and Regulations. Landlord shall not be liable to Tenant for violation of such Rules and Regulations by any other person. In the event of any conflict between the provisions of this Lease and the Rules and Regulations, the provisions of this Lease shall govern. 14 19 ARTICLE 12. COMMON AREAS. - -------------------------- As used in this Lease, the term "Common Areas" means, without limitation, the above ground parking area, hallways, entryways, stairs, elevators, driveways, walkways, terraces, docks, loading areas, restrooms, trash facilities, and all other areas and facilities in the Project that are provided and designated from time to time by Landlord for the general nonexclusive use and convenience of Tenant with Landlord and their guests, invitees, employees, licensees, or visitors. Without advance written notice to Tenant, except with respect to matters covered by Article 12(a) below, and without any liability to Tenant in any respect, provided Landlord will take no action permitted under Article 12(a) in such a manner as to materially impair or adversely affect Tenant's substantial benefit and enjoyment of the Premises, Landlord will have the right to: (a) Close off any of the Common Areas to whatever extent required in the reasonable opinion of Landlord to prevent a dedication of any of the Common Areas or the accrual of any rights by any person or the public to the Common Areas; (b) Temporarily close any of the Common Areas for maintenance, alteration, or improvement purposes; and (c) Subject to the provisions of Article 27, change the size, use, shape, or nature of any such Common Areas, including erecting additional Buildings on the Common Areas, expanding the Building or other Buildings to cover a portion of the Common Areas, converting Common Areas to a portion of the Building or other Buildings, altering the Common Areas in order to comply with the ADA, or converting any portion of the Building (excluding the Premises) or other Buildings to Common Areas. Upon erection of any additional Buildings or change in Common Areas, the portion of the Project upon which Buildings or structures have been erected shall no longer be deemed to be a part of the Common Areas. ARTICLE 13. LANDLORD'S SERVICES. - --------------------------------- 13.1 LANDLORD'S REPAIR AND MAINTENANCE. Landlord shall maintain and repair the Common Areas of the Project, including lobbies, stairs, elevators, corridors, and restrooms, the windows in the Building, the mechanical, plumbing and electrical equipment serving the Building, and the structural elements of the Building in reasonably good order and condition, the cost of which is included in Operating Expenses. 13.2 LANDLORD'S OTHER SERVICES. (a) Landlord shall furnish the Premises with those services customarily provided in comparable office buildings in the vicinity of the Project, including without limitation (1) heat and air conditioning reasonably required for the comfortable occupation of the Premises during business hours; (2) access and elevator service; (3) lighting replacement during business hours (for Building standard lights, but not for any special Tenant lights, which will be replaced at Tenant's sole cost and expense); (4) restroom supplies; (5) window washing with reasonable frequency, as determined by Landlord; and (6) cleaning service five (5) days per week in accordance with the cleaning specifications attached hereto as Exhibit G. Landlord may, but will not be obligated to provide, any such services (except access and elevator service) on holidays. Landlord shall not provide electricity for lighting, receptables and outlets or incidental uses in the Premises which shall be separately metered to Tenant. Tenant, at its sole cost and expense, shall make all necessary arrangements with the utility company for the provision of electric service and shall pay for electric current furnished by it to Tenant and Tenant shall pay for all charges for electric current consumed on the Premises during Tenant's occupancy thereof. Landlord will cause the initial Premises to be separately metered for electricity, and will bear the cost of such meter and the installation thereof. (b) Tenant will have the right to purchase for use during business hours and non-business hours the services described in Article 13.2(a)(1) and (2) in excess of the amounts Landlord has agreed to furnish so long as 15 20 (1) Tenant gives Landlord reasonable prior written notice of its desire to do so; (2) the excess services are reasonably available to Landlord and to the Premises; and (3) Tenant pays as Additional Rent (at the time the next payment of Monthly Rent is due) the cost of such excess service from time to time charged by Landlord; subject to the procedures established by Landlord from time to time for providing such additional or excess services. (c) The term "business hours" means 8:00 a.m. to 6:00 p.m. on Monday through Friday, except holidays (as that term is defined below), and 8:00 a.m. to 1:00 p.m. on Saturdays, except holidays. The term "holidays" means New Year's Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. 13.3 TENANT'S COSTS. Whenever equipment or lighting (other than building standard lights) is used in the Premises by Tenant and such equipment or lighting affects the temperature otherwise normally maintained by the design of the Building's air conditioning system, Landlord shall have the right, after prior written notice to Tenant, to install supplementary air conditioning facilities in the Premises or otherwise modify the ventilating and air conditioning system serving the Premises; and the cost of such facilities, modifications, and additional service shall be paid by Tenant as Additional Rent within thirty (30) days of receipt of an invoice. Should Tenant desire any additional service beyond that described in Article 13.2 hereof, Landlord may, at Landlord's option upon reasonable advance notice from Tenant to Landlord, (i) refuse to consent to such services or (ii) consent to such services upon such conditions as Landlord elects (including the requirement that submeters be installed at Tenant's expense, that Tenant pay directly to the provider of such service (in the case of submetered services) or to Landlord, as Additional Rent within thirty (30) days of receipt of an invoice, Landlord's additional expenses resulting therefrom, and that Tenant pay the cost of all alterations or additions made to accommodate such excess use, including the cost of a submeter and installation of the same.) Neither party to this Lease is aware of anything set forth in the Working Drawings (as defined in the Work Letter) that would require supplemental heating or air conditioning. 13.4 LIMITATION ON LIABILITY. Landlord shall not be in default under this Lease or be liable to Tenant or any other person for direct or consequential damage, or otherwise, for any failure to supply any heat, air conditioning, elevator, cleaning, lighting, security; for surges or interruptions of electricity; or for other services which Landlord has agreed to supply during any period provided that Landlord uses commercially reasonable diligence to supply such services. Landlord will use commercially reasonable efforts to diligently remedy any interruption in the furnishing of such services. Landlord reserves the right temporarily to discontinue such services at such times as may be necessary by reason of accident, repairs, alterations or improvements, strikes, lockouts, riots, acts of God, governmental preemption in connection with a national or local emergency, any rule, order, or regulation of any governmental agency, conditions of supply and demand that make any product unavailable, Landlord's compliance with any mandatory governmental energy conservation or environmental protection program, or any voluntary governmental energy conservation program at the request of or with consent or acquiescence of Tenant, mandatory or prohibitive injunction issued in connection with the enforcement of the ADA, or any other event or condition beyond the control of Landlord. Landlord shall not be liable to Tenant or any other person or entity for direct or consequential damages resulting from the admission to or exclusion from the Building or Project of any person. In the event of invasion, mob, riot, public excitement, strikes, lockouts, or other circumstances rendering such action advisable in Landlord's sole opinion, Landlord shall have the right to prevent access to the Building or Project during the continuance of the same by such means as Landlord, in its sole discretion, may deem appropriate, including without limitation locking doors and closing parking areas and other Common Areas. Landlord shall not be liable for damages to person or property or for injury to, or interruption of, business for any discontinuance permitted under this Article 13, nor will such discontinuance in any way be construed as an eviction of Tenant or (except as otherwise provided below in this Article 13.4) cause an abatement of Rent or operate to release Tenant from any of Tenant's obligations under this Lease. If any utility or other service described in this Article 13.4 is interrupted, Tenant will promptly notify Landlord in writing. If (a) any utility or other service described in this Article 13.4 is discontinued or interrupted and (b) such discontinuance or interruption is within Landlord's reasonable control, and (c) such discontinuance or interruption continues for at least five consecutive business days and renders all or a material portion of the Premises untenantable for such period such that Tenant cannot and does not operate its business from the Premises or such portion for such period, then as Tenant's sole and exclusive remedy for such discontinuance or interruption Landlord will equitably abate Tenant's obligation to pay Monthly Rent and Tenant's Proportionate Share of Operating Expenses (as set forth in Article 5) beginning on the sixth business day after the later of (i) the first day of such interruption and (ii) the date of Landlord's receipt of Tenant's notice thereof, and ending on the date on which such service is substantially restored. 16 21 ARTICLE 14. TENANT'S CARE OF THE PREMISES. - ------------------------------------------- Tenant shall maintain the Premises (including Tenant's equipment, personal property, and trade fixtures located in the Premises) in the same condition as at the time they were delivered to Tenant, reasonable wear and tear and damage by casualty excluded. Tenant shall immediately advise Landlord of any damage to the Premises, Building or the Project. All damage or injury to the Premises, Building or the Project, or the fixtures, appurtenances, and equipment therein that is caused by Tenant, its agents, employees, or invitees may be repaired, restored, or replaced by Landlord, at the expense of Tenant. Such expense (plus 10% of such expense for Landlord's overhead) will be collectible as Additional Rent and will be paid by Tenant within ten (10) days after delivery of a statement for such expense. ARTICLE 15. ALTERATIONS. - ------------------------- 15.1 GENERAL. (a) Except as otherwise specifically set forth in the Work Letter, Tenant shall not make or allow to be made any alterations, additions, or improvements to or of the Premises, the Building or the Project or any part thereof, or attach any fixtures or equipment thereto after the Lease Date, without first obtaining Landlord's prior written consent, which consent shall not be unreasonably withheld or delayed; provided however that Landlord may withhold its consent, in its sole and absolute discretion, to any alteration, addition or improvement to the structural portions or the HVAC, plumbing or electrical systems of the Building. All such alterations, additions, and improvements consented to by Landlord, and capital improvements that are required to be made to the Project as a result of the nature of Tenant's use of the Premises: (1) Shall be performed by contractors reasonably approved by Landlord and subject to conditions specified by Landlord (which may include requiring the posting of a mechanic's or materialmen's lien bond); and (2) At Landlord's option, will be made by Landlord for Tenant's account, and Tenant will reimburse Landlord for their cost within ten (10) days after receipt of a statement of such cost. (b) Subject to Tenant's rights in Article 17 herein, all alterations, additions, fixtures, and improvements, whether temporary or permanent in character, made in or upon the Premises either by Tenant or Landlord, shall immediately become Landlord's property, and at the end of the Term shall remain on the Premises without compensation to Tenant, unless when consenting to such alterations, additions, fixtures, or improvements, Landlord has advised Tenant in writing that such alterations, additions, fixtures, or improvements must be removed at the expiration or other termination of this Lease. 15.2 FREE-STANDING PARTITIONS. Tenant shall have the right to install free-standing work station partitions, without Landlord's prior written consent, so long as no building or other governmental permit is required for their installation or relocation; however, if a permit is required, Landlord shall not unreasonably withhold its consent to such relocation or installation. The free-standing work station partitions for which Tenant pays shall be part of Tenant's trade fixtures for all purposes under this Lease. 