-----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, NJhGlUMEKYDULuSLEWj5i1algDX0dL0FvuSXztP57fHGOq0Oh/fw7XAMJpqazP21 mIXWX3Dw0fOEiotY9hsuJA== 0000892569-99-001980.txt : 19990723 0000892569-99-001980.hdr.sgml : 19990723 ACCESSION NUMBER: 0000892569-99-001980 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 19990722 FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUEST SOFTWARE INC CENTRAL INDEX KEY: 0001088033 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330231678 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-80543 FILM NUMBER: 99668541 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/A 1 FORM S-1 AMENDMENT #2 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 22, 1999 REGISTRATION NO. 333-80543 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 2 TO 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 M. 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 TITLE OF EACH CLASS OF MAXIMUM AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE(2) - ------------------------------------------------------------------------------------------------------------------- Common Stock............................................... $70,840,000 $19,693.52 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
(1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o). (2) The Registrant previously paid $16,680 of the total registration fee. ------------------------ 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 JULY 22, 1999 [QUEST SOFTWARE LOGO] 4,400,000 SHARES COMMON STOCK ---------------------------------- Quest Software, Inc. is offering 4,400,000 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 $12.00 and $14.00 per share. ---------------------------------- INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 7. ----------------------------------
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 660,000 shares of common stock to cover over-allotments. We have requested that the underwriters reserve up to 12% of the shares of common stock for sale at the initial public offering price to individuals designated by us. 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 both application and information availability solutions that enhance the performance and reliability of e-business, enterprise and custom applications and facilitate the delivery of information across the extended enterprise. [Schematic depiction of enterprise software environment showing the functionality of and relationships among Quest's products and this underlying environment.] [Three columns of text at the bottom of the page. The first column is entitled "Development -- Deployment" and reads, "Integrated products that aid in the rapid development, testing and automated deployment of Internet software applications in quickly changing, mission-critical environments." The second column is entitled "Production Management" and reads, "Software solutions designed to maintain high performance and provide constant access to critical business applications, as well as monitoring these systems to detect and correct problems before they impact users." The third column is entitled "Information Delivery" and reads, "An output management system that captures and delivers reports and data from nearly any software application for immediate and secure distribution to information consumers within an organization or over the Internet."] 2 4 YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED. ------------------------ TABLE OF CONTENTS
PAGE ---- Summary..................................................... 4 Risk Factors................................................ 7 Information Regarding Forward-Looking Statements............ 16 Use of Proceeds............................................. 17 Dividend Policy............................................. 17 Capitalization.............................................. 18 Dilution.................................................... 19 Selected Consolidated Financial Data........................ 20 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 21 Business.................................................... 31 Management.................................................. 45 Certain Transactions........................................ 55 Principal Shareholders...................................... 57 Description of Capital Stock................................ 59 Shares Eligible for Future Sale............................. 61 Underwriting................................................ 63 Legal Matters............................................... 65 Experts..................................................... 65 Additional Information...................................... 65 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. QUEST SOFTWARE, INC. We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, enterprise and custom applications and enable the delivery of information across the 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 initiatives, commonly referred to as e-business, are raising the strategic importance of real-time information and are increasing the challenges of building and maintaining the systems to effectively manage and distribute information. As a result, organizations must assure that their systems provide: - Application availability -- uninterrupted and high performance access to applications under widely varying conditions; and - Information availability -- broad distribution of critical business information from underlying applications to decision-makers throughout the 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 by utilizing a number of integrated products that tune and monitor applications and the underlying database which stores an enterprise's critical information. Other primary components of our application availability solution include our database replication products that maintain a real-time copy of a database for load balancing and high availability, as well as our products that manage the complex and error-prone process of development and deployment of rapidly changing applications. Our information availability products deliver an enterprise, report-based information management solution that captures, stores, indexes, prints and archives report data or electronic documents from virtually any application for instant distribution over intranets or the Internet. The key elements of our strategy include extending our product leadership, continuing our focus on the e-business applications market, leveraging our significant installed base, expanding our sales force and international distribution channels and extending our existing strategic relationships and developing new partnerships with leading global systems integrators. We have thousands of customers across a range of industries including technology, financial services, manufacturing, healthcare, energy, insurance and telecommunications. We market and sell our software and services worldwide through a combination of direct sales and telesales in the United States, Australia, the United Kingdom and Germany, as well as through resellers and distributors. 