-----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, JYw4rhmYPq8Fzt+73/baYL31q3w8Vyxg45PtTRZp4m+Ugsapb9zYjieTIIVeBjts kQZClYQKCoq+ytvNJiy7Ww== 0000892569-99-001712.txt : 19990615 0000892569-99-001712.hdr.sgml : 19990615 ACCESSION NUMBER: 0000892569-99-001712 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19990611 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUEST SOFTWARE INC CENTRAL INDEX KEY: 0001088033 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 330231678 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-80543 FILM NUMBER: 99645135 BUSINESS ADDRESS: STREET 1: 610 NEWPORT CENTER DRIVE CITY: NEWPORT BEACH STATE: CA ZIP: 92660 MAIL ADDRESS: STREET 1: 610 NEWPORT CENTER DRIVE CITY: NEWPORT BEACH STATE: CA ZIP: 92660 S-1 1 FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 11, 1999 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)
610 NEWPORT CENTER DRIVE NEWPORT BEACH, CA 92660 (949) 720-1434 (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. 610 NEWPORT CENTER DRIVE NEWPORT BEACH, CA 92660 (949) 720-1434 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: GREG T. WILLIAMS, ESQ. ALAN K. AUSTIN, ESQ. CHRISTINE P. LE, ESQ. BRIAN C. ERB, ESQ. PATTY H. LE, ESQ. BRIAN MCDANIEL, ESQ. BROBECK, PHLEGER & HARRISON LLP WILSON SONSINI GOODRICH & ROSATI 38 TECHNOLOGY DRIVE PROFESSIONAL CORPORATION IRVINE, CALIFORNIA 92618 650 PAGE MILL ROAD (949) 790-6300 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 TITLE OF EACH CLASS OF AGGREGATE OFFERING AMOUNT OF SECURITIES TO BE REGISTERED PRICE(1) REGISTRATION FEE - ------------------------------------------------------------------------------------------------------------------------- Common Stock........................................... $60,000,000 $16,680.00 - ------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------
(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o). ------------------------ 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 BE CHANGED. 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 WE ARE NOT SOLICITING OFFERS TO BUY THESE SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION, DATED JUNE 11, 1999 [QUEST SOFTWARE LOGO] SHARES COMMON STOCK ---------------------------------- Quest Software, Inc. is offering shares of common stock. This is our initial public offering, and no public market currently exists for our shares. We have filed an application for the common stock to be quoted on the Nasdaq National Market under the symbol "QSFT." We anticipate that the initial public offering price will be between $ and $ per share. ---------------------------------- INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 6. ----------------------------------
PER SHARE TOTAL --------- ----- Public Offering Price....................................... $ $ Underwriting Discounts and Commissions...................... $ $ Proceeds to Quest Software, Inc............................. $ $
---------------------------------- 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. Quest Software, Inc. has granted the underwriters a 30-day option to purchase up to an additional shares of our common stock to cover over-allotments. BancBoston Robertson Stephens Inc. expects to deliver the shares of common stock to purchasers on , 1999. ---------------------------------- BANCBOSTON ROBERTSON STEPHENS DONALDSON, LUFKIN & JENRETTE CIBC WORLD MARKETS FAC/EQUITIES THE DATE OF THIS PROSPECTUS IS , 1999. 3 Inside Front Cover [Quest Software Logo] The Quest Solution. Quest offers application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications and enable the delivery of information across the extended enterprise. [Schematic depiction of enterprise software environment showing the functionality of and relationships among Quest's products and this underlying environment.] 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. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS PROSPECTUS OR OF ANY SALE OF THE COMMON STOCK. IN THIS PROSPECTUS, REFERENCES TO "QUEST," "WE," "OUR" AND "US" REFER TO QUEST SOFTWARE, INC., TOGETHER WITH ITS SUBSIDIARIES. ------------------------ TABLE OF CONTENTS
PAGE ---- Summary..................................................... 4 Risk Factors................................................ 7 You Should Not Rely on Any Forward-Looking Statements Contained in this Prospectus Because They Are Subject to Risks and Uncertainties................................... 17 Use of Proceeds............................................. 18 Dividend Policy............................................. 18 Capitalization.............................................. 19 Dilution.................................................... 20 Selected Consolidated Financial Data........................ 21 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 22 Business.................................................... 32 Management.................................................. 46 Certain Transactions........................................ 56 Principal Shareholders...................................... 58 Description of Capital Stock................................ 60 Shares Eligible for Future Sale............................. 62 Underwriting................................................ 64 Legal Matters............................................... 66 Experts..................................................... 66 Additional Information...................................... 66 Index to Consolidated 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. We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. QUEST SOFTWARE, INC. We are a leading provider of application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications and enable the delivery of information across the extended enterprise. Organizations are constantly seeking ways to use information 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 core business processes over the Internet to directly reach a large number of geographically dispersed end-users. These e-business initiatives 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 extended 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 through database replication, enterprise monitoring, database and application performance optimization, change management and database programming solutions for thin-client development. 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, Australia, the United Kingdom and Germany, as well as through resellers and distributors. 4 6 THE OFFERING Common stock offered.................. shares Common stock to be outstanding after this offering......................... shares Use of proceeds....................... To redeem all outstanding shares of our Series B Redeemable Preferred Stock, to repay indebtedness and 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. See "Use of Proceeds." Proposed 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 March 31, 1999 which excludes: - 4,576,125 shares of common stock issuable upon exercise of stock options outstanding as of June 1, 1999 at a weighted average exercise price of $1.65 per share; - 1,500 shares of common stock issued upon exercise of options subsequent to March 31, 1999; - 2,923,875 shares of common stock reserved for future issuance under our stock incentive plan; and - 600,000 shares of common stock reserved for issuance under our employee stock purchase plan. See "Capitalization," "Management -- 1999 Stock Incentive Plan," "-- 1999 Employee Stock Purchase Plan" and note 5 of the notes to our consolidated financial statements. CORPORATE INFORMATION We were incorporated in California in April 1987. Our principal executive offices are located at 610 Newport Center Drive, Newport Beach, California 92660 and our telephone number is (949) 720-1434. 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: - reflects a three-for-two stock split that was effected in June 1999; - reflects the issuance of 2,666,667 shares of our Series A Preferred Stock in April 1999 and the automatic conversion of such shares into 4,000,000 shares of common stock immediately prior to the closing of this offering; and - assumes that the underwriters' over-allotment option is not exercised. 5 7 SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) The pro forma information below gives effect, as of March 31, 1999, to the receipt of $25.0 million from the issuance of 2,666,667 shares of Series A Preferred Stock and 1,777,778 shares of Series B Redeemable Preferred Stock in April 1999, the receipt of $10.0 million in proceeds from the issuance of long-term debt in April 1999, the repurchase of 14,820,000 shares of our common stock by us for $35.0 million in April 1999 and the issuance of 4,000,000 shares of common stock upon the conversion of all outstanding shares of the Series A Preferred Stock immediately prior to the closing of this offering. The pro forma as adjusted information below gives effect as of March 31, 1999, to the pro forma adjustment set forth above and our receipt of the estimated net proceeds of $ from the sale of shares of common stock offered by us hereby at an assumed initial public offering price of $ per share and the uses of the estimated proceeds therefrom described in "Use of Proceeds."
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, --------------------------------------------- ------------------- 1994 1995 1996 1997 1998 1998 1999 ------ ------ ------- ------- ------- -------- -------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Total revenues......................... $5,686 $9,524 $12,862 $18,315 $34,790 $ 7,043 $12,814 Gross profit........................... 3,461 8,284 10,445 15,036 28,850 5,965 11,250 Income (loss) from operations.......... 37 2,335 (372) 1,448 3,689 1,435 1,416 Net income............................. 17 2,358 16 289 2,346 868 883 Basic and diluted net income per share................................ $ -- $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.02 $ 0.02 Weighted average common shares outstanding: Basic................................ 19,500 19,500 38,350 40,373 44,261 43,497 44,539 Diluted.............................. 19,500 19,500 38,350 40,373 44,559 43,721 45,650 Pro forma basic and diluted net income per share............................ $ 0.05 $ 0.02 Pro forma weighted average shares outstanding: Basic................................ 48,261 48,539 Diluted.............................. 48,559 49,650
MARCH 31, 1999 ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED ------- --------- ----------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................... $12,502 $12,502 $ Working capital............................................. 3,309 3,309 Total assets................................................ 22,472 22,472 Long-term debt.............................................. -- 10,000 -- Series B Redeemable Preferred Stock......................... -- 10,000 -- Retained earnings........................................... 4,874 -- -- Total shareholders' equity (deficit)........................ 5,911 (14,089)
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. In addition, you should keep in mind that the risks described below are not the only risks that we face. 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. However, additional risks not presently known to us, or risks that we currently believe are immaterial, may also impair our business. 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 Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors, including the following: - variations in demand for our products; - the size and timing of customer orders; - 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. We have difficulty predicting the volume and timing of orders for our products. In any given quarter, sales of some of our products have involved, and we expect will continue to involve, large financial commitments from a relatively small number of customers. The cancellation or deferral of these large contracts would reduce our revenues, which would adversely affect our quarterly financial performance. Also, we have often booked a large amount of our sales in the last month or weeks of each quarter. Accordingly, delays in the closing of sales near the end of a quarter could cause quarterly revenue to fall short of anticipated levels. In addition, 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. A significant portion of our expenses are fixed in the short term and cannot be quickly reduced to respond to decreases in revenue. As a result, a delay in generating or recognizing revenue could cause significant variations in our operating results from quarter-to-quarter and could result in substantial operating losses. 7 9 MANY OF OUR PRODUCTS SUPPORT ORACLE'S TECHNOLOGIES AND THEREFORE OUR SUCCESS IS DEPENDENT IN PART ON ORACLE We believe that our success has depended in part, and will continue to depend in part for the foreseeable future, upon our relationship with Oracle and our status as a complementary software provider for Oracle's database and application products. Many versions of our principal products, including SharePlex, SQLab Xpert, and SQL Navigator, are designed specifically to be used with Oracle databases. Although a number of our products work with other environments, our competitive advantage consists in substantial part on the integration between our products and Oracle's products, and our extensive knowledge of Oracle's technology. Currently, a significant portion of our total revenues 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 COMPETE WITH PRODUCTS AND FUNCTIONALITY OFFERED BY 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. OUR SUCCESS DEPENDS ON OUR ABILITY TO HIRE AND RETAIN QUALIFIED SALES PERSONNEL AND EXPAND OUR INDIRECT SALES CHANNELS Our ability to increase revenues in the future substantially depends on the success of our direct sales force and our success in recruiting, training and retaining additional direct salespeople. In this regard, we intend to continue to expand our direct sales and telesales forces. There has in the past been and there may in the future be a shortage of direct sales personnel with the skills and expertise necessary to sell our products effectively. Also, it may take our new sales personnel and sales personnel that we may hire in the future several months before they become productive. Our business will be harmed if we fail to continue to hire or retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more slowly than we anticipate. In certain 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 assurance that we will successfully augment these arrangements or that the expansion of indirect sales distribution methods will increase revenues. DIFFICULTIES WE MAY ENCOUNTER MANAGING OUR GROWTH COULD ADVERSELY AFFECT OUR BUSINESS 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 8 10 operations. The number of our full-time employees increased from 67 as of December 31, 1996 to 129 as of December 31, 1997, to 253 as of December 31, 1998, to 307 as of March 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. OUR FUTURE SUCCESS MAY DEPEND ON INCREASED BUSINESS FROM OUR CURRENT CUSTOMERS 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 We intend to substantially increase our operating expenses for the foreseeable future as we: - increase our sales and marketing activities, including expanding our direct sales and telesales forces; - increase our research and development activities; - expand our general and administrative activities; and - expand our customer support organizations. Accordingly, we will be required to significantly increase our revenues in order to maintain profitability. These expenses will be incurred before we generate any revenues by this increased spending. If we do not significantly increase revenues from these efforts, our business and operating results would be negatively impacted. IT IS DIFFICULT TO PREDICT THE TIMING OF INDIVIDUAL ORDERS BECAUSE SOME OF OUR PRODUCTS HAVE A RELATIVELY LONG SALES CYCLE To date, the sales cycle for Vista Plus and SharePlex have been up to six months and often require pre-purchase evaluation periods. For example, as part of our sales effort for Vista Plus, we spend significant time educating our prospective customers regarding the use and benefits of this product. The relatively long sales cycles for these products may cause license revenues and operating results for those products to vary significantly from period to period. 9 11 ACQUISITIONS OF COMPANIES OR TECHNOLOGIES MAY RESULT IN DISRUPTIONS TO OUR BUSINESS AND DIVERSION OF MANAGEMENT ATTENTION We have in the past and we expect to continue to make acquisitions of complementary companies, products or technologies. If we make any 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 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. 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 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 $2.3 million in the three months ended March 31, 1999, representing 18.2% 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. 10 12 OUR FUTURE SUCCESS DEPENDS IN PART ON THE ACCEPTANCE OF OUR VISTA PLUS PRODUCT Our recent operating results have depended in part upon the commercial success of our Vista Plus product line and we expect a significant portion of our licensing revenues for the foreseeable future to come from sales of these products. As a result, any future growth of Quest for the foreseeable future will depend on the continued commercial success of these products. Our future financial performance will also depend in part on the successful development, introduction and customer acceptance of new and enhanced versions of Vista Plus products. In the future we may not be successful in marketing our existing products or any new or enhanced products or services. SEASONALITY MAY CONTRIBUTE TO FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS Our business has experienced, and is expected to continue to experience, seasonal customer buying patterns. In recent years, we have had 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. We believe that this pattern will continue. 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. FAILURE TO DEVELOP STRATEGIC RELATIONSHIPS COULD HARM OUR BUSINESS 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 Oracle and certain regional offices of a number of the national accounting firms that provide system integration services, in areas such as product development, marketing, distribution and implementation. We could lose sales opportunities if we fail to work effectively with these parties. Moreover, we expect that maintaining and enhancing these and other relationships will become a more meaningful part of our business strategy in the future. However, many of our current partners are either actual or potential competitors with us. In addition, many of these third parties also work with competing software companies and we may not be able to maintain these existing relationships, due to the fact that these relationships are informal or, if written, are terminable with little or no notice. OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED, AND THERE IS RISK OF INFRINGEMENT CLAIMS IN OUR BUSINESS 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 11 13 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. 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. There can be no assurance that third parties will not claim infringement by us of their 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. On May 25, 1999, Mobius Management Systems, Inc. filed a lawsuit against us in the United States District Court for the District of New Jersey. The complaint alleges, among other things, that we misappropriated unspecified trade secrets belonging to Mobius. No factual basis was set forth in the complaint in support of this claim. The suit seeks injunctive relief and unspecified damages. See "Business -- Legal Proceedings." 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. 12 14 In addition, a product liability claim, whether or not successful, could harm our business by increasing our costs and distracting our management. PRODUCT DEVELOPMENT DELAYS COULD HARM OUR BUSINESS If we fail to release new products and upgrades on time, our business may suffer one or more of the following consequences: - customer dissatisfaction; - cancellation of orders and license agreements; - negative publicity; - loss of revenues; or - slower market acceptance. 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 HARM OUR BUSINESS Our SQL Navigator, TOAD and Vista Plus products contain components developed and maintained by third-party software vendors. We expect that we may have to incorporate software from third-party vendors in our future products. We may not be able to replace the functionality provided by the third-party software currently offered with our products if that software becomes obsolete, defective or incompatible with future versions of our products or is not adequately maintained or updated. Any significant interruption in the availability of these third-party software products or defects in these products could harm our sales unless and until we can secure an alternative source. RISKS RELATED TO OUR INDUSTRY YEAR 2000 ISSUES PRESENT TECHNOLOGICAL RISKS AND COULD CAUSE DISRUPTION TO OUR BUSINESS Software that records only the last two digits of the calendar year may not be able to distinguish whether "00" means 1900 or 2000. This may result in software failures or the creation of erroneous results. Year 2000-related errors or defects that affect the operation of our software could result in: - delay or loss of revenue; - cancellation of customer contracts; - diversion of development resources; - damage to our reputation; - increased customer support and warranty costs; and - litigation costs. We are in the process of commencing our Year 2000 review program for the hardware, software and systems we use to run our operations. The Year 2000 problem could affect computers, software and other equipment that we use internally as well as divert management's attention from ordinary business activities. In addition to computers and related systems, the operation of our office and facilities equipment, such as fax machines, photocopiers, telephone switches, security systems, elevators and other common devices may be affected by the Year 2000 problem. In addition, there can be no assurance that our suppliers or other third parties that we rely upon will resolve any or all Year 2000 problems with their systems on a timely basis. Because we have not yet completed our Year 2000 review program, we face uncertainty. Even though we do not expect our internal Year 2000 compliance efforts to involve significant 13 15 time and expense based on currently available information, any material, undetected or uncorrected problem could materially adversely affect our business, financial condition and operating results. Success of our Year 2000 compliance efforts may also depend on the success of our customers in dealing with their Year 2000 issues. Our products are generally integrated into enterprise systems involving sophisticated hardware and complex software products which may not be Year 2000 compliant. In addition, third party applications in which our products are embedded, or for which our products are separately licensed, may not comply with Year 2000 requirements, which may have an adverse impact on or demand for our products. In some cases even certain earlier Year 2000 compliant versions of our software, while compatible with earlier, non-Year 2000 compliant versions of other software products with which our software is integrated, are not compatible with certain more recent Year 2000 compliant versions of such other software providers. While we do not believe we have any obligation under these circumstances given that these customers are using older versions of our software products, there can be no assurance that we will not be subject to claims or complaints by our customers. Although we have not been a party to any litigation or arbitration proceeding to date involving our products or services and related to Year 2000 compliance issues, there can be no assurance that we will not in the future be required to defend our products or services in such proceedings, or to negotiate resolutions of claims based on Year 2000 issues. The costs of defending and resolving Year 2000-related disputes, regardless of the merits of such disputes, and any liability for Year 2000-related damages, including consequential damages, would have a material adverse effect on our business, results of operations and financial condition. CUSTOMER FOCUS AND SPENDING ON YEAR 2000 REMEDIATION MAKES IT DIFFICULT TO PREDICT THE BUYING PATTERNS OF OUR CUSTOMERS DURING THE THIRD AND FOURTH QUARTERS OF 1999 The purchasing patterns of our customers and potential customers based on Year 2000 issues make it difficult to predict future sales of our products, especially in the third and fourth quarters of 1999. Many customers may spend their limited financial and personnel resources remediating Year 2000 problems, thereby delaying or foregoing purchases of other software products such as ours. This trend could reduce our revenues in 1999 and 2000. Other companies are accelerating purchases of software products prior to 2000, causing an increase in short-term demand which may in turn cause a corresponding decrease in long-term demand for software products. OUR FUTURE SUCCESS 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 14 16 - achieving market acceptance for our new products and product enhancements. OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY 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, including our Chief Financial Officer, 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. 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 WE HAVE SUBSTANTIAL DISCRETION AS TO HOW TO USE THE PROCEEDS FROM THIS OFFERING Our management has broad discretion as to how to spend a substantial portion of the proceeds from this offering and may spend these proceeds in ways with which our shareholders may not agree. We cannot predict that investment of the proceeds will yield a favorable or any return. 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 % 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. THERE HAS BEEN NO PRIOR MARKET FOR OUR COMMON STOCK, AND WE EXPECT THE PRICE OF OUR COMMON STOCK TO BE VOLATILE Prior to this offering, you could not buy or sell our common stock publicly. An active public market for our common stock may not develop or be sustained after the offering, and the market price might fall below the initial public offering price. The initial public offering price may bear no relationship to the price at which the common stock will trade upon completion of this offering. The initial public offering price will be determined based on negotiations between us and the representatives of the underwriters, based on factors that may not be indicative of future market performance. 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 15 17 - stock market price and volume fluctuations, which are particularly common among highly volatile securities of Internet and software companies. 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. On completion of this offering, we will have shares of common stock outstanding with shares if the underwriters' option to purchase additional shares is exercised in full. The shares sold in this offering, which would be 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. The remaining shares of common stock outstanding on completion of this offering will be "restricted securities" as that term is defined in Rule 144. Our stock and 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 180 days after the date of this prospectus without the prior written approval of BancBoston 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." 16 18 YOU SHOULD NOT RELY ON ANY FORWARD-LOOKING STATEMENTS CONTAINED IN THIS PROSPECTUS BECAUSE THEY ARE SUBJECT TO RISKS AND UNCERTAINTIES 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. These forward-looking statements are made as of the date of this prospectus, and we assume no obligation to update them or to explain the reasons why actual results may differ. In light of these assumptions, risks and uncertainties, the forward-looking events discussed in this prospectus might not occur. 17 19 USE OF PROCEEDS The net proceeds to us from the sale of the shares of common stock offered hereby are estimated to be approximately $ , or $ million if the underwriters exercise their over-allotment option in full, based upon an assumed initial offering price per share of $ and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We intend to use the net proceeds of this offering: - to redeem all outstanding shares of our Series B Preferred Stock, including all accrued dividends thereon, for $10.0 million; - to repay $10.0 million of outstanding term indebtedness that matures in May 2002 and bears interest at a rate of 7.75% per annum, and all accrued and unpaid interest thereon; and - for other 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, create a public market for our common stock, facilitate our future access to public equity markets and increase our visibility in the marketplace. As of the date of this prospectus, other than the redemption of the preferred stock and repayment of indebtedness, 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. We currently have no formal arrangements, agreements or understandings, and are not engaged in active negotiations with respect to such acquisitions or investments. 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. 18 20 CAPITALIZATION The Actual column in the following table sets forth our actual capitalization as of March 31, 1999. The Pro Forma column in the following table gives effect to: - the receipt of $25.0 million from the issuance and sale of 2,666,667 shares of Series A Preferred Stock and 1,777,778 shares of Series B Redeemable Preferred Stock in April 1999; - the conversion of all outstanding shares of our Series A Preferred Stock into 4,000,000 shares of common stock which will occur immediately prior to the closing of this offering; - the issuance of $10.0 million of long-term debt in April 1999; and - the repurchase of 14,820,000 shares of our common stock by us for $35.0 million in April 1999. The Pro Forma As Adjusted column in the following table gives effect to the pro forma adjustments described above and: - the filing of our Amended and Restated Articles of Incorporation concurrently with the closing of this offering to provide for authorized capital stock of 75,000,000 shares of common stock and 5,000,000 shares of undesignated preferred stock; - the redemption of all outstanding shares of our Series B Redeemable Preferred Stock and all accrued dividends thereon for $10.0 million with a portion of the net proceeds of this offering; - the repayment of $10.0 million of long-term debt and all accrued and unpaid interest thereon with a portion of the net proceeds of this offering; and - the sale of shares of common stock in this offering at an initial public offering price of $ per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses. See "Use of Proceeds" and the notes to our consolidated financial statements. The Pro Forma and Pro Forma As Adjusted information set forth below should be read in conjunction with our consolidated financial statements and the notes thereto.
MARCH 31, 1999 ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED ------- --------- ----------- (DOLLARS IN THOUSANDS) Long-term debt.............................................. $ -- $ 10,000 $ -- ------- -------- -------- Series B Redeemable Preferred Stock, no par value, 1,800,000 shares authorized, no shares issued and outstanding actual and pro forma as adjusted; 1,777,778 shares issued and outstanding, pro forma.................................... -- 10,000 -- Stockholders' equity (deficit): Preferred stock, no par value; 5,000,000 shares authorized, no shares issued or outstanding, pro forma as adjusted.... -- Common stock, no par value; 75,000,000 shares authorized, 44,538,000, 33,721,300 and shares issued and outstanding, actual, pro forma and pro forma as adjusted.................................................. 4,243 19,239 Retained earnings........................................... 4,874 -- -- Notes receivable from sale of common stock.................. (3,206) (3,206) (3,206) Capital distribution in excess of basis in common stock..... -- (30,122) (30,122) ------- -------- -------- Total shareholders' equity (deficit)...................... 5,911 (14,089) ------- -------- -------- Total capitalization...................................... $ 5,911 $ 5,911 $ ======= ======== ========
The information in the table above excludes: - 4,576,125 shares of common stock issuable upon exercise of stock options outstanding as of June 1, 1999 at a weighted average exercise price of $1.65 per share; - 1,500 shares of common stock issued upon exercise of options subsequent to March 31, 1999; - 2,923,875 shares of common stock reserved for future issuance under our stock incentive plan; and - 600,000 shares of common stock reserved for issuance under our employee stock purchase plan. See "Capitalization," "Management -- 1999 Stock Incentive Plan," "-- 1999 Employee Stock Purchase Plan" and note 5 of the notes to our consolidated financial statements. 19 21 DILUTION Our pro forma net tangible book value (deficit) as of March 31, 1999 was $(14,600,000), or $(.43) per share of common stock. Pro forma net tangible book value (deficit) per share represents the amount of our total assets reduced by the amount of our purchased technology and software and total liabilities, divided by the pro forma number of shares of common stock outstanding after giving effect to the issuance and conversion of 2,666,667 shares of Series A Preferred Stock into 4,000,000 shares of common stock and the repurchase of 14,280,000 shares of our common stock in April 1999 for $35.0 million. After giving effect to the sale of the shares of common stock offered hereby at an assumed initial public offering price of $ per share and our receipt of the estimated net proceeds therefrom, our pro forma net tangible book value as of March 31, 1999 would have been approximately $ million, or $ per share. This represents an immediate increase in pro forma net tangible book value of $ per share to existing stockholders and an immediate dilution in pro forma net tangible book value of $ per share to new investors. The following table illustrates this per share dilution: Assumed initial public offering price per share............. $ Pro forma net tangible book value (deficit) per share..... $(.43) Increase per share attributable to new investors.......... ----- Pro forma net tangible book value per share after this offering.................................................. ----- Dilution per share to new investors......................... $ =====
The following table summarizes on a pro forma basis, as of March 31, 1999, the differences between the existing shareholders, as adjusted, and new investors with respect to the number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid.