15.3 REMOVAL. If Landlord has required Tenant to remove any or all alterations, additions, fixtures, and improvements that are made in or upon the Premises pursuant to this Article 15 prior to the Expiration Date, Tenant shall remove such alterations, additions, fixtures, and improvements at Tenant's sole cost and shall restore the Premises to the condition in which they were before such alterations, additions, fixtures, improvements, and additions were made, reasonable wear and tear excepted. However, at the time that Tenant requests Landlord's consent to specific alterations, Tenant may also request that Landlord notify Tenant whether Landlord will, upon expiration or termination of the Lease Term, require Tenant to remove the subject improvements. If Tenant so requests and if Landlord consents to the alterations, then Landlord will also notify Tenant whether Landlord will require removal of any such alterations or improvements at the expiration or termination of the Lease Term. At the expiration or termination of the Lease Term, Tenant will not be required to remove any alterations or improvements which Landlord has previously notified would not be required to be removed. Landlord will not require removal of 17 22 any of the initial Tenant Improvements performed under the Work Letter attached hereto as Exhibit B. 15.4 ADA COMPLIANCE. Landlord shall comply with ADA Requirements, defined below, with respect to the Common Areas. Tenant, with respect to the Premises, at Tenant's sole cost and expense (but subject to Landlord's prior written approval, which approval shall not be unreasonably withheld or delayed), shall comply with the requirements imposed by the Americans with Disabilities Act (42 U.S.C. Article 12101 et seq.) and any regulations promulgated pursuant thereto effective from time to time during the Term ("ADA Requirements") if: (a) the requirement for such alteration or addition arises as a result of: (1) Any alteration or addition by Tenant after the Lease Date; (2) Any violation by Tenant of any ADA Requirements; (3) A special use of the Premises or any part thereof by Tenant or any assignee or subtenant of Tenant (including but not limited to use for a facility which constitutes, or if open to the public generally would constitute, a "place of public accommodation" under the ADA Requirements); (4) The special needs of the employee(s) of Tenant or any assignee or subtenant of Tenant; or (b) The ADA Requirements would otherwise make Tenant rather than Landlord primarily responsible for making such alteration or addition. ARTICLE 16. MECHANICS' LIENS. - ------------------------------- Tenant shall pay or cause to be paid all costs and charges for work (a) done by Tenant or caused to be done by Tenant, in or to the Premises, and (b) for all materials furnished for or in connection with such work. Tenant shall indemnify Landlord against and hold Landlord, the Premises, and the Project free, clear, and harmless of and from all mechanics' liens and claims of liens, and all other liabilities, liens, claims, and demands on account of such work by or on behalf of Tenant, other than work performed by Landlord pursuant to this Lease. If any such lien, at any time, is filed against the Premises or any part of the Project, Tenant shall cause such lien to be discharged of record within ten (10) days after the filing of such lien, except that if Tenant desires to contest such lien, it shall deliver to Landlord, within such 10-day period, at least one hundred percent (100%) of the amount of the claim, plus estimated costs and interest, by cashier's check or certified funds, which shall be held by Landlord as security to insure payment of the lien and to prevent any sale of the Project by foreclosure or otherwise by reason of such lien, or, at Tenant's option, Tenant may within such time cause such lien to be insured over or bonded over, by a title insurance or bonding company and in an amount reasonably satisfactory to Landlord. If a final judgment establishing the validity or existence of a lien for any amount is entered, Tenant shall pay and satisfy the same at once. If Tenant fails to pay any charge, cost or expense for which a mechanics' lien has been filed, and has not given Landlord security as described above, Landlord may, at its option, pay such charge and related costs and interest, and the amount so paid, together with reasonable attorneys' fees incurred in connection with such lien, shall be immediately due from Tenant to Landlord as Additional Rent. Nothing contained in this Lease will be deemed the consent or agreement of Landlord to subject Landlord's interest in the Project to liability under any mechanics' or other lien law. If Tenant receives written notice that a lien has been or is about to be filed against the Premises or the Project, or that any action affecting title to the Project has been commenced on account of work done by or for or materials furnished to or for Tenant, it shall immediately give Landlord written notice of such notice. At least fifteen (15) days prior to the commencement of any work (including but not limited to any maintenance, repairs, alterations, additions, improvements, or installations) in or to the Premises, by or for Tenant, Tenant shall give Landlord (i) written notice of the proposed work and the names and addresses of the persons supplying labor and materials for the proposed work and (ii) two copies of Tenant's plans and specifications for such work. ARTICLE 17. END OF TERM. - ------------------------- On the Expiration Date or earlier termination of this Lease, Tenant shall promptly quit and surrender the Premises broom-clean, in good order and repair, ordinary wear and tear and damage from casualty or condemnation. If Tenant is not then in default, Tenant may remove from the Premises any trade fixtures, equipment, and movable furniture placed in the Premises by Tenant, whether or not such trade fixtures or equipment 18 23 are fastened to the Building. Tenant shall not remove any trade fixtures or equipment without Landlord's prior written consent if such fixtures or equipment are used in the operation of the Building, or if the removal of such fixtures or equipment may result in impairing the structural strength of the Building. Whether or not Tenant is in default, Tenant shall remove such alterations, additions, improvements, trade fixtures, equipment, and furniture as Landlord has requested in accordance with Article 15. Tenant shall fully repair any damage occasioned by the removal of any trade fixtures, equipment, furniture, alterations, additions, and improvements. All trade fixtures, equipment, furniture, inventory, effects, alterations, additions, and improvements on the Premises after the end of the Term shall be deemed conclusively to have been abandoned and may be appropriated, sold, stored, destroyed, or otherwise disposed of by Landlord without written notice to Tenant or any other person and without obligation to account for them. Tenant shall pay Landlord for all expenses reasonably incurred in connection with the removal of such property, including but not limited to the cost of repairing any damage to the Building or Premises caused by the removal of such property. Tenant's obligation to observe and perform this covenant will survive the expiration or other termination of this Lease. ARTICLE 18. EMINENT DOMAIN. - ---------------------------- If all of the Premises are taken by exercise of the power of eminent domain (or conveyed by Landlord in lieu of such exercise) this Lease shall terminate on a date (the "Termination Date") which is the earlier of the date upon which the condemning authority takes possession of the Premises or the date on which title to the Premises is vested in the condemning authority. If any material portion of the Premises is so taken which prevents Tenant's reasonable use of the Premises for its intended purpose ("Material Portion"), Tenant will have the right to cancel this Lease by written notice to Landlord given within twenty (20) days after the termination date. If less than a Material Portion of the Premises is so taken, or if the Tenant does not cancel this Lease according to the preceding sentence, the Monthly Rent shall be abated in the proportion of the rentable area of the Premises so taken to the rentable area of the Premises immediately before such taking, and Tenant's Proportionate Share shall be appropriately recalculated. If twenty-five percent (25%) or more of the Building or the Project is so taken, Landlord may cancel this Lease by written notice to Tenant given within thirty (30) days after the termination date. In the event of any such taking, the entire award shall be paid to Landlord and Tenant will have no right or claim to any part of such award; however, Tenant shall have the right to assert a claim against the condemning authority in a separate action, so long as Landlord's award is not otherwise reduced, for Tenant's moving expenses and leasehold improvements owned by Tenant. ARTICLE 19. DAMAGE AND DESTRUCTION. - ------------------------------------ (a) If the Premises or the Building are damaged by fire or other insured casualty, Landlord shall give Tenant written notice of the time which will be needed to repair such damage, as determined by Landlord in its reasonable discretion, and the election (if any) which Landlord has made according to this Article 19. Such notice will be given before the thirtieth (30th) day (the "notice date") after the fire or other insured casualty. (b) If the Premises or the Building are damaged by fire or other insured casualty to an extent which may be repaired within 180 days after the notice date, as reasonably determined by Landlord, Landlord shall promptly begin to repair the damage after the notice date and will diligently pursue the completion of such repair. In that event this Lease will continue in full force and effect except that Monthly Rent shall be abated on a pro rata basis from the date of the damage until the date of the completion of such repairs (the "repair period") based on the proportion of the rentable area of the Premises Tenant is unable to use during the repair period. (c) If the Premises or the Building are damaged by fire or other insured casualty to an extent that may not be repaired within 180 days after the notice date, as reasonably determined by Landlord, then (1) Landlord may cancel this Lease as of the date of such damage by written notice given to Tenant on or before the notice date or (2) Tenant may cancel this Lease as of the date of such damage by written notice given to Landlord within 30 days after Landlord's delivery of a written notice that the repairs cannot be made within such 180-day period. If neither Landlord nor Tenant so elects to cancel this Lease, Landlord shall diligently proceed to repair the Building and Premises and Monthly Rent shall be abated on a pro rata basis during the repair period based on the proportion of the rentable area of the Premises Tenant is unable to use during the repair period. 19 24 (d) Notwithstanding the provisions of Article 19(a), (b), and (c) above, if the Premises or the Building are damaged by uninsured casualty, or if the proceeds of insurance are insufficient to pay for the repair of any damage to the Premises or the Building, Landlord shall have the option to repair such damage or cancel this Lease as of the date of such casualty by written notice to Tenant on or before the notice date. However, nothing in this clause (d) will waive or diminish Tenant's remedies for Landlord's failure to maintain the property insurance that Landlord is required to maintain under Article 6.1(a). (e) If any such damage by fire or other casualty is the result of the willful conduct or negligence or failure to act of Tenant, its agents, contractors, employees, or invitees, there will be no abatement of Monthly Rent as otherwise provided for in this Article 19. Tenant shall have no rights to terminate this Lease on account of any damage to the Premises, the Building, or the Project except as specifically set forth herein, Tenant hereby waiving any such right which exists at law or in equity to the extent Tenant is not in violation of any laws. ARTICLE 20. SUBORDINATION. - --------------------------- 20.1 GENERAL. This Lease and Tenant's rights under this Lease are subject and subordinate to any ground or underlying lease, mortgage, indenture, deed of trust, or other lien encumbrance (each a "superior lien"), together with any renewals, extensions, modifications, consolidations, and replacements of such superior lien, now or after the date affecting or placed, charged, or enforced against the Land, the Building, or all or any portion of the Project or any interest of Landlord in them or Landlord's interest in this Lease and the leasehold estate created by this Lease (except to the extent any such instrument expressly provides that this Lease is superior to such instrument); provided, however, that any such subordination shall be subject to the right of Tenant to remain in possession of the Premises pursuant to the terms of this Lease, notwithstanding any foreclosure of such superior lien or any sale pursuant thereto, so long as Tenant is not in default under this Lease. This provision shall be self-operative and no further instrument shall be required in order to effect it. Notwithstanding the foregoing, Tenant shall execute, acknowledge, and deliver to Landlord, within twenty (20) days after written demand by Landlord, such documents as may be reasonably requested by Landlord or the holder of any superior lien to confirm or effect any such subordination and non-disturbance agreement. 20.2 ATTORNMENT. Tenant agrees that in the event that any holder of a superior lien succeeds to Landlord's interest in the Premises, Tenant shall pay to such holder all Rent subsequently payable under this Lease provided Tenant is given notice of such lien and succession. Further, Tenant agrees that in the event of the enforcement by the holder of a superior lien of the remedies provided for by law or by such superior lien, Tenant shall, upon request of any person or party succeeding to the interest of Landlord as a result of such enforcement, automatically become the Tenant of and attorn to such successor in interest without change in the terms or provisions of this Lease provided Tenant is given notice of such lien and succession. Such successor in interest, however, shall not be bound by: (a) Any payment of rent for more than one month in advance, except prepayments in the nature of security for the performance by Tenant of its obligations under this Lease; (b) Any amendment or modification of this Lease made without the written consent of such successor in interest (if such consent was required under the terms of such superior lien and Tenant was notified of such required consent); (c) Any claim against Landlord arising prior to the date on which such successor in interest succeeded to Landlord's interest; or (d) Any claim or offset of Rent against the Landlord. Upon request by such successor in interest and without cost to Landlord or such successor in interest, Tenant shall, within twenty (20) days after written demand, execute, acknowledge, and deliver an instrument or instruments confirming the attornment, so long as such instrument provides that such successor in interest will not disturb Tenant in its use of the Premises in accordance with this Lease. 