4 6 THE OFFERING Common stock offered.................. 4,400,000 shares Common stock to be outstanding after this offering......................... 38,124,600 shares Use of proceeds....................... We intend to use the net proceeds as follows: - $10.6 million to redeem all outstanding shares of our Series B Redeemable Preferred Stock; - $10.0 million to repay indebtedness; and - the balance 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. 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 June 30, 1999 which excludes: - 4,578,875 shares of common stock issuable upon exercise of stock options outstanding as of June 30, 1999, at a weighted average exercise price of $1.88 per share; - 15,438 shares of common stock issued upon the exercise of options in July 1999; - 2,914,525 shares of common stock reserved for future issuance under our stock incentive plans; 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 automatic conversion of our Series A Preferred Stock 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 following table should be read with the consolidated financial statements and notes thereto appearing elsewhere in this prospectus. The pro forma information gives effect, as of June 30, 1999, to the issuance of 4,000,000 shares of common stock upon the conversion of all outstanding shares of our Series A Preferred Stock immediately prior to the closing of this offering. The pro forma as adjusted information reflects the conversion of the Series A Preferred Stock and our receipt of the estimated net proceeds from the sale of 4,400,000 shares of our common stock offered by us hereby at an assumed initial public offering price of $13.00 per share and the applications of the estimated proceeds described in "Use of Proceeds."
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, --------------------------------------------- ----------------- 1994 1995 1996 1997 1998 1998 1999 ------ ------ ------- ------- ------- ------- ------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Total revenues......................... $5,686 $9,524 $12,862 $18,315 $34,790 $14,035 $28,289 Gross profit........................... 3,461 8,284 10,445 15,036 28,850 11,487 25,147 Income (loss) from operations.......... 37 2,335 (372) 1,448 3,689 1,417 2,191 Net income............................. 17 2,358 16 289 2,346 899 1,314 Net income applicable to common shareholders......................... 974 Net income per share: Basic................................ $ -- $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.02 $ 0.03 Diluted.............................. $ -- $ 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 43,990 38,809 Diluted.............................. 19,500 19,500 38,350 40,617 44,459 43,990 43,580 Pro forma basic and diluted net income per share............................ $ 0.05 $ 0.02 Pro forma weighted average shares outstanding: Basic................................ 48,261 42,809 Diluted.............................. 48,459 45,016
JUNE 30, 1999 ----------------------- PRO FORMA PRO FORMA AS ADJUSTED --------- ----------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................... $11,777 $43,133 Working capital............................................. 3,151 34,507 Total assets................................................ 27,468 58,824 Long-term debt.............................................. 10,000 -- Series A Redeemable Preferred Stock......................... 15,000 -- Series B Redeemable Preferred Stock......................... 10,340 -- Retained earnings (deficit)................................. 31 (269) Total shareholders' equity (deficit)........................ (13,751) 37,945
6 8 RISK FACTORS An investment in our shares involves risks and uncertainties. You should carefully consider the factors described below before making an investment decision in our securities. The risks described below are the risks that we currently believe are material risks of business, the industry in which we compete and this offering. Our business, financial condition and results of operations could be adversely affected by any of the following risks. If we are adversely affected by such risks, then the trading price of our common stock could decline, and you could lose all or part of your investment. RISKS RELATED TO OUR BUSINESS OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS, AND, AS A RESULT, WE MAY FAIL TO MEET EXPECTATIONS OF INVESTORS AND ANALYSTS, CAUSING OUR STOCK PRICE TO FLUCTUATE OR DECLINE Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors. One factor has been, and we expect to continue to be, the size and timing of customer orders. In any given quarter, sales of some of our products have involved large financial commitments from a relatively small number of customers, and cancellation or deferral of these large contracts would reduce our revenues. In addition, the sales cycles for Vista Plus and SharePlex have been up to six months and often require pre-purchase evaluation periods and customer education. These relatively long sales cycles may cause significant periodic variation in our license revenues. Also, we have often booked a large amount of our sales in the last month or weeks of each quarter and delays in the closing of sales near the end of a quarter could cause quarterly revenue to fall short of anticipated levels. Finally, while a portion of our revenues each quarter is recognized from previously deferred revenue, our quarterly performance will depend primarily upon entering into new contracts to generate revenues for that quarter. Other factors that may impact our operating results include the following: - 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. See "-- Customer focus and spending on Year 2000 remediation make it difficult to predict the buying patterns of our customers during the third and fourth quarters of 1999." 