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE -------------------- --------------------- PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- ------- ----------- ------- --------- Existing shareholders.................. 33,721,300 % $19,239,000 % $0.57 New investors.......................... ---------- ----- ----------- ----- Totals....................... 100.0% $ 100.0% ========== ===== =========== =====
The information in the table above excludes: - 4,576,125 shares of common stock issuable upon exercise of stock options outstanding as of June 1, 1999 at a weighted average exercise price of $1.65 per share; - 1,500 shares of common stock issued upon exercise of options subsequent to March 31, 1999; - 2,923,875 shares of common stock reserved for future issuance under our stock incentive plan; and - 600,000 shares of common stock reserved for issuance under our employee stock purchase plan. See "Capitalization," "Management -- 1999 Stock Incentive Plan," "-- 1999 Employee Stock Purchase Plan" and note 5 of the notes to our consolidated financial statements. The issuance of common stock under our stock plans will result in further dilution to new investors. 20 22 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 operations data for the years ended December 31, 1996, 1997 and 1998 and the three months ended March 31, 1998 and 1999 and the consolidated balance sheet data at December 31, 1997 and 1998 and March 31, 1999 have been derived from audited and unaudited consolidated financial statements included elsewhere in this prospectus. The consolidated data presented below for the year ended December 31, 1995 and at December 31, 1995 and 1996 are derived from audited consolidated financial statements that are not included in this prospectus. The consolidated data presented below for the year ended December 31, 1994 and at December 31, 1994 are derived from unaudited consolidated financial statements that are not included in this prospectus.
THREE MONTHS YEAR ENDED DECEMBER 31, ENDED MARCH 31, --------------------------------------------------- ----------------- 1994 1995 1996 1997 1998 1998 1999 ----------- ------- ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues: Licenses..................................... $ 4,835 $ 7,219 $ 9,316 $12,195 $24,901 $ 4,840 $ 9,540 Services..................................... 851 2,305 3,546 6,120 9,889 2,203 3,274 ------- ------- ------- ------- ------- ------- ------- Total revenues......................... 5,686 9,524 12,862 18,315 34,790 7,043 12,814 ------- ------- ------- ------- ------- ------- ------- Cost of revenues: Licenses..................................... 99 260 950 1,307 3,433 557 660 Services..................................... 2,126 980 1,467 1,972 2,507 521 904 ------- ------- ------- ------- ------- ------- ------- Total cost of revenues................. 2,225 1,240 2,417 3,279 5,940 1,078 1,564 ------- ------- ------- ------- ------- ------- ------- Gross profit................................... 3,461 8,284 10,445 15,036 28,850 5,965 11,250 Operating expenses: Sales and marketing.......................... 672 2,179 4,328 5,845 12,914 2,114 5,544 Research and development..................... 502 1,134 2,995 4,293 6,549 1,470 2,373 General and administrative................... 2,250 2,636 3,494 3,450 5,698 946 1,917 ------- ------- ------- ------- ------- ------- ------- Total operating expenses............... 3,424 5,949 10,817 13,588 25,161 4,530 9,834 ------- ------- ------- ------- ------- ------- ------- Income (loss) from operations.................. 37 2,335 (372) 1,448 3,689 1,435 1,416 Other income (expense), net.................... 6 51 389 (137) 336 48 112 ------- ------- ------- ------- ------- ------- ------- Income before income tax provision............. 43 2,386 17 1,311 4,025 1,483 1,528 Income tax provision(1)........................ 26 28 1 1,022 1,679 615 645 ------- ------- ------- ------- ------- ------- ------- Net income..................................... $ 17 $ 2,358 $ 16 $ 289 $ 2,346 $ 868 $ 883 ======= ======= ======= ======= ======= ======= ======= Basic and diluted net income per share......... $ -- $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.02 $ 0.02 Weighted average shares outstanding Basic........................................ 19,500 19,500 38,350 40,373 44,261 43,497 44,539 Diluted...................................... 19,500 19,500 38,350 40,373 44,559 43,721 45,650
DECEMBER 31, -------------------------------------------------- MARCH 31, 1994 1995 1996 1997 1998 1999 ----------- ------ ------- ------- ------- ----------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents........................... $1,801 $2,709 $ -- $ 2,096 $ 8,981 $12,502 Working capital..................................... 1,158 2,594 553 374 2,771 3,309 Total assets........................................ 4,281 6,171 6,408 9,713 19,645 22,472 Total stockholders' equity.......................... 1,681 2,996 2,429 2,836 5,074 5,911
- ------------------------- (1) Does not include pro forma adjustments to reflect the income tax provision as if we were a C corporation in fiscal years 1994, 1995 and 1996. 21 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of the Financial Condition and Results of Operations contains forward-looking statements relating to future events or the future financial performance of Quest, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under "Risk Factors," "Business" and elsewhere in this prospectus. See also "You Should Not Rely on any Forward-Looking Statements Contained in this Prospectus Because they are Subject to Risks and Uncertainties." 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 are a leading provider of application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications and enable the delivery of information across the extended enterprise. We 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. 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 $5.7 million in 1994 to $34.8 million in 1998. 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. We market our software and services primarily through our direct sales organization in the United States, the United Kingdom, Germany and Australia. International revenues from licenses and services sold to customers outside of North America were $1.3 million in 1996, $1.4 million in 1997, $5.8 million in 1998 and $2.3 million in the three months ended March 31, 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 22 24 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. RESULTS OF OPERATIONS The following table sets forth certain consolidated statement of operations data as a percentage of total revenues for the periods indicated:
THREE MONTHS YEAR ENDED DECEMBER 31, ENDED MARCH 31, ----------------------- ---------------- 1996 1997 1998 1998 1999 ----- ----- ----- ------ ------ Revenues: Licenses......................................... 72.4% 66.6% 71.6% 68.7% 74.4% Services......................................... 27.6 33.4 28.4 31.3 25.6 ----- ----- ----- ----- ----- Total revenues........................... 100.0 100.0 100.0 100.0 100.0 ----- ----- ----- ----- ----- Cost of revenues: Licenses......................................... 7.4 7.1 9.9 7.9 5.1 Services......................................... 11.4 10.8 7.2 7.4 7.1 ----- ----- ----- ----- ----- Total cost of revenues................... 18.8 17.9 17.1 15.3 12.2 ----- ----- ----- ----- ----- Gross profit....................................... 81.2 82.1 82.9 84.7 87.8 Operating expenses: Sales and marketing.............................. 33.6 31.9 37.1 30.0 43.3 Research and development......................... 23.3 23.5 18.8 20.9 18.5 General and administrative....................... 27.2 18.8 16.4 13.4 14.9 ----- ----- ----- ----- ----- Total operating expenses................. 84.1 74.2 72.3 64.3 76.7 ----- ----- ----- ----- ----- Income (loss) from operations...................... (2.9) 7.9 10.6 20.4 11.1 Other income (expense), net........................ 3.0 (0.7) 0.9 0.6 0.8 ----- ----- ----- ----- ----- Income before income tax provision................. 0.1 7.2 11.5 21.0 11.9 Income tax provision............................... 0.0 5.6 4.8 8.7 5.0 ----- ----- ----- ----- ----- Net income......................................... 0.1% 1.6% 6.7% 12.3% 6.9% ===== ===== ===== ===== =====
THREE MONTHS ENDED MARCH 31, 1998 AND 1999 Revenues Revenues are derived from the sale of software licenses and related services. Total revenues were $7.0 million and $12.8 million for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $5.8 million, or 82.9%. International revenues accounted for 10.5% and 18.2% of total revenues for the three months ended March 31, 1998 and 1999, respectively. Licenses. Licenses were $4.8 million and $9.5 million for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $4.7 million, or 97.9%. This increase resulted from both an increase in the size of both the domestic and international sales organizations as well as the availability 23 25 of new products. Products available in the first three months of 1999 which were not available in 1998 included Schema Manager, I/Watch and TOAD along with the Vista Plus interface module for SAP R/3. Licenses represented 68.7% and 74.4% of total revenues for the three months ended March 31, 1998 and 1999, respectively. International licenses represented 10.4% and 19.0% of total licenses in the three months ended March 31, 1998 and 1999, respectively. Services. Services were $2.2 million and $3.3 million for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $1.1 million, or 50.0%. Services consist primarily of annual maintenance fees for technical support and product enhancements. Maintenance fees are generally renewable annually at the customer's option and are recognized over the term of each agreement. The increase in services for the three months ended March 31, 1999 reflected increases in the installed base of customers that purchased maintenance. Services represented 31.3% and 25.6% of total revenues for the three months ended March 31, 1998 and 1999, respectively. International services accounted for 10.8% and 15.6% of services for the three months ended March 31, 1998 and 1999, respectively. Cost of Revenues Cost of Licenses. Cost of licenses includes amortization of purchased technology and software licenses, product media, printing and duplication costs, and royalties to former owners of acquired technologies. Cost of licenses was $557,000 and $660,000 for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $103,000, or 18.5%. This increase was principally a result of increased product media, printing and duplication costs, and amortization of purchased technology and software licenses, offset in part by reduced royalties. Cost of licenses represented 11.6% and 6.9% of license revenue for the three months ended March 31, 1998 and 1999, respectively. The decrease as a percentage of license revenue resulted from increased license revenue without a corresponding increase in amortization of technology rights and software licenses which do not vary by the number of licenses sold. We do not expect the cost of licenses to increase as a percentage of licenses based upon our current amortization projections and existing royalty obligations. Cost of Services. Cost of services includes salaries and related costs for customer support personnel. Cost of services was $521,000 and $904,000 for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $383,000, or 73.5%. This increase was primarily due to an increase in the number of customer support personnel to manage and support our growing customer base as well as the increased number of product offerings. Cost of services was 23.7% and 27.4% of service revenues for the three months ended March 31, 1998 and 1999, respectively. We expect the cost of services to increase in absolute dollars for the foreseeable future as additional customer support personnel are retained. Operating Expenses Sales and Marketing. Sales and marketing expenses consist primarily of salaries and commissions earned by sales personnel, recruiting costs, trade show and conference costs, travel and entertainment, and advertising and promotional expenses. Sales and marketing expenses were $2.1 million and $5.5 million for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $3.4 million, or 162.0%. This increase primarily reflects increased commissions and the rapid expansion of our sales and marketing organization which we commenced in early 1998, including the costs to recruit and hire sales personnel. Sales and marketing expenses represented 30.0% and 43.3% of total revenues for the three months ended March 31, 1998 and 1999, respectively. We expect that sales and marketing expenses will continue to increase in absolute dollars for the foreseeable future as commissions increase with expected increases in revenues and as we continue to expand the size of our sales and marketing organization. Research and Development. Research and development expenses consist primarily of salaries and benefits for software developers, software product managers and quality assurance personnel and payments to outside software development contractors. Research and development expenses were $1.5 million and $2.4 million for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $900,000, or 60.0%. This increase was primarily related to an increase in the number of software 24 26 developers, both in our domestic and Australian development operations. Research and development costs represented 20.9% and 18.5% of total revenues for the three months ended March 31, 1998 and 1999, respectively. We expect that research and development expenses will continue to increase in absolute dollars for the foreseeable future as additional development personnel are hired. General and Administrative. General and administrative expenses consist primarily of salaries, benefits and related costs for our executive, finance, administrative and information services personnel. General and administrative expenses were $946,000 and $1.9 million for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $954,000, or 100.8%. This increase was primarily due to an increase in the number of general and administrative personnel necessary to support our expanding operations. General and administrative costs represented 13.4% and 14.9% of total revenues for the three months ended March 31, 1998 and 1999, respectively. We expect that general and administrative expenses will continue to increase in absolute dollars for the foreseeable future as a result of the continued expansion of administrative staff and expenses associated with being a public company, including annual and other public reporting costs, directors' and officers' liability insurance premiums, investor relations programs and professional services fees. Other Income (Expense), net. Other income (expense), net is comprised of interest income, interest expense and foreign currency transaction gains and losses. Other (expense) income, net was $48,000 and $112,000 for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $64,000. Provision for Income Taxes. Provision for income taxes was $615,000 and $645,000 for the three months ended March 31, 1998 and 1999, respectively, representing an increase of $30,000. Our effective income tax rate was 41.5% and 42.2% for the three months ended March 31, 1998 and 1999, respectively. YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 Revenues Revenues were $12.9 million, $18.3 million and $34.8 million for 1996, 1997 and 1998, respectively, representing increases of $5.4 million, or 41.9%, from 1996 to 1997 and $16.5 million, or 90.2%, from 1997 to 1998. International revenues accounted for 10.1%, 7.4%, and 16.7% of total revenues for 1996, 1997, and 1998, respectively. One customer accounted for 12% of total revenues in 1996. No customer accounted for more than 10.0% of total revenues in 1997 or 1998. Licenses. Licenses were $9.3 million, $12.2 million and $24.9 million in 1996, 1997 and 1998, respectively, representing increases of $2.9 million, or 31.2%, from 1996 to 1997 and $12.7 million, or 104.1%, from 1997 to 1998. Licenses represented 72.4%, 66.6% and 71.6% of total revenues in 1996, 1997 and 1998, respectively. International licenses accounted for 11.9%, 8.2%, and 18.6% of total licenses in 1996, 1997, and 1998, respectively. The increase in licenses from 1996 to 1997 was due to the increase in the size of the domestic sales organization combined with the availability in 1997 of our SQL Navigator product. The increase in licenses from 1997 to 1998 was due to the expansion of our domestic sales organization, a substantial 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. Services. Services were $3.5 million, $6.1 million and $9.9 million in 1996, 1997 and 1998, respectively, representing increases of $2.6 million, or 74.3%, from 1996 to 1997 and $3.8 million, or 62.3%, from 1997 to 1998. Services represented 27.6%, 33.4% and 28.4% of total revenues in 1996, 1997 and 1998, respectively. The increase in services from 1996 to 1997 and 1997 to 1998 reflects the increase in the number of software licenses sold with maintenance agreements. International services accounted for 5.6%, 5.8% and 11.9% of total services in 1996, 1997 and 1998, respectively. Cost of Revenues Cost of Licenses. Cost of licenses was $950,000, $1.3 million and $3.4 million in 1996, 1997 and 1998, respectively, representing increases of $350,000, or 36.8%, from 1996 to 1997 and $2.1 million, or 25 27 161.5%, from 1997 to 1998. Cost of licenses as a percentage of license revenue was 10.2%, 10.7% and 13.7% for 1996, 1997 and 1998, respectively. The increase in cost of licenses as a percentage of license revenue from 1997 to 1998 was attributable to higher amortization of purchased technology and royalties. Cost of Services. Cost of services was $1.5 million, $2.0 million and $2.5 million in 1996, 1997 and 1998, respectively, representing increases of $500,000, or 33.3%, from 1996 to 1997 and $500,000, or 25.0%, from 1997 to 1998. 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 42.9%, 32.8% and 25.3% for 1996, 1997 and 1998, 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 $4.3 million, $5.8 million and $12.9 million in 1996, 1997 and 1998, respectively, representing increases of $1.5 million, or 34.8%, from 1996 to 1997 and $7.1 million, or 122.4%, from 1997 to 1998. The increases for these periods primarily reflect our increasing investment in our sales and marketing organization, which included significant personnel-related expenses such as salaries, benefits and commissions, travel and entertainment expenses, and related costs of hiring sales and marketing management and sales representatives. In addition, we increase marketing expenses related to advertising, promotion, trade show and conference activities. Research and Development. Research and development expenses were $3.0 million, $4.3 million and $6.5 million in 1996, 1997 and 1998, respectively, representing increases of $1.3 million, or 43.3%, from 1996 to 1997 and $2.2 million, or 51.2%, from 1997 to 1998. The increases for these periods were primarily related to the increase in the number of software developers and quality assurance personnel and, to a lesser extent, outside contractors to support product development activities. General and Administrative. General and administrative expenses were $3.5 million, $3.5 million and $5.7 million in 1996, 1997 and 1998, respectively, representing a decrease of $44,000, or 1.3%, from 1996 to 1997 and an increase of $2.2 million, or 62.9%, from 1997 to 1998. The increase from 1997 to 1998 was primarily the result of hiring additional finance, executive and administrative personnel. Other Income (Expense), net. Other income (expense), net was $389,000 in 1996, $(137,000) in 1997 and $336,000 in 1998, representing a decrease of $526,000 from 1996 to 1997 and an increase of $473,000 from 1997 to 1998. The decrease from 1996 to 1997 was due to the loss on the disposal of fixed assets and other costs associated with Quest International, a subsidiary in the UK which was put into liquidation. The increase from 1997 to 1998 reflects increased interest income from higher cash and short-term investments. Provision for Income Taxes. Provision for income taxes was $1,000, $1.0 million and $1.7 million in 1996, 1997 and 1998, respectively, representing increases of $999,000, from 1996 to 1997 and $700,000, or 70.0%, from 1997 to 1998. The effective income tax rate was 5.9%, 78.0%, and 41.7% in 1996, 1997 and 1998, 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 4 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, 1996, 1997 and 1998 and the three months ended March 31, 1998 and 1999. 26 28 QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited consolidated statement of operations data for the nine quarters in the period ended March 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 -------------------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, 1997 1997 1997 1997 1998 1998 1998 1998 1999 -------- -------- --------- -------- -------- -------- --------- -------- -------- (IN THOUSANDS) Revenues: Licenses................... $2,505 $2,737 $3,066 $3,887 $4,840 $4,740 $6,190 $9,131 $9,540 Services................... 1,487 1,563 1,405 1,665 2,203 2,252 2,544 2,890 3,274 ------ ------ ------ ------ ------ ------ ------ ------ ------ Total revenues....... 3,992 4,300 4,471 5,552 7,043 6,992 8,734 12,021 12,814 ------ ------ ------ ------ ------ ------ ------ ------ ------ Cost of revenues: Licenses................... 215 183 179 730 557 947 1,081 848 660 Services................... 420 474 500 578 521 523 609 854 904 ------ ------ ------ ------ ------ ------ ------ ------ ------ Total cost of revenues........... 635 657 679 1,308 1,078 1,470 1,690 1,702 1,564 ------ ------ ------ ------ ------ ------ ------ ------ ------ Gross profit................. 3,357 3,643 3,792 4,244 5,965 5,522 7,044 10,319 11,250 Operating expenses: Sales and marketing........ 1,245 1,265 1,461 1,874 2,114 2,648 3,413 4,740 5,544 Research and development... 856 1,230 1,087 1,120 1,470 1,558 1,579 1,942 2,373 General and administrative........... 723 849 900 978 946 1,334 1,085 2,333 1,917 ------ ------ ------ ------ ------ ------ ------ ------ ------ Total operating expenses........... 2,824 3,344 3,448 3,972 4,530 5,540 6,077 9,015 9,834 ------ ------ ------ ------ ------ ------ ------ ------ ------ Income (loss) from operations................. 533 299 344 272 1,435 (18) 967 1,304 1,416 Other income (expense), net........................ (84) (62) (9) 18 48 71 106 111 112 ------ ------ ------ ------ ------ ------ ------ ------ ------ Income before provision for income taxes............... 449 237 335 290 1,483 53 1,073 1,415 1,528 Provision for income taxes... 350 183 262 227 615 22 446 596 645 ] ------ ------ ------ ------ ------ ------ ------ ------ ------ Net income................... $ 99 $ 54 $ 73 $ 63 $ 868 $ 31 $ 627 $ 819 $ 883 ====== ====== ====== ====== ====== ====== ====== ====== ====== AS A PERCENTAGE OF TOTAL REVENUES Revenues: Licenses................... 62.8% 63.7% 68.6% 70.0% 68.7% 67.8% 70.9% 76.0% 74.4% Services................... 37.2 36.3 31.4 30.0 31.3 32.2 29.1 24.0 25.6 ------ ------ ------ ------ ------ ------ ------ ------ ------ Total revenues....... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ------ ------ ------ ------ ------ ------ ------ ------ ------ Cost of revenues: Licenses................... 5.4 4.3 4.0 13.2 7.9 13.5 12.3 7.1 5.1 Services................... 10.5 11.0 11.2 10.4 7.4 7.5 7.0 7.1 7.1 ------ ------ ------ ------ ------ ------ ------ ------ ------ Total cost of revenues........... 15.9 15.3 15.2 23.6 15.3 21.0 19.3 14.2 12.2 ------ ------ ------ ------ ------ ------ ------ ------ ------ Gross profit................. 84.1 84.7 84.8 76.4 84.7 79.0 80.7 85.8 87.8 Operating expenses: Sales and marketing........ 31.2 29.4 32.7 33.8 30.0 37.9 39.1 39.4 43.3 Research and development... 21.4 28.6 24.3 20.2 20.9 22.3 18.1 16.2 18.5 General and administrative........... 18.1 19.8 20.1 17.5 13.4 19.1 12.4 19.4 14.9 ------ ------ ------ ------ ------ ------ ------ ------ ------ Total operating expenses........... 70.7 77.8 77.1 71.5 64.3 79.3 69.6 75.0 76.7 ------ ------ ------ ------ ------ ------ ------ ------ ------ Income (loss) from operations................. 13.4 6.9 7.7 4.9 20.4 (0.3) 11.1 10.8 11.1 Other income (expense), net........................ (2.1) (1.4) (0.2) 0.3 0.6 1.0 1.2 0.9 0.8 Income before provision for income taxes............... 11.3 5.5 7.5 5.2 21.0 0.7 12.3 11.7 11.9 Provision for income taxes... 8.8 4.3 5.9 4.1 8.7 0.3 5.1 5.0 5.0 ------ ------ ------ ------ ------ ------ ------ ------ ------ Net income................... 2.5% 1.2% 1.6% 1.1% 12.3% 0.4% 7.2% 6.7% 6.9% ====== ====== ====== ====== ====== ====== ====== ====== ======
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. 27 29 LIQUIDITY AND CAPITAL RESOURCES We have funded our business to date primarily from cash generated by our operations. Our sources of liquidity as of March 31, 1999 consisted principally of cash and cash equivalents of $12.5 million. Net cash provided by operating activities was $16,000, $3.6 million and $8.2 million in 1996, 1997 and 1998, respectively, and $4.4 million for the three months ended March 31, 1999. The increases in 1997, 1998 and 1999 were primarily due to increases in net income, depreciation and amortization, deferred revenue and accrued expenses, offset by increases in accounts receivable. Investing activities have consisted of purchases of property and equipment and the acquisition of technology and software licenses. Capital expenditures totaled $589,000, $536,000 and $1.2 million in 1996, 1997 and 1998, respectively, and $652,000 in the three months ended March 31, 1999. Purchases of technology and software licenses were $769,000, $831,000 and $157,000 in 1996, 1997 and 1998, respectively, and $232,000 for the three months ended March 31, 1999. See note 1 of the notes to our consolidated financial statements. Financing activities used $1.4 million, $270,000 and $8,000 in 1996, 1997 and 1998, respectively, and generated $2,000 for the three months ended March 31, 1999, and are comprised in 1996 and 1997 primarily of distributions to shareholders as a result of our status as an S corporation for federal income tax purposes. 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 8 of the notes to our consolidated financial statements. We believe that the net proceeds from this offering, our existing cash balances and cash equivalents 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. YEAR 2000 Many currently installed computer systems and software products are unable to distinguish between twentieth century dates and twenty-first century dates because such systems were developed using two digits rather than four to determine the applicable year. For example, computer programs that have date- sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This error could result in system failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. As a result, many companies' software and computer systems may need to be upgraded or replaced to comply with such "Year 2000" requirements. State of Readiness. Our business is dependent on the operation of numerous systems that could potentially be affected by Year 2000-related problems. Those systems include, among others: - the software products we sell to customers; - hardware and software systems used by us in our operations, including our proprietary software systems as well as software supplied by third parties; - communications networks such as our client/server network, the Internet and our private intranet; - the hardware and software systems of our customers and suppliers; - non-information technology systems and services, such as utilities, telephone systems and building systems. 28 30 We are in the process of commencing a Year 2000 review program for the hardware, software and systems we depend on to run our operations. The phases of our Year 2000 program will be as follows: - assignment of responsibility for issues, such as systems, facilities, equipment, software and legal audit; - inventory of all aspects of our operations and relationships subject to the Year 2000 problem; - communication as necessary with significant suppliers to determine the readiness of their products and systems; - comprehensive analysis, including impact analysis and cost analysis, of our Year 2000 readiness; and - testing and remediation. To date, we have not encountered any material Year 2000 problems with the hardware and software systems we use in our operations. In the event that any such third parties' products, services or systems do not meet the Year 2000 requirements on a timely basis, our business could be materially adversely affected. Based on our review of the use of dates within our products, each of the current versions of our products was found to be Year 2000 compliant -- that is, they are capable of adequately distinguishing 21st century dates from 20th century dates when used in accordance with the related documentation, and subject to the Year 2000 compliance of the underlying system of the host machine and any other software used in conjunction with our products. Earlier versions of certain of our products and certain other discontinued products were not Year 2000 compliant; however, we currently make available versions of our non-discontinued software designed to be Year 2000 compliant for customers that have current maintenance contracts. Risks. Year 2000-related errors or defects that affect the operation of our software could result in: - delay or loss of revenue; - cancellation of customer contracts; - diversion of development resources; - damage to our reputation; - increased customer support and warranty costs; and - litigation costs. Success of our Year 2000 compliance efforts may also depend on the success of our customers in dealing with their Year 2000 issues. Our products are generally integrated into enterprise systems involving sophisticated hardware and complex software products which may not be Year 2000 compliant. In addition, third party applications in which our products are embedded, or for which our products are separately licensed, may not comply with Year 2000 requirements, which may have an adverse impact on or demand for our products. In some cases even certain earlier Year 2000 compliant versions of our software, while compatible with earlier, non-Year 2000 compliant versions of other software products with which our software is integrated, are not compatible with certain more recent Year 2000 compliant versions of such other software providers. While we do not believe we have any obligation under these circumstances given that these customers are using older versions of our software products, there can be no assurance that we will not be subject to claims or complaints by our customers. Although we have not been a party to any litigation or arbitration proceeding to date involving our products or services and related to Year 2000 compliance issues, there can be no assurance that we will not in the future be required to defend our products or services in such proceedings, or to negotiate resolutions of claims based on Year 2000 issues. The costs of defending and resolving Year 2000-related disputes, regardless of the merits of such disputes, and any liability for Year 2000-related damages, including consequential damages, would have a material adverse effect on our business, results of operations and financial condition. 