20 25 ARTICLE 21. ENTRY BY LANDLORD. - ------------------------------- Landlord, its agents, employees, and contractors may enter the Premises at reasonable hours after reasonable notice, or at any time in response to an emergency, to: (a) Inspect the Premises; (b) Exhibit the Premises to prospective purchasers, lenders, or, during the last twelve (12) months of the Term, to prospective tenants; (c) Determine whether Tenant is complying with all its obligations in this Lease; (d) Supply cleaning service and any other service to be provided by Landlord to Tenant according to this Lease; (e) Post written notices of nonresponsibility or similar notices; or (f) Make repairs required of Landlord under the terms of this Lease or make repairs to any adjoining space or utility services or make repairs, alterations, or improvements to any other portion of the Building; however, all such work shall be done as promptly as reasonably possible and so as to cause as little interference to Tenant as reasonably possible. Tenant, pursuant to this Article 21, waives any claim against Landlord, its agents, employees, or contractors for damages for any injury or inconvenience to or interference with Tenant's business, any loss of occupancy or quiet enjoyment of the Premises, or any other loss occasioned by any permitted entry in accordance with this Article 21. Landlord shall at all times have and retain a key with which to unlock all of the doors in, on, or about the Premises (excluding Tenant's vaults, safes, and similar areas designated in writing by Tenant in advance). Landlord shall have the right to use any and all lawful means Landlord may deem proper to open doors in and to the Premises in an emergency in order to obtain entry to the Premises, provided that Landlord will promptly repair any damages caused by any forced entry. Any entry to the Premises by Landlord in accordance with this Article 21 will not be construed or deemed to be a forcible or unlawful entry into or a detainer of the Premises or an eviction, actual or constructive, of Tenant from the Premises or any portion of the Premises, nor shall any such entry entitle Tenant to damages or an abatement of Monthly Rent, Additional Rent, or other charges that this Lease requires Tenant to pay. ARTICLE 22. INDEMNIFICATION, WAIVER AND RELEASE. - ------------------------------------------------- 22.1 TENANT'S INDEMNIFICATION. Except for any injury to persons or damage to property on the Premises that is proximately caused by or results proximately from the negligence or deliberate act of Landlord, its employees or agents, and subject to the provisions of Article 6.4 herein, Tenant shall indemnify and hold Landlord, Landlord's wholly owned subsidiaries and the employees and agents of Landlord and Landlord's wholly owned subsidiaries, (hereinafter collectively referred to as the "Indemnified Parties" and individually as an "Indemnified Party"), their employees and agents harmless from and against, any and all demands, claims, causes of action, fines, penalties, damages, liabilities, judgments, and expenses (including, without limitation, reasonable attorney's fees) incurred in connection with or arising from: (a) the use or occupancy or manner of use or occupancy of the Premises by Tenant or any person claiming under Tenant; (b) any activity, work, or thing done or permitted by Tenant in or about the Premises, the Building, or the Project; (c) any breach by Tenant or its employees, agents, contractors, or invitees of this Lease; (d) any injury or damage to the person, property, or business of Tenant, its employees, agents, contractors, or invitees entering upon the Premises under the express or implied invitation of Tenant; and (e) any alleged violation by Tenant of any statutes, laws, rules, regulations, including, without limitation, the ADA. If any action or proceeding is brought against an Indemnified Party by reason of any such claim for which Tenant has indemnified the Indemnified Parties, Tenant, upon written notice from such Indemnified Party, shall defend the same at Tenant's expense, with counsel reasonably satisfactory to Landlord. 22.2 WAIVER AND RELEASE. Tenant, as a material part of the consideration to Landlord for this Lease, by this Article 22.2 waives and releases all claims against Landlord, Landlord's wholly owned subsidiaries, and their employees and agents with respect to all matters for which Landlord has disclaimed liability pursuant to the provisions of this Lease. 21 26 ARTICLE 23. QUIET ENJOYMENT. - ----------------------------- Landlord covenants and agrees with Tenant that, so long as Tenant pays the Rent and observes and performs all the terms, covenants, and conditions of this Lease on Tenant's part to be observed and performed, Tenant may peaceably and quietly enjoy the Premises and Tenant's possession will not be disturbed by anyone claiming by, through, or under Landlord, subject to the terms and conditions of this Lease. ARTICLE 24. EFFECT OF SALE. - ---------------------------- A sale, conveyance, or assignment of the Building or the Project shall operate to release Landlord from liability from and after the effective date of such sale, conveyance, or assignment upon all of the covenants, terms, and conditions of this Lease, express or implied, except those liabilities that arose prior to such effective date, and, after the effective date of such sale, conveyance, or assignment, Tenant shall look solely to Landlord's successor in interest in and to this Lease. Landlord will deliver or credit to any such successor in interest the unapplied portion of any security deposit paid by Tenant under this Lease. This Lease shall not be affected by any such sale, conveyance, or assignment, and Tenant shall attorn to Landlord's successor in interest to this Lease, so long as such successor in interest assumes Landlord's obligations under the Lease from and after such effective date. ARTICLE 25. DEFAULT. - --------------------- 25.1 EVENTS OF DEFAULT BY TENANT. The following events are referred to, collectively, as "events of default" or, individually, as an "Event of Default": (a) Tenant fails to pay Rent when due, and such failure continues for five (5) days after written notice from Landlord; (b) Tenant breaches any of the other agreements, terms, covenants, or conditions that this Lease requires Tenant to perform, and such breach continues for a period of fifteen (15) days after written notice from Landlord to Tenant or, if such breach cannot be cured reasonably within such fifteen (15-day) period, if Tenant fails to diligently commence to cure such breach within fifteen (15) days after written notice from Landlord and to complete such cure within a reasonable time thereafter. (c) This Lease or the Premises or any part of the Premises are taken upon execution or by other process of law directed against Tenant, or are taken upon or subject to any attachment by any creditor of Tenant or claimant against Tenant, and said attachment is not discharged or disposed of within fifteen (15) days after its levy; (d) Tenant files a petition in bankruptcy or insolvency or for reorganization or arrangement under the bankruptcy laws of the United States or under any insolvency act of any state, or admits the material allegations of any such petition by answer or otherwise, or is dissolved or makes an assignment for the benefit of creditors; (e) Involuntary proceedings under any such bankruptcy law or insolvency act or for the dissolution of Tenant are instituted against Tenant, or a receiver or trustee is appointed for all or substantially all of the property of Tenant, and such proceeding is not dismissed or such receivership or trusteeship vacated within sixty (60) days after such institution or appointment; (f) Tenant shall repeatedly default in the timely payment of Rent or any other charges required to be paid, or shall repeatedly default in keeping, observing or performing any other covenant, agreement, condition or provision of this Lease, whether or not Tenant shall timely cure any such payment or other default. For the purposes of this Article 25.1, the occurrence of similar defaults three (3) times during any twelve (12) month period shall constitute a repeated default. 22 27 25.2 LANDLORD'S REMEDIES. If any one or more events of default set forth in Article 25.1 occurs then Landlord has the right, at its election: (a) To give Tenant written notice of Landlord's intention to terminate this Lease on the earliest date permitted by law or on any later date specified in such notice, in which case Tenant's right to possession of the Premises shall cease and this Lease shall be terminated, except as to Tenant's liability, on the date specified by Landlord; (b) Without further demand or notice, to reenter and take possession of the Premises or any part of the Premises, repossess the same, expel Tenant and those claiming through or under Tenant, and remove the effects of both or either, using such lawful force for such purposes as may be necessary, without being liable for prosecution, without being deemed guilty of any manner of trespass, and without prejudice to any remedies for arrears of Monthly Rent or other amounts payable under this Lease or as a result of any preceding breach of covenants or conditions; or (c) Without further demand or notice to cure any Event of Default and to charge Tenant for the cost of effecting such cure, including without limitation reasonable attorneys' fees and interest on the amount so advanced at the rate set forth in Article 28.32, provided that Landlord will have no obligation to cure any such Event of Default of Tenant. Should Landlord elect to reenter as provided in Article 25.2(b), or should Landlord take possession pursuant to legal proceedings or pursuant to any notice provided by law, Landlord may, from time to time, without terminating this Lease, relet the Premises or any part of the Premises in Landlord's or Tenant's name, but for the account of Tenant, for such term or terms (which may be greater or less than the period which would otherwise have constituted the balance of the Term) and on such conditions and upon such other terms (which may include concessions of free rent and alteration and repair of the Premises) as Landlord, in its reasonable discretion, may determine, and Landlord may collect and receive the Rent. Landlord will in no way be responsible or liable for any failure to relet the Premises, or any part of the Premises, or for any failure to collect any Rent due upon such reletting. No such reentry or taking possession of the Premises by Landlord will be construed as an election on Landlord's part to terminate this Lease unless a written notice of such intention is given to Tenant. No written notice from Landlord under this Article or under a forcible or unlawful entry and detainer statute or similar law will constitute an election by Landlord to terminate this Lease unless such notice specifically so states. Landlord reserves the right following any such reentry or reletting to exercise its right to terminate this Lease by giving Tenant such written notice, in which event this Lease will terminate as specified in such notice. 25.3 DAMAGES; NO TERMINATION. In the event that Landlord does not elect to terminate this Lease as permitted in Article 25.2(a), but on the contrary elects to take possession as provided in Article 25.2(b), Tenant shall pay to Landlord Monthly Rent and other sums as provided in this Lease that would be payable under this Lease if such repossession had not occurred, less the net proceeds, if any, of any reletting of the Premises after deducting all of Landlord's reasonable expenses in connection with such reletting, including without limitation all repossession costs, brokerage commissions, reasonable attorneys' fees, expenses of employees, alteration and repair costs, and expenses of preparation for such reletting. If, in connection with any reletting, the new lease term extends beyond the Term, or the Premises covered by such new lease includes other premises not part of the Premises, a fair apportionment of the Rent received from such reletting and the expenses incurred in connection with such reletting as provided in this Article 25.3 will be made in determining the net proceeds from such reletting, and any Rent concessions will be equally apportioned over the term of the new lease. Tenant will pay such rent and other sums to Landlord monthly on the day on which the Monthly Rent would have been payable under this Lease if possession had not been retaken, and Landlord shall be entitled to receive such rent and other sums from Tenant on each such day. 25.4 DAMAGES UPON TERMINATION. (i) If this Lease is terminated on account of the occurrence of an Event of Default, Tenant shall remain liable to Landlord for damages in an amount equal to Monthly Rent and other amounts that would have been owing by Tenant for the balance of the Term, had this Lease not been terminated, less the net proceeds, if any, of any reletting of the Premises by Landlord subsequent to such termination, after deducting all of Landlord's expenses in connection with such reletting, including without limitation the expenses enumerated in Article 25.3. Landlord shall be entitled to collect such damages from Tenant monthly on the day on which Monthly Rent and other amounts would have been payable under this Lease if this Lease had not been terminated, and Landlord shall be entitled to receive such Monthly Rent and other amounts from Tenant on each such day. 23 28 (ii) Alternatively, at the option of Landlord, in the event this Lease is so terminated, Landlord shall be entitled, upon written notice to Tenant at any time after such termination, to declare the present cash value (as of the date of such default) of the entire balance of Rent for the remainder of the Term to be due and payable, and to collect such balance in addition to any additional amounts due prior to such termination in any manner not inconsistent with applicable law. For the purpose of this Article 25.4, the "present cash value" shall be computed by adding interest at the per annum interest rate described in Article 28.34 herein from the date on which this Lease is terminated to the date Landlord obtains a court judgment against Tenant for the amount due and discounting the entire balance due to Landlord at the Discount Rate charged by the Federal Reserve Banks as published in the "Money Rates" section of the Wall Street Journal on the day the Lease is terminated or if not published on such date, the publication date immediately prior to the termination date, plus two percent (2%). 