7 9 MANY OF OUR PRODUCTS ARE DEPENDENT ON ORACLE'S TECHNOLOGIES AND IF ORACLE'S TECHNOLOGIES LOSE MARKET SHARE OR BECOME INCOMPATIBLE WITH OUR PRODUCTS, OUR BUSINESS COULD SUFFER We believe that our success has depended in part, and will continue to depend in part for the foreseeable future, upon our relationship with Oracle and our status as a complementary software provider for Oracle's database and application products. Many versions of our principal products, including SharePlex, SQLab Xpert, and SQL Navigator, are designed specifically to be used with Oracle databases. Although a number of our products work with other environments, our competitive advantage consists in substantial part on the integration between our products and Oracle's products, and our extensive knowledge of Oracle's technology. Currently, a significant portion of our total revenues are derived from products that specifically support Oracle-based products. If Oracle for any reason decides to promote technologies and standards that are not compatible with our technology, or if Oracle loses market share for its database products, our business, operating results and financial condition would be materially adversely affected. MANY OF OUR PRODUCTS ARE VULNERABLE TO DIRECT COMPETITION FROM ORACLE We currently compete with Oracle in the market for database management solutions. We expect that Oracle's commitment to and presence in the database management product market will increase in the future and therefore substantially increase competitive pressures. We believe that Oracle will continue to incorporate database management technology into its server software offerings, possibly at no additional cost to its users. We believe that Oracle will also continue to enhance its database management technology. Furthermore, Oracle could attempt to increase its presence in this market by acquiring or forming strategic alliances with our competitors, and Oracle may be in better position to withstand and respond to the current factors impacting this industry. Oracle has a longer operating history, a larger installed base of customers and substantially greater financial, distribution, marketing and technical resources than we do. In addition, Oracle has well-established relationships with many of our present and potential customers. As a result, we may not be able to compete effectively with Oracle in the future which could materially adversely affect our business, operating results and financial condition. See "Business -- Competition." OUR SUCCESS DEPENDS ON OUR ABILITY TO EXPAND OUR INDIRECT SALES CHANNELS Our ability to increase revenues in the future substantially depends on our ability to expand our indirect sales channel. In certain domestic and international markets we may miss sales opportunities if we are unable to enter into successful relationships with locally based resellers. In the future, we intend to augment our current limited indirect sales distribution methods through additional third-party distribution arrangements and, therefore, we will likely become more dependent on these type of relationships. There can be no assurance that we will successfully augment these arrangements or that the expansion of indirect sales distribution methods will increase revenues. 8 10 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 operations. The number of our full-time employees increased from 66 as of December 31, 1996 to 123 as of December 31, 1997, to 257 as of December 31, 1998, to 415 as of June 30, 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, WHICH MAY AFFECT OUR FUTURE PROFITABILITY We intend to substantially increase our operating expenses for the foreseeable future as we: - increase our sales and marketing activities, including expanding our direct sales and telesales forces; - increase our research and development activities; - expand our general and administrative activities; and - expand our customer support organizations. Accordingly, we will be required to significantly increase our revenues in order to maintain profitability. These expenses will be incurred before we generate any revenues by this increased spending. If we do not significantly increase revenues from these efforts, our business and operating results would be negatively impacted. 9 11 ACQUISITIONS OF COMPANIES OR TECHNOLOGIES MAY RESULT IN DISRUPTIONS TO OUR BUSINESS AND DIVERSION OF MANAGEMENT ATTENTION We have in the past made and we expect to continue to make acquisitions of complementary companies, products or technologies. If we make any acquisitions, we will be required to assimilate the operations, products and personnel of the acquired businesses and train, retain and motivate key personnel from the acquired businesses. We may be unable to maintain uniform standards, controls, procedures and policies if we fail in these efforts. Similarly, acquisitions may subject us to liabilities and risks that are not known or identifiable at the time of the acquisition or may cause disruptions in our operations and divert management's attention from day-to-day operations, which could impair our relationships with our current employees, customers and strategic partners. We may have to incur debt or issue equity securities to pay for any future acquisitions. The issuance of equity securities for any acquisition could be substantially dilutive to our shareholders. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for acquired goodwill and other intangible assets. In consummating acquisitions, we are also subject to risks of entering geographic and business markets in which we have no or limited prior experience. If we are unable to fully integrate acquired businesses, products or technologies with our existing operations, we may not receive the intended benefits of acquisition. OUR 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 $6.2 million in the six months ended June 30, 1999, representing 22.0% 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. 