29 31 In addition, we believe that purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or upgrade their current software systems for Year 2000 compliance or defer additional software purchases until after 2000. As a result, some customers and potential customers may have more limited budgets available to purchase software products such as those offered by us, and others may choose to refrain from changes in their information technology environment until after 2000. Still other companies are accelerating purchases of software products prior to 2000, causing an increase in short-term demand which may, in turn, cause a corresponding decrease in long-term demand for software products. To the extent Year 2000 issues cause significant change in, delay in, or cancellation of, decisions to purchase our products or services, our business could be materially adversely affected. Contingency Plan. We could experience material adverse effects on our business if we fail to identify all Year 2000 dependencies in our systems and in the systems of our suppliers, customers and financial institutions. Therefore, we plan to develop contingency plans for continuing operations in the event such problems arise. We do not presently have a comprehensive contingency plan for handling Year 2000 problems that are not detected and corrected prior to their occurrence, but we expect to develop such a plan by the end of the third quarter of 1999. Costs. To date, we have not incurred any material costs directly associated with our Year 2000 compliance efforts, except for compensation expense associated with our salaried employees who have devoted some of their time to our Year 2000 assessment and remediation efforts. We do not expect the total cost of Year 2000 problems to be material to our business, financial condition and operating results. However, we have not completed our Year 2000 investigation and we will continue to evaluate our products, software provided by third parties and infrastructure systems that we rely on. Despite our efforts, we may not identify and remediate all significant Year 2000 problems on a timely basis, remediation efforts may involve significant time and expense, and unremediated problems may have a material adverse effect on our business. See "Risk Factors -- Year 2000 issues present technological risks and could cause disruption of our business." 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 . 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. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK 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 30 32 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. FIXED INCOME INVESTMENTS Our general investing policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market and credit risk. We currently place our investments in highly liquid money market accounts. All highly liquid investments with a maturity of three months or less at the date of purchase are considered to be cash equivalents. 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. 31 33 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 are a leading provider of application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications and enable the delivery of information across the extended enterprise. Our application availability products are designed to help ensure uninterrupted and high performance access to software systems through database replication, enterprise monitoring, database and application performance optimization, change management and database programming solutions for thin-client development. 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 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 core business processes 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 extended enterprise. 32 34 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 packaged 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. 33 35 THE QUEST SOLUTION Quest offers application and information availability software solutions that enhance the performance and reliability of e-business, packaged and custom applications and enable the delivery of information across the extended 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 thin-client applications; accurately deploy database and application changes; provide replication solutions for fail-over capability, data distribution and load balancing; 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 packaged 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. 34 36 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 thin-client networks. 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, packaged and custom applications. We also believe that we offer the leading Web-based information availability software solutions. We intend to advance our 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 packaged 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 enterprise applications by extending them over the Internet. For example, according to AMR Research, a leading enterprise application market analysis firm, over $39 billion was spent on enterprise resource planning software since 1995. 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. 35 37 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 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 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 enterprise software solutions that support e-business and packaged application software. We believe that these relationships will both facilitate the successful enterprise deployment of our products and generate additional product sales opportunities. 36 38 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. - ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------ APPLICATION AVAILABILITY - ------------------------------------------------------------------------------------------------------------ DATABASE REPLICATION - ------------------------------------------------------------------------------------------------------------ SHAREPLEX(R) REPLICATION Replicates high volumes of data from Oracle databases to improve performance and manage future growth. - ------------------------------------------------------------------------------------------------------------ ENTERPRISE MONITORING - ------------------------------------------------------------------------------------------------------------ I/WATCH Offers a centralized console for monitoring, alerting, diagnosing and resolving problems in databases, operating systems and 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 schema versioning, 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. - ------------------------------------------------------------------------------------------------------------
37 39 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-based 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 drill-down 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. The Vista Plus e-purposing engine 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. APPLICATION AVAILABILITY We provide a broad range of products that together provide a comprehensive application availability solution. Our products encompass the areas of database replication, enterprise monitoring, database performance and monitoring, application and database change management, and database programming environments. 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 OLTP 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 I/Watch. I/Watch offers a central console for monitoring databases, operating systems and 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 drill-downs 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. I/Watch is fully customizable and can be further extended by plugging in one or more optional knowledge cartridges, which provide monitoring solutions for other specific services in the enterprise, including market leading ERP packages and other Quest products. 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 38 40 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. Database Programming SQL Navigator and TOAD enable development of server side code for databases, a key component of thin-client development. SQL Navigator and TOAD allow developers to rapidly and accurately develop and tune 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. One customer accounted for 12% of total revenues in 1996. In 1997, 1998 and the first three months of 1999, no customer accounted for more than 10% of our total revenues. 39 41 A sampling of customers who have purchased at least $100,000 of software licenses since January 1, 1996 includes: TECHNOLOGY ENERGY MANUFACTURING 3Com Detroit Edison 3M Applied Materials FirstEnergy Corp. American Cynamid Computer Sciences Corp. Pennsylvania Power & Light Boeing Dell Computer PG&E Texas Management General Electric Plastics Diamond Multimedia Shell Services International Gulf States Steel Earthlink Sun Chemical Honeywell Imation Valero Energy Johnson Controls Merisel FINANCIAL SERVICES Koch Industries Micro Warehouse Lockheed Martin Micron Electronics ADP Rockwell NCR AIG Marketing Rogers Tool Works Oracle American United Life Sara Lee Hosiery Smith-Gardner & Associates Ceridian Tax Service Smuckers Sony Chase Manhattan Mortgage Weyerhaeuser Sun Microsystems Credit Suisse/First Boston OTHER Tandy Corporation Fidelity Investments HEALTHCARE/PHARMACEUTICAL First National Bank Chicago American Home Shield Mercury Insurance Group Andersen Consulting 3M Health Information Systems Nations Bank Aramark Acuson Wellington Management Bausch & Lomb Worldwide AVMED Health Plan Wells Fargo Carlson Companies Blue Cross-Blue Shield (FL) TELECOMMUNICATIONS Dun & Bradstreet Info. Systems Cardinal Health Earth Tech GE Medical Systems Air Touch Communications Hertz Harvard Pilgrim Health Care AT&T JC Penney Hoechst Marion Roussel British Telecom Pepsi-Cola Merck Lucent Technologies Southwest Airlines Partners Health Plan MCI System House Time Qualmed Rohm Corporation United Space Alliance US Surgical Southwestern Bell Mobile University of Michigan Communications Yamaha TCI Communications Williams Information Services
The following case studies illustrate how selected customers are using Quest products to ensure high application and information availability across their increasingly heterogeneous and distributed networks. These case studies are based on information supplied by our customers. We believe the information supplied by our customers is accurate in all material respects. 40 42 EarthLink EarthLink is the world's largest independent Internet service provider, with a full range of innovative access and hosting solutions used by hundreds of thousands of individuals and businesses every day. Running on Oracle databases, EarthLink needed a better way to diagnose and address day-to-day application availability and management issues. EarthLink selected a number of our application availability products to satisfy their requirements. To manage their applications, EarthLink uses I/Watch and Instance Monitor for database monitoring, diagnostics and resolution. These products, along with SQLab Xpert, enable the information technology personnel of EarthLink to perform 'targeted tuning' with intelligent tuning recommendations that optimize the performance of the databases. Due to the growth and the dynamic nature of the ISP business, downtime would be catastrophic. Space Manager provides EarthLink with a comprehensive solution for database reorganization and capacity planning for application availability through preventative 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 achieve database synchronicity across the extended 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 schema 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. According to NCR, as a result of implementing our products, it was able to realize a reduction in processing time and an increase in productivity by improving code integrity and reducing the development effort. Royal Automobile Club The RAC provides roadside assistance 24 hours a day, seven days a week in the United Kingdom. Availability of member services is crucial to the RAC, therefore they needed a data replication solution to guarantee availability of member information in the event of a system failure. Their key requirements in selecting a replication solution were reliability, ease of implementation and minimized disruption to the existing production environment. The RAC chose SharePlex because of its ease of implementation and maintenance, high performance replication availability and ability to interface with existing applications. The RAC expects to expand its use of SharePlex in the future for load balancing and scalability testing. SALES, MARKETING AND DISTRIBUTION We market and sell our products 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 Newport Beach, 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 41 43 involves technology presentations and pilot implementations, and many times involves numerous decision makers. As a result, a key feature of our sales effort 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 Newport Beach 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. 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 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 highly graphical output. 42 44 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: (1) providers of enterprise report management products such as Actuate, Computer Associates, Mobius, and IBM; (2) providers of hardware and software replication tools such as EMC and Veritas; and (3) providers of database and database management products such as BMC, Compuware, Oracle, and Platinum Technology. 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. In addition, providers of database solutions such as Oracle and Microsoft 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. 43 45 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 infringement by us of their 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. 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 March 31, 1999, we employed 307 full-time employees, including 149 in sales and marketing, 93 in research and development, 28 in customer service and support and 37 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. 44 46 FACILITIES Our principal administrative, sales, marketing, support and research and development facility is currently located in approximately 33,000 square feet of space in Newport Beach, California. We intend to relocate our headquarters in Newport Beach to a leased facility in nearby Irvine, California, consisting of approximately 67,000 square feet of office space. The new facility will be under a five-year lease and will have an option to renew for an additional five-year term. We also lease sales offices in the metropolitan areas of Atlanta, Boston, Chicago, Dallas, Detroit, New York, Raleigh, San Francisco, and Washington, D.C. 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 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 alleges that we published three advertisements that were false and misleading and therefore in violation of the Lanham Act and common law, and that we misappropriated unspecified trade secrets belonging to Mobius. The complaint seeks injunctive relief and unspecified damages. No factual basis was set forth in the complaint in support of Mobius' misappropriation of trade secrets claim. We intend to defend this action vigorously, and, based on the complaint and the facts underlying the complaint of which we are currently aware, we do not believe that this lawsuit will have a material adverse effect on our business, results of operations or financial condition; however, it is too early to determine the ultimate outcome of the lawsuit. In the normal course of business, we are subject to various other legal matters. While the results of litigation and claims cannot be predicted with certainty, we believe that the final outcome of these other matters will not have a material adverse effect on our business, operating results or financial condition. 45 47 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information regarding our executive officers and directors as of June 10, 1999:
NAME AGE POSITION - ---- --- -------- Vincent C. Smith....................... 35 Chief Executive Officer and Chairman of the Board David M. Doyle(2)...................... 38 President, Secretary and Director John J. Laskey......................... 49 Chief Financial Officer and Vice President, Finance Eyal M. Aronoff........................ 35 Vice President, Technology and Engineering Douglas F. Garn........................ 40 Vice President, Worldwide Sales Carla S. Fitzgerald.................... 34 Vice President, Marketing Terence J. Mullin...................... 44 Vice President, Output Management Business Unit Charles C. Ramsey...................... 45 Vice President, International Sales Raymond J. Lane(1)..................... 52 Director Doran G. Machin(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. 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. 46 48 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 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. Carla S. Fitzgerald is our Vice President, Marketing. Ms. Fitzgerald has held this position since February 1999. From November 1988 to February 1999, Ms. Fitzgerald worked for Computer Associates International, where she most recently served as Vice President, Global Technology Delivery Services. Ms. Fitzgerald received her B.A. in Economics and Computer Studies from Claremont McKenna College. Terence J. Mullin has been our Vice President of Output Management Business Unit since August 1998. Prior to joining Quest, Mr. Mullin was the Vice President of Marketing and Business Development of Clarion Corporation of America's Advanced Technology Division. Prior to that time, Mr. Mullin was the vice president of marketing and business development for NetSoft/NetManage. Prior to his employment with NetSoft/NetManage, Mr. Mullin held the position of strategic planner of Internet technologies at FileNet Corporation, in addition to holding several positions within Product Marketing. Charles C. Ramsey is our Vice President of International Sales. Mr. Ramsey heads up the expansion of our international direct-sales and support teams and will complete the development of a worldwide channel organization. Prior to joining Quest, Mr. Ramsey was a sales manager for IBM. He also held a sales management position at Ziff-Davis Market Intelligence, where he specialized in customer relations. Raymond J. Lane has served as a member of our board since June 1999. Mr. Lane has been the president and chief operating officer of Oracle Corporation since January 1997 and has been a director of Oracle since June 1995. Previously, Mr. Lane served as the executive vice president of Worldwide Operations for Oracle from October 1993 to January 1997. Mr. Lane served as a senior vice president of Oracle USA from June 1992 to October 1993. Before joining Oracle, Mr. Lane served as senior vice president and managing partner of the Worldwide Information Technology Group at Booz, Allen & Hamilton from July 1986 to May 1992. He served on the Booz, Allen & Hamilton Executive Committee and its Board of Directors from April 1987 to May 1992. Mr. Lane is also a member of the Board of Trustees of Carnegie Mellon University. Mr. Lane received his B.S. in Math from West Virginia University. 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. 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 to time be determined by the board. The compensation committee is currently comprised of Messrs. Lane and Murdock. 47 49 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 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. 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." 48 50 EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth for the year ended December 31, 1998, 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 1998. These officers are referred to in this prospectus as the "Named Executive Officers." No individual who would otherwise have been includable in such table on the basis of salary and bonus earned during 1998 has resigned or otherwise terminated his employment during 1998. The compensation table excludes other compensation in the form of perquisites and other personal benefits that constitutes the lesser of $50,000 or 10% of the total annual salary and bonus earned by each of the Named Executive Officers in 1998.
LONG-TERM ANNUAL COMPENSATION COMPENSATION --------------------- ------------------ SECURITIES ALL OTHER NAME AND PRINCIPAL POSITION(1) SALARY($) BONUS($) UNDERLYING OPTIONS COMPENSATION ($) - ------------------------------ --------- -------- ------------------ ---------------- Vincent C. Smith...................... 191,666 175,000 -- -- Chief Executive Officer David M. Doyle........................ 200,000 175,000 -- -- President Doran G. Machin....................... 200,000 -- -- $25,081(2) Secretary Eyal M. Aronoff....................... 191,931 -- 39,000 -- Vice President, Technology and Engineering Douglas F. Garn....................... 184,510 125,000 576,000 -- Vice President, Worldwide Sales
- ------------------------- (1) Mr. Machin resigned from his position as Secretary in April 1999. (2) Includes matching contributions under our 401(k) Plan and expenses paid by us for Mr. Machin's car and the automobile insurance thereon. 49 51 OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth certain information with respect to stock options granted to each of the Named Executive Officers in 1998, including the potential realizable value over the ten-year term of the options, based on assumed rates of stock appreciation of 5% and 10%, compounded annually. These assumed rates of appreciation comply with the rules of the Commission and do not represent our estimate of future stock price. Actual gains, if any, on stock option exercises will be dependent on the future performance of our common stock. No stock appreciation rights were granted to the Named Executive Officers during 1998.
OPTIONS GRANTS IN 1998 -------------------------------------------------------- POTENTIAL REALIZABLE PERCENT OF VALUE AT ASSUMED ANNUAL NUMBER OF TOTAL RATES OF STOCK PRICE SECURITIES OPTIONS EXERCISE APPRECIATION FOR UNDERLYING GRANTED TO PRICE OPTION TERM ($)(4) OPTIONS EMPLOYEES IN PER-SHARE EXPIRATION ------------------------ NAME GRANTED(#)(1) 1998 (%)(2) ($)(3) DATE 5% 10% ---- ------------- ------------ --------- ---------- ---------- ---------- Vincent C. Smith..... -- -- -- -- -- -- David M. Doyle....... -- -- -- -- -- -- Doran G. Machin...... -- -- -- -- -- -- Eyal M. Aronoff...... 24,000 * $1.00 6/23/08 $ 9,770 $ 22,769 15,000 * 1.17 10/1/08 7,144 16,650 Douglas F. Garn(5)... 450,000 13.3% 1.00 6/23/08 183,195 426,922 126,000 3.7 1.00 7/1/08 51,294 119,538
- ------------------------- * Less than one percent. (1) Each option listed in the table was granted under our 1998 Stock Option/Stock Issuance Plan, the predecessor plan to our 1999 Stock Incentive Plan, and represents the right to purchase one share of common stock. Except as otherwise indicated, the options shown in this table are all nonqualified stock options. These options vest as follows: (1) 20% upon the completion of one year of employment, (2) 13% upon the completion of each of the next five six-month periods of employment, and (3) 15% upon the completion of the sixth six-month period. 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. (2) During 1998 we granted options to purchase up to an aggregate of 3,332,700 shares of common stock. (3) 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. (4) Potential realizable values are net of exercise price, but before the payment of taxes associated with exercise. Amounts represent hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the Commission and do not represent our estimate or projection of our future common stock prices. These amounts represent certain assumed rates of appreciation in the value of our common stock from the exercise price of such options (which was equal to the fair market value of the common stock on the date of grant as determined by our board of directors), as determined by our board of directors. 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. (5) Of the 450,000 options, 300,000 are incentive stock options. 50 52 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 1998.
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY DECEMBER 31, 1998 OPTIONS AT DECEMBER 31, 1998 ---------------------------- ---------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- Vincent C. Smith........................... -- -- -- -- David M. Doyle............................. -- -- -- -- Doran G. Machin............................ -- -- -- -- Eyal M. Aronoff............................ -- 39,000 -- Douglas F. Garn............................ -- 576,000 --
There was no public trading market for our common stock as of December 31, 1998. Accordingly, these values have been calculated on the basis of the initial public offering price of $ per share, 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 will become effective upon the effective date of this offering. At that time, all outstanding options under our predecessor plan will be incorporated into the 1999 Stock Incentive Plan, and no further option grants will be 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. 7,498,500 shares of common stock have been authorized for issuance under the 1999 Stock Incentive Plan. This share reserve 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. 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 not less than 100% of the fair market value of those shares on the grant date; - 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 not less than 100% of their fair market value at the time of issuance 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 51 53 - 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 will include 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 will include 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 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 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. 52 54 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. As a result, the total spread on the option shares at the time of grant (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 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 held after the completion of this offering, each non-employee board member who is to continue to serve as a non-employee board member will automatically be granted an option to purchase 7,500 shares of common stock, provided such individual has served on the board for at least six months. 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 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 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 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 Software outstanding voting stock. In return for the surrendered option, the optionee will be entitled 53 55 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 9, 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 execution of the underwriting agreement for this offering. 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 will initially be reserved for issuance. Purchase Periods. The plan will have a series of successive purchase periods, each with a maximum duration of six months. The initial purchase period will begin on the date of the underwriting agreement for this offering covered by this prospectus is signed and will end on the last business day in January 2000. Thereafter, purchase periods will run for the first business day in February to the last business day in July each year, and for 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 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. 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; 54 56 - 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 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. 55 57 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. We intend to use approximately $10.0 million of the net proceeds of this offering to redeem the Series B Redeemable Preferred Stock, including all accrued, cumulative dividends thereon. See "Use of Proceeds." 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 current 1-for-1.5 conversion ratio for each share of Series A Preferred Stock.
SERIES B SERIES A REDEEMABLE TOTAL SHARES ON AN PREFERRED PREFERRED AS-CONVERTED AGGREGATE INVESTOR STOCK STOCK(1) BASIS(1) CONSIDERATION - -------- --------- ---------- ------------------ ------------- Entities affiliated with InSight Capital Partners(2)................. 1,688,889 -- 2,533,333 $ 9,500,000 UBS Capital LLC....................... 977,778 1,777,778 1,466,667 15,500,000
- ------------------------- (1) The Series B Redeemable Preferred Stock is convertible into Series A Preferred Stock in certain circumstances. (2) Includes shares held by InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P. and WI Software Investors LLC. Holders of shares of our Series A Preferred Stock, including the common stock issuable upon the conversion of those shares, are entitled to certain registration rights with respect to the common stock issuable upon conversion thereof. See "Description of Capital Stock -- Registration Rights." REPURCHASE OF SHARES FROM AND SEVERANCE PAYMENTS TO 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. 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. 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 for a total purchase price of $750,000, for which Mr. Aronoff executed a promissory note and agreed to cancel the option to purchase shares of our common stock that he received in May 1996. 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. Until such time as the note or any part thereof is repaid, we 56 58 have the right to repurchase from Mr. Aronoff at the original cost all or a portion of the 975,000 shares equal to the unpaid portion of the principal amount of the note at the time Mr. Aronoff's services with Quest are terminated. 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. 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. This note is due and payable on April 1, 2002 and bears interest at a rate of 6.2%. This note is also secured in part by the 3,900,000 shares of common stock. 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 October 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 December 1998, 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 June 1999, we granted options to purchase 35,000 shares of our common stock at an exercise price of $7.50 per share to Raymond Lane, one of our directors. 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. 57 59 PRINCIPAL SHAREHOLDERS The table below sets forth information regarding the beneficial ownership of our common stock as of June 1, 1999 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; and - all directors and executive officers as a group, which for us is eleven persons. Applicable percentage ownership in the following table is based on the number of shares of common stock outstanding as of June 1, 1999, as adjusted to reflect (1) a three-for-two stock split that was effected in June 1999, (2) the conversion of all outstanding shares of our Series A Preferred Stock into 4,000,000 shares of common stock, and (3) the redemption for cash of all outstanding shares of our Series B Redeemable Preferred Stock, and 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 33,721,300 shares of common stock outstanding as of June 1, 1999 and 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 June 1, 1999 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., 610 Newport Center Drive, Newport Beach, California 92660.