25.5 CUMULATIVE REMEDIES. Any suit or suits for the recovery of the amounts and damages set forth in Articles 25.3 and 25.4 may be brought by Landlord, from time to time, at Landlord's election, and nothing in this Lease will be deemed to require Landlord to await the date upon which this Lease or the Term would have expired had there occurred no Event of Default. Tenant agrees that Landlord may file suit to recover any sums due to Landlord under this Lease from time to time and that such suit or recovery of any amount due Landlord hereunder shall not be any defense to any subsequent action brought for any amount not previously reduced to judgment in favor of Landlord. Each right and remedy provided for in this Lease is cumulative and is in addition to every other right or remedy provided for in this Lease or now or after the Lease date existing at law or in equity or by statute or otherwise, and the exercise or beginning of the exercise by Landlord of any one or more of the rights or remedies provided for in this Lease or now or after the Lease Date existing at law or in equity or by statute or otherwise will not preclude the simultaneous or later exercise by Landlord of any or all other rights or remedies provided for in this Lease or now or after the Lease Date existing at law or in equity or by statute or otherwise. All costs incurred by Landlord in collecting any amounts and damages owing by Tenant pursuant to the provisions of this Lease or to enforce any provision of this Lease, including reasonable attorneys' fees from the date any such matter is turned over to an attorney, whether or not one or more actions are commenced by Landlord, will also be recoverable by Landlord from Tenant. 25.6 Landlord shall take reasonable measures to mitigate the damages recoverable against Tenant. Tenant shall bear the burden of proving Landlord failed to take such reasonable measures to mitigate damages in any lawsuit filed by Landlord to recover damages under or pursuant to this Lease. ARTICLE 26. INTENTIONALLY OMITTED. - ----------------------------------- ARTICLE 27. PARKING. - --------------------- At all times during the Term of this Lease and any duly exercised Renewal Term, and conditioned upon this Lease being in full force and effect and there being no Event of Default thereunder as defined herein, Tenant shall be permitted to use the above ground, outdoor surface areas of the Project (the "Outdoor Parking") as Landlord may designate from time to time for parking automobiles, subject to the Rules and Regulations set forth in Exhibit D, and any amendments or additions to such Rules and Regulations. The Outdoor Parking will be used by Tenant and/ or tenant's guests and/or visitors on an unassigned, nonreserved, and nondesignated basis or such other basis as Landlord directs from time to time. During the Term of this Lease, Tenant will have the right to use 3 vehicular parking spaces in the below-ground parking facility at an no charge, together with the vehicular drives affording ingress to and egress from said below-ground parking facility. In addition, during the Term of this Lease, Tenant will have the right to use 2 additional vehicular parking spaces in the below-ground parking facility, at an initial monthly charge of $50.00 per space, together with the vehicular drives affording ingress to and egress from said below-ground parking facility. Such charge will be subject to periodic increases by Landlord, but not more than once per Lease Year. Tenant's specific below-ground parking spaces will be designated by Landlord, and Tenant will use the below-ground parking facility in common with others whom Landlord may permit to use the same. Landlord represents that for the Term of this Lease there will be at least 520 paved parking spaces serving the Project. In the event such parking is not reasonably adequate for tenants at the Building in Landlord's reasonable judgment, Landlord shall provide additional parking at the Building so that a total of at least 570 paved parking spaces are serving the Project. 24 29 ARTICLE 28. MISCELLANEOUS. - --------------------------- 28.1 INTENTIONALLY OMITTED. 28.2 SECURITY DEPOSIT. As of the Lease Date, Tenant has deposited the Security Deposit referred to in Article 1. of this Lease with Landlord as security for the full, faithful, and timely performance of every provision of this Lease to be performed by Tenant. If Tenant defaults with respect to any provision of this Lease, including but not limited to the provisions relating to the payment of Rent, Landlord may use, apply, or retain all or any part of the Security Deposit for the payment of any Rent, or any other sum in default, or for the payment of any other amount Landlord may spend or become obligated to spend by reason of Tenant's default, or to compensate Landlord for any other loss or damage Landlord may suffer by reason of Tenant's default. If any portion of the Security Deposit is so used, applied, or retained, Tenant shall, within five (5) days after written demand, deposit cash with Landlord in an amount sufficient to restore the Security Deposit to its original amount. Landlord will not be required to keep the Security Deposit separate from its general funds, and Tenant will not be entitled to interest on the Security Deposit. The Security Deposit shall not be deemed a limitation on Landlord's damages or a payment of liquidated damages or a payment of the Monthly Rent due for the last month of the Term. If Tenant fully, faithfully, and timely performs every provision of this Lease to be performed by it, the Security Deposit or any balance of the Security Deposit will be returned to Tenant within sixty (60) days after the expiration of the Term. Landlord may deliver the funds deposited under this Lease by Tenant to the purchaser of the Building in the event the Building is sold, and after such time Landlord will have no further liability to Tenant with respect to the Security Deposit. If Tenant notifies Landlord that Tenant desires to replace Tenant's cash Security Deposit with a letter of credit, Landlord will not unreasonably withhold its consent thereto. The form and terms of the letter of credit and the issuing bank will be subject to Landlord's approval. 28.3 SIGNS. (a) Except for signs that are located inside the Building and are not visible outside the Building, no signs will be placed in the Premises, Building or Project without the prior written consent of Landlord as to size, design, color, location, content, illumination, composition, material, and mobility, which consent may be withheld for any reason in the sole discretion of Landlord. All signs will be maintained by Tenant in good condition during the Term and any duly exercised Renewal Term and shall, in any event, comply with the Design Guidelines of the Cantera Owners Association. Tenant shall remove all signs at the end of the Term or duly exercised Renewal Term and shall repair and restore any damage caused by their installation or removal. (b) So long as Tenant is not in default under this Lease and so long as Tenant is primarily in the business of writing computer software and computer operating systems, Landlord agrees that during the initial Term of this Lease Landlord will not grant to another tenant of the Building the right to have such tenant's sign installed on the exterior surface of the Building if such tenant is primarily in the business of writing computer software or computer operating systems unless, at the time Landlord grants such right to such tenant, such tenant leases or has agreed in writing to lease a greater number of rentable square feet in the Building than is then being leased by Landlord to Tenant in the Building. 28.4 NO OFFER. This Lease is submitted to Tenant on the understanding that it will not be considered an offer and will not bind Landlord in any way until Tenant has duly executed and delivered duplicate originals to Landlord and Landlord has executed and delivered one of such originals to Tenant. 28.5 JOINT AND SEVERAL LIABILITY. If Tenant is composed of more than one signatory to this Lease, each signatory will be jointly and severally liable with each other signatory for payment and performance according to this Lease. The act of, written notice to, written notice from, refund to, or signature of any signatory to this Lease (including without limitation modifications of this Lease made by fewer than all such signatories) will bind every other signatory as though every other signatory had so acted, or received or given the written notice or refund, or signed. 25 30 28.6 NO CONSTRUCTION AGAINST DRAFTING PARTY. Landlord and Tenant acknowledge that each of them and their counsel have had an opportunity to review this Lease and that this Lease will not be construed against Landlord merely because Landlord has prepared it. 28.7 TIME OF THE ESSENCE. Time is of the essence of each and every provision of this Lease. 28.8 NO RECORDATION. Tenant's recordation of this Lease or any memorandum or short form of it will be void and a default under this Lease. 28.9 NO WAIVER. The waiver by Landlord of any agreement, condition, or provision contained in this Lease will not be deemed to be a waiver of any subsequent breach of the same or any other agreement, condition, or provision contained in this Lease, nor will any custom or practice that may grow up between the parties in the administration of the Terms of this Lease be construed to waive or to lessen the right of Landlord to insist upon the performance by Tenant in strict accordance with the Terms of this Lease. The subsequent acceptance of rent by Landlord will not be deemed to be a waiver of any preceding breach by Tenant of any agreement, condition, or provision of this Lease, other than the failure of Tenant to pay the particular rent so accepted, regardless of Landlord's knowledge of such preceding breach at the time of acceptance of such rent. 28.10 LIMITATION ON RECOURSE. It is expressly understood and agreed by Tenant that none of Landlord's covenants, undertaking or agreements continued in this Lease are made or intended as personal covenants, undertaking or agreements by Landlord or its partners. Tenant specifically agrees to look solely to Landlord's interest in the Project for the recovery of any judgments from Landlord. It is agreed that Landlord (and its shareholders, venturers, and partners, and their shareholders, venturers, and partners and all of their officers, directors, and employees) shall not be personally liable for any such judgments. The provisions contained in the preceding sentences are not intended to and will not limit any right that Tenant might otherwise have to obtain injunctive relief against Landlord or relief in any suit or action in connection with enforcement or collection of amounts that may become owing or payable under or on account of insurance maintained by Landlord. 28.11 ESTOPPEL CERTIFICATES. At any time and from time to time but within ten (10) days after prior written request by Landlord, Tenant shall execute, acknowledge, and deliver to Landlord, promptly upon request, a certificate in the form attached hereto as Exhibit E certifying as to the matters set forth therein. Any such certificate may be relied upon by any prospective purchaser or existing or prospective mortgagee or beneficiary under any deed of trust of the Building or any part of the Project. Tenant's failure to deliver such a certificate within such time will be conclusive evidence of the matters set forth in it. Landlord will, at the request of Tenant, at any time and from time to time upon not less than 10 days' prior notice, execute and deliver to Tenant a certificate stating the following, as requested: (a) that this Lease is unmodified and in full force and effect, (or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect); (b) the date the Lease commenced and the rent commencement date (if different); (c) the current monthly installments of Monthly Rent and Tenant's Proportionate Share of Operating Expenses, the dates to which such rental and other charges have been paid, and that no such rent has been paid for more than 30 days in advance of its due date; (d) the amount of the Security Deposit paid to Landlord; (e) that Tenant is paying rent on a current basis, and there are not, to Landlord's knowledge, any uncured defaults on the part of Tenant (or specifying such offsets, claims or defaults, if any are claimed); and (f) such other matters as may be reasonably requested. 