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 Hewlett-Packard and Oracle and certain regional offices of a number of the national accounting firms that provide system integration services, in areas such as product development, marketing, distribution and implementation. We could lose sales opportunities if we fail to work effectively with these parties. Moreover, we expect that maintaining and enhancing these and other relationships will become a more meaningful part of our business strategy in the future. However, many of our current partners are either actual or potential competitors with us. In addition, many of these third parties also work with competing software companies and we may not be able to maintain these existing relationships, due to the fact that these relationships are informal or, if written, are terminable with little or no notice. OUR PROPRIETARY RIGHTS MAY BE INADEQUATELY PROTECTED, AND THERE IS RISK OF INFRINGEMENT CLAIMS OR INDEPENDENT DEVELOPMENT OF COMPETING TECHNOLOGY THAT COULD HARM OUR 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 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. Our means of protecting our proprietary rights may prove to be inadequate and competitors may independently develop similar or superior technology. Policing unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. We also believe that, because of the rapid rate of technological change in the software industry, trade secret and copyright protection are less significant than factors such as the knowledge, 11 13 ability and experience of our employees, frequent product enhancements and the timeliness and quality of customer support services. Our success and ability to compete are also dependent on our ability to operate without infringing upon the proprietary rights of others. Third parties may claim infringement by us of their intellectual property rights. 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 the misappropriation of trade secrets claim. In response to Mobius' complaint, we have filed a motion to dismiss which is set for hearing on September 13, 1999. The suit seeks injunctive relief and unspecified damages. See "Business -- Legal Proceedings" and "Business -- Proprietary Rights." OUR BUSINESS WILL SUFFER IF OUR SOFTWARE CONTAINS ERRORS The software products we offer are inherently complex. Despite testing and quality control, we cannot be certain that errors will not be found in current versions, new versions or enhancements of our products after commencement of commercial shipments. Significant technical challenges also arise with our products because our customers purchase and deploy our products across a variety of computer platforms and integrate it with a number of third-party software applications and databases. If new or existing customers have difficulty deploying our products or require significant amounts of customer support, our operating margins could be harmed. Moreover, we could face possible claims and higher development costs if our software contains undetected errors or if we fail to meet our customers' expectations. As a result of the foregoing, we could experience: - loss of or delay in revenues and loss of market share; - loss of customers; - damage to our reputation; - failure to achieve market acceptance; - diversion of development resources; - increased service and warranty costs; - legal actions by customers against us which could, whether or not successful, increase costs and distract our management; and - increased insurance costs. In addition, a product liability claim, whether or not successful, could harm our business by increasing our costs and distracting our management. 12 14 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. For example, we incorporate software licensed from Inso Corporation and Artifex Software into add-on options for our Vista Plus products. We expect that we may have to incorporate software from third-party vendors in our future products. We may not be able to replace the functionality provided by the third-party software currently offered with our products if that software becomes obsolete, defective or incompatible with future versions of our products or is not adequately maintained or updated. Any significant interruption in the availability of these third-party software products or defects in these products could harm our sales unless and until we can secure an alternative source. Although we believe there are adequate alternate sources for the technology licensed to us by Inso and Artifex, such alternate sources may not provide us with the same functionality as that currently provided to us. Further, we may experience a delay in obtaining an alternate source for the file viewing technology licensed to us by Inso if our license with Inso becomes unavailable for any reason. RISKS RELATED TO OUR INDUSTRY YEAR 2000 ISSUES PRESENT TECHNOLOGICAL RISKS AND COULD CAUSE DISRUPTION TO OUR BUSINESS 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 for services 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. However, based on currently available information, we do not expect our internal Year 2000 compliance efforts to involve significant time and expense. 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 13 15 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 related to Year 2000, we may 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, could have a material adverse effect on our business, results of operations and financial condition. Failure of our internal computer systems or third-party hardware or software, or of systems maintained by third parties, to operate properly with regard to Year 2000 could cause systems interruptions or loss of data or could require us to incur significant unanticipated expenses to remedy any problems. We are unable to reasonably estimate the duration and extent of any such unanticipated interruption, or quantify the effect it may have on our future operating results. We have not yet developed a comprehensive contingency plan to address these issues but we intend to continue developing such a plan, to the extent possible, throughout 1999. If our present efforts to address the Year 2000 compliance issues are not successful, or if third party vendors, licensors and providers of hardware, software and services with which we conduct business do not successfully address such issues, our business, operating results and financial condition would be materially adversely affected. Please refer to our discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000" for further information. Quest believes that the following consequences are possible in a "reasonable worst case" Year 2000 scenario: - costly business disputes and claims for pricing adjustments, damages, product returns and warranty