PERCENTAGE OF CLASS NUMBER OF SHARES ------------------- NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BEFORE AFTER - ------------------------ ------------------ ------- ------ Vincent C. Smith(1)........................................ 18,257,500 54.1% David M. Doyle............................................. 7,397,100 21.9% Eyal M. Aronoff(2)......................................... 2,932,920 8.7% Jerry Murdock(3)........................................... 2,798,533 8.3% c/o InSight Capital Partners 122 East 42nd Street New York, NY 10168 InSight Capital Partners II, L.P.(4)....................... 2,533,333 7.5% InSight Capital Partners 122 East 42nd Street New York, NY 10168 UBS Capital LLC(5)......................................... 1,466,667 4.3% 299 Park Avenue 34th Floor New York, NY 10171 Douglas F. Garn(6)......................................... 173,700 * Raymond J. Lane............................................ 50,000 * Doran G. Machin............................................ -- -- All executive officers and directors as a group (11 persons)(7).............................................. 31,692,253 93.3%
- ------------------------- * Less than one percent. 58 60 (1) Includes 11,700 shares held in the name of McNair Smith and 11,700 shares held in the name of McKenzie Smith, Mr. Smith's minor children. Mr. Smith disclaims beneficial ownership of the shares held in the names of his 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 7,920 shares issuable upon the exercise of stock options that are exercisable within 60 days of June 1, 1999. (3) Includes 265,200 shares of common stock owned directly by Mr. Murdock. Also includes 800,000 shares held by InSight Capital Partners II, L.P., 88,889 shares held by InSight Capital Partners (Cayman) II, L.P., and 800,000 shares held by WI Software Investors LLC., which will be converted into 2,533,333 shares of common stock immediately prior to the closing of this offering. 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) Includes 88,889 shares of Series A Preferred Stock held by InSight Capital Partners (Cayman) II, L.P., 800,000 shares of Series A Preferred Stock held by InSight Capital Partners II, L.P., and 800,000 shares of Series A Preferred Stock held by WI Software Investors LLC, which shares will be converted into an aggregate of 2,533,333 shares of common stock immediately prior to the closing of this offering. (5) Includes 977,778 shares of Series A Preferred Stock, which shares will be converted into 1,466,667 shares of common stock immediately prior to the closing of this offering. (6) Consists of 173,700 shares issuable upon the exercise of stock options that are exercisable within 60 days of June 1, 1999. (7) Includes 264,120 shares issuable upon the exercise of stock options that are exercisable within 60 days of June 1, 1999. See Notes 2 and 6. 59 61 DESCRIPTION OF CAPITAL STOCK Upon the completion of this offering, the authorized capital stock of Quest will consist 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. Copies of the Amended and Restated Articles of Incorporation and Bylaws have been filed as exhibits to the registration statement of which this prospectus is a part. COMMON STOCK As of June 1, 1999, there were 33,721,300 shares of common stock outstanding held of record by 24 shareholders, and options to purchase an aggregate of 4,576,125 shares of common stock were also outstanding. There will be shares of common stock outstanding (assuming no exercise of the underwriters' option to purchase additional shares, exercise of outstanding options under the stock plans after June 1, 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 Upon the closing of this offering, our board of directors will be 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 (including sinking fund provisions), 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 60 62 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. REGISTRATION RIGHTS Upon completion of this offering, the holders of an aggregate of approximately 4,000,000 shares of common stock will be 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 Application has been made for listing the common stock on the Nasdaq National Market under the trading symbol "QSFT." 61 63 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has not been any public market for our common stock. 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 shares of common stock outstanding assuming the issuance of shares of common stock offered, no exercise of the underwriters' over-allotment option and no exercise of outstanding stock options after , 1999. Of the total outstanding shares of common stock, the 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. The remaining shares of common stock are "restricted securities" as that term is defined in Rule 144. Of the total number of restricted securities, will be available for sale in the public market following the expiration of the 180 day lock-up agreement further described below. Beginning six months after the date of this prospectus the holders of 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, immediately upon the effectiveness of such registration. If these holders sell in the public market these sales would have a material adverse effect on the market price of the common stock. 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 180 days after the date of this prospectus, without the prior written consent of BancBoston Robertson Stephens, except that we may, without such consent, grant options and sell shares pursuant to our stock plans. BancBoston 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. BancBoston 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, BancBoston 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 180-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. 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 1% of the then-outstanding shares of common stock (approximately 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 62 64 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. Prior to this offering, there has been no public market for our common stock, and 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. We have filed, as of the date of this prospectus, Form S-8 registration statement under the Securities Act to register all shares of common stock issuable under the 1999 Stock Incentive Plan, and shares of common stock issuable under the Employee Stock Purchase Plan. Such registration statements became effective immediately upon filing, and shares covered by those registration statements will thereupon be 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 Stock Incentive Plan," "Description of Capital Stock -- Registration Rights" and "Underwriting." 63 65 UNDERWRITING The underwriters named below, acting through their representatives, BancBoston Robertson Stephens Inc., Donaldson, Lufkin & Jenrette Securities Corporation, CIBC World Markets Corp. and FAC/Equities, a division of First Albany Corporation (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 - ----------- --------- BancBoston Robertson Stephens Inc. ......................... Donaldson, Lufkin & Jenrette Securities Corporation ........ CIBC World Markets Corp. ................................... First Albany Corporation.................................... -------- Total............................................. ========
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 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 We have granted to the underwriters an option, exercisable during the 30-day period after the date of this prospectus, to purchase up to additional shares of common stock at the same price per share as we will receive for the 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 shares offered hereby. If purchased, such additional shares will be sold by the underwriters on the same terms as those on which the 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 $ , $ and $ , 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. 64 66 Lock-Up Agreements Each of our executive officers, directors and shareholders and substantially all of optionholders have agreed with the Representatives, for a period of 180 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 BancBoston Robertson Stephens. However, BancBoston 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 180 days after this prospectus. Future Sales In addition, we have agreed that during the period of 180 days after this prospectus, we will not, subject to certain exceptions, without the prior written consent of BancBoston Robertson Stephens: - Consent to the disposition of any shares held by shareholders prior to the expiration of the period of 180 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. No Prior Public Market Prior to this offering, there has been no public market for our common stock. Consequently, the initial public offering price for the common stock offered hereby will be determined through negotiations between us and the representatives. Among the factors to be considered in such negotiations are prevailing market conditions, certain of our financial information, market valuations of other companies that we and the Representatives believe to be comparable to us, estimates of our business potential, the present state of our development and other factors deemed relevant. 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. 65 67 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 and related financial schedule as of December 31, 1997 and 1998 and for each of the three years in the period ended December 31, 1998 included in this prospectus and registration statement have been audited by Deloitte & Touche LLP, independent auditors, as stated in their reports, which we have included in this prospectus and registration statement and are given upon the authority of Deloitte & Touche 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 not necessarily 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. 66 68 QUEST SOFTWARE, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report................................ F-2 Consolidated Balance Sheets as of December 31, 1997, 1998 and March 31, 1999 (Unaudited)............................ F-3 Consolidated Statements of Operations for the Years ended December 31, 1996, 1997 and 1998 and the Three Months ended March 31, 1998 and 1999 (Unaudited)................. F-4 Consolidated Statements of Shareholders' Equity for the Years ended December 31, 1996, 1997 and 1998 and the Three Months ended March 31, 1999 (Unaudited)................... F-5 Consolidated Statements of Cash Flows for the Years ended December 31, 1996, 1997 and 1998 and the Three Months ended March 31, 1998 and 1999 (Unaudited)................. F-6 Notes to Consolidated Financial Statements.................. F-7
F-1 69 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, 1997 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. 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 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 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, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Costa Mesa, California June 9, 1999 (except for paragraph 3 of note 1 and the 1999 Stock Incentive Plan and 1999 Employee Stock Purchase Plan described in note 5 as to which the date is June , 1999) The accompanying consolidated financial statements include the effect of the amendment to the Company's Articles of Incorporation and the adoption of the 1999 Stock Incentive Plan and the 1999 Employee Stock Purchase Plan anticipated to be effective prior to the closing of this offering. The above opinion is in the form which will be signed by Deloitte & Touche LLP upon consummation of the items described in note 1 and note 5 of the notes to the consolidated financial statements and assuming that from June 9, 1999 to the effective date of such items, no other events have occurred that would affect the accompanying consolidated financial statements and notes thereto. Deloitte & Touche LLP Costa Mesa, California June 11, 1999 F-2 70 QUEST SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, ---------------- MARCH 31, 1997 1998 1999 ------ ------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $2,096 $ 8,981 $12,502 Accounts receivable, net of allowance for doubtful accounts and sales returns of $783 (1997), $1,052 (1998) and $1,016 (1999)............................... 4,815 7,443 6,551 Income taxes receivable................................... 122 -- -- Prepaid expenses and other current assets................. 100 720 619 Deferred income taxes..................................... -- 198 198 ------ ------- ------- Total current assets................................. 7,133 17,342 19,870 Property and equipment: Furniture and fixtures.................................... 397 596 806 Machinery and equipment................................... 140 270 303 Computer equipment........................................ 1,001 1,711 1,992 Computer software......................................... 186 315 389 Leasehold improvements.................................... 56 109 163 ------ ------- ------- 1,780 3,001 3,653 Less accumulated depreciation and amortization.............. (857) (1,613) (1,976) ------ ------- ------- Property and equipment, net................................. 923 1,388 1,677 Purchased technology and software licenses, net............. 1,531 527 511 Deferred income taxes....................................... -- 267 267 Other assets................................................ 126 121 147 ------ ------- ------- $9,713 $19,645 $22,472 ====== ======= =======
PRO FORMA ----------- (UNAUDITED) LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 527 $ 1,468 $ 1,511 Accrued compensation...................................... 775 1,937 2,560 Other accrued expenses.................................... 1,170 2,243 2,188 Deferred support revenue.................................. 4,005 7,298 8,420 Deferred license revenue.................................. 282 1,625 1,882 ------ ------- ------- Total current liabilities............................. 6,759 14,571 16,561 Deferred income taxes....................................... 118 -- -- Bank loan payable........................................... $ 10,000 Series B Redeemable Preferred Stock -- no par value, 1,800 shares authorized, none issued and outstanding, 1,778 shares issued and outstanding pro forma................... 10,000 Commitments and contingencies (Note 6) 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; 43,497, 44,538, and 44,540 shares issued and outstanding at December 31, 1997 and 1998, and March 31, 1999, respectively, 33,721 shares issued and outstanding, pro forma................................................... 3,425 4,241 4,243 19,239 Retained earnings........................................... 1,645 3,991 4,874 -- Notes receivable from sale of common stock.................. (2,234) (3,158) (3,206) (3,206) Capital distribution in excess of basis in common stock..... (30,122) ------ ------- ------- -------- Total shareholders' equity (deficit).................. 2,836 5,074 5,911 $(14,089) ------ ------- ------- ======== $9,713 $19,645 $22,472 ====== ======= =======
See accompanying notes to consolidated financial statements. F-3 71 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ----------------------------- ------------------ 1996 1997 1998 1998 1999 ------- ------- ------- ------- ------- (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Revenues: Licenses............................... $ 9,316 $12,195 $24,901 $ 4,840 $ 9,540 Services............................... 3,546 6,120 9,889 2,203 3,274 ------- ------- ------- ------- ------- Total revenues.................... 12,862 18,315 34,790 7,043 12,814 Cost of revenues: Licenses............................... 950 1,307 3,433 557 660 Services............................... 1,467 1,972 2,507 521 904 ------- ------- ------- ------- ------- Total cost of revenues............ 2,417 3,279 5,940 1,078 1,564 ------- ------- ------- ------- ------- Gross profit............................. 10,445 15,036 28,850 5,965 11,250 Operating expenses: Sales and marketing.................... 4,328 5,845 12,914 2,114 5,544 Research and development............... 2,995 4,293 6,549 1,470 2,373 General and administrative............. 3,494 3,450 5,698 946 1,917 ------- ------- ------- ------- ------- Total operating expenses.......... 10,817 13,588 25,161 4,530 9,834 ------- ------- ------- ------- ------- Income (loss) from operations............ (372) 1,448 3,689 1,435 1,416 Other income (expense), net.............. 389 (137) 336 48 112 ------- ------- ------- ------- ------- Income before income tax provision....... 17 1,311 4,025 1,483 1,528 Income tax provision..................... 1 1,022 1,679 615 645 ------- ------- ------- ------- ------- Net income............................... $ 16 $ 289 $ 2,346 $ 868 $ 883 ======= ======= ======= ======= ======= Basic and diluted net income per share... $ -- $ .01 $ 0.05 $ 0.02 $ 0.02 Weighted Average Basic Shares Outstanding............................ 38,350 40,373 44,261 43,497 44,539 Weighted Average Diluted Shares Outstanding............................ 38,350 40,373 44,559 43,721 45,650 Pro forma basic and diluted net income per share.............................. $ .05 $ .02 Pro forma weighted average basic shares outstanding............................ 48,261 48,539 Pro forma weighted average diluted shares outstanding............................ 48,559 49,650
See accompanying notes to consolidated financial statements. F-4 72 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
NOTE COMMON STOCK RECEIVABLE TOTAL --------------- RETAINED FROM SHAREHOLDERS' SHARES AMOUNT EARNINGS SHAREHOLDER EQUITY ------ ------ -------- ------------ ------------- BALANCE, January 1, 1996.............................. 37,050 $ 35 $ 2,961 $ -- $ 2,996 Issuance of common stock.............................. 1,950 777 -- -- 777 Net income............................................ -- -- 16 -- 16 Distributions paid.................................... -- -- (1,360) -- (1,360) ------ ------ ------- ------- ------- BALANCE, December 31, 1996............................ 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 ------ ------ ------- ------- ------- Unaudited: Exercise of stock options............................. 2 2 -- -- 2 Accrued interest receivable from shareholders......... -- -- -- (48) (48) Net income............................................ -- -- 883 -- 883 ------ ------ ------- ------- ------- BALANCE, March 31, 1999............................... 44,540 $4,243 $ 4,874 $(3,206) $ 5,911 ====== ====== ======= ======= =======
See accompanying notes to consolidated financial statements. F-5 73 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ----------------------------- ------------------- 1996 1997 1998 1998 1999 ------- ------- ------- ------- -------- (UNAUDITED) Cash flows from operating activities: Net income.............................................. $ 16 $ 289 $ 2,346 $ 868 $ 883 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization....................... 743 964 1,893 404 611 Loss from disposal of property and equipment........ 25 52 -- -- -- Accrued interest from shareholders.................. -- (34) (174) (32) (48) Deferred income taxes............................... -- 178 (643) -- -- Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable.............................. (1,051) (683) (2,628) (198) 892 Income taxes receivable.......................... -- (122) 122 (14) -- Prepaid expenses and other current assets........ (363) 282 (620) (175) 101 Other assets..................................... (131) 38 5 5 (26) Accounts payable................................. 263 113 941 (235) 43 Bank overdraft................................... 393 (393) -- -- -- Accrued compensation............................. (703) 108 1,162 290 623 Other accrued expenses........................... 119 881 1,141 573 (55) Deferred revenue................................. 705 1,960 4,636 57 1,379 ------- ------- ------- ------ ------- Net cash provided by operating activities........ 16 3,633 8,181 1,543 4,403 Cash flows from investing activities: Purchases of property and equipment..................... (589) (536) (1,231) (351) (652) Purchases of software licenses.......................... -- (831) (57) -- (232) Cash received (paid) for acquisitions................... (769) 100 -- -- -- ------- ------- ------- ------ ------- Net cash used in investing activities............ (1,358) (1,267) (1,288) (351) (884) Cash flows from financing activities: Distributions to stockholders........................... (1,360) (261) -- -- -- Proceeds from the exercise of stock options............. -- -- -- -- 2 Repayment of note payable to related party.............. (7) (9) (8) -- -- ------- ------- ------- ------ ------- Net cash (provided by) used in financing activities..................................... (1,367) (270) (8) -- 2 ------- ------- ------- ------ ------- Net increase (decrease) in cash and cash equivalents...... $(2,709) $ 2,096 $ 6,885 $1,192 $ 3,521 Cash and cash equivalents, beginning of period............ 2,709 2,096 2,096 8,981 ------- ------- ------- ------ ------- Cash and cash equivalents, end of period.................. $ -- $ 2,096 $ 8,981 $3,288 $12,502 ======= ======= ======= ====== ======= Supplemental disclosures of consolidated cash flow information: Cash paid during the year for: Interest.............................................. $ 2 $ 8 $ 1 $ -- $ -- ======= ======= ======= ====== ======= Income taxes.......................................... $ 28 $ 938 $ 2,054 $ 12 $ 85 ======= ======= ======= ====== ======= Supplemental schedule of noncash investing and financing activities: Note receivable from shareholders for purchase of common stock................................................. $ 2,200 $ 750 ======= ======= Accrued interest receivable from shareholders........... $ 34 $ 174 $ 48 ======= ======= =======
See Note 2 for details of assets acquired and liabilities assumed in purchase transactions. See accompanying notes to consolidated financial statements. F-6 74 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") is a leading provider of application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications and enable the delivery of information across the extended enterprise. 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, and Germany, and a majority-owned subsidiary in the United Kingdom. All significant intercompany transactions and balances have been eliminated in consolidation. Unaudited Information -- The information set forth in these consolidated financial statements as of March 31, 1999 and for the three months ended March 31, 1998 and March 31, 1999 is unaudited and reflects all adjustments, consisting only of normal recurring adjustments, that, in the opinion of management, are necessary to present fairly the financial position and results of operations of the Company for the period. Results of operations for the interim periods are not necessarily indicative of the results of operations for the full fiscal year. 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 a proposed 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. Concurrently with the closing of the Company's proposed initial public offering, the Company will file amended Articles of Incorporation to provide for the issuance of up to 5,000 shares of undesignated preferred stock. Such amendment will be effective upon the completion of the Company's proposed initial public offering. 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 amendments to the articles of incorporation 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, 1996, 1997, and 1998, and the three months ended March 31, 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 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, 1998 and March 31, 1999 was approximately $3,290 and $3,371, respectively. Cash and Cash Equivalents -- Cash equivalents include short-term, highly liquid investments with original maturities of three months or less. 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 F-7 75 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and generally does not require collateral. The Company maintains reserves for potential credit losses and sales returns. Such losses have been within management's expectations. 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 March 31, 1999, there was no impairment of long-lived assets. Purchased Technology and Software Licenses -- Purchased technology is recorded at cost and amortized using the straight-line method over the estimated useful life of three years. Accumulated amortization was $916, $1,483, and $1,599 at December 31, 1997 and 1998, and March 31, 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 $90, $644, and $775 at December 31, 1997 and 1998, and March 31, 1999, respectively. The net carrying amount of purchased technology and software licenses was considered recoverable at December 31, 1998 and March 31, 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 $53 of the settlement receivable is recorded in other current assets in the accompanying consolidated financial statements at December 31, 1998 and March 31, 1999, respectively. 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 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. 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 F-8 76 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS software is essentially completed concurrently with the establishment of technical feasibility, no software development costs have been capitalized as of December 31, 1997, 1998 and March 31, 1999. 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. Prior to January 1, 1997, the Company elected to be treated as an S corporation under the provisions of subchapter S of the Internal Revenue Code and California Revenue and Taxation Code. Accordingly, the provision for income taxes for the year ended December 31, 1996, is computed by applying the California franchise tax rate for S corporations of 1.5% to the Company's pretax earnings. 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. 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 and Pro Forma 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. Pro forma basic earnings per share are based upon the weighted average number of common shares outstanding and the pro forma effect of the conversion of all outstanding shares of Series A preferred stock into common stock (Note 8). Pro forma diluted earnings per share is based upon the weighted average number of common and common equivalent shares for each period presented and the pro forma effect of the conversion of all outstanding shares of Series A preferred stock into common stock. Common equivalent shares include stock options using the treasury stock method. The table below sets forth the reconciliation of the numerators and denominators of the earnings per share calculation:
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, --------------------------- ------------------- 1996 1997 1998 1998 1999 ------- ------- ------- -------- -------- Shares used in computing basic net income per share.............................. 38,350 40,373 44,261 43,497 44,539 Dilutive effect of stock options......... -- -- 298 224 1,111 ------- ------- ------- ------- ------- Shares used in computing diluted net income per share....................... 38,350 40,373 44,559 43,721 45,650 ======= ======= ======= Conversion of Series A Preferred Stock... 4,000 4,000 ------- ------- Shares used in computing proforma basic and diluted net income per share....... 48,559 49,650 ======= =======
Pro Forma Information -- The Company is preparing for an initial public offering of its common stock which, upon completion, will result in the conversion of all outstanding shares of Series A preferred stock issued in April 1999 into shares of common stock (Note 8). The accompanying pro forma information, which is unaudited, gives effect to the conversion of all outstanding shares of preferred stock into common stock immediately prior to the closing of the offering and the repurchase of common stock F-9 77 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS by the Company from a shareholder described in Note 9. The excess of the repurchase price of $35,000 over the original cost of the shares at March 31, 1999 has been recorded as a capital distribution in excess of the basis of such common stock. 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: 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, 1996, 1997 and 1998 and the three months ended March 31, 1998 and 1999. 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 7 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 2000. 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 March 1, 1996, the Company acquired the net assets of R*Tech Systems, Inc. (R*Tech) pursuant to a merger agreement. The Company agreed to pay $650 cash and issued 1,950 shares of the Company's common stock, valued at $777, in exchange for 100% of R*Tech's common stock. At the closing date, $520 cash was paid to the seller, with the remaining $130 withheld by the Company to be paid one year after the closing date, provided that the seller performed certain obligations under the indemnification provisions in the agreement. In March 1997 approximately $96 was paid to the seller as final consideration for the acquisition. The acquisition was accounted for under the purchase method of accounting and the purchase was allocated $1,386 to technology rights based upon the estimated fair values at the date of acquisition, $75 to other assets acquired and $34 to liabilities assumed. R*Tech's operating results have been included in the Company's consolidated financial statements from the date of acquisition. 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 F-10 78 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS subsidiary, and in July 1997 commenced liquidation proceedings. At December 31, 1998 and March 31, 1999, the subsidiary was not conducting operations and the liquidation process was not completed. The Company does not expect to incur a material loss as a result of the liquidation of the subsidiary. 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. 3. 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 and $7 were included in other accrued expenses in the accompanying consolidated financial statements representing the remaining outstanding note payable balance at December 31, 1998 and March 31, 1999, respectively. 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 $.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 $.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. F-11 79 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. INCOME TAXES The provision for income taxes consists of the following for the years ended December 31:
1996 1997 1998 ---- ------ ------ Current: Federal.......................................... $-- $1,359 $1,819 State............................................ 1 102 425 Foreign.......................................... -- -- 78 --- ------ ------ 1 1,461 2,322 Deferred: Federal.......................................... -- (360) (568) State............................................ -- (79) (75) Foreign.......................................... -- (85) (165) --- ------ ------ -- (524) (808) Change in valuation allowance...................... -- 85 165 --- ------ ------ Total income tax provision......................... $ 1 $1,022 $1,679 === ====== ======
The reconciliation of income tax expense computed at U.S. federal statutory rates to income tax expense for the years ended December 31, 1997 and 1998, is as follows:
1997 1998 ----- ---- Tax at U.S. federal statutory rates......................... 35.0% 35.0% State taxes................................................. 2.0 5.7 Recording of deferred income tax liabilities in connection with the conversion to a C corporation.................... 45.2 -- Foreign losses without benefit.............................. 6.2 6.0 Research and development credits............................ (10.4) (4.6) Other....................................................... -- (0.4) ----- ---- 78.0% 41.7% ===== ====
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 F-12 80 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS purposes. Significant components of the Company's deferred taxes as of December 31, 1997 and 1998, are as follows:
1997 1998 ----- ------ Deferred tax assets: Accounts receivable and sales returns reserves........... $ 249 $ 313 Accrued liabilities...................................... 72 165 Research and development credits......................... 64 -- Foreign net operating loss carryforwards................. 134 250 Intangible assets........................................ (172) 264 Other.................................................... -- 56 ----- ------ Total gross deferred assets................................ 347 1,048 Deferred tax liabilities: Cash to accrual adjustment............................... (440) (301) State taxes.............................................. -- (32) ----- ------ Total gross deferred liabilities........................... (440) (333) Valuation allowance........................................ (85) (250) ----- ------ Net deferred income taxes.................................. $(178) $ 465 ===== ====== Less current portion....................................... 60 (198) ----- ------ $(118) $ 267 ===== ======