28.12 WAIVER OF JURY TRIAL. LANDLORD AND TENANT, BY THIS ARTICLE 28.12, WAIVE TRIAL BY JURY IN ANY ACTION, PROCEEDING, OR COUNTERCLAIM BROUGHT BY EITHER OF THE PARTIES TO THIS LEASE AGAINST THE OTHER ON ANY MATTERS WHATSOEVER ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS LEASE, THE RELATIONSHIP OF LANDLORD AND TENANT, TENANT'S USE OR OCCUPANCY OF THE PREMISES, OR ANY OTHER CLAIMS (EXCEPT CLAIMS FOR PERSONAL INJURY OR PROPERTY DAMAGE), AND ANY EMERGENCY STATUTORY OR ANY OTHER STATUTORY REMEDY. 28.13 NO MERGER. The voluntary or other surrender of this Lease by Tenant or the cancellation of this Lease by mutual agreement of Tenant and Landlord or the termination of this Lease on account of Tenant's default shall not work a merger, and shall, at Landlord's option, (a) terminate all or any subleases and subtenancies or (b) operate as an assignment to Landlord of all or any subleases or subtenancies. Landlord's option under this Article 28.13 shall be exercised by written notice to Tenant and all known sublessees or subtenants in the Premises or any part of the Premises. 26 31 28.14 HOLDING OVER. Tenant shall have no right to remain in possession of all or any part of the Premises after the expiration of the Term. If Tenant remains in possession of all or any part of the Premises after the expiration of the Term, with the express or implied consent of Landlord: (a) such tenancy shall be deemed to be a periodic tenancy from month-to-month only; (b) such tenancy shall not constitute a renewal or extension of this Lease for any further Term; and (c) such tenancy may be terminated by Landlord upon the earlier of 30 days' prior written notice or the earliest date permitted by law. In the event Tenant remains in possession after the expiration of the Term, Monthly Rent shall be increased to an amount equal to one hundred fifty percent (150%) of the Monthly Rent payable during the last month of the Term, and any other sums due under this Lease shall be payable in the amount and at the times specified in this Lease. Such month-to-month tenancy shall be subject to every other term, condition, and covenant contained in this Lease. 28.15 NOTICES. Any notice, request, demand, consent, approval, or other communication required or permitted under this Lease must be in writing and shall be deemed to have been given when (a) hand-delivered, effective upon receipt, (b) sent by United States Express Mail or by private overnight courier, effective upon receipt, or (c) sent by certified mail, return receipt requested, addressed to the party for whom it is intended at its address set forth in Article 1.1, deposited in the United States Mail, with postage thereon fully prepaid, effective on the day of actual delivery as shown by the addressee's return receipt or the expiration of three (3) business days after the date of mailing, whichever is earlier, or (d) sent by facsimile transmission, effective upon receipt provided that a hard copy is delivered by one of the methods outlined in clauses (a) through (c) above within three (3) days thereafter. Either Landlord or Tenant may add additional addresses or change its address for purposes of receipt of any such communication by giving ten (10) days' prior written notice of such change to the other party in the manner prescribed in this Article 28.15. 28.16 SEVERABILITY. If any provision of this Lease proves to be illegal, invalid, or unenforceable, the remainder of this Lease will not be affected by such finding, and in lieu of each provision of this Lease that is illegal, invalid, or unenforceable a provision will be added as a part of this Lease as similar in terms to such illegal, invalid, or unenforceable provision as may be possible and be legal, valid, and enforceable. 28.17 WRITTEN AMENDMENT REQUIRED. No amendment, alteration, modification of, or addition to the Lease shall be valid or binding unless expressed in writing and signed by Landlord and Tenant. Tenant agrees to make any modifications of the Terms and provisions of this Lease required or requested by any lending institution providing financing for the Building, or Project, as the case may be, provided that no such modifications will materially adversely affect Tenant's rights and obligations under this Lease. 28.18 CAPTIONS. The captions of the various articles of this Lease are for convenience only and do not necessarily define, limit, describe, or construe the contents of such articles. 28.19 AUTHORITY. Tenant and the party executing this Lease on behalf of Tenant represent to Landlord that such party is authorized to do so by requisite action of the board of directors or partners, as the case may be, and agrees, upon execution of this Lease, to deliver to Landlord a resolution or similar document to that effect. 28.20 BROKERS. Landlord and Tenant respectively represent and warrant to each other that neither of them has consulted or negotiated with any broker or finder with regard to the Premises except that Landlord has retained the Broker and Tenant has retained the Tenant's Broker, each as named in Article 1.1 hereof. Landlord agrees to be responsible for payment of Broker's fees and for the payment of Tenant's Broker's fees pursuant to separate agreement. Landlord and Tenant shall mutually indemnify and hold each other harmless from and against any claim for brokerage or finder's fees or other like payment based in any way upon agreements, arrangements or understanding made or claimed to have been made by Landlord or Tenant with any person other than Broker and Tenant's Broker. 28.21 GOVERNING LAW. This Lease shall be governed by and construed pursuant to the laws of the state of Illinois. 28.22 NO EASEMENTS FOR AIR OR LIGHT. Any diminution or shutting off of light, air, or view by any structure that may be erected on lands adjacent to the Building shall in no way affect this Lease or impose any liability on Landlord. 27 32 28.23 TAX CREDITS. Landlord is entitled to claim all tax credits and depreciation attributable to leasehold improvements in the Premises. Promptly after Landlord's demand, Landlord and Tenant shall prepare a detailed list of the leasehold improvements and fixtures and their respective costs for which Landlord or Tenant has paid. Landlord shall be entitled to all credits and depreciation for those items for which Landlord has paid by means of any Tenant finish allowance or otherwise. Tenant shall be entitled to any tax credits and depreciation for all items for which Tenant has paid with funds not provided or reimbursed by Landlord. 28.24 INTENTIONALLY OMITTED. 28.25 LANDLORD'S FEES. Whenever Tenant requests Landlord to take any action or give any consent required or permitted under this Lease, Tenant shall reimburse Landlord for all of Landlord's reasonable costs incurred in reviewing the proposed action or consent, including without limitation reasonable attorneys', engineers' or architects' fees, within ten (10) days after Landlord's delivery to Tenant of a statement of such costs. Tenant shall be obligated to make such reimbursement without regard to whether Landlord consents to any such proposed action. However, in any action for the enforcement, defense or interpretation of either party's right under this Lease, in addition to the rents and other sums, found to be due hereunder, the prevailing party will be entitled to payment of all collection and court costs incurred together with reasonable attorneys' and paralegals' fees, whether such fees and costs be incurred out of court, at trial, on appeal, or in any bankruptcy, arbitration or other administrative proceedings. 28.26 NON-WAIVER. Any default in the payment of Monthly Rent or Additional Rent or other charges, or any failure of Landlord to enforce the provisions of this Lease upon any default by the Tenant shall not be construed as creating a custom of deferring payment or as modifying in any way the Terms of this Lease or as a waiver of Landlord's right to terminate this Lease as herein provided, or otherwise, to enforce the provisions hereof for any prior or subsequent default. 28.27 PRESUMPTION. In all cases hereunder, and in any suit, action or proceeding of any kind between the parties, it shall be presumptive evidence of the fact a charge being due, if Landlord shall produce a bill, notice or certificate to the effect that such charge appears of record on the books in Landlord's office or appears as an open charge on the books, records or official bills of municipal authorities, and has not been paid. 28.28 WAIVER OF TECHNICAL DEFECTS IN NOTICES. In lieu of Landlord or Tenant waiving the right to receive any notices, both parties hereby waives any technical defects as to form, substance and delivery in the giving of any notices required by this Lease and Illinois Compiled Statutes so long as the notice reasonably apprises the appropriate party of the general nature of the reason for the giving of the notice and affords such party a reasonable opportunity to cure, if applicable. 28.29 NO RIGHT TO TERMINATE. Tenant hereby waives the remedies of termination and rescission and hereby agrees that Tenant's sole remedies for Landlord's default hereunder and for breach of any promise or inducement shall be limited to a suit for damages and/or injunction. 28.30 NO LIABILITY FOR CRIMES. Landlord makes no representations or warranties with respect to crime in the area, undertakes no duty to protect against criminal acts and shall not be liable for any injury, wrongful death or property damage arising from any criminal acts. The Landlord may, from time to time, employ or caused to be employed security personnel and equipment, however, such personnel and equipment are only for the protection of Landlord's property. Landlord reserves the right, in its sole and absolute discretion, to start, alter or terminate any such security services without notice. Tenant is urged to provide security for its invitees, its own personnel, and property as it deems necessary. Tenant is urged to obtain insurance to protect against criminal acts. 28.31 BINDING EFFECT. The covenants, conditions, and agreements contained in this Lease will bind and inure to the benefit of Landlord and Tenant and their respective heirs, distributees, executors, administrators, successors, and, except as otherwise provided in this Lease, their assigns. 28.32 CONFIDENTIALITY. Tenant acknowledges that the terms and conditions of this Lease are to remain confidential for the Landlord's benefit, and shall not be disclosed by Tenant to anyone, by any manner or means, 28 33 directly or indirectly, without Landlord's prior written consent; provided, however, Tenant may disclose such terms or conditions to affiliates of Tenant and prospective subtenants and assignee for the sole purpose of evaluating a potential sublease or assignment so long as such affiliates and prospective subtenants and assignees agree to abide by the terms of this Article 28.32. Tenant may also disclose the terms of this Lease to Tenant's attorneys, accountants and consultants on a need-to-know basis, so long as Tenant advises such attorneys, accountants and consultants of the confidential nature of such information and such attorneys, accountants and consultants (as the case may be) agree to maintain such confidentiality. The consent by Landlord to any disclosures shall not be deemed to be a waiver on the part of Landlord of any prohibition against any future disclosure. 28.33 FORCE MAJEURE. Landlord shall have no liability to Tenant, nor will Tenant have any right to terminate this Lease or abate Rent or assert a claim of partial or total actual or constructive eviction, because of Landlord's failure to perform any of its obligations in the Lease if the failure is due to reasons beyond Landlord's reasonable control, including without limitation strikes or other labor difficulties; inability to obtain necessary governmental permits and approvals (including building permits or certificates of occupancy); unavailability or scarcity of materials; war; riot; civil insurrection; accidents; acts of God; and governmental preemption in connection with a national emergency. If Landlord fails to perform its obligations because of any reasons beyond Landlord's reasonable control (including those enumerated above), the period for Tenant's performance will be extended day for day for the duration of the cause of Landlord's failure. 28.34 INTEREST. All Rent and other sums dues under this Lease which are not paid when due shall accrue interest at the lesser of 12% per annum or the highest rate allowed by law. 28.35 ENTIRE AGREEMENT. This Lease, the exhibits and addenda, if any, contain the entire agreement between Landlord and Tenant. No promises or representations, except as contained in this Lease, have been made to Tenant respecting the condition or the manner of operating the Premises, the Building, or the Project. 29 34 IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the Lease Date. LANDLORD: THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY By: NORTHWESTERN INVESTMENT MANAGEMENT COMPANY, its wholly owned subsidiary and authorized representative By: --------------------------------- Its: -------------------------------- TENANT: QUEST SOFTWARE, INC. By: --------------------------------- Its: -------------------------------- 30 35 EXHIBIT A LAYOUT OF THE PREMISES 31 36 EXHIBIT B WORK LETTER This Work Letter is attached to and forms part of the Office Lease dated September 30, 1999 between THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY and QUEST SOFTWARE, INC., leasing space in the Building commonly known as Cornerstone At Cantera, Warrenville, Illinois To induce Tenant to enter into the Lease, and in consideration of the mutual covenants in the Lease and this agreement, Landlord and Tenant mutually agree as follows: 1. Landlord will improve the Premises (the"Tenant Improvements" or "Work") at its sole cost and expense in accordance with those certain plans (the "Working Drawings") dated October 4, 1999, prepared by Gensler Inc. (the "Architect"). However, if Tenant requests any changes in the Working Drawings, Tenant will be solely responsible for any additional costs resulting from such changes. Landlord will pay for the preparation of the Working Drawings. All additional costs and expenses relating to the preparation and completion of plans or space plans for the Premises will be borne by Tenant, and will be due and payable to Landlord by Tenant when billed. 