obligations related to our products, any of which could cause a delay in receipt of revenues from our customers; - a significant number of operational inconveniences and inefficiencies for Quest and its customers that will divert management's time and attention; and - Year 2000 non-compliance by third parties that would disrupt, reduce or eliminate for a period of time the ability of our customers to purchase our products, thereby reducing our revenues. CUSTOMER FOCUS AND SPENDING ON YEAR 2000 REMEDIATION MAKE 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 14 16 performance demanded by customers for embedded databases and Web-based products, new products and product enhancements can require long development and testing periods. As a result, significant delays in the general availability of such new releases or significant problems in the installation or implementation of such new releases could have a material adverse effect on our business, operating results and financial condition. We may not be successful in: - developing and marketing, on a timely and cost-effective basis, new products or new product enhancements that respond to technological change, evolving industry standards or customer requirements; - avoiding difficulties that could delay or prevent the successful development, introduction or marketing of these products; or - achieving market acceptance for our new products and product enhancements. 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. There has in the past been and there may in the future be a shortage of personnel that possess the technical background necessary to sell, support and develop our products effectively. Competition for skilled personnel is intense, and we may not be able to attract, assimilate or retain highly qualified personnel in the future. Our business may not be able to grow if we cannot attract qualified personnel. Hiring qualified sales, marketing, administrative, research and development and customer support personnel, is very competitive in our industry, particularly in Southern California, where Quest is headquartered. RISKS RELATED TO THIS OFFERING OUR OFFICERS AND DIRECTORS WILL BE ABLE TO EXERT SIGNIFICANT CONTROL ON QUEST AFTER THIS OFFERING Executive officers, directors and persons and entities affiliated with them will, in the aggregate, own approximately 80% 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; 15 17 - failure to complete significant license transactions; - additions or departures of key personnel; - any shortfall in revenue or net income or any increase in losses from levels expected by securities analysts; - future sales of common stock; and - stock market price and volume fluctuations, which are particularly common among highly volatile securities of Internet and software companies. 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 38,124,600 shares of common stock outstanding, or 38,784,600 shares if the underwriters' option to purchase additional shares is exercised in full. The 4,400,000 shares sold in this offering, which would be 5,060,000 shares if the underwriters' option to purchase additional shares is exercised in full, will be freely tradable without restriction or further registration under the Federal securities laws unless purchased by our "affiliates" as that term is defined in Rule 144. The remaining 33,724,600 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 substantially all of our option holders are subject to agreements that limit their ability to sell common stock. These holders cannot sell or otherwise dispose of any shares of common stock for a period of at least 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." INFORMATION REGARDING FORWARD-LOOKING STATEMENTS Some of the matters discussed under the captions "Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this prospectus include forward-looking statements. We have based these forward-looking statements on currently available information and our current beliefs, expectations and projections about future events, including, among other things, - successfully implementing our business strategy; - maintaining and expanding market acceptance of the products we offer; and - our ability to successfully compete in our marketplace. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "potential," "continue," "expects," "anticipates," "intends," "plans," "believes," "estimates" and similar expressions. All forward-looking statements contained herein are subject to numerous risks and uncertainties. Our actual results and events may vary significantly from those discussed in the forward-looking statements. In light of these assumptions, risks and uncertainties, the forward-looking events discussed in this prospectus might not occur. 16 18 USE OF PROCEEDS The net proceeds to us from the sale of the 4,400,000 shares of common stock offered hereby are estimated to be approximately $52.0, or $60.0 million if the underwriters exercise their over-allotment option in full, based upon an assumed initial offering price per share of $13.00 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 $10.6 million; - to repay $10.0 million of outstanding term indebtedness that matures in May 2002 and bears interest at the prime rate, 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 proceeds from the issuance of the Series B Preferred Stock and the $10.0 million of term indebtedness in April 1999 originally financed a portion of our repurchase of the 14,820,000 shares of our common stock held by Doran Machin, one of our co-founders. The total purchase price for Mr. Machin's shares was $35.0 million. 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. 17 19 CAPITALIZATION The Actual column in the following table sets forth our actual capitalization as of June 30, 1999. The Pro Forma column in the following table gives effect to the conversion of all outstanding shares of Series A Preferred Stock into 4,000,000 shares of common stock which will occur immediately prior to the closing of this offering. 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 $10.6 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 4,400,000 shares of common stock in this offering at an assumed initial public offering price of $13.00 per share and the application of the estimated net proceeds therefrom. See "Use of Proceeds" and the notes to our consolidated financial statements. The 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.