The Company has foreign net operating loss carryforwards of approximately $735 which will reduce foreign income tax expense when realized. Prior to January 1, 1997, the Company elected to be treated as an S corporation under the provisions of subchapter S of the Internal Revenue Code and California Revenue and Taxation Code. Accordingly, the provisions for income taxes for the year ended December 31, 1996, are computed by applying the California franchise tax rate for S corporations of 1.5%. 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 $1,360 and $261 in 1996 and 1997, respectively, made to the Company's shareholders. 5. STOCK OPTION PLANS The Company entered into an agreement with a key employee in July 1995 under which options to purchase common stock were to be granted for up to 5% of the Company's common stock upon the attainment of certain growth levels in net sales and net income through fiscal year 1998. The employee was terminated in June 1997 and all outstanding options were canceled. In connection with the acquisition of R*Tech (Note 2), the Company entered into an employment agreement with the president of R*Tech 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 3), the option was cancelled. F-13 81 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 in June 1999 and will become effective upon the effective date of the Company's initial public offering. At that time, all outstanding options under the 1998 plan will be incorporated into the 1999 Stock Incentive Plan, and no further option grants will 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 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. 7,499 shares of common stock have been authorized for issuance under the 1999 Stock Incentive Plan. 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 500,000 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 not less than 100% of the fair market value of those shares on the grant date; - the stock issuance program under which individuals may be issued shares of common stock directly, through the purchase of such shares at a price not less than 100% of their fair market value at the time of issuance 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 will include 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. F-14 82 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 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. 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 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. As a result, the total spread on the option shares at the time of grant (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 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. F-15 83 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 the Company. In addition, on the date of each annual shareholders meeting held after the completion of this offering, each non-employee board member who is to continue to serve as a non-employee board member will automatically be granted an option to purchase 7,500 shares of common stock, provided such individual has served on the board for at least six months. 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 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 date. Director Fee Option Grant Program. If this program is put into effect, 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 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 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 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 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 9, 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 F-16 84 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS employees and the employees of participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through their periodic payroll deductions. Share Reserve. 600,000 shares of common stock will initially be reserved for issuance. Purchase Periods. The plan will have a series of successive purchase periods, each with a maximum duration for six months. The initial purchase period will begin on the date of the underwriting agreement for this offering covered by this prospectus is signed and will end on the last business day in 2000. Thereafter, purchase periods will run for the first business day in February to the last business day in July each year, and for 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 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 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 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. In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation. As permitted by SFAS No. 123, 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 1996 and 1997. Had compensation cost been determined using the provisions of SFAS No. 123, the Company's net income would have been decreased to the pro forma amounts indicated below:
DECEMBER 31, MARCH 31, 1998 1999 ------------ --------- Net income: As reported............................................... $2,346 $ 883 ====== ===== Pro forma................................................. $2,177 $ 725 ====== ===== Basic and diluted net income per share: As reported............................................... $ 0.05 $0.02 ====== ===== Pro forma................................................. $ 0.05 $0.01 ====== =====
F-17 85 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 1996, 1997 and 1998 and the three months ended March 31, 1998 and 1999: expected volatility of zero; risk-free interest rates of 6%; and expected lives of ten years. A summary of the status of the Plans is presented below:
DECEMBER 31, MARCH 31, --------------------------------------------------------- ------------------------------------- 1996 1997 1998 1998 1999 ----------------- ----------------- ----------------- ----------------- ----------------- WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- Outstanding, beginning of period.................. 556 $0.40 1,531 $0.64 975 $0.77 975 $0.77 3,367 $1.19 Granted................... 975 $0.77 -- $ -- 3,383 $1.19 -- $ -- 797 $2.37 Exercised................. -- $ -- -- $ -- -- $ -- -- $ -- (2) $1.00 Canceled.................. -- $ -- (556) $0.40 (991) $0.77 -- $ -- (32) $1.10 ----- ----- ----- --- ----- Balance, end of period.... 1,531 $0.64 975 $0.77 3,367 $1.19 975 $0.77 4,130 $1.42 Weighted average fair value of options granted during the year......... $0.00 -- $0.53 -- $1.09 ===== ===== ===== ===== =====
The following tables summarize information about stock options outstanding as of December 31, 1998 and March 31, 1999:
DECEMBER 31, 1998 ------------------------------------------------------------- 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 -- 1.15........................... 2,271 9.5 $1.00 12 $1.00 1.16 -- 2.00........................... 713 9.8 1.17 -- -- 2.01 -- 2.37........................... 383 9.9 2.37 -- -- ----- -- 3,367 12 ===== ==
MARCH 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 -- 1.15........................... 2,250 9.3 $1.00 239 $1.00 1.16 -- 2.00........................... 701 9.5 1.17 -- -- 2.00 -- 2.37........................... 1,179 9.7 2.37 -- -- ----- --- 4,130 239 ===== ===
From April 1, 1999 to June 4, 1999, the Company issued options to purchase 448 shares of common stock at $3.77 per share and options to purchase 1.5 shares of common stock at $1.00 per share were exercised. F-18 86 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. COMMITMENTS AND CONTINGENCIES The Company leases its office facilities and certain equipment under various operating leases. Total rent expense was $456, $732, $1,038, $159, and $280, for the years ended December 31, 1997, 1998, and 1999, and the three months ended March 31, 1998 and 1999, respectively. Minimum lease commitments under noncancelable operating leases at December 31, 1998, are as follows: Year ending December 31: 1999.............................................. $1,107 2000.............................................. 683 2001.............................................. 79 2002.............................................. 20 ------ $1,889 ======
The Company maintains a profit-sharing plan covering substantially all employees. Quarterly contributions may be made by the Company based upon employee salaries. The Company did not contribute to the plan for the year ended December 31, 1996. Effective January 1, 1997, the Company amended and restated the profit sharing plan to include a 401(k) plan. The Company contributed $134, $466, $92, and $255 to the amended plan for the years ended December 31, 1997 and 1998 and the three months ended March 31, 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 alleges 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 complaint seeks injunctive relief and unspecified damages. No factual basis was set forth in the complaint in support of Mobius' misappropriation of trade secrets claim. The Company intends to defend this action vigorously, and, based on the complaint and the facts underlying the complaint of which the Company is currently aware, the Company does not believe that this lawsuit will have a material adverse effect on its business, results of operations or financial position; however, it is too early to determine the ultimate outcome of the lawsuit. The Company is involved in other 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, upon the advice of legal counsel, that the ultimate disposition of these matters will not materially affect the Company's results of operations or financial position. 7. 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-19 87 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. Operating segment data for the three years in the period ended December 31, 1998 and the three months ended March 31, 1998 and 1999 was as follows:
LICENSES SERVICES TOTAL -------- -------- ------- Year ended December 31, 1996: Revenues.................................................. $ 9,316 $ 3,546 $12,862 Cost of revenues.......................................... 950 1,467 2,417 ------- ------- ------- Gross profit........................................... $ 8,366 $ 2,079 $10,445 ======= ======= ======= Year ended December 31, 1997: Revenues.................................................. $12,195 $ 6,120 $18,315 Cost of revenues.......................................... 1,307 1,972 3,279 ------- ------- ------- Gross profit........................................... $10,888 $ 4,148 $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 ======= ======= ======= Three months ended March 31, 1998: Revenues.................................................. $ 4,840 $ 2,203 $ 7,043 Cost of revenues.......................................... 557 521 1,078 ------- ------- ------- Gross profit........................................... $ 4,283 $ 1,682 $ 5,965 ======= ======= ======= Three months ended March 31, 1999: Revenues.................................................. $ 9,540 $ 3,274 $12,814 Cost of revenues.......................................... 660 904 1,564 ------- ------- ------- Gross profit........................................... $ 8,880 $ 2,370 $11,250 ======= ======= =======
F-20 88 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 assets concerning principal geographic areas in which the Company operates are as follows:
NORTH AMERICA INTERNATIONAL ELIMINATIONS TOTAL ------- ------------- ------------ ------- Year ended December 31, 1996: Revenues..................................... $11,687 $1,136 $ 39 $12,862 Gross profit................................. 9,435 971 39 10,445 Loss from operations......................... (396) (266) 290 (372) Assets....................................... 6,165 451 (208) 6,408 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 Assets....................................... 9,431 1,118 (836) 9,713 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 Assets....................................... 16,352 3,914 (621) 19,645 Three months ended March 31, 1998: Revenues..................................... $ 6,664 $ 593 $ (214) $ 7,043 Gross profit................................. 5,632 512 (179) 5,965 Income (loss) from operations................ 1,477 (7) (35) 1,435 Assets....................................... 10,483 1,411 (660) 11,234 Three months ended March 31, 1999: Revenues..................................... $11,461 $1,780 $ (427) $12,814 Gross profit................................. 9,993 1,688 (431) 11,250 Income (loss) from operations................ 1,193 115 108 1,416 Assets....................................... 18,409 4,567 (504) 22,472
During the year ended December 31, 1996, sales to a single customer accounted for approximately 12.0% of total revenue for the year. In fiscal 1997 and 1998 and the three months ended March 31, 1998 and 1999, no single customer accounted for 10% or more of total revenue. 8. SUBSEQUENT EVENT On 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. Such costs have been recorded in April 1999. 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. Additionally, the Company borrowed $10,000 under a term note with a bank. The borrowings under the term note are secured by substantially all assets of the Company, bears interest, at the Company's option, at either the F-21 89 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS bank's prime rate or at the LIBOR rate plus a maximum of 2.75% per annum, requires monthly interest payments commencing June 1, 1999, and principal is payable in 24 monthly installments of $417 commencing June 1, 2000. All unpaid principal and interest is due on May 1, 2002. The loan contains 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. Series A shares are convertible at the holder's option into shares of common stock, based on the conversion ratio defined in the agreement. The conversion ratio may be adjusted from time to time in the event of certain diluting events, as defined. Conversion is automatic in the event of a public offering of the Company's common stock, that meets 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 have 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 is 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 will be redeemed. Dividends on Series A are cumulative and the dividend rate is 8% per share per annum. Series A shareholders have 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 has 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. Series B shares are 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 have not been converted into common stock, Series B shares are 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 may be adjusted from time to time in the event of certain diluting events, as defined. Dividends on Series B are cumulative and may be declared at the discretion of the Board of Directors. The dividend rate is 18% per share per annum. Series B shareholders do 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 has 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 have 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 is determined on the redemption date by the then applicable liquidation preference. * * * * * * F-22 90 Inside Back Cover [Background consists of the names of certain Quest customers] The 24x7 "instant on", "zero latency," "webified" enterprise becomes the standard. Computing infrastructure availability becomes the most important success measure. Between 1998 and 2004, continuous restructuring of markets, value chains and enterprises will drive a 500% increase in the demand for rapid development and modification of information technology application and infrastructure. Traditionally, availability investments were made only for high-end OLTP applications. With expansion of business critical applications and data, high availability has gone from niche to mainstream. Market analysis excerpts from Gartner Group, Stamford, Connecticut. 91 [QUEST SOFTWARE LOGO] 92 THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. 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 WE ARE NOT SOLICITING OFFERS TO BUY THESE SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION, DATED JUNE 11, 1999 [QUEST SOFTWARE LOGO] SHARES COMMON STOCK ---------------------------------- Quest Software, Inc. is offering shares of common stock. This is our initial public offering, and no public market currently exists for our shares. We have filed an application for the common stock to be quoted on the Nasdaq National Market under the symbol "QSFT." We anticipate that the initial public offering price will be between $ and $ per share. ---------------------------------- INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 6. ----------------------------------
PER SHARE TOTAL --------- ----- Public Offering Price....................................... $ $ Underwriting Discounts and Commissions...................... $ $ Proceeds to Quest Software, Inc............................. $ $
---------------------------------- 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. Quest Software, Inc. has granted the underwriters a 30-day option to purchase up to an additional shares of our common stock to cover over-allotments. BancBoston Robertson Stephens Inc. expects to deliver the shares of common stock to purchasers on , 1999. ---------------------------------- BANCBOSTON ROBERTSON STEPHENS INTERNATIONAL LIMITED DONALDSON, LUFKIN & JENRETTE CIBC WORLD MARKETS FAC/EQUITIES THE DATE OF THIS PROSPECTUS IS , 1999. 93 UNDERWRITING The underwriters named below, acting through their representatives, BancBoston Robertson Stephens International Limited, Donaldson, Lufkin & Jenrette Securities Corporation, CIBC World Markets Corp. and FAC/Equities, a division of First Albany Corporation (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 - ----------- --------- BancBoston Robertson Stephens Inc. ......................... Donaldson, Lufkin & Jenrette Securities Corporation ........ CIBC World Markets Corp. ................................... First Albany Corporation....................................
INTERNATIONAL UNDERWRITER - ------------------------- BancBoston Robertson Stephens International Limited......... Donaldson, Lufkin & Jenrette International.................. CIBC World Markets International Limited.................... -------- Total............................................. ========
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 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 We have granted to the underwriters an option, exercisable during the 30-day period after the date of this prospectus, to purchase up to additional shares of common stock at the same price per share as we will receive for the 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 shares offered hereby. If purchased, such additional shares will be sold by the underwriters on the same terms as those on which the 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 $ , $ and $ , 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. 63 94 Lock-Up Agreements Each of our executive officers, directors and shareholders and substantially all of optionholders have agreed with the Representatives, for a period of 180 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 BancBoston Robertson Stephens International Limited. However, BancBoston Robertson Stephens International Limited 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 180 days after this prospectus. Future Sales In addition, we have agreed that during the period of 180 days after this prospectus, we will not, subject to certain exceptions, without the prior written consent of BancBoston Robertson Stephens International Limited: - Consent to the disposition of any shares held by shareholders prior to the expiration of the period of 180 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. No Prior Public Market Prior to this offering, there has been no public market for our common stock. Consequently, the initial public offering price for the common stock offered hereby will be determined through negotiations between us and the representatives. Among the factors to be considered in such negotiations are prevailing market conditions, certain of our financial information, market valuations of other companies that we and the Representatives believe to be comparable to us, estimates of our business potential, the present state of our development and other factors deemed relevant. 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. 64 95 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........................................ $ 16,680 NASD Filing Fee............................................. 6,500 Nasdaq National Market Listing Fee.......................... * Printing and Engraving Expenses............................. * Legal Fees and Expenses..................................... * Accounting Fees and Expenses................................ * Blue Sky Fees and Expenses.................................. * Transfer Agent Fees......................................... * Miscellaneous............................................... * -------- Total............................................. $ * ========
- ------------------------- * To be filed by amendment 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, II-1 96 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 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 97 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. 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 Section 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. 3.1* Second Amended and Restated Articles of Incorporation. 3.2* Second Amended and Restated Bylaws. 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. 10.8* OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP. 23.2* Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1 Power of Attorney (Included on signature pages hereto). 27.1 Financial Data Schedule (In EDGAR format only).
- ------------------------- * To be filed by amendment (B) FINANCIAL STATEMENT SCHEDULE II-3 98 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, 1996: Allowance for doubtful accounts and sales returns......................................... $129 $ 417 $ -- $ 546 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
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-4 99 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all the requirements for filing on Form S-1 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Newport Beach, State of California, on this 11th day of June, 1999. QUEST SOFTWARE, INC. By: /s/ VINCENT C. SMITH ------------------------------------ Vincent C. Smith Chief Executive Officer 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 (principal June 11, 1999 - --------------------------------------------------- executive officer) and Chairman Vincent C. Smith of the Board /s/ DAVID M. DOYLE President, Secretary and Director June 11, 1999 - --------------------------------------------------- David M. Doyle /s/ JOHN J. LASKEY Chief Financial Officer (principal June 11, 1999 - --------------------------------------------------- financial and accounting officer) John J. Laskey and Vice President, Finance /s/ DORAN G. MACHIN Director June 11, 1999 - --------------------------------------------------- Doran G. Machin
100
SIGNATURE TITLE DATE - --------- ----- ---- /s/ JERRY MURDOCK, JR. Director June 11, 1999 - --------------------------------------------------- Jerry Murdock, Jr. /s/ RAYMOND J. LANE Director June 11, 1999 - --------------------------------------------------- Raymond J. Lane
101 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 1.1* Form of Underwriting Agreement. 3.1* Second Amended and Restated Articles of Incorporation. 3.2* Second Amended and Restated Bylaws. 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. 10.8* OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP. 23.2* Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1 Power of Attorney (Included on signature pages hereto). 27.1 Financial Data Schedule (In EDGAR format only).
- ------------------------- * To be filed by amendment EX-10.4 2 FORM OF DIRECTORS' AND OFFICERS' INDEMNIFICATION 1 EXHIBIT 10.4 INDEMNIFICATION AGREEMENT THIS AGREEMENT (this "Agreement"), is made and entered into as of this _____ day of ______________, 1999, between Quest Software, Inc., a California corporation (the "Corporation"), and ____________________ ("Indemnitee"). WHEREAS, Indemnitee, as a member of the Board of Directors and/or an officer of the Corporation, performs a valuable service in such capacity for the Corporation; WHEREAS, the Articles of Incorporation and Bylaws of the Corporation authorize and permit contracts between the Corporation and a member of its Board of Directors or officers with respect to indemnification of such individuals; WHEREAS, in accordance with the authorization as provided by the California General Corporation Law, as amended ("Code"), the Corporation may purchase and maintain a policy or policies of Directors' and Officers' Liability Insurance ("D & O Insurance"), covering certain liabilities which may be incurred by Indemnitee in his or her performance as a director or officer of the Corporation; WHEREAS, as a result of developments affecting the terms, scope and availability of D & O Insurance there exists general uncertainty as to the extent of protection afforded members of the Board of Directors and officers of the Corporation by such D & O Insurance and by statutory and bylaw indemnification provisions; and WHEREAS, in recognition of past services and in order to induce Indemnitee to continue to serve as an officer and/or a director of the Corporation, the Corporation has determined and agreed to enter into this Agreement with Indemnitee. NOW, THEREFORE, in consideration of Indemnitee's service as a director and/or officer, the parties hereto agree as follows: 1. Indemnity of Indemnitee. The Corporation hereby agrees to hold harmless and indemnify Indemnitee to the fullest extent authorized or permitted by the provisions of the Code, as it may be amended from time to time. 2. Additional Indemnity. Subject only to the limitations set forth in Section 3 hereof, the Corporation hereby further agrees to hold harmless and indemnify Indemnitee: a. against any and all expenses (including attorneys' fees), witness fees, judgments, fines and amounts paid in settlement actually and reasonably incurred by Indemnitee in connection with any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (including an action by or in the right of the Corporation) to which Indemnitee is, was, or at any time becomes a party, or is threatened to be made a party, by reason of the fact that Indemnitee is, was, or at any time becomes a director, officer, employee or agent of the Corporation, or is or was serving or at any time serves at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise; and 2 b. otherwise to the fullest extent as may be provided to Indemnitee by the Corporation under the Articles of Incorporation of the Corporation and the Code. 3. Limitations on Additional Indemnity. a. No indemnity pursuant to Section 2 hereof shall be paid by the Corporation for any of the following: (i) except to the extent the aggregate of losses to be indemnified thereunder exceeds the sum of such losses for which Indemnitee is indemnified pursuant to Section 1 hereof or pursuant to any D & O Insurance purchased and maintained by the Corporation; (ii) in respect to remuneration paid to Indemnitee if it shall be determined by a final judgment or other final adjudication that such remuneration was in violation of law; (iii) on account of Indemnitee's acts or omissions that involve intentional misconduct or a knowing and culpable violation of law; (iv) on account of any action, claim or proceeding initiated by Indemnitee unless such action, claim or proceeding was authorized in the specific case by action of the Board of Directors; (v) on account of Indemnitee's conduct which is the subject of an action, suit or proceeding described in Section 7(c)(ii) hereof; or (vi) if a final decision by a Court having jurisdiction in the matter shall determine that such indemnification is not lawful (and, in this respect, both the Corporation and Indemnitee have been advised that the Securities and Exchange Commission believes that indemnification for liabilities arising under the federal securities laws is against public policy and is, therefore, unenforceable and that claims for indemnification should be submitted to appropriate courts for adjudication). b. In addition to those limitations set forth above in paragraph (a) of this Section 3, no indemnity pursuant to Section 2 hereof in an action by or in the right of the Corporation shall be paid by the Corporation for any of the following: (i) on account of acts or omissions that Indemnitee believes to be contrary to the best interests of the Corporation or its shareholders or that involve the absence of good faith on the part of Indemnitee; (ii) with respect to any transaction from which Indemnitee derived an improper personal benefit; (iii) on account of acts or omissions that show a reckless disregard for Indemnitee's duty to the Corporation or its shareholders in circumstances in which 2 3 Indemnitee was aware, or should have been aware, in the ordinary course of performing such Indemnitee's duties, of a risk of serious injury to the Corporation or its shareholders; (iv) on account of acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of Indemnitee's duty to the corporation or its shareholders; (v) to the extent prohibited by Section 310 of the California Corporations Code, "Contracts In Which Indemnitee Has Material Financial Interest"; (vi) to the extent prohibited by Section 316 of the California Corporations Code, "Corporate Actions Subjecting Directors To Joint And Several Liability" (for prohibited distributions, loans and guarantees); (vii) in respect of any claim, issue or matter as to which Indemnitee shall have been adjudged to be liable to the Corporation in the performance of Indemnitee's duty to the Corporation and its shareholders, unless and only to the extent that the court in which such proceeding is or was pending shall determine upon application that, in view of all the circumstances of the case, Indemnitee is fairly and reasonably entitled to indemnity for expenses and then only to the extent that the court shall determine; (viii) of amounts paid in settling or otherwise disposing of a pending action without court approval; or (ix) of expenses incurred in defending a pending action which is settled or otherwise disposed of without court approval. 4. Contribution. If the indemnification provided in Sections 1 and 2 hereof is unavailable and may not be paid to Indemnitee by reason of a Court decision described in subsection 3(a)(vi) hereof based on grounds other than any of those set forth in subsections 3(a)(ii) through (v) hereof or in subsections 3(b)(i) through (vi) hereof, then in respect of any threatened, pending or completed action, suit or proceeding in which the Corporation is jointly liable with Indemnitee (or would be if joined in such action, suit or proceeding), the Corporation shall contribute to the amount of expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred and paid or payable by Indemnitee in such proportion as is appropriate to reflect (i) the relative benefits received by the Corporation on the one hand and Indemnitee on the other hand from the transaction from which such action, suit or proceeding arose, and (ii) the relative fault of the Corporation on the one hand and of Indemnitee on the other hand in connection with the events which resulted in such expenses, judgments, fines or settlement amounts, as well as any other relevant equitable considerations. The relative fault of the Corporation on the one hand and of Indemnitee on the other hand shall be determined by reference to, among other things, the parties' relative intent, knowledge, access to information and opportunity to correct or prevent the circumstances resulting in such expenses, judgments, fines or settlement amounts. The Corporation agrees that it would not be just and equitable if contribution pursuant to this Section 4 were determined by pro rata allocation or any other method of allocation which does not take account of the foregoing equitable considerations. 3 4 5. Continuation of Obligations. All agreements and obligations of the Corporation contained herein shall continue during the period Indemnitee is a director, officer, employee or agent of the Corporation (or is or was serving at the request of the Corporation as a director, officer employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise) and shall continue thereafter so long as Indemnitee shall be subject to any possible claim or threatened, pending or completed action, suit or proceeding, whether civil, criminal or investigative, by reason of the fact that Indemnitee was an officer or director of the Corporation or serving in any other capacity referred to herein. 6. Notification and Defense of Claim. Not later than thirty (30) days after receipt by Indemnitee of notice of the commencement of any action, suit or proceeding, Indemnitee will, if a claim in respect thereof is to be made against the Corporation under this Agreement, notify the Corporation of the commencement thereof; but the omission so to notify the Corporation will not relieve it from any liability which it may have to Indemnitee otherwise than under this Agreement. With respect to any such action, suit or proceeding as to which Indemnitee notifies the Corporation of the commencement thereof: a. the Corporation will be entitled to participate therein at its own expense; b. except as otherwise provided below, to the extent that it may wish, the Corporation jointly with any other indemnifying party similarly notified will be entitled to assume the defense thereof, with counsel reasonably satisfactory to Indemnitee. After notice from the Corporation to Indemnitee of its election to assume the defense thereof, the Corporation will not be liable to Indemnitee under this Agreement for any legal or other expenses subsequently incurred by Indemnitee in connection with the defense thereof other than reasonable costs of investigation or as otherwise provided below. Indemnitee shall have the right to employ its counsel in such action, suit or proceeding but the fees and expenses of such counsel incurred after notice from the Corporation of its assumption of the defense thereof shall be at the expense of Indemnitee unless (i) the employment of counsel by Indemnitee has been authorized by the Corporation, (ii) Indemnitee shall have reasonably concluded that there may be a conflict of interest between the Corporation and Indemnitee in the conduct of the defense of such action or (iii) the Corporation shall not in fact have employed counsel to assume the defense of such action, in each of which cases the fees and expenses of Indemnitee's separate counsel shall be at the expense of the Corporation. The Corporation shall not be entitled to assume the defense of any action, suit or proceeding brought by or on behalf of the Corporation or as to which Indemnitee shall have made the conclusion provided for in (ii) above; and c. the Corporation shall not be liable to indemnify Indemnitee under this Agreement for any amounts paid in settlement of any action or claim effected without its written consent. The Corporation shall be permitted to settle any action except that it shall not settle any action or claim in any manner which would impose any penalty or limitation on Indemnitee without Indemnitee's written consent. Neither the Corporation nor Indemnitee will unreasonably withhold its consent to any proposed settlement. 