2. Subject to the other terms and conditions of this Work Letter and the Lease, Landlord will proceed diligently and use reasonable efforts to cause the Work to be substantially completed on or before the Commencement Date set forth in Section 1.1(m) of the Lease. Unless a Tenant Delay (defined below) occurs, the Term of the Lease and Tenant's obligation to pay rent under the Lease will not commence until the Work has been substantially completed, as reasonably determined by Landlord. If Landlord fails to substantially complete the Work by the Commencement Date set forth in Section 1.1(m) of the Lease and any Tenant Delay (defined below) occurs, then the Term and Tenant's obligation to pay rent under the Lease will commence on the date on which the Work would have been substantially completed but for the Tenant Delay, as reasonably determined by Landlord. All work to be done in the Premises, including, without limitation, the Work, will be subject to Landlord's approval, and no work may be undertaken in the Premises until such approval is given. 3. (a) When Landlord is of the opinion that the Tenant Improvements are substantially complete, then Landlord shall notify Tenant. Tenant agrees that, upon such notification, Tenant will promptly (and not later than two (2) business days after the date of Landlord's notice) inspect the Premises and, if applicable, furnish to Landlord a written statement that the Tenant Improvements are substantially completed, with the exception of certain specified and enumerated incomplete items consisting of insubstantial details of construction, decoration or mechanical adjustment, none of which interferes with Tenant's use and occupancy of the Premises for the conduct of its business, if any ("Punch List"). If Tenant fails to inspect the Premises or to provide Landlord a Punch List, the Tenant Improvements shall be deemed complete. Substantial completion of the Work will include a final inspection by the City of Warrenville and the oral or written approval by such City for occupancy of the Premises. (b) Tenant agrees that, at the request of Landlord from time to time thereafter, Tenant will promptly furnish to Landlord revised Punch Lists reflecting any completion of any prior Punch List items. If the Punch List or any revised Punch List consists only of items, the non-completion of which would not materially impair Tenant's occupancy of the Premises, then, in such event, the Premises shall be deemed to be substantially complete and Tenant will acknowledge in writing that the Premises are substantially complete and accept possession of the Premises. Tenant's acknowledgement or acceptance of the Premises shall not relieve Landlord of its obligation to complete all Punch List items. 4. Tenant shall have the right to inspect the Work from time to time, provided that Tenant does not interfere with the progress of the Work. All procedures and requirements relating to extras, changes and deletions 32 37 in the Work, and the costs thereof, shall be governed by the terms of the construction contract documents. No extras, changes, or deletions in the Work materially affecting any structural elements, windows, elevators or HVAC, electrical, plumbing or other systems serving portions of the Building, or affecting the character or design of the Work shall be permitted without the prior written consent of Landlord, which Landlord may withhold in its sole discretion. 5. If Tenant wishes Landlord to do any work in connection with the Premises prior to the Lease Commencement Date other than the Work (such other work hereinafter is referred to as "Tenant's Extra Work"), the following terms, conditions, agreements and procedures shall apply and control: a. Tenant, at its sole cost and expense, shall submit to Landlord, all necessary drawings, plans and specifications for the proposed Tenant's Extra Work (such drawings, plans and specifications hereinafter are referred to as "Tenant's Extra Work Plans"). Tenant's Extra Work Plans must be acceptable in all respects to Landlord, which acceptance Landlord may withhold in its sole discretion. b. Landlord will construct or cause to be constructed Tenant's Extra Work substantially in accordance with Tenant's Extra Work Plans provided that Tenant's Extra Work Plans have been accepted in writing by Landlord, and that Tenant has complied with all provisions, terms and conditions of this Work Letter. c. All of Tenant's Extra Work shall be done at Tenant's sole cost and expense. Within 15 days after the submission by Tenant to Landlord of proposed Tenant's Extra Work Plans, Landlord shall submit to Tenant for Tenant's approval a written estimate of the cost of Tenant's Extra Work (hereinafter referred to as an "Estimate"). Landlord may elect not to proceed with Tenant's Extra Work unless and until: (i) one Estimate covering the same is approved in writing by Tenant and an approved copy is delivered to Landlord; and (ii) Tenant has deposited with Landlord in escrow an amount sufficient to cover all costs of performing Tenant's Extra Work. d. If Tenant desires any extras, changes or deletions in Tenant's Extra Work at any time, Tenant in each instance shall follow the same procedure prescribed in this Paragraph 5 for the initiation, approval and commencement of Tenant's Extra Work. e. Tenant agrees to pay or reimburse Landlord for all Architect's, Landlord's general contractor's, subcontractor's and general conditions' costs pertaining to Tenant's Extra Work. In the event Tenant has not deposited in escrow an amount sufficient to cover all costs of performing Tenant's Extra Work or any extra or change as provided in paragraph 5d hereof, then within 15 days after being billed therefor, Tenant shall pay to Landlord or as Landlord otherwise directs, all such costs for Tenant's Extra Work. Landlord shall have, in connection with all such costs, all the rights and remedies that Landlord has under the Lease in connection with Rent that is due and payable by Tenant thereunder. All such costs shall be deemed Additional Rent due and payable under the Lease. However, the noncompletion of Tenant's Extra Work will not delay the Lease Commencement Date. 6. Tenant, with Landlord's prior written permission, may enter the Premises up to 5 days prior to the date specified in the Lease for the commencement of payment of Rent, in order that Tenant may perform, through Tenant's own contractors (which contractors shall be subject to Landlord's approval), such other work and decorations as Tenant may desire and as may be permitted in accordance with the terms and conditions of the Lease at the same time that Landlord's contractors are working in the space. However, the foregoing license to enter is conditioned upon Tenant's first obtaining the insurance coverage required under the Lease and furnishing Landlord with certificates of such insurance and paid premium receipts, and upon Tenant's contractors and workmen working in harmony and not interfering with the labor employed by Landlord, Landlord's contractors or any other tenant or their contractors. If, at any time, such entry shall cause disharmony or interference therewith, this license may be withdrawn by Landlord immediately (with no notice being required). Such entry shall be deemed to be under all of 33 38 the terms, covenants, conditions, provisions and agreements of the Lease except the covenant to pay Rent. Landlord shall not be liable in any way for any work, decorations or installations which are made prior to the date specified in the commencement of the payment of Rent or to the equipment, materials or tools of Tenant or its contractors, the same being solely at Tenant's risk. Prior to commencement of any work under this paragraph, Tenant shall deliver to Landlord all necessary permits, licenses, approvals, certificates and authorizations for prosecution and completion of the work. 7. Miscellaneous: a. The Work and Tenant's Extra Work, if any, shall be done by Landlord and/or its designers, contractors and subcontractors, in accordance with the terms, conditions and provisions herein contained. b. Except as provided in the Lease and the Working Drawings, and except as herein expressly set forth, Landlord has no agreement with Tenant and has no obligation to perform or provide any other work with respect to the Premises. Any other work in the Premises which may be permitted by Landlord pursuant to the terms and conditions of the Lease shall be done at Tenant's sole cost and expense and in accordance with the terms and conditions and provisions of the Lease and this Work Letter. c. Under no circumstances shall the Lease Commencement Date or Tenant's obligation to commence paying Rent be delayed in whole or in part because of any delay or cost arising from or incurred in connection with (i) any extra, change or deletion requested or caused by Tenant or its agents or contractors at any time to any of the Work, (ii) Tenant's Extra Work or (iii) delay due to special equipment, fixtures or materials requested by Tenant or the unavailability of materials specified for Tenant Improvements (each, a "Tenant Delay"). d. Time is of the essence under this Agreement. e. Landlord's preparation of Working Drawings and the construction of Tenant Improvements shall not create or imply any responsibility or liability on the part of Landlord with regard to the completeness and design sufficiency of both the Working Drawings and the Tenant Improvements, or with regard to the compliance of the Working Drawings and the Tenant Improvements with all laws, rules and regulations of governmental agencies. f. Any person signing this Work Letter on behalf of the Tenant warrants and represents that he has the express authority of Tenant to do so. g. Landlord appoints Janet Reuter as Landlord's representative to act for Landlord in all matters associated with this Work Letter. Tenant appoints Susan Twellman, as Tenant's representative to act for Tenant in all matters associated with this Work Letter. All inquiries, requests, instructions, authorizations, and other communications with respect to the matters covered by this Work Letter shall be made to Landlord's representative or Tenant's representative, as the case may be. Tenant shall not make any inquiries of or requests to, and will not give any instructions or authorizations to, any employee or agent of Landlord, including, without limitation, Landlord's architect, engineers, and contractors or any of their agents or employees, with regard to matters associated with this Work Letter at any time by providing three (3) days' prior written notice to the other party. h. This Work Letter shall not be deemed applicable to any additional space added to the original Premises at any time, whether by any options under the Lease or otherwise, or to 34 39 any portion of the original Premises or any additions thereto in the event of a renewal or extension of the original Term of the Lease, whether obtained pursuant to any options under the Lease or otherwise, unless expressly so provided in the Lease or a written amendment or supplement thereto. i. This Work Letter shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, legal representatives, successors and assigns. j. All capitalized terms contained in this Work Letter and all terms otherwise undefined shall have the same meaning set forth in the Lease to the extent the same are used or defined therein. LANDLORD: THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY By: NORTHWESTERN INVESTMENT MANAGEMENT COMPANY, its wholly owned subsidiary and authorized representative By: ------------------------------------------ Its: ----------------------------------------- TENANT: QUEST SOFTWARE, INC. By: ------------------------------------------ Its: ----------------------------------------- 35 40 EXHIBIT C COMMENCEMENT DATE CERTIFICATE This Commencement Date certificate is entered into by Landlord and Tenant pursuant to Article 3.1 of the Lease. 1. DEFINITIONS. In this certificate the following terms have the meanings given to them in the Lease: (a) Landlord: __________________________________________ (b) Tenant: ____________________________________________ (c) Lease: Office Lease dated [date] between Landlord and Tenant. (d) Premises: ___________________________________________ (e) Building Address: ____________________________________ 2. CONFIRMATION OF LEASE COMMENCEMENT: Landlord and Tenant confirm that the Commencement Date of the Lease is ____________ and the Expiration Date is ____________ and that Article 1.1 of the Lease is amended accordingly. Landlord and Tenant have executed this Commencement Date certificate as of the dates set forth below. TENANT: ___________________________ LANDLORD: ________________________ By: ___________________________ By: _________________________ Its: ___________________________ Its: _________________________ Date: Date: 36 41 EXHIBIT D RULES AND REGULATIONS 1. Landlord may from time to time adopt reasonable and appropriate systems and procedures for the security or safety of the Building, or any equipment, furnishings, or contents of the Building, and Tenant will comply with Landlord's reasonable requirements relative to such systems and procedures. 2. The sidewalks, halls, passages, exits, entrances, elevators, and stairways of the Building shall not be obstructed by Tenant or used by Tenant for any purpose other than for ingress to and egress from the Premises. The halls, passages, exits, entrances, elevators, escalators, and stairways are not for the general public, and Landlord shall in all cases retain the right to control and prevent access to such halls, passages, exits, entrances, elevators, and stairways of all persons whose presence in the judgment of Landlord would be prejudicial to the safety, character, reputation, and interests of the Building, provided that nothing contained in these Rules and Regulations shall be construed to prevent such access to persons with whom any Tenant normally deals in the ordinary course of its business, unless such persons are engaged in illegal activities. Neither Tenant nor any employee or invitee of Tenant shall go upon the roof of the Building. Tenant shall not be permitted to place or install any object (including without limitation radio and television antennas, loudspeakers, sound amplifiers, microwave dishes, solar devices, or similar devices) on the exterior of the Building or on the roof of the Building. 