JUNE 30, 1999 ------------------------------------ PRO FORMA ACTUAL PRO FORMA AS ADJUSTED -------- --------- ----------- (DOLLARS IN THOUSANDS) Long-term debt.............................................. $ 10,000 $ 10,000 $ -- -------- -------- -------- Series A Redeemable Preferred Stock, no par value, 2,666,667 shares authorized, 2,666,667 shares issued and outstanding actual and pro forma, no shares issued or outstanding pro forma as adjusted......................................... 15,000 -- -- Series B Redeemable Preferred Stock, no par value, 1,800,000 shares authorized; 1,777,778 shares issued and outstanding, pro forma; no shares issued and outstanding, pro forma as adjusted..................................... 10,340 10,340 -- Shareholders' 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, 29,724,600, 33,724,600 and 38,124,600 shares issued and outstanding, actual, pro forma and pro forma as adjusted.................................................. 4,306 19,306 71,302 Retained earnings (deficit)................................. 31 31 (269) Notes receivable from sale of common stock.................. (3,024) (3,024) (3,024) Capital distribution in excess of basis in common stock..... (30,064) (30,064) (30,064) -------- -------- -------- Total shareholders' equity (deficit)...................... (28,751) (13,751) 37,945 -------- -------- -------- Total capitalization...................................... $ 6,589 $ 6,589 $ 37,945 ======== ======== ========
The information in the table above excludes: - 4,578,875 shares of common stock issuable upon exercise of stock options outstanding as of June 30, 1999 at a weighted average exercise price of $1.88 per share; - 15,438 shares of common stock issued upon the exercise of options in July 1999; - 2,914,525 shares of common stock reserved for future issuance under our stock incentive plans; 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. 18 20 DILUTION Our pro forma net tangible book value (deficit) as of June 30, 1999 was $(14,127,000), or $(0.42) 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. After giving effect to the sale of the 4,400,000 shares of common stock offered hereby at an assumed initial public offering price of $13.00 per share and our receipt of the estimated net proceeds therefrom, our pro forma net tangible book value as of June 30, 1999 would have been approximately $37,569,000, or $0.99 per share. This represents an immediate increase in pro forma net tangible book value of $1.41 per share to existing shareholders and an immediate dilution in pro forma net tangible book value of $12.01 per share to new investors. The following table illustrates this per share dilution: Assumed initial public offering price per share............. $13.00 Pro forma net tangible book value (deficit) per share..... $(0.42) Increase per share attributable to new investors.......... 1.41 ------ Pro forma net tangible book value per share after this offering.................................................. 0.99 ------ Dilution per share to new investors......................... $12.01 ======
The following table summarizes on a pro forma basis, as of June 30, 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.................. 33,724,600 88.5% $19,249,000 18% $ 0.57 New investors.......................... 4,400,000 11.5 57,200,000 72 $13.00 ---------- ----- ----------- ----- Totals....................... 38,124,600 100.0% $76,449,000 100.0% ========== ===== =========== =====
The information in the table above excludes: - 4,578,875 shares of common stock issuable upon exercise of stock options outstanding as of June 30, 1999 at a weighted average exercise price of $1.88 per share; - 15,438 shares of common stock issued upon the exercise of options in July