4 5 7. Advancement and Repayment of Expenses. a. In the event that Indemnitee employs his own counsel pursuant to Section 6(b)(i) through (iii) above, the Corporation shall advance to Indemnitee, prior to any final disposition of any threatened or pending action, suit or proceeding, whether civil, criminal, administrative or investigative, any and all reasonable expenses (including legal fees and expenses) incurred in investigating or defending any such action, suit or proceeding within ten (10) days after receiving copies of invoices presented to Indemnitee for such expenses; and b. Indemnitee agrees that Indemnitee will reimburse the Corporation for all reasonable expenses paid by the Corporation in defending any civil or criminal action, suit or proceeding against Indemnitee in the event and only to the extent it shall be ultimately determined by a final judicial decision (from which there is no right of appeal) that Indemnitee is not entitled, under applicable law, the Bylaws, this Agreement or otherwise, to be indemnified by the Corporation for such expenses. c. Notwithstanding the foregoing, the Corporation shall not be required to advance such expenses to Indemnitee if Indemnitee (i) commences any action, suit or proceeding as a plaintiff unless such advance is specifically approved by a majority of the Board of Directors or (ii) is a party to an action, suit or proceeding brought by the Corporation and approved by a majority of the Board of Directors which alleges willful misappropriation of corporate assets by Indemnitee, disclosure of confidential information in violation of Indemnitee's fiduciary or contractual obligations to the Corporation, or any other willful and deliberate breach in bad faith of Indemnitee's duty to the Corporation or its shareholders. 8. Indemnification for Expenses of a Witness. Notwithstanding any other provision of this Agreement, to the extent that Indemnitee is, by reason of his position as an officer and/or director of the Corporation, called as a witness in any action, suit or proceeding to which Indemnitee is not a party, he shall be indemnified against all expenses actually and reasonably incurred by him or on his behalf in connection therewith. 9. Enforcement. In the event Indemnitee is required to bring any action to enforce rights or to collect moneys due under this Agreement and is successful in such action, the Corporation shall reimburse Indemnitee for all of Indemnitee's reasonable fees and expenses in bringing and pursuing such action. 10. Subrogation. In the event of payment under this Agreement, the Corporation shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Corporation effectively to bring suit to enforce such rights. 11. Non-Exclusivity of Rights. The rights conferred on Indemnitee by this Agreement shall not be exclusive of any other right which Indemnitee may have or hereafter acquire under any statute, provision of the Corporation's Articles of Incorporation or Bylaws, agreement, vote of shareholders or directors, or otherwise, both as to action in his official capacity and as to action in another capacity while holding office. 5 6 12. Survival of Rights. The rights conferred on Indemnitee by this Agreement shall continue after Indemnitee has ceased to be a director, officer, employee or other agent of the Corporation and shall inure to the benefit of Indemnitee's heirs, executors and administrators. 13. Severability. Each of the provisions of this Agreement is a separate and distinct agreement and independent of the others, so that if any provision hereof shall be held to be invalid or unenforceable for any reason, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions hereof. 14. Governing Law. This Agreement shall be interpreted and enforced in accordance with the laws of the State of California. 15. Binding Effect. This Agreement shall be binding upon Indemnitee and upon the Corporation, its successors and assigns, and shall inure to the benefit of Indemnitee, his heirs, personal representatives and assigns and to the benefit of the Corporation, its successors and assigns. 16. Amendment and Termination. No amendment, modification, termination or cancellation of this Agreement shall be effective unless in writing signed by both parties hereto. 6 7 IN WITNESS WHEREOF, the parties hereto have executed this Indemnification Agreement on and as of the day and year first above written. QUEST SOFTWARE, INC. By ---------------------------------- Name: Title: INDEMNITEE ------------------------------------- Name: 7 EX-10.5 3 SECURITIES PURCHASE AGREEMENT 1 EXHIBIT 10.5 QUEST SOFTWARE, INC. SECURITIES PURCHASE AGREEMENT DATED AS OF APRIL 21, 1999 2 TABLE OF CONTENTS 1. Purchase and Sale of Securities.....................................1 1.1. Sale and Issuance of Securities............................1 1.2. Closing....................................................1 2. Representations and Warranties of the Company.......................1 2.1. Organization, Good Standing and Qualification..............1 2.2. Capitalization.............................................2 2.3. Subsidiaries...............................................3 2.4. Authorization..............................................3 2.5. Valid Issuance of Series A Stock and Series B Stock........3 2.6. Governmental Consents......................................3 2.7. Offering...................................................4 2.8. Litigation.................................................4 2.9. Proprietary Information and Invention Agreements...........4 2.10. Patents and Trademarks.....................................4 2.11. Compliance.................................................5 2.12. Agreements.................................................6 2.13. Related-Party Transactions.................................6 2.14. Permits....................................................6 2.15. Manufacturing and Marketing Rights.........................7 2.16. Disclosure.................................................7 2.17. Registration Rights........................................7 2.18. Corporate Documents........................................7 2.19. Title to Property and Assets...............................7 2.20. Financial Statements.......................................7 2.21. Changes....................................................8 2.22. Tax Returns, Payments and Elections........................9 2.23. Insurance..................................................9 2.24. Compliance with ERISA; Benefit Plans.......................9 2.25. No Brokers.................................................9 2.26. Minute Books...............................................9 2.27. Labor Agreements and Actions...............................9 2.28. Real Property Holding Company.............................10 2.29. Use of Proceeds...........................................10 3. Representations and Warranties of the Investor.....................10 3.1. Organization, Good Standing and Qualification.............10 3.2. Authorization.............................................10 3.3. Purchase Entirely for Own Account.........................10 3.4. Disclosure of Information.................................10 3.5. Investment Experience.....................................11 3.6. Accredited Investor.......................................11 3.7. Restricted Securities.....................................11
i 3 TABLE OF CONTENTS (Continued) 3.8. Further Limitations on Disposition........................11 3.9. Legends...................................................12 4. Conditions of Investors' Obligations at Closing....................12 4.1. Representations and Warranties............................12 4.2. Performance...............................................12 4.3. Compliance Certificate....................................12 4.4. Amended and Restated Articles Effective...................12 4.5. Proceedings and Documents.................................13 4.6. Proprietary Information and Inventions Agreement..........13 4.7. Board of Directors........................................13 4.8. Opinion of Company Counsel................................13 4.9. Investors' Rights Agreement and Shareholders Agreement....13 4.10. Financial Statements......................................13 4.11. Common Stock Purchase Agreement...........................13 5. Conditions of the Company's Obligations at Closing.................14 5.1. Representations and Warranties............................14 5.2. Payment of Purchase Price.................................14 5.3. Qualifications............................................14 5.4. Amended and Restated Articles Effective...................14 5.5. Investors' Rights Agreement and Shareholders Agreement....14 6. Miscellaneous......................................................14 6.1. Survival of Warranties....................................14 6.2. Successors and Assigns....................................14 6.3. Disclosure................................................14 6.4. Governing Law.............................................15 6.5. Counterparts..............................................15 6.6. Titles and Subtitles......................................15 6.7. Notices...................................................15 6.8. Finder's Fee..............................................15 6.9. Expenses..................................................15 6.10. Amendments and Waivers....................................15 6.11. Severability..............................................16 6.12. Aggregation of Stock......................................16 6.13. Entire Agreement..........................................16 6.14. Remedies..................................................16 6.15. Key-Man Insurance.........................................16
ii 4 TABLE OF CONTENTS (Continued) Exhibits - -------- Exhibit A Amended and Restated Articles Exhibit B Schedule of Investors Exhibit C Schedule of Exceptions Exhibit D Investors' Rights Agreement Exhibit E Shareholders Agreement Exhibit G Form of Common Stock Repurchase Agreement Exhibit H Opinion of Counsel for Company iii 5 SECURITIES PURCHASE AGREEMENT THIS SECURITIES PURCHASE AGREEMENT (this "Agreement") is made as of the 21st day of April, 1999, by and among Quest Software, Inc., a California corporation (the "Company") and the Investors listed on the schedule of purchasers attached hereto (each an "Investor" and collectively, the "Investors"). THE PARTIES HEREBY AGREE AS FOLLOWS: 1. Purchase and Sale of Securities. 1.1. Sale and Issuance of Securities. (a) The Company shall adopt and file with the Secretary of State of the State of California on or before the Closing (as hereinafter defined) an Amended and Restated Articles of Incorporation in the form attached hereto as Exhibit A (the "Amended and Restated Articles"). (b) Subject to the terms and conditions of this Agreement, each Investor agrees, severally and not jointly, to purchase at the Closing, and the Company agrees, in consideration for the payment by each Investor at the Closing, to issue and sell to each Investor at the Closing, that number of shares of the Series A Preferred Stock (the "Series A Stock"), the Series B Redeemable Preferred Stock ("the Series B Stock" and collectively, the "Securities"), set forth opposite each Investor's name on Exhibit B hereto for the purchase price set forth thereon. The total aggregate purchase price paid by each Investor shall hereinafter be referred to as the "Purchase Price." 1.2. Closing (a) The purchase and sale of the Securities shall take place at the offices of Brobeck, Phleger & Harrison LLP, Two Embarcadero Place, 2200 Geng Road, Palo Alto, CA 94303, at 10:00 a.m. (California time) on the first practicable date after all of the conditions set forth in Sections 4 and 5 hereof have been met, or at such other time and place as the Company and the Investors mutually agree upon in writing (which time and place are designated as the "Closing"). At the Closing, the Company shall deliver to each Investor a certificate or certificates representing the Securities that such Investor is purchasing against payment of the Purchase Price therefor by check or wire transfer. 2. Representations and Warranties of the Company. As of the date hereof, the Company, except as set forth in the Schedule of Exceptions attached to this Agreement as Exhibit C (the "Schedule of Exceptions"), which exceptions shall be deemed to be representations and warranties as if made hereunder, hereby represents and warrants to each Investor that: 2.1. Organization, Good Standing and Qualification. The Company is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has all requisite corporate power and authority to carry on its 6 business as now conducted and as proposed to be conducted. The Company has not received any written notice that any of its Subsidiaries (as defined below) is not in good standing. The Company is duly qualified to transact business and is in good standing in each jurisdiction in which the failure to so qualify would have a material adverse effect on the business, properties, assets, results of operations or financial condition of the Company and its Subsidiaries taken as a whole (a "Material Adverse Effect"). 2.2. Capitalization. The authorized capital of the Company will consist at Closing, of: (a) Preferred Stock. Six Million Three Hundred Thousand (6,300,000) shares of preferred stock, no par value per share (the "Preferred Stock"), of which Four Million Five Hundred Thousand (4,500,000) shall have been designated as Series A Preferred Stock and of which One Million Eight Hundred Thousand (1,800,000) shall have been designated as Series B Redeemable Preferred Stock (the "Series B Stock"). The rights, privileges and preferences of the Series A Stock and the Series B Stock will be as stated in the Company's Amended and Restated Articles. (b) Common Stock. Fifty Million (50,000,000) shares of common stock, no par value per share (the "Common Stock"), of which Twenty-Nine Million Six Hundred Ninety-Two Thousand (29,692,000) are issued and outstanding. (c) The issued and outstanding shares of Common Stock are owned by the shareholders in the numbers specified in Section 2.2(c) to the Schedule of Exceptions. Section 2.2(c) to the Schedule of Exceptions also sets forth the number of shares of Common Stock underlying all outstanding options, warrants and other convertible securities of the Company, including without limitation under the Option Plan (as hereinafter defined). (d) All shares of Common Stock issued by the Company to date have been duly and validly authorized and issued, fully paid and nonassessable, and all such shares were issued in accordance with the registration or qualification provisions of the Securities Act of 1933, as amended (the "Securities Act"), and all applicable state securities laws or pursuant to valid exemptions therefrom. (e) Except for (A) the conversion privileges of the Series A Stock to be issued under this Agreement (including without limitation upon conversion of the Series B Preferred Stock), (B) the rights provided in the Investors' Rights Agreement to be entered into simultaneously with this Agreement by and between the Company and the Investors, in the form attached hereto as Exhibit D (the "Investors' Rights Agreement") and the Shareholders Agreement to be entered into simultaneously with this Agreement by and between the Company, certain shareholders of the Company and the Investors, in the form attached hereto as Exhibit E (the "Shareholders Agreement") and (C) the Five Million (5,000,000) shares of Common Stock reserved for issuance upon exercise of options granted or to be granted in the future under the Company's stock option plan (the "Option Plan"), there are not outstanding any options, warrants, rights (including conversion or preemptive rights), instruments or agreements for the purchase or acquisition from the Company of any shares of its capital stock or any securities exercisable, convertible or exchangeable for or into shares of its capital stock and (y) there is no 7 agreement, restriction or encumbrance (including without limitation a right of first refusal, right of first offer, proxy or voting agreement) with respect to the sale or voting of any shares of capital stock of the Company (whether outstanding or issuable upon conversion or exercise of outstanding securities). 2.3. Subsidiaries. Except for the subsidiaries of the Company identified in Section 2.3 to the Schedule of Exceptions (the "Subsidiaries"), the Company does not presently own or control, directly or indirectly, any interest in any other corporation, association, or other business entity. Except for the subsidiary of the Company identified in Section 2.3 to the Schedule of Exceptions, none of the Subsidiaries accounted for in excess of ten percent (10%) of the Company's revenues or total assets in the last fiscal year. Section 2.3 to the Schedule of Exceptions correctly sets forth the authorized and outstanding capital stock of each Subsidiary and the beneficial owners of all such equity interests. The Company is not a participant in any joint venture, partnership, or similar arrangement. 2.4. Authorization. All corporate action on the part of the Company, its officers, directors and shareholders necessary for the authorization, execution and delivery of this Agreement, the Shareholders Agreement and the Investors' Rights Agreement, the performance of all obligations of the Company hereunder and thereunder, and the authorization, issuance (or reservation for issuance), sale and delivery of the Series A Stock (including without limitation the Series A Stock issuable upon conversion of the Series B Stock); and the Series B Stock being sold hereunder and the Common Stock issuable upon conversion of the Series A Stock has been taken or will be taken prior to the Closing, as appropriate. This Agreement, the Shareholders Agreement and the Investors' Rights Agreement each constitute valid and legally binding obligations of the Company, enforceable in accordance with their respective terms, except (i) as limited by applicable bankruptcy, insolvency, reorganization, moratorium, and other laws of general application affecting enforcement of creditors' rights generally, (ii) as limited by laws relating to the availability of specific performance, injunctive relief or other equitable remedies and (iii) to the extent the indemnification provisions contained in the Investors' Rights Agreement may be limited by applicable federal or state securities laws. 2.5. Valid Issuance of Series A Stock and Series B Stock. The Series A Stock and the Series B Stock being purchased by the Investor hereunder, when issued, sold and delivered in accordance with the terms of this Agreement for the consideration expressed herein, will be duly and validly issued, fully paid and nonassessable, and will be free of restrictions on transfer other than restrictions on transfer under this Agreement, the Shareholders Agreement and the Investors' Rights Agreement and under applicable state and federal securities laws. The Series A Stock issuable upon conversion of the Series B Stock, and the Common Stock issuable upon conversion of the Series A Stock has been duly and validly reserved for issuance and, upon issuance, will be duly and validly issued, fully paid and nonassessable, and will be free of restrictions on transfer other than restrictions on transfer under this Agreement, the Shareholders' Agreement, or the Investors' Rights Agreement. 2.6. Governmental Consents. No consent, approval, order or authorization of, or registration, qualification, designation, declaration or filing with, any federal, state or local governmental authority on the part of the Company is required in connection with the consummation of the transactions contemplated by this Agreement, except (i) the filing of the 8 Amended and Restated Articles with the Secretary of State of the State of California and (ii) the filing of a Notice of Transaction pursuant to Section 25102(f) of the California Corporate Securities Law of 1968, as amended, and the rules thereunder, or such other post-closing filings as may be required under applicable state securities laws, which filings will be timely made within the applicable periods therefor. 2.7. Offering. Subject in part to the truth and accuracy of each Investor's representations set forth in Section 3 of this Agreement, the offer, sale and issuance of the Series A Stock and the Series B Stock and the conversion of the Series A Stock into Common Stock and the conversion of the Series B Stock into Series A Stock, are exempt from the registration requirements of the Securities Act, and neither the Company nor any authorized agent acting on its behalf will take any action hereafter that would reasonably be expected to cause the loss of such exemption. 2.8. Litigation. Except as set forth in Section 2.8 to the Schedule of Exceptions, there is no action, suit, proceeding, claim or investigation pending or, to the Company's knowledge, currently threatened against the Company that questions the validity of this Agreement, the Shareholders Agreement or the Investors' Rights Agreement, or the right of the Company to enter into such agreements, or to consummate the transactions contemplated hereby or thereby, or that might result, either individually or in the aggregate, in any Material Adverse Effect. The foregoing includes, without limitation, actions, suits, proceedings, claims or investigations pending or threatened involving the prior employment of any of the Company's employees, their use in connection with the Company's business of any information or techniques allegedly proprietary to any of their former employers, or their obligations under any agreements with prior employers and product return, warranty or liability matters. The Company is not a party or subject to the provisions of any order, writ, injunction, judgment or decree of any court or government agency or instrumentality. There is no action, suit, proceeding, claim or investigation by the Company to its knowledge currently pending or that the Company intends to initiate. 2.9. Proprietary Information and Invention Agreements. Each U.S. employee, officer and consultant of the Company has executed a Proprietary Information and Inventions Agreement in the form provided to the Investors, except to the extent that any failure to execute such a Proprietary Information and Inventions Agreement will not result in a Material Adverse Effect. To the Company's knowledge, but without having conducted any special investigation or inquiry, none of the Company's employees, officers or consultants are in violation thereof, and the Company will use its best efforts to prevent any such violation. 2.10. Patents and Trademarks. The Company has sufficient title and ownership of, or has a currently valid license to, all patents, trademarks, service marks, trade names, copyrights, licenses, information, proprietary rights and processes necessary for its business as now conducted and as currently proposed to be conducted (collectively, the "Rights"). Section 2.10 to the Schedule of Exceptions sets forth a complete and accurate list of the Rights. Except as set forth in Section 2.10 to the Schedule of Exceptions, all of the patents, trademark and service mark registrations, and copyright registrations listed in Section 2.10 are valid and in full force, are held of record in the name of the Company, and to the Company's knowledge, are not the subject of any cancellation, reexamination opposition, extension of time to oppose, 9 interference, rejection, refusal to register or any other proceeding challenging their extent or validity. The Rights do not conflict with or infringe upon the rights of any third party. There are no outstanding options, licenses, or agreements of any kind relating to the foregoing, nor is the Company or any Subsidiary bound by or a party to any options, licenses or agreements of any kind with respect to the patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, proprietary rights and processes of any other person or entity. The Company is not aware that it has violated or, by conducting its business as proposed, would violate any of the patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information, proprietary rights or processes rights of any other person or entity. To the Company's knowledge, but without having conducted any special investigation or inquiry, none of the Company's or any Subsidiary's employees is obligated under any contract (including licenses, covenants or commitments of any nature) or other agreement, or subject to any order, writ, injunction, judgment or decree of any court or administrative agency that would interfere with the promotion of the interests of the Company or any Subsidiary or that would conflict with the Company's and the Subsidiaries' business as currently proposed to be conducted. Except as set forth in Section 2.10 to the Schedule of Exceptions, all software owned, licensed or used in and which is material to the Company's business is Year 2000 Compliant. As used herein, "Year 2000 Compliant" shall mean with respect to any such software, the ability of such software to perform the following date/time-related functions: (i) consistently and properly interpret, calculate, manipulate, store and exchange date/time data from, into, and between the twentieth and twenty-first centuries, including, without limitation the years 1999 and 2000 and any leap year calculations; (ii) function accurately in accordance with the documentation relating to the applicable software and without interruption before, during and after January 1, 2000, without any change in operations associated with the advent of the new century; (iii) respond to a two-digit date input in a way that resolves any ambiguity as to the century; and (iv) store and provide output of date information in ways that are unambiguous as to century. 2.11. Compliance. The Company is not in violation or default of any provision of its Amended and Restated Articles or Bylaws, each as amended to date, or of any instrument, judgment, order, writ, decree, contract, agreement or understanding to which it is a party or by which it is bound, and except for violations that individually or in the aggregate would not have a Material Adverse Effect, the Company, and to its actual knowledge, without independent investigation, each of the Subsidiaries, is in compliance with all federal, state, local or foreign statute, rule or regulation (including without limitation those relating to environmental, occupational, health and safety matters) applicable to the Company or any Subsidiary. The execution, delivery and performance of this Agreement, the Shareholders Agreement and the Investors' Rights Agreement, and the consummation of the transactions contemplated hereby and thereby, will not result in (i) any violation or default of any provision of its Amended and Restated Articles or Bylaws, (ii) any conflict with or constitute, with or without the passage of time and giving of notice, either a default under any instrument, judgment, order, writ, decree, contract, agreement or understanding to which the Company is a party or by which it is bound, (iii) an event that results in the creation of any lien, charge or encumbrance upon any assets of the Company or the suspension, revocation, impairment, forfeiture, or nonrenewal of any permit, license, authorization, or approval applicable to the Company, its business prospects or operations or any of its assets or properties, except for such lien, change or encumbrance which does not individually, or in the aggregate, have a Material Adverse Effect, or (iv) any violation 10 or conflict with any provision of any federal or state statute, rule or regulation applicable to the Company. 2.12. Agreements. (a) Except as set forth in Section 2.12 to the Schedule of Exceptions and for agreements explicitly contemplated hereby and by the Investors' Rights Agreement and the Shareholders Agreement, there are no agreements, understandings or proposed transactions between the Company and any of its officers, directors, affiliates, or any affiliate thereof. (b) Except as set forth in Section 2.12 to the Schedule of Exceptions, there are no agreements, understandings, instruments, contracts, proposed transactions, judgments, orders, writs or decrees to which the Company or if applicable, in clauses (i) through (vii) below, any Subsidiary is a party or by which it is bound that would reasonably be expected to involve (i) obligations (contingent or otherwise) of, or payments to, or by, the Company or any Subsidiary in excess of Five Hundred Thousand Dollars ($500,000), or (ii) the purchase or sale of the Rights by or from the Company, or (iii) the license of the Rights by or from the Company or any Subsidiary outside of the ordinary course of business, (iv) the lease of real property, (v) employment of any officer or key employee of the Company, or (vi) provisions restricting or affecting the development, manufacture, distribution or provision of the Company's products or services, or (vii) indemnification by the Company with respect to infringements of proprietary rights outside of the ordinary course of business. Copies of all such agreements, understandings, instruments, contracts, proposed transactions, judgments, orders, writs or decrees have been provided to the Investor. For the purposes of this subsection, all indebtedness, liabilities, agreements, understandings, instruments, contracts and proposed transactions involving the same person or entity (including persons or entities the Company has reason to believe are affiliated therewith) shall be aggregated for the purpose of meeting the individual minimum dollar amounts of such subsections. 2.13. Related-Party Transactions. To the Company's knowledge, no employee, officer, director or shareholder of the Company has any direct or indirect ownership interest in any firm or corporation with which the Company is affiliated or with which the Company has a business relationship, or any firm or corporation which competes with the Company, except that employees, officers and/or directors of the Company, or any members of their immediate families, may own up to three percent (3%) of the outstanding stock of publicly traded companies which may compete with the Company. Except as set forth in Section 2.13 to the Schedule of Exceptions, no officer, director, or any member of their immediate families, or shareholder, is, indirectly, interested in any contract, including without limitation with respect to indebtedness, with the Company (other than such contracts as relate to any such person's ownership of capital stock or other securities of the Company). 2.14. Permits. The Company has all franchises, permits, licenses, and any similar authority necessary for the conduct of its business as now being conducted by it or as proposed to be conducted by it, the lack of which could have a Material Adverse Effect. The Company is not in default in any material respect under any of such franchises, permits, licenses, or other similar authority. 11 2.15. Manufacturing and Marketing Rights. Except as set forth in Section 2.15 to the Schedule of Exceptions, neither the Company nor any Subsidiary has granted rights to manufacture, produce, assemble, license, market, or sell its products to any other person and is not bound by any agreement that affects the Company's or such Subsidiary's exclusive right to develop, manufacture, assemble, distribute, market or sell its products. 2.16. Disclosure. The Company has fully provided each Investor, either directly or through special counsel to the Investors, with all the information that such Investor has requested for deciding whether to purchase the Series A Stock and the Series B Stock and all information that the Company believes is reasonably necessary to enable such Investor to make such decision. Neither this Agreement, the Shareholders Agreement, the Investors' Rights Agreement, nor any exhibit or schedule hereto or thereto contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements herein or therein not misleading; provided, however, that the Company makes no such representation or warranty with regard to information contained in this Agreement, the Shareholders Agreement, the Investors' Rights Agreement nor any exhibit or schedule hereto or thereto which was furnished to the Company by the Investors. 2.17. Registration Rights. Except as provided in the Investors' Rights Agreement, the Company has not granted or agreed to grant any registration rights to any person or entity. 2.18. Corporate Documents. The Amended and Restated Articles and Bylaws, each as amended to date, of the Company are in the form previously provided to the Investor and the special counsel to the Investor. 2.19. Title to Property and Assets. The Company has valid and marketable title to all of its property (whether personal, real or fixed) and assets free and clear of all mortgages, liens, loans and encumbrances, except such encumbrances and liens that arise in the ordinary course of business and do not materially impair the Company's ownership or use of such property or assets. With respect to the property and assets it leases, the Company is in compliance with such leases and, to the best of its knowledge, holds a valid leasehold interest free of any liens, claims or encumbrances. 2.20. Financial Statements. The Company has delivered to special counsel for the Investors its audited consolidated financial statements (balance sheet and profit and loss statement, statement of shareholders' equity and statement of cash flows) as at, and for the fiscal year ended December 31, 1997 (the "Audited Financial Statements") and its unaudited consolidated financial statements as at and for the fiscal year ended December 31, 1998 (the "Unaudited Financials" and together with the Audited Financial Statement, the "Financial Statement"). The Financial Statements have been prepared in accordance with generally accepted accounting principles applied on a basis consistent with past practices, except that the Unaudited Financials do not contain footnotes. The Financial Statements are correct and complete in all material respects and fairly present the financial condition and results of operations of the Company and its Subsidiaries as of the date, and for the period, indicated therein, subject in the case of the Unaudited Financials to normal year-end audit adjustments. Except as set forth in the Financial Statements, neither the Company nor any Subsidiary has any 12 material liability, contingent or otherwise, other than (i) liabilities incurred in the ordinary course of business subsequent to December 31, 1998, and (ii) obligations under contracts and commitments incurred in the ordinary course of business and not required under generally accepted accounting principles to be reflected in the Financial Statements, which, in both cases, individually or in the aggregate, are not material to the financial condition or results of operations of the Company or any Subsidiary. Except as disclosed in the Financial Statements, the Company nor any Subsidiary is a guarantor or indemnitor of any indebtedness of any other person, firm or corporation. 