3. Other than draperies expressly permitted by Landlord and building standard mini-blinds, material visible from outside the building shall not be permitted. In the event of the violation of this rule by Tenant, Landlord may remove the violating items without any liability, and may charge the expense incurred by such removal to the Tenant. 4. No cooking shall be done or permitted by Tenant on the Premises, except in areas of the Premises which are specially constructed for cooking and except that use by the Tenant of microwave ovens and Underwriters' Laboratory approved equipment for brewing coffee, tea, hot chocolate, and similar beverages shall be permitted, provided that such use is in accordance with all applicable federal, state, and city laws, codes, ordinances, rules, and regulations. 5. Tenant shall not employ any person or persons other than the cleaning service of Landlord for the purpose of cleaning the Premises, unless otherwise agreed to by Landlord in writing. Except with the written consent of Landlord, no person or persons other than those approved by Landlord shall be permitted to enter the Building for the purpose of cleaning it. No Tenant shall cause any unnecessary labor by reason of Tenant's carelessness or indifference in the preservation of good order and cleanliness. Should Tenant's actions result in any increased expense for any required cleaning, Landlord reserves the right to assess Tenant for such expenses. 6. The toilet rooms, toilets, urinals, wash bowls and other plumbing fixtures shall not be used for any purposes other than those for which they were constructed, and no sweepings, rubbish, rags, or other foreign substances shall be thrown in such plumbing fixtures. All damages resulting from any misuse of the fixtures shall be borne by the Tenant who, or whose servants, employees, agents, visitors, or licensees, caused the same. 7. Tenant shall not in any way deface any part of the Premises or the Building of which they form a part. In those portions of the Premises where carpet has been provided directly or indirectly by Landlord, Tenant shall at its own expense install and maintain pads to protect the carpet under all furniture having casters other than carpet casters. 8. Tenant shall not alter, change, replace, or rekey any lock or install a new lock or a knocker on any door of the Premises. Landlord, its agents, or employees shall retain a pass (master) key to all door locks on the Premises. Any new door locks required by Tenant or any change in keying of existing locks shall be installed or changed by Landlord following Tenant's written request to Landlord and shall be at Tenant's expense. All new locks and rekeyed locks shall remain operable by Landlord's pass (master) key. Tenant, upon termination of its tenancy, shall deliver to Landlord all keys and access cards for the Premises and Building that have been furnished to Tenant. Landlord will not unreasonably withhold its consent to Tenant's installation of a card key access system for accessing the Premises. 37 42 9. The elevator designated for freight by Landlord shall be available for use by Tenant during the hours and pursuant to such procedures as Landlord may determine from time to time. The persons employed to move Tenant's equipment, material, furniture, or other property in or out of the Building must be acceptable to Landlord. The moving company must be a locally recognized professional mover, whose primary business is the performing of relocation services, and must be bonded and fully insured. A certificate or other verification of such insurance must be received and approved by Landlord prior to the start of any moving operations. Insurance must be sufficient, in Landlord's sole opinion, to cover all personal liability, theft or damage to the Project, including but not limited to floor coverings, doors, walls, elevators, stairs, foliage, and landscaping. Special care must be taken to prevent damage to foliage and landscaping during adverse weather. All moving operations shall be conducted at such times and in such a manner as Landlord shall direct, and all moving shall take place during non-business hours unless Landlord agrees in writing otherwise. Tenant shall be responsible for the provision of Building security during all moving operations, and shall be liable for all losses and damages sustained by any party as a result of the failure to supply adequate security. Landlord shall have the right to prescribe the weight, size, and position of all equipment, materials, furniture, or other property brought into the Building. Heavy objects shall, if considered necessary by Landlord, stand on wood strips of such thickness as is necessary to properly distribute the weight. Landlord shall not be responsible for loss of or damage to any such property from any cause, and all damage done to the Building by moving or maintaining such property shall be repaired at the expense of Tenant. Landlord reserves the right to inspect all such property to be brought into the Building and to exclude from the Building all such property which violates any of these Rules and Regulations or the Lease of which these Rules and Regulations are a part. Supplies, goods, materials, packages, furniture, and all other items of every kind delivered to or taken from the Premises shall be delivered or removed through the entrance and route designated by Landlord, and Landlord shall not be responsible for the loss or damage of any such property unless such loss or damage results from the negligence of Landlord, its agents, or employees. 10. Tenant shall not use or keep in the Premises or the Building any kerosene, gasoline, or any flammable, combustible or explosive fluid or material or chemical substance other than cleaning fluids and solvents required in Tenant's normal operations in the Premises. Without Landlord's prior written approval, Tenant shall not use any method of heating or air conditioning other than that supplied by Landlord. Tenant shall not use or keep or permit to be used or kept any foul or noxious gas or substance in the Premises. 11. Subject to the restrictions set forth in Section 28.3(b), Landlord shall have the right, exercisable upon written notice and without liability to Tenant, to change the name and street address of the Building. If Landlord changes the street address of the Building, Landlord will, upon written request from Tenant, reimburse Tenant for Tenant's reasonable out-of-pocket costs of replacing its stationery and business cards due to such change (not to exceed a 6-month supply) 12. Landlord shall have the right to prohibit any advertising by Tenant mentioning the Building that, in Landlord's reasonable opinion, tends to impair the reputation of the Building or its desirability as a Building for offices, and upon written notice from Landlord, Tenant shall refrain from or discontinue such advertising. 13. Tenant shall not bring any animals (except "Seeing Eye" dogs or other guide animals) or birds into the Building, and shall not permit bicycles or other vehicles inside or on the sidewalks outside the Building except in areas designated from time to time by Landlord for such purposes. 14. All persons entering or leaving the Building between the hours of 6 p.m. and 7 a.m. Monday through Friday, and at all hours on Saturdays, Sundays, and holidays shall comply with such off-hour regulations as Landlord may establish and modify from time to time. 15. Tenant shall store all its trash and garbage within its Premises. No material shall be placed in the trash boxes or receptacles if such material is of such nature that it may not be disposed of in the ordinary and customary manner of removing and disposing of trash and garbage without being in violation of any law or ordinance governing such disposal. All garbage and refuse disposal shall be made only through entryways and elevators provided for such purposes and at such times as Landlord designates. Removal of any furniture or furnishings, large equipment, packing crates, packing materials, and boxes shall be the responsibility of each Tenant 38 43 and such items may not be disposed of in the Building trash receptacles nor shall they be removed by the Building's janitorial service, except at Landlord's sole option and at the Tenant's expense. No furniture, appliances, equipment, or flammable products of any type may be disposed of in the Building trash receptacles. 16. Canvassing, peddling, soliciting, and distributing handbills or any other written materials in the Building are prohibited, and Tenant shall cooperate to prevent the same. 17. The requirements of the Tenant shall be attended to only upon application by written, personal, or telephone notice at the office of the Building. Employees of Landlord shall not perform any work or do anything outside of their regular duties unless under special instructions from Landlord. 18. Tenant shall see that the doors of the Premises are closed and locked and that all water faucets, water apparatus, and utilities are shut off before Tenant or Tenant's employees leave the Premises, so as to prevent waste or damage, and for any default or carelessness in this regard Tenant shall make good all injuries sustained by other Tenants or occupants of the Building or Landlord. 19. Tenant shall not conduct itself in any manner that is inconsistent with the character of the Building as a first quality Building. 20. Neither Landlord nor any operator of the parking areas within the Project wherein the parking is located, as the same are designated and modified by Landlord, in its sole discretion, from time to time (sometimes collectively the "parking areas") shall be liable for loss of or damage to any vehicle or any contents of such vehicle or accessories to any such vehicle, or any property left in any of the parking areas, resulting from fire, theft, vandalism, accident, conduct of other users of the parking areas and other persons, or any other casualty or cause. Further, Tenant understands and agrees that: (a) Landlord shall not be obligated to provide any traffic control, security protection or operator for the parking areas; (b) Tenant uses the parking areas at its own risk; and (c) Landlord shall not be liable for personal injury or death, or theft, loss of, or damage to property. Tenant waives and releases Landlord from any and all liability arising out of the use of the parking areas by Tenant, its employees, agents, invitees, and visitors, whether brought by any of such persons or any other person. 21. Tenant [including Tenant's employees, agents, invitees, and visitors] shall use the parking described in Paragraph 27 of the Lease solely for the purpose of parking passenger cars, small vans, and small trucks and shall comply in all respects with any rules and regulations that may be promulgated by Landlord from time to time with respect thereto. Tenant shall ensure that any vehicle parked in any of the parking spaces shall be kept in proper repair, good operating condition, currently licensed, and shall not leak excessive amounts of oil or grease or any amount of gasoline. If any of the parking is at any time used (a) for any purpose other than parking as provided above; (b) in any way or manner reasonably objectionable to Landlord; or (c) by Tenant after default by Tenant under the Lease, Landlord, in addition to any other rights otherwise available to Landlord, including, at the Tenant's expense, the right to tow or boot the offending vehicle, may consider such default an Event of Default under the Lease. 22. Tenant's right to use the parking shall be in common with other parties permitted by Landlord to use the parking areas. Subject to the terms of the Lease, Landlord shall not be liable to Tenant for any unavailability of parking nor shall any unavailability entitle Tenant to any refund, deduction, or allowance. 23. If the parking areas are damaged or destroyed, or if the use of the parking areas is limited or prohibited by any governmental authority, or the use or operation of the parking areas is limited or prevented by strikes or other labor difficulties or other causes beyond Landlord's control, Tenant's inability to use the parking areas shall not subject Landlord or any operator of the parking areas to any liability to Tenant and shall not relieve Tenant of any of its obligations under the Lease and the Lease shall remain in full force and effect, subject to the terms of the Lease. 24. Tenant has no right to assign, sublease or sublicense, as the case may be, any of its rights in the parking, except as part of a permitted assignment or sublease of the Lease. However, Tenant may allocate the parking among its employees. 39 44 25. No act or thing done or omitted to be done by Landlord or Landlord's agent during the Term of the Lease in connection with the enforcement of these Rules and Regulations shall constitute an eviction by Landlord of any Tenant nor shall it be deemed an acceptance of surrender of the Premises by any Tenant, and no agreement to accept such termination or surrender shall be valid unless in a writing signed by Landlord. The delivery of keys to any employee or agent of Landlord shall not operate as a termination of the Lease or a surrender of the Premises unless such delivery of keys is done in connection with a written instrument executed by Landlord approving the Termination or surrender. 