2.21. Changes. Since December 31, 1998, there has not been: (a) any Material Adverse Change from that reflected in the Financial Statements; (b) any damage, destruction or loss, whether or not covered by insurance, which has had a Material Adverse Effect; (c) any waiver or compromise by the Company of a valuable right or of a material debt owed to it; (d) any termination of, or material change or amendment to, a material contract or arrangement by which the Company or any of its assets or properties is bound or subject; (e) any sale, assignment or transfer of any Rights; (f) any mortgage, pledge, transfer of a security interest in, or lien created by the Company, with respect to any of its material properties or assets, except liens for taxes not yet due or payable; (g) any material change in any compensation arrangement or agreement with any employee, officer, director or stockholder; (h) any loans or guaranties made by the Company to or for the benefit of its employees, stockholders, officers or directors, or any members of their immediate families, other than travel advances made in the ordinary course of business. (i) any resignation or termination of employment of any key officer or key employee of the Company or any Subsidiary; and the Company, to the best of its knowledge, does not know of the impending resignation or termination of employment of any such officer or employee; (j) receipt of notice that there has been a loss of, or a material order cancellation by, any major customer or supplier of the Company; (k) any declaration, setting aside or payment or other distribution in respect of any of the Company's capital stock, or any direct or indirect redemption, purchase or other acquisition of any such stock by the Company; 13 (l) to the best of the Company's knowledge, any other event or condition that reasonably would be expected to have a Material Adverse Effect, or (m) any agreement or commitment by the Company to do any of the things described in this Section 2.21. 2.22. Tax Returns, Payments and Elections. The Company has timely filed all tax returns and reports as are required by law. These returns and reports are true and correct in all material respects. The Company has paid all taxes and other assessments due, except those contested by it in good faith. The provision for taxes shown in the Financial Statements is adequate for taxes due or accrued as of the date thereof. Since the date of the Financial Statements, the Company has made adequate provisions on its books of account for all taxes, assessments and governmental charges with respect to its businesses, properties and operations for such period. The Company has never had any tax deficiency proposed or assessed against it and has not executed any waiver of any statute of limitations on the assessment or collection of any tax or governmental charge. None of the Company's federal income tax returns and none of its state income or franchise tax or sales or use tax returns has been audited by governmental authorities The Company has withheld or collected from each payment made to each of its employees, the amount of all taxes required to be withheld or collected therefrom, and has paid the same to the proper tax receiving officers or authorized depositaries. 2.23. Insurance. The Company and its Subsidiaries have in full force and effect and will maintain policies of insurance, including, but not limited to, fire, casualty, workmen's compensation and umbrella insurance policies in such amounts and covering such risks as is reasonably prudent for companies similarly situated. 2.24. Compliance with ERISA; Benefit Plans. The Company does not have any Employee Benefit Plan as defined in the Employment Retirement Income Security Act of 1976, as amended ("ERISA"), other than a 401(k) plan (the "Plan"). The Plan has been managed in accordance with it terms and, in all material respects, with the provisions of ERISA. 2.25. No Brokers. The Company is not obligated for the payment of any brokerage fees, agents' fees, commissions or finders' fees or the expenses of any investment banker, broker or finder in connection with the origin, negotiation or execution of this Agreement, the Shareholders Agreement or the Investors' Rights Agreement, or in connection with any transaction contemplated hereby or thereby. 2.26. Minute Books. The minute books of the Company provided to the Investor contain a complete summary of all meetings of directors and shareholders since the time of incorporation and reflect all transactions referred to in such minutes accurately in all material respects. 2.27. Labor Agreements and Actions. The Company is not bound by or subject to (and none of its assets or properties is bound by or subject to) any written or oral, express or implied, contract, commitment or arrangement with any labor union, and no labor union has requested or, to the best of the Company's knowledge, has sought to represent any of the employees, representatives or agents of the Company. There is no strike or other labor dispute 14 involving the Company pending, or to the best of the Company's knowledge, threatened, that could have a Material Adverse Effect. 2.28. Real Property Holding Company. The Company is not a real property holding company within the meaning of Section 897 of the Code. 2.29. Use of Proceeds. The Company will use the proceeds from this Agreement to repurchase from a founder (or his affiliates) Nine Million Eight Hundred Eighty Thousand (9,880,000) shares of its Common Stock for an aggregate purchase price of $3.5425 per share pursuant to the terms and conditions of a Common Stock Repurchase Agreement, form of which is attached hereto as Exhibit G. 3. Representations and Warranties of the Investor. Each Investor, severally but not jointly, hereby represents and warrants to the Company that: 3.1. Organization, Good Standing and Qualification. Each Investor is an entity duly organized under the laws of the jurisdiction of its organization and has all requisite power and authority to carry on its business as now conducted. The principal place of business of each Investor is set out on the signature pages hereof. 3.2. Authorization. Such Investor has full power and authority to enter into this Agreement, the Shareholders Agreement and the Investors' Rights Agreement, and each such agreement constitutes a valid and legally binding obligation, enforceable in accordance with its terms, except (i) as limited by applicable bankruptcy, insolvency, reorganization, moratorium, and other laws of general application affecting enforcement of creditors' rights generally, (ii) as limited by laws relating to the availability of specific performance, injunctive relief, or other equitable remedies, and (iii) to the extent the indemnification provisions contained in the Investors' Rights Agreement may be limited by applicable federal or state securities laws. 3.3. Purchase Entirely for Own Account. This Agreement is made with such Investor in reliance upon such Investor's representation to the Company, which by such Investor's execution of this Agreement such Investor hereby confirms, that the Series A Stock and the Series B Stock to be received by such Investor, the Series A Stock issuable upon conversion of the Series B Stock and the Common Stock issuable upon conversion of the Series A Stock, will be acquired for investment for such Investor's own account, not as a nominee or agent, and not with a view to the resale or distribution of any part thereof, and that each Investor has no present intention of selling, granting any participation in, or otherwise distributing the same. By executing this Agreement, each Investor further represents that each Investor does not have any contract, undertaking, agreement or arrangement with any person or entity to sell, transfer or grant participations to such person or entity or to any third person or entity, with respect to any of the Series A Stock, the Series B Stock, the Series A Stock issuable upon conversion of the Series B Stock or the Common Stock issuable upon conversion of the Series A Stock. 3.4. Disclosure of Information. Such Investor has had an opportunity to ask questions and receive answers from the Company regarding the terms and conditions of the offering of the Series A Stock and the Series B Stock and the business, properties and financial 15 condition of the Company. All such questions posed to the Company have been answered to the satisfaction of the Investor. The foregoing, however, does not limit or modify the representations and warranties of the Company in Section 2 of this Agreement, any remedy of the Investors under this Agreement or the right of the Investor to rely thereon. 3.5. Investment Experience. Such Investor is an investor in securities of companies in the Company's industry and at the Company's stage of development and acknowledges that it is able to fend for itself, can bear the economic risk of its investment, and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of the investment in the Series A Stock and the Series B Stock. Each Investor also represents it has not been organized solely for the purpose of acquiring the Series A Stock and the Series B Stock. 3.6. Accredited Investor. Such Investor is an "accredited investor" within the meaning of Securities and Exchange Commission ("SEC") Rule 501 of Regulation D promulgated under the Securities Act, as presently in effect. 3.7. Restricted Securities. Such Investor understands that the Series A Stock and the Series B Stock it is purchasing and the shares of Common Stock into which the Series A Stock are convertible, are characterized as "restricted securities" under the federal securities laws inasmuch as they are being acquired from the Company in a transaction not involving a public offering and that under such laws and applicable regulations such securities may be resold without registration under the Securities Act, only in certain limited circumstances. In this connection, such Investor represents that it is familiar with SEC Rule 144, as presently in effect, and understands the resale limitations imposed thereby and by the Securities Act. 3.8. Further Limitations on Disposition. Without in any way limiting the representations set forth above and any restrictions set forth in the Shareholders Agreement or Investors' Rights Agreement, such Investor further agrees not to make any disposition of all or any portion of the shares of the Series A Stock, the Series B Stock or the shares of Common Stock issuable upon conversion of the Series A Stock, unless and until the transferee has agreed in writing for the benefit of the Company to be bound by this Section 3, the Shareholders Agreement and the Investors' Rights Agreement, provided and to the extent this Section and such agreement are then applicable, and: (a) There is then in effect a registration statement under the Securities Act and under applicable state securities laws covering such proposed disposition and such disposition is made in accordance with such registration statement; or (b) (i) Such Investor shall have notified the Company of the proposed disposition and shall have furnished the Company with a detailed statement of the circumstances surrounding the proposed disposition, and (ii) such Investor shall have furnished the Company with an opinion of counsel, reasonably satisfactory to the Company, that such disposition will not require registration of such shares under the Securities Act or under applicable state securities laws. 16 (c) Notwithstanding the provisions of paragraphs (A) and (B) above, no such registration statement or opinion of counsel shall be necessary for a transfer by an Investor that is a partnership to a partner of such partnership or a retired partner of such partnership who retires after the date hereof, or to the estate of any such partner or retired partner or the transfer by gift, will or intestate succession of any partner to his or her spouse or to the siblings, lineal descendants or ancestors of such partner or his or her spouse, by an Investor that is a limited liability corporation ("LLC") to a member of such LLC or by any Investor to a person or entity that controls, is controlled by or is under common control with such Investor; if in any such case the transferee agrees in writing to be subject to the terms hereof to the same extent as if he or she were an original Investor hereunder. 3.9. Legends. It is understood that the certificates evidencing the shares of Series A Stock, the shares of Series B Stock and the shares of Common Stock issuable upon conversion of the Series A Stock, may bear one or all of the following legends: (a) "THESE SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF (i) AN EFFECTIVE REGISTRATION STATEMENT WITH RESPECT TO THE SECURITIES UNDER SUCH ACT, OR (ii) AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED." (b) Any legend required by the laws of any jurisdiction including any legend required by any state or "blue sky" securities laws. 4. Conditions of Investors' Obligations at Closing. The obligations of the Investor under Section 1.1(b) of this Agreement are subject to the fulfillment on or before the Closing of each of the following conditions, the waiver of which shall not be effective against any Investor who does not consent in writing thereto: 4.1. Representations and Warranties. The representations and warranties of the Company contained in Section 2 shall be true, in all respects, on and as of the Closing with the same effect as though such representations and warranties had been made on and as of the date of such Closing. 4.2. Performance. The Company shall have performed and complied with all agreements, obligations and conditions contained in this Agreement that are required to be performed or complied with by it on or before the Closing. 4.3. Compliance Certificate. The President of the Company shall deliver to each Investor at the Closing a certificate stating that the conditions specified in Sections 4.1 and 4.2 have been fulfilled and stating that there shall have been no Material Adverse Change since the date of the Financial Statements. 4.4. Amended and Restated Articles Effective. The Amended and Restated Articles shall have been duly adopted by the Company by all necessary corporate action of its 17 Board of Directors and shareholders, and shall have been duly filed with, and accepted by, the Secretary of State of the State of California. 4.5. Proceedings and Documents. All corporate proceedings in connection with the transactions contemplated at the Closing shall be reasonably satisfactory in form and substance to Investor' special counsel, and such counsel shall have received all such counterpart original and certified or other copies of such documents. Such documents shall consist of the following: (a) Certified Charter Documents. A copy of the Amended and Restated Articles and the Bylaws of the Company (as amended through the date of the Closing), certified by an officer of the Company to be true, complete and correct copies thereof as of the Closing. (b) Certified Corporate Actions. A copy of the resolutions of the Board of Directors and the Company's shareholders evidencing the approval of the Amended and Restated Articles, the execution of this Agreement, the Shareholders Agreement and the Investors' Rights Agreement (including any agreements which are exhibits thereto), the reservation of shares of Series A Stock issuable upon conversion of the Series B Stock, the reservation of shares of Common Stock issuable upon conversion of the shares of Series A Stock (including without limitation Series A Stock issuable upon conversion of the Series B Stock) to be issued pursuant to this Agreement and the taking of other actions related to the sale and issuance of the Company's Series A Stock and the Series B Stock, certified by an officer of the Company to be a true, complete and correct copy thereof. 4.6. Proprietary Information and Inventions Agreement.. Each employee of and consultant to the Company shall have entered into a Proprietary Information and Inventions Agreement in the form previously provided to special counsel for the Investor. 4.7. Board of Directors. Contingent upon the Closing, the directors of the Company shall be David Doyle, Vinnie Smith, Doran Machin, Jerry Murdoch and one vacancy. 4.8. Opinion of Company Counsel. Each Investor shall have received from Brobeck, Phleger & Harrison LLP, counsel to the Company, an opinion, dated as of the Closing, in the form attached hereto as Exhibit H. 4.9. Investors' Rights Agreement and Shareholders Agreement. The Company shall have entered into the Investors' Rights Agreement and Shareholders Agreement in the forms attached hereto as Exhibit B and Exhibit E, respectively. 4.10. Financial Statements. The Investor shall have received the Financial Statements. 4.11. Common Stock Purchase Agreement. The Common Stock Purchase Agreement dated April 20, 1999 between Doran Machin, MFH-1 and the Company shall have been duly executed and delivered by each party thereto. 18 5. Conditions of the Company's Obligations at Closing. The obligations of the Company to any Investor under this Agreement are subject to the fulfillment on or before the Closing of each of the following conditions by each Investor: 5.1. Representations and Warranties. The representations and warranties of the Investor contained in Section 3 shall be true on and as of the Closing with the same effect as though such representations and warranties had been made on and as of the Closing. 5.2. Payment of Purchase Price. Each Investor shall have delivered the Purchase Price specified in Section 1.1. 5.3. Qualifications. All authorizations, approvals, or permits, if any, of any governmental authority or regulatory body of the United States or of any state that are required in connection with the lawful issuance and sale of the Series A Stock and the Series B Stock pursuant to this Agreement shall be duly obtained and effective as of the Closing. 5.4. Amended and Restated Articles Effective. The Amended and Restated Articles shall have been duly adopted by the Company by all necessary corporate action of its Board of Directors and shareholders, and shall have been duly filed with, and accepted by, the Secretary of State of the State of California. 5.5. Investors' Rights Agreement and Shareholders Agreement. Each Investor shall have entered into the Investors' Rights Agreement and Shareholders Agreement in the forms attached hereto as Exhibit B and Exhibit E, respectively. 6. Miscellaneous 6.1. Survival of Warranties. The representations and warranties of the Company and each Investor contained in or made pursuant to this Agreement shall survive the execution and delivery of this Agreement for a period of twelve (12) months from the date hereof (provided that (a) the representations and warranties of the Company in Sections 2.22 and 2.24 shall survive until the date which is 60 days after the expiration of the statute of limitations applicable to such matters, (b) the representations and warranties of the Company in Sections 2.2 and 2.5 shall survive in perpetuity) and shall in no way be affected by any investigation of the subject matter thereof made by or on behalf of the Investors or the Company. 6.2. Successors and Assigns. Except as otherwise provided herein, the terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties (including transferees of any Shares of the Series A Stock or the Series B Stock). Nothing in this Agreement, express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations, or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. 6.3. Disclosure. Except as otherwise required by law, the Investors and the Company agree that they shall make no written or other public disclosures regarding this transaction or regarding the parties hereto to any individual or organization without the prior 19 written consent of the other parties hereto, which consent shall not be unreasonably withheld, or as required by applicable law. 6.4. Governing Law. This Agreement shall be governed by and construed under the laws of the State of California, exclusive of the provisions thereof governing conflicts of laws. 6.5. Counterparts. This Agreement may be executed in two (2) or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 6.6. Titles and Subtitles. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 6.7. Notices. Any notice, request, demand or other communication required or permitted hereunder shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified, upon the date of transmittal of services via telecopy to the party to whom notice is being given, or on the fifth (5th) day after deposit in the United States Post Office, by registered or certified mail, with postage and fees prepaid and addressed to the other party hereto at his or her address hereinafter shown below his or her signature or at such other address as such party may designate by ten (10) days' advance written notice to the other party hereto. 6.8. Finder's Fee. Each party hereto agrees to indemnify and to hold harmless each other party hereto from any liability for any commission or compensation in the nature of a finders' fee (and the costs and expenses of defending against such liability or asserted liability) for which such party or any of its officers, partners, employees, or representatives is responsible. 6.9. Expenses. Each of the parties shall pay all costs and expenses incurred or to be incurred by it in negotiating, executing, delivering and preparing the agreements and in closing and carrying out the transactions contemplated hereby and thereby. Notwithstanding the foregoing, the Company shall be responsible and shall pay for the first Thirty Five Thousand Dollars ($35,000) of the fees and expenses of special counsel for the Investor. If any action at law or in equity is necessary to enforce or interpret the terms of this Agreement, the Investors' Rights Agreement or the Amended and Restated Articles, the prevailing party shall be entitled to reasonable attorney's fees, costs and necessary disbursements in addition to any other relief to which such party may be entitled. 6.10. Amendments and Waivers. Any term of this Agreement may be amended and the observance of any term of this Agreement may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of (i) the Company, (ii) the holders of a majority of the Series A Stock, excluding shares of Series A Stock issued upon conversion of shares of Series B Stock, (or, if there shall be no such Series A Stock outstanding, a majority of the Common Stock issued upon conversion of such Series A Stock) and (iii) the holders of a majority of the Series B Stock (or, if there shall be no such Series B Stock outstanding, a majority of the Series A stock issued upon conversion of the Series B 20 Stock, or, if there shall be no such shares of Series A Stock outstanding, a majority of the shares of Common Stock issued upon conversion of such Series A Stock) as of the date of the amendment of waiver. Any amendment or waiver effected in accordance with this paragraph shall be binding upon each holder of any securities purchased under the Securities Purchase Agreement then outstanding, each future holder of all such securities, and the Company. 6.11. Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of the Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 6.12. Aggregation of Stock. All shares of the Series A Stock or Series B Stock held or acquired by affiliated entities or persons shall be aggregated together for the purpose of determining the availability of any rights under this Agreement, the Investors' Rights Agreement or the Shareholders Agreement. 6.13. Entire Agreement. This Agreement, the Amended and Restated Articles, the Investors' Rights Agreement, the Shareholders Agreement, and the Common Stock Re-Purchase Agreement and the documents to which the Investor and the Company are parties constitute the entire agreement among the parties and no party shall be liable or bound to any other party in any manner by any warranties, representations, or covenants except as specifically set forth herein or therein. 6.14. Remedies. In case any one or more of the representations, warranties, covenants and/or agreements set forth in this Agreement shall have been breached by the Company, an Investor may proceed to protect and enforce its rights either by suit in equity and/or by action at law, including, but not limited to, an action for damages as a result of any such untruth, inaccuracy or breach and/or an action for specific performance of any such covenant or agreement contained in this Agreement. 6.15. Key-Man Insurance. Following the Closing, the Company shall use its best efforts to obtain, as beneficiary, key-man life insurance with respect to Vincent C. Smith in an insured amount of no less than $3,000,000; provided, however, that in no event shall the date on which the Company obtains such insurance exceed forty five (45) days from the date hereof. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 21 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. QUEST SOFTWARE, INC. By: --------------------------------------------- Name: Vinny Smith Its: Chief Executive Officer Address: 610 Newport Center Drive Newport Beach, CA 92660 INSIGHT CAPITAL PARTNERS II, L.P. By: Insight Venture Associates II, LLC Its General Partner By: --------------------------------------------- Name: Jeffrey Horing Its: Managing Member INSIGHT CAPITAL PARTNERS (CAYMAN) II, L.P. By: Insight Venture Associates II, LLC Its General Partner By: --------------------------------------------- Name: Jeffrey Horing Its: Managing Member UBS CAPITAL II LLC By: --------------------------------------------- Name: Title: By: --------------------------------------------- Name: Title: [SIGNATURE PAGE TO SECURITIES PURCHASE AGREEMENT] 22 WI SOFTWARE INVESTORS LLC By: --------------------------------------------- Name: Title: [SIGNATURE PAGE TO SECURITIES PURCHASE AGREEMENT] 23 EXHIBIT A AMENDED AND RESTATED ARTICLES SEE TAB 8 24 EXHIBIT B SCHEDULE OF INVESTORS
Investor Name and Purchase Price - -------- Type of Securities -------------- ------------------ Insight Capital 800,000 Shares $ 4,500,000 Partners II, L.P. of Series A Preferred Stock Insight Capital 88,889 Shares $ 500,000 Partners (Cayman) II, L.P. of Series A Preferred Stock UBS Capital LLC 977,778 Shares of $ 5,500,000 Series A Preferred Stock 1,777,778 Shares of $10,000,000 Series B Redeemable Preferred Stock WI Software Investors LLC 800,000 Shares of $ 4,500,000 Series A Preferred Stock TOTAL ----- TOTAL SERIES A: 2,666,667 shares $25,000,000 -------------- TOTAL SERIES B: 1,777,778 shares REDEEMABLE ----------
25 EXHIBIT C SCHEDULE OF EXCEPTIONS SEE TAB 2 26 EXHIBIT D INVESTORS' RIGHTS AGREEMENT SEE TAB 3 27 EXHIBIT E SHAREHOLDERS AGREEMENT SEE TAB 4 28 EXHIBIT F FORM OF COMMON STOCK RE-PURCHASE AGREEMENT INTENTIONALLY OMITTED 29 EXHIBIT G OPINION OF COUNSEL FOR THE COMPANY SEE TAB 12 EX-10.6 4 INVESTORS' RIGHTS AGREEMENT 1 EXHIBIT 10.6 QUEST SOFTWARE, INC. INVESTORS' RIGHTS AGREEMENT DATED AS OF APRIL 21, 1999 2 INVESTORS' RIGHTS AGREEMENT THIS INVESTORS' RIGHTS AGREEMENT (this "Agreement") is made as of the 21st day of April 1999, by and between Quest Software, Inc., a California corporation (the "Company") and the Investors listed on the Schedule of Investors attached as Exhibit B to the Securities Purchase Agreement (as defined herein) ("each an "Investor" and together the "Investors"). RECITALS WHEREAS, the Company, and the Investors are parties to the Securities Purchase Agreement of even date herewith (the "Securities Purchase Agreement"); and WHEREAS, in order to induce the Company to enter into the Securities Purchase Agreement and to induce the Investors to invest funds in the Company pursuant to the Securities Purchase Agreement, the Investors and the Company hereby agree that this Agreement shall govern the rights of the Investors to cause the Company to register shares of the Company's Common Stock (the "Common Stock") issuable upon conversion of its Series A Preferred Stock (the "Series A Stock") as set forth herein. NOW, THEREFORE, THE PARTIES HEREBY AGREE AS FOLLOWS: 1. Registration Rights. The Company covenants and agrees as follows: 1.1 Definitions. For purposes of this Section 1: (a) The term "Form S-3" means such form under the Securities Act as in effect on the date hereof or any registration form under the Securities Act subsequently adopted by the SEC which permits inclusion or incorporation of substantial information by reference to other documents filed by the Company with the SEC. (b) The term "Holder" means any person owning or having the right to acquire Registrable Securities or any assignee thereof in accordance with Section 1.12 hereof. (c) The term "Initial Public Offering" shall mean the closing of the sale of securities pursuant to an effective registration statement filed by the Company under the Securities Act (as hereinafter defined) in connection with a firm commitment underwritten offering of its securities to the general public. (d) The term "1934 Act" shall mean the Securities Exchange Act of 1934, as amended. (e) The terms "register," "registered," and "registration" refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Securities Act, and the declaration or ordering of effectiveness of such registration statement or document. 3 (f) The term "Registrable Securities" means the Common Stock issuable or issued upon conversion of the Series A Stock (including without limitation shares of Series A Stock issuable upon conversion of the Company's Series B Redeemable Preferred Stock) sold and issued to the Investors pursuant to the Securities Purchase Agreement. (g) The number of shares of "Registrable Securities then outstanding" shall be determined by the number of shares of Common Stock outstanding which are, and the number of shares of Common Stock issuable pursuant to then exercisable or convertible securities which are, Registrable Securities. (h) The term "SEC" shall mean the Securities and Exchange Commission. (i) The term "Securities Act" means the Securities Act of 1933, as amended. 1.2 Demand Registration Rights. (a) If the Company shall receive at any time after the earlier of (i) the effective date of the first registration statement for an Initial Public Offering of securities of the Company (other than a registration statement relating either to the sale of securities to employees of the Company pursuant to a stock option, stock purchase or similar plan or a SEC Rule 145 transaction) or (ii) three (3) years from the date hereof, a written request from Holders of at least 40% of the Registrable Securities that the Company file a registration statement under the Securities Act covering the registration of Registrable Securities then outstanding, then the Company shall: (i) within ten (10) days of the receipt thereof, give written notice of such request to all Holders; and (ii) use its best efforts to effect, as soon as practicable and in any event within ninety (90) days of the receipt of such request, the registration under the Securities Act of all Registrable Securities which the Holders request to be registered (within twenty (20) days of the mailing of such notice by the Company in accordance with Section 4.5) subject to the limitations of Section 1.2(b). (b) If the Holders initiating the registration request hereunder (the "Initiating Holders") intend to distribute the Registrable Securities covered by their request by means of an underwriting, they shall so advise the Company as a part of their request made pursuant to Section 1.2(a) and the Company shall include such information in the written notice referred to in Section 1.2(a). The underwriter will be selected by a majority in interest of the Initiating Holders and shall be reasonably acceptable to the Company. In such event, the right of any Holder to include his Registrable Securities in such registration shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting (unless otherwise mutually agreed by a majority in interest of the Initiating Holders and such Holder) to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall (together with the Company as 4 provided in Section 1.4(e)) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting. Notwithstanding any other provision of this Section 1.2, if the underwriter advises the Initiating Holders in writing that marketing factors require a limitation of the number of shares to be underwritten, then the Initiating Holders shall so advise all Holders of Registrable Securities which would otherwise be underwritten pursuant hereto, and the number of shares of Registrable Securities that may be included in the underwriting shall be allocated among all Holders thereof, including the Initiating Holders, in proportion (as nearly as practicable) to the amount of Registrable Securities of the Company owned by each Holder; provided, however, that the number of shares of Registrable Securities to be included in such underwriting shall not be reduced unless all other securities are first entirely excluded from the underwriting. (c) Notwithstanding the foregoing, if the Company shall furnish to Holders requesting a registration statement pursuant to this Section 1.2 a certificate signed by the Chief Executive Officer of the Company stating that in the good faith judgment of the Board of Directors of the Company it would be materially detrimental to the Company and its Shareholders for such registration statement to be filed and it is therefore necessary to defer the filing of such registration statement, the Company shall have the right to defer taking action with respect to such filing for a period of not more than ninety (90) days after receipt of the request of the Initiating Holders; provided, however, that the Company may not utilize this right more than twice in any twelve month period. (d) In addition, the Company shall not be obligated to effect, or to take any action to effect, any registration pursuant to this Section 1.2: (i) After the Company has effected two (2) registrations pursuant to this Section 1.2 and such registrations have been declared or ordered effective; (ii) During the period starting with the date Ninety (90) days prior to the Company's good faith estimate of the date of filing of, and ending on a date Ninety (90) days after the effective date of, a registration subject to Section 1.3 hereof; provided that the Company is actively employing in good faith all reasonable efforts to cause such registration statement to become effective; or (iii) If the Initiating Holders propose to dispose of shares of Registrable Securities that may be immediately registered on Form S-3 pursuant to a request made pursuant to Section 1.11 below. 1.3 Company Registration. If the Company at any time proposes to register (including for this purpose a registration effected by the Company for shareholders other than the Holders) any of its stock or other securities under the Securities Act in connection with the public offering of such securities solely for cash (other than an Initial Public Offering that does not include a sale of shares other than by the Company or a registration statement relating either to the sale of securities to employees of the Company pursuant to a stock option, stock purchase or similar plan or a SEC Rule 145 transaction), the Company shall, at such time, promptly give each Holder at least thirty (30) days written notice of such registration. Upon the written request of each Holder given within twenty (20) days after receipt of such notice by the Holder in 5 accordance with Section 3.5, the Company shall, subject to the provisions of Section 1.7, cause to be registered under the Securities Act all of the Registrable Securities that each such Holder has requested to be registered. 1.4 Obligations of the Company. Whenever required under this Section 1 to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible: (a) Prepare and file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective for a period of up to One Hundred Eighty (180) days; provided, however, that (i) such One Hundred Eighty (180) day period shall be extended for a period of time equal to the period the Holder refrains from selling any securities included in such registration at the request of an underwriter of Common Stock (or other securities) of the Company; and (ii) in the case of any registration of Registrable Securities on Form S-3 which are intended to be offered on a continuous or delayed basis, such One Hundred Eighty (180) day period shall be extended, if necessary, to keep the registration statement effective until all such Registrable Securities are sold, provided that Rule 415, or any successor rule under the Securities Act, permits an offering on a continuous or delayed basis, and provided further that applicable rules under the Securities Act governing the obligation to file a post-effective amendment permit, in lieu of filing a post-effective amendment which (I) includes any prospectus required by Section 10(a)(3) of the Securities Act or (II) reflects facts or events representing a material or fundamental change in the information set forth in the registration statement, the incorporation by reference of information required to be included in (I) and (II) above to be contained in periodic reports filed pursuant to Section 13 or 15(d) of the 1934 Act in the registration statement. (b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement. (c) Furnish to the Holders such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registrable Securities owned by them. (d) Use its best efforts to register and qualify the securities covered by such registration statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions, unless the Company is already subject to service in such jurisdiction and except as may be required by the Securities Act. (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the 6 managing underwriter of such offering. Each Holder participating in such underwriting shall also enter into and perform its obligations under such an agreement. (f) Notify each Holder of Registrable Securities covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Securities Act of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. (g) Cause all such Registrable Securities registered pursuant hereunder to be listed on each securities exchange on which similar securities issued by the Company are then listed, or if such securities are not already so listed, on NASDAQ (or, if such listing is not permitted under the rules of NASDAQ, on a securities exchange reasonably designated by a majority of the holders of such Registrable Securities). (h) Provide a transfer agent and registrar for all Registrable Securities registered pursuant hereunder and a CUSIP number for all such Registrable Securities, in each case not later than the effective date of such registration. (i) Furnish, at the request of any Holder requesting registration of Registrable Securities pursuant to this Section 1, on the date that such Registrable Securities are delivered to the underwriters for sale in connection with a registration pursuant to this Section 1, if such securities are being sold through underwriters, or, if such securities are not being sold through underwriters, on the date that the registration statement with respect to such securities becomes effective, (i) an opinion, dated such date, of the counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the Holders requesting registration of Registrable Securities, and (ii) a letter dated such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering, addressed to the underwriters, if any, and to the Holders requesting registration of Registrable Securities. 1.5 Furnish Information. It shall be a condition precedent to the obligations of the Company to take any action pursuant to this Section 1 with respect to the Registrable Securities of any selling Holder that such Holder shall furnish to the Company such information regarding itself, the Registrable Securities held by it, and the intended method of disposition of such securities as shall be required to effect the registration of such Holder's Registrable Securities. 1.6 Expenses of Registration. All expenses (other than underwriting discounts and commissions relating solely to Registrable Securities so registered) incurred in connection with registrations, filings or qualifications pursuant to Section 1.2, Section 1.3 or Section 1.11 (which right may be assigned as provided in Section 1.12), including (without limitation) all registration, filing and qualification fees, printers' and accounting fees, fees and disbursements 7 of counsel for the Company (including without limitation fees and disbursements of a single counsel for the selling Holders) shall be borne by the Company. 1.7 Underwriting Requirements. In connection with any offering involving an underwriting of shares of the Company's capital stock, the Company shall not be required under Section 1.3 to include any of the Holders' securities in such underwriting unless such Holders accept the terms of the underwriting as agreed upon between the Company and the underwriters selected by the Company (or by other persons entitled to select the underwriters), and then only in such quantity as the underwriters determine in their sole discretion will not jeopardize the success of the offering by the Company. If the total amount of securities, including Registrable Securities, requested by shareholders to be included in such offering exceeds the amount of securities sold other than by the Company that the underwriters determine in their sole discretion is compatible with the success of the offering, then the Company shall be required to include in the offering only that number of such securities, including Registrable Securities, which the underwriters determine in their sole discretion will not jeopardize the success of the offering (the securities so included to be apportioned pro rata among the selling Holders according to the total amount of securities entitled to be included therein owned by each selling Holder or in such other proportions as shall mutually be agreed to by such selling Holders), notwithstanding the foregoing, in no event shall any Registrable Securities be excluded from such offering, unless all other securities being offered, other than those being offered by the Company, are first excluded from such offering. For purposes of the preceding parenthetical concerning apportionment, for any selling Holder which is a holder of Registrable Securities and which is a partnership, corporation or limited liability company, the partners, retired partners, shareholders and members of such holder, or the estates and family members of any such partners and retired partners and any trusts for the benefit of any of the foregoing persons shall be deemed to be a single "selling Holder", and any pro-rata reduction with respect to such "selling Holder" shall be based upon the aggregate amount of shares carrying registration rights owned by all entities and individuals included in such "selling Holder", as defined in this sentence. 1.8 Delay of Registration. No Holder shall have any right to obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Section 1. 1.9 Indemnification. In the event any Registrable Securities are included in a registration statement under this Section 1: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Holder, any underwriter (as defined in the Securities Act) for such Holder and each person, if any, who controls such Holder or underwriter within the meaning of the Securities Act or the 1934 Act, against any losses, claims, damages, or liabilities (joint or several) to which they may become subject under the Securities Act, the 1934 Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively, a "Violation"): (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to 8 make the statements therein not misleading, or (iii) any violation or alleged violation by the Company of the Securities Act, the 1934 Act, any state securities law or any rule or regulation promulgated under the Securities Act, the 1934 Act or any state securities law, and the Company will pay to each such Holder, underwriter or controlling person, as incurred, any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Section 1.9(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld), nor shall the Company be liable in any such case for any such loss, claim, damage, liability, or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by such Holder, underwriter or controlling person. (b) To the extent permitted by law, each selling Holder will indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the registration statement, each person, if any, who controls the Company within the meaning of the Securities Act, any underwriter, any other Holder selling securities in such registration statement and any controlling person of any such underwriter or other Holder, against any losses, claims, damages, or liabilities (joint or several) to which any of the foregoing persons may become subject, under the Securities Act, the 1934 Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereto) arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Holder expressly for use in connection with such registration; and each such Holder will pay, as incurred, any legal or other expenses reasonably incurred by any person intended to be indemnified pursuant to this Section 1.9(b), in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Section 1.9(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Holder (which consent shall not be unreasonably withheld); provided, that, in no event shall any indemnity under this Section 1.9(b) exceed the net proceeds from the offering received by such Holder. (c) Promptly after receipt by an indemnified party under this Section 1.9 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 1.9, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties; provided, however, that an indemnified party (together with all other indemnified parties which may be represented without conflict by one counsel) shall have the right to retain one separate counsel, with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action, if materially prejudicial to its 9 ability to defend such action, shall relieve such indemnifying party, to the extent of such prejudice, of any liability to the indemnified party for any losses, claims, damages or liabilities for which indemnification would otherwise be available under this Section 1.9, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this Section 1.9. (d) If the indemnification provided for in this Section 1.9 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage, or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such statement or omission. (e) Notwithstanding the foregoing, to the extent that the provisions on indemnification and contribution contained in the underwriting agreement entered into in connection with the underwritten public offering are in conflict with the foregoing provisions, the provisions in the underwriting agreement shall control. (f) The obligations of the Company and Holders under this Section 1.9 shall survive the completion of any offering of Registrable Securities in a registration statement under this Section 1, and otherwise. 1.10 Reports Under Securities Exchange Act of 1934. With a view to making available to the Holders the benefits of Rule 144 promulgated under the Securities Act and any other rule or regulation of the SEC that may at any time permit a Holder to sell securities of the Company to the public without registration or pursuant to a registration on Form S-3, the Company agrees to: (a) make and keep public information available, as those terms are understood and defined in SEC Rule 144, at all times after ninety (90) days after the effective date of the first registration statement filed by the Company for the offering of its securities to the general public; (b) take such action, including the voluntary registration of its Common Stock under Section 12 of the 1934 Act, as is necessary to enable the Holders to utilize Form S-3 for the sale of their Registrable Securities, such action to be taken as soon as practicable after the end of the fiscal year in which the first registration statement filed by the Company for the offering of its securities to the general public is declared effective; 10 (c) file with the SEC in a timely manner all reports and other documents required of the Company under the Securities Act and the 1934 Act; and (d) furnish to any Holder, so long as the Holder owns any Registrable Securities, forthwith upon request (i) a written statement by the Company that it has complied with the reporting requirements of SEC Rule 144 (at any time after ninety (90) days after the effective date of the first registration statement filed by the Company), the Securities Act and the 1934 Act (at any time after it has become subject to such reporting requirements), or that it qualifies as a registrant whose securities may be resold pursuant to Form S-3 (at any time after it so qualifies), (ii) a copy of the most recent annual or quarterly report of the Company and such other reports and documents so filed by the Company, and (iii) such other information as may be reasonably requested in availing any Holder of any rule or regulation of the SEC which permits the selling of any such securities without registration or pursuant to such form. 1.11 Form S-3 Registration. In case the Company shall receive from any Holder or Holders a written request or requests that the Company effect a registration on Form S-3 and any related qualification or compliance with respect to all or a part of the Registrable Securities owned by such Holder or Holders, the Company will: (a) promptly give at least twenty (20) days written notice of the proposed registration, and any related qualification or compliance, to all other Holders; and (b) as soon as practicable, effect such registration and all such qualifications and compliances as may be so requested and as would permit or facilitate the sale and distribution of all or such portion of such Holder's or Holders' Registrable Securities as are specified in such request, together with all or such portion of the Registrable Securities of any other Holder or Holders joining in such request as are specified in a written request given within fifteen (15) days after receipt of such written notice from the Company; provided, however, that the Company shall not be obligated to effect any such registration, qualification or compliance, pursuant to this Section 1.11: (1) if Form S-3 is not available for such offering by the Holders; (2) if the Holders, together with the holders of any other securities of the Company entitled to inclusion in such registration, propose to sell Registrable Securities and such other securities (if any) at an aggregate price to the public (net of any underwriters' discounts or commissions) of less than Five Hundred Thousand Dollars ($500,000); (3) if the Company shall furnish to the Holders a certificate signed by the Chief Executive Officer of the Company stating that in the good faith judgment of the Board of Directors of the Company, it would be materially detrimental to the Company and its Shareholders for such Form S-3 Registration to be effected at such time, in which event the Company shall have the right to defer the filing of the Form S-3 registration statement for a period of not more than ninety (90) days after receipt of the request of the Holder or Holders under this Section 1.11; provided, however, that the Company shall not utilize this right more than twice in any twelve (12) month period; (4) if the Company has, within the twelve (12) month period preceding the date of such request, already effected two (2) registrations on Form S-3 for the Holders pursuant to this Section 1.11; or (5) in any particular jurisdiction in which the Company would be required to qualify to do business or to execute a general consent to service of process in effecting such registration, qualification or compliance. 11 (c) Subject to the foregoing, the Company shall file a registration statement covering the Registrable Securities and other securities so requested to be registered as soon as practicable after receipt of the request or requests of the Holders. All expenses incurred in connection with a registration requested pursuant to Section 1.11, including (without limitation) all registration, filing, qualification, printer's and accounting fees and the reasonable fees and disbursements of counsel for the selling Holder or Holders and counsel for the Company, but excluding any underwriters' discounts or commissions associated with Registrable Securities, shall be borne by the Company. Registrations effected pursuant to this Section 1.11 shall not be counted as demands for registration or registrations effected pursuant to Sections 1.2 or 1.3, respectively. 1.12 Assignment of Registration Rights. The rights to cause the Company to register Registrable Securities pursuant to this Section 1 may be assigned (but only with all related obligations) by a Holder to a transferee or assignee of such securities, provided: (a) the Company is, within a reasonable time after such transfer, furnished with written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned; (b) such transferee or assignee agrees in writing to be bound by and subject to the terms and conditions of this Agreement, including without limitation the provisions of Section 1.13 below; (c) such assignment shall be effective only if immediately following such transfer the further disposition of such securities by the transferee or assignee is restricted under the Securities Act and (d) such transferee or assignee acquires at least 25% of such Holders shares of Registrable Securities. 1.13 "Market Stand-Off" Agreement. Each Investor hereby agrees that, during the period of duration specified by the Company and an underwriter of common stock or other securities of the Company, following the date of a sale to the public pursuant to a registration statement of the Company filed under the Securities Act, it shall not, to the extent requested by the Company and such underwriter, directly or indirectly sell, offer to sell, contract to sell (including, without limitation, any short sale), grant any option to purchase or otherwise transfer or dispose of (other than to donees who agree to be similarly bound) any securities of the Company held by it at any time during such period except common stock included in such registration; provided, however, that: (a) all officers, directors and ten percent (10%) or greater stockholders of the Company (whether or not pursuant to this Agreement) enter into similar agreements; and (b) such market stand-off time period shall not exceed one hundred eighty (180) days in the case of the Company's Initial Public Offering, and shall not exceed ninety (90) days in all other registrations. In order to enforce the foregoing covenant, the Company may impose stop-transfer instructions with respect to the Registrable Securities of each Investor (and the shares or securities of every other person subject to the foregoing restriction) until the end of such period. Notwithstanding the foregoing, the obligations described in this Section 1.13 shall not apply to a registration relating solely to employee benefit plans on Form S-8 or similar forms 12 which may be promulgated in the future, or a registration relating solely to a SEC Rule 145 transaction on Form S-4 or similar forms which may be promulgated in the future. 2. Covenants of the Company. 2.1 Pre-emptive Rights. For so long as shares of the Series A Stock or the Series B Stock remain outstanding, the Company hereby grants the Investors pre-emptive rights with respect to future sales of equity securities by the Company. Each time the Company offers any shares of, or securities convertible into or exercisable for any shares of, any class of its capital stock ("Shares"), the Company shall make an offering of such Shares to the Investor in accordance with the following provisions: (a) The Company shall deliver a notice by certified mail ("Notice") to the Investors stating (i) that the Company is offering such Shares, (ii) the number of such Shares to be offered and (iii) the price and terms, if any, upon which it proposes to offer such Shares. (b) Within twenty (20) days after receipt of the Notice, the Investors may elect to purchase or obtain, at the price and on the terms specified in the Notice, up to that portion of such Shares which equals the proportion that the number of shares of Common Stock issued and held, or issuable upon conversion of the Series A Stock, then held, by such Investor bears to the total number of shares of Common Stock issued and outstanding and issuable upon the conversion of the Series A Stock then outstanding (the "Pro Rata Share"); provided, however that if the issuance of such Shares is at a price of less than $5.625 per share (subject to adjustment after the date hereof for stock splits, dividends, reclassifications and the like), such Investors may elect to purchase or obtain, at the price and on the terms specified in the Notice, up to twice such Investor's Pro Rata Share. (c) Notwithstanding the foregoing, if the Shares to be issued by the Company are an equity security, the proceeds of which will be used by the Company to redeem the Redeemable Preferred Stock purchased by the Investors under the Securities Purchase Agreement, in lieu of the rights granted in subsection (b) above, the Investors shall have the right to purchase or obtain, at the price and on the terms specified in the Notice, up to twice such Investors Pro Rata Share. (d) Thereafter, the Company may, during the six (6) month period following the expiration of the period provided in Section 2.1(b) hereof, offer the remaining unsubscribed portion of such Shares to any person or persons at a price not less than, and upon terms no more favorable to the offeree than those specified in the Notice. If the Company does not enter into an agreement for the sale of the Shares within such period, or if such agreement is not consummated within six (6) months of the execution thereof, the right provided hereunder shall be deemed to be revived and such Shares shall not be offered unless first reoffered to the Investor in accordance herewith. (e) The pre-emptive rights in this Section 2.1 shall not be applicable (i) to the issuance or sale of shares of Common Stock (or options or warrants therefor) to service providers of the Company for the primary purpose of soliciting or retaining their employment, or otherwise providing compensation to such person, provided that such issuance or sale is 13 consummated pursuant to the terms of a stock option plan or other equity incentive program approved by the Board of Directors, and provided that the Company has not issued to Vincent Smith and David Doyle, in any twelve (12) month period, the lesser of (A) 3% of the outstanding Common Stock of the Company or (B) an amount equal to the industry standard for officers of similarly situated companies, and provided further, that each service provider of the Company executes an agreement, in the form of an option agreement, in form and substance reasonably satisfactory to the Board of Directors of the Company, (ii) with respect to, or after consummation of, a firm commitment public offering by the Company pursuant to an effective registration statement under the Securities Act of 1933, as amended, provided, that such registration statement covers the offer and sale of Common Stock of which the aggregate net proceeds after deducting underwriting discounts and commissions attributable to sales for the account of the Corporation exceed $25,000,000 at a per share price to public (as set forth in the final prospectus in connection with such public offering) equal to at least $8 (subject to adjustment for stock splits, combinations, stock dividends or recapitalizations), (iii) to the issuance of securities pursuant to the conversion or exercise of convertible or exercisable securities, (iv) to the issuance of securities in connection with a bona fide business acquisition of or by the Company, whether by merger, consolidation, sale of assets, sale or exchange of stock or otherwise, (v) to the issuance of stock, warrants or other securities or rights to persons or entities with which the Company has business relationships, provided such issuances are for other than primarily equity financing purposes, that such issuances are not to affiliates of the Company and that at the time of any such issuance, the aggregate of such issuances and similar issuances in the preceeding twelve (12) month period do not exceed 2% of the then outstanding Common Stock of the Company (assuming full conversion and exercise of all convertible and exercisable securities) and (vi) warrants issued to persons or entities that are not affiliates of the Company and in connection with a bona-fide debt financing, joint venture, strategic development agreement, lease line or credit arrangement or bank financing approved by the Board of Directors. (f) The pre-emptive rights set forth in this Section 2.1 may not be assigned or transferred, except that (i) such right is assignable by each Holder to any wholly-owned subsidiary or parent of, or to any corporation or entity that is, within the meaning of the Securities Act, controlling, controlled by or under common control with, any such Holder, and (ii) such right is assignable between and among any of the Holders. 2.2 Delivery of Financial Statements. The Company shall deliver to each Investor: (a) as soon as practicable, but in any event within one hundred twenty (120) days after the end of each fiscal year of the Company, an income statement for such fiscal year, a balance sheet of the Company, statement of shareholders' equity as of the end of such year and a statement of cash flows for such year, audited and prepared in accordance with generally accepted accounting principles; (b) as soon as practicable, but in any event within forty-five (45) days after the end of each of the first three (3) quarters of each fiscal year of the Company, an unaudited profit or loss statement, a statement of cash flows schedule for such fiscal quarter, an unaudited balance sheet and a statement of shareholder's equity as of the end of such fiscal quarter; 14 (c) as soon as practicable, but in any event sixty (60) days after the end of each fiscal year, beginning with the fiscal year ending December 31, 1999, a budget and business plan for the next fiscal year, prepared on a quarterly basis, including balance sheets and a statement of cash flows for such months and, as soon as prepared, any other budgets or revised budgets prepared by the Company; and (d) such other information relating to the financial condition, business, prospects or corporate affairs of the Company as the Investor or any assignee of the Investor may from time to time request, provided, however, that the Company shall not be obligated under this subsection (d) or any other subsection of Section 2.2 to provide information which it deems in good faith to be a trade secret or similar confidential information. (e) Each Investor hereby agrees to hold in confidence and trust and not to misuse or disclose any confidential information of the Company, including the financial statements referred to in this Section 2.2 ("Confidentially Disclosed Information"), without the prior written consent of the Company; provided, however that an Investor shall not be required to obtain the prior written consent of the Company to distribute the Confidentially Disclosed Information to any affiliate of limited partner of such Investor provided that such affiliate or limited partner has agreed to hold such information in the same manner as set forth in this paragraph (e). 2.3 Termination of Information Covenants. The covenants set forth in Section 2.2 shall terminate as to Investor and be of no further force or effect upon either (a) the sale of securities pursuant to a registration statement filed by the Company under the Securities Act in connection with the Initial Public Offering or (b) the date on which 25% of the Series A Stock ceases to be outstanding. 3. Miscellaneous. 3.1 Successors and Assigns. Except as otherwise provided herein, the terms and conditions of this Agreement shall inure to the benefit of and be binding upon the respective successors and assigns of the parties (including transferees of any Securities). Nothing in this Agreement, express or implied, is intended to confer upon any party other than the parties hereto or their respective successors and assigns any rights, remedies, obligations, or liabilities under or by reason of this Agreement, except as expressly provided in this Agreement. 3.2 Governing Law. This Agreement shall be governed by and construed under the laws of the State of California, exclusive of the provisions thereof governing conflicts of laws. 3.3 Counterparts. This Agreement may be executed in two (2) or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 3.4 Titles and Subtitles. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 15 3.5 Notices. Unless otherwise provided, any notice required or permitted under this Agreement shall be given in writing and shall be deemed effectively given upon personal delivery to the party to be notified or upon deposit with the United States Post Office, by registered or certified mail, postage prepaid and addressed to the party to be notified at the address indicated for such party on the signature page hereof, or at such other address as such party may designate by ten (10) days' advance written notice to the other parties. 3.6 Expenses. If any action at law or in equity is necessary to enforce or interpret the terms of this Agreement, the prevailing party shall be entitled to reasonable attorneys' fees, costs and necessary disbursements in addition to any other relief to which such party may be entitled. 3.7 Amendments and Waivers. Any term of this Agreement may be amended and the observance of any term of this Agreement may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of (i) the Company, (ii) the holders of a majority of the Series A Stock, excluding shares of Series A Stock issued upon conversion of shares of Series B Stock, (or, if there shall be no such Series A Stock outstanding, a majority of the Common Stock issued upon conversion of such Series A Stock, and (iii) the holders of a majority of the Series B Stock (or, if there shall be no Series B Stock outstanding, a majority of the Series A Stock issued upon conversion of the Series B Stock, or, if there shall be no such shares of Series A Stock outstanding, a majority of the shares of Common Stock issued upon conversion of such Series A Stock) as of the date of the amendment or waiver. Any amendment or waiver effected in accordance with this paragraph shall be binding upon each holder of any securities purchased under the Securities Purchase Agreement then outstanding, each future holder of all such securities, and the Company. 3.8 Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of the Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 3.9 Aggregation of Stock. All shares of Series A Stock, Series B Stock and Common Stock issued or issuable upon conversion of the Series A Stock held or acquired by affiliated entities or persons shall be aggregated together for the purpose of determining the availability of any rights under this Agreement. 3.10 Entire Agreement. This Agreement and the documents referred to herein constitute the entire agreement among the parties with regard to the subjects hereof and thereof. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 16 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. QUEST SOFTWARE, INC. By: --------------------------------- Name: Vinny Smith Its: Chief Executive Officer Address: 610 Newport Center Drive Newport Beach, CA 92660 INSIGHT CAPITAL PARTNERS II, L.P. By: Insight Venture Associates II, LLC Its General Partner By: --------------------------------- Name: Jeffrey Horing Its: Managing Member INSIGHT CAPITAL PARTNERS (CAYMAN) II, L.P. By: Insight Venture Associates II, LLC Its General Partner By: --------------------------------- Name: Jeffrey Horing Its: Managing Member UBS CAPITAL II LLC By: --------------------------------- Name: Title: By: --------------------------------- Name: Title: [SIGNATURE PAGE TO INVESTORS' RIGHTS AGREEMENT] 17 WI SOFTWARE INVESTORS LLC By: --------------------------------- Name: Title: [SIGNATURE PAGE TO INVESTORS' RIGHTS AGREEMENT] EX-21.1 5 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.
EX-23.1 6 CONSENT OF DELOITTE & TOUCHE 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. and subsidiaries on Form S-1 of our report dated June 9, 1999, (except for paragraphs 3 of note 1 and the 1999 Stock Incentive Plan and 1999 Employee Stock Purchase Plan described in note 5 as to which the date is June , 1999) 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. Costa Mesa, California June , 1999 The above consent is in the form which will be signed by Deloitte & Touche LLP upon the consummation of the items described in notes 1 and 5 of the notes to the consolidated financial statements and assuming that from June 9, 1999 to the effective date of such items, no other events have occurred that would affect the accompanying consolidated financial statements and notes thereto. Deloitte & Touche LLP Costa Mesa, California June 11, 1999 EX-27.1 7 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 12,502,000 0 7,567,000 1,016,000 0 19,870,000 3,653,000 1,976,000 22,472,000 16,561,000 0 0 0 4,243,000 1,668,000 22,472,000 9,540,000 12,814,000 660,000 1,564,000 0 0 0 1,528,000 645,000 883,000 0 0 0 883,000 .02 .02
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