26. As used in these Rules and Regulations, the word "Tenant" includes the employees, agents, invitees, and licensees of Tenant and others permitted by Tenant to use or occupy the Premises. 27. Landlord shall have the right to designate all or any portion of the Building and/or Project as a non-smoking facility at any time during the Term. 28. These rules and regulations are in addition to, and shall not be construed to modify or amend, in whole or in part, the terms, covenants, agreements, and conditions of the Lease. 40 45 EXHIBIT E TENANT ESTOPPEL CERTIFICATE RE: Lease dated ____________________ ("Lease") between The Northwestern Mutual Life Insurance Company ("Landlord") and ____________________ ("Tenant") for Suite _______ ("Premises") in a building located at ________________ and commonly known as ________________("Building"). The Tenant hereby certifies to Landlord, and to _________________, a ______________ ("_____________________") that the following information with respect to the Lease is true and correct: 1. The Lease is in full force and effect and has not been modified or amended except as specifically set forth in Paragraph 4. below. There are no other agreements, understandings, contracts or commitments of any kind with respect to the Lease or the Premises except as expressly provided in the Lease or in any amendment or supplement thereto set forth in Paragraph 4., below. 2. The Tenant asserts no claim of default, offset or defense against rent or other charges payable by the maintenance of the property of which the Premises are a part. To the best of Tenant's knowledge and belief, there is no default by Landlord under the Lease and all commitments made by Landlord to Tenant to induce Tenant to enter into the Lease have been satisfied. 3. All rent due under the Lease has been paid to the end of the current calendar month, which is ____, ____, and no rent due under the Lease has been paid more than one month in advance of its due date. 4. Dates of any Lease amendments or modifications: _____________________. 5. Current Monthly Rental: ___________________________. 6. Lease Commencement Date: ___________________________________. 7. Lease Expiration Date: _______________________________________. 8. The Lease contains no options to renew, first rights of refusal, options to expand, or options to terminate, except as follows: ______________________. 9. The Tenant has not assigned, or otherwise transferred its interest under the Lease, except as follows: ____________________________. 10. Tenant is using the Premises only for those purposes specifically permitted under the Lease, which is ____________________________. 11. Landlord is holding Tenant's security deposit of $__________________. 12. Tenant is not in default under the Lease nor are there any conditions, or events which have occurred or which, with the passage of time or the giving of notice or both, would constitute a default or breach. Tenant is current in the payment of all taxes, utilities, common area maintenance payments, and other charges required to be paid by the Tenant pursuant to the Lease, and there exists no dispute relative to any such amounts. 13. The improvements and space required to be furnished according to the Lease have been duly delivered by the Landlord and accepted by the Tenant. 41 46 14. The undersigned has all requisite authority to execute this Estoppel Certificate on behalf of Tenant. Dated: _______________________, ____. By: ------------------------------------ Its: ----------------------------------- 42 47 EXHIBIT F OPTION TO RENEW Subject to the provisions set forth below, the Lease Term may be renewed as to all (but not less than all) of the Premises as it then exists (including any expansion space then leased by Tenant in the Building under this Lease), at the option of Tenant, for one (1) additional period of 60 months (the "RENEWAL TERM"). The Renewal Term will be upon the same terms, covenants and conditions contained in the Lease, excluding the provision of Sections 2.2 (Termination Right), 3.3 (ROFO) and 28.3(b) (Signage Restrictions) of the Lease and excluding the Work Letter, and except for the amount of Monthly Rent payable during the Renewal Term, and any reference in the Lease to the "Lease Term" will be deemed to include the Renewal Term and apply thereto, unless it is expressly provided otherwise. Tenant will be deemed to have accepted the Premises in "as-is" condition as of the commencement of the Renewal Term, it being understood that Landlord will have no additional obligation to renovate or remodel the Premises or any portion of the Building as a result of Tenant's renewal of the Lease. Tenant will have no renewal option beyond the aforesaid 60-month period. (a) The initial Monthly Rent during the Renewal Term for any space then constituting a portion of the Premises will be at a rate equal to the then prevailing market rate as reasonably determined by Landlord for fully credit worthy tenants for comparable space in the Building, for a term equal or comparable to the Renewal Term. The Monthly Rent will increase by fixed amounts on each anniversary of the commencement of the Renewal Term based on prevailing-market Monthly Rent increases applicable at the commencement of the Renewal Term, as reasonably determined by Landlord. Tenant's obligation to pay Tenant's Proportionate Share of the Excess (actual Operating Expenses minus Base Year Operating Expenses) pursuant to the Lease will continue during the Renewal Term. (b) Such option to renew will be exercised by Tenant by delivering an initial nonbinding notice to Landlord no later than February 1, 2006, and not earlier than 60 days before such date, in which Tenant expresses its intention to exercise such option to renew. Thereafter, Landlord will notify Tenant ("LANDLORD'S NOTICE") of Landlord's calculation of (i) the initial prevailing market rate of Monthly Rent for the Premises, which calculation will reflect the market rate that would be payable per annum for a term commencing on the first day of the Renewal Term, and (ii) the prevailing market rate of increase in Monthly Rent applicable for such Renewal Term. If Tenant fails to give its initial nonbinding notice of intent to exercise its option to renew when due as provided in this Exhibit, Tenant will irrevocably be deemed to have waived such option to renew. Such calculation by Landlord will be final and will not be recalculated at the actual commencement of the Renewal Term (if any). (c) Within 15 days after Landlord delivers Landlord's Notice, Tenant will deliver to Landlord a final binding notice in which Tenant (i) elects to renew the Lease and accepts the terms stated in Landlord's Notice, or (ii) declines to renew the Lease term, in which case Tenant's rights under this Exhibit will be null and void. If Tenant fails to notify Landlord within the 15-day period described above (after having given its initial nonbinding notice within the required time), time being of the essence, then Tenant will conclusively be deemed to have elected to renew the Lease on the terms set forth in Landlord's Notice and in this Exhibit. (d) Tenant's right to exercise its option to renew this Lease pursuant to this Exhibit is subject to the following conditions: (i) that on the date that Tenant delivers notice of its election to exercise its option to renew, no Event of Default exists, and no condition exists which, with the giving of notice or the passage of time, or both, would constitute an Event of Default; and (ii) that Tenant has not assigned the Lease or sublet the Premises, at any time during the period commencing with the date that Tenant delivers its notice to Landlord of Tenant's exercise of such option to renew and ending on the commencement date of the Renewal Term, or at any time prior to such period, if such assignment or sublease extends into such period. 43 48 EXHIBIT G JANITORIAL SPECIFICATIONS 1. NIGHT CLEANING A. Night Cleaning Services Service Contractor shall perform the following Night Cleaning Services for the Property: OFFICES & COMMON AREA'S: ------------------------ o Vacuum all high traffic carpeted area's (Hallways, receptionist area, etc.) o Light vacuum individual office areas at least twice per week. o Empty wastepaper baskets, and other trash receptacles, and remove to appropriate outside trash container. Large cardboard boxes must be broken down by tenant prior to removal. o Clean cigarette urns (if any), and replace sand as necessary. o Sanitize and clean all drinking fountains. o Sweep all resilient tile and hard surface floors, and damp mop as necessary. o Damp dust tops of filing cabinets (any personal items and papers must be removed), bookcases, window ledges & shelves. o Dust all telephones. o Desk tops and computer screens will be feather dusted. Desktops must be clear and free of all paper and personal items for us to damp dust. We will do this per your instructions. o Clean upper side of all glass furniture tops (if any). o Designated lights are to be turned off after work and buildings to be left in a neat and orderly condition. RESTROOMS: ---------- o Empty and clean all paper towel and sanitary disposal receptacles. o Clean all mirrors, powder shelves, and bright work (includes flushometers and piping). o Refill soap, toilet tissue, and towel dispensers. Restroom stock is to be supplied by the customer. o Sanitary napkin dispensers (if any) are to be stocked and serviced by customer. o Mop all hard surface floors with a disinfectant cleaner three times a week. o Remove wastepaper and refuse to designated trash pick up area or bin. KITCHEN AREA & LUNCHROOM: ------------------------- o Clean and sanitize sinks. o Clean inside of Microwave Ovens. o Dispose of any left over coffee and clean coffee pots. o Clean tops of counter tops with disinfectant cleaner. o Wipe down fronts of appliances and vending machines (if any). o Sweep and spot damp mot tile flooring daily to remove spillage or track-in. o Clean tops of tables and spot clean chairs (as needed) with disinfectant cleaner. o Damp mop tile floor thoroughly twice a week. o Vacuum any carpeting (if any) and spot clean as necessary. 44 49 VESTIBULES: ----------- o All entry doors to be checked for finger marks and smudges and cleaned. o Roll up mats (if any) cleaned. o Mop hard surface flooring (as needed). LAB AREA: --------- o Clean as per instructed by tenant. Labs are critical areas that need to be discussed. MONTHLY: -------- o Dust blinds (if any) in individual offices and receptionist area. QUARTERLY: ---------- o Perform all high dusting which includes vertical surfaces such as walls (cobwebs), partitions, and other surfaces not reached in daily cleaning. o Wash partitions and tile walls with disinfectant in all restrooms. o Vacuum upholstered furniture (if any). o Clean leather furniture (if any) with leather cleaner. SEMI-ANNUAL: ------------ o Carpet Cleaning: Recommend that carpeting in the high traffic areas be cleaned at least semi-annually, and in the individual offices annually. A separate bid will be submitted on this when the tenant is ready. INTERIOR AND EXTERIOR WINDOW CLEANING: -------------------------------------- o Interior and exterior cleaning of windows will be done on a separate bid basis. 45 EX-21.1 4 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21.1
JURISDICTION OF NAME ORGANIZATION - ---- --------------- Common Sense Computing (U.K.) Ltd. U.K. Quest Software GmbH Germany Quest Software Pty Ltd. Australia Quest Software Company Ltd. Ireland Quest Software Israel Ltd. Israel Quest Software Foreign Sales Corporation Barbados Quest Software International Ltd. U.K. MBR Technologies, Inc. California Foglight Software, Inc. Delaware Quest Software Canada, Inc. Canada QMASTER Software Solutions, Inc. Canada
EX-23.1 5 CONSENT OF DELOITTE & TOUCHE LLP. 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE To the Board of Directors and Stockholders of Quest Software, Inc. and subsidiaries We consent to the use in this Registration Statement of Quest Software, Inc. on Form S-1 of our report dated February 1, 2000 (except for Note 12 as to which the date is February 11, 2000) appearing in the Prospectus, which is a part of this Registration Statement, and to the reference to us under the heading "Experts" in such Prospectus. Our audits of the financial statements referred to in our aforementioned report also included the financial statement schedule of Quest Software, Inc. and subsidiaries, listed in Item 16. This financial statement schedule is the responsibility of the corporation's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California February 17, 2000 EX-23.2 6 CONSENT OF SWENSON ADVISORS LLP. 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We hereby consent to the use in the Prospectus constituting part of this Registration Statement (No. 333- ) on Form S-1 of our report dated September 29, 1999 relating to the financial statements of MBR Technologies, Inc., which appears in such Prospectus. We also consent to the references to us under the headings "Experts." SWENSON ADVISORS, LLP Temecula, California February 18, 2000 EX-23.3 7 CONSENT OF PRICEWATERHOUSECOOPERS LLP. 1 EXHIBIT 23.3 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in this Registration Statement on Form S-1 of our report dated September 13, 1999, except for Note 10, for which it is October 29, 1999 relating to the financial statements and financial statement schedules of Foglight Software, Inc. as of December 31, 1998 and for the period from November 10, 1997 (date of inception) to December 31, 1998, which appear in such Registration Statement. We also consent to the references to us under the headings "Experts" and "Selected Financial Data" in such Registration Statement. /s/ PricewaterhouseCoopers LLP San Jose, California February 17, 2000 EX-27.1 8 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1999 DEC-31-1998 DEC-31-1999 39,643 11,000 22,010 3,239 0 74,747 9,430 2,251 99,149 36,077 0 0 0 94,010 (31,341) 99,149 54,269 70,868 2,998 7,193 59,207 352 257 5,670 2,273 3,397 0 0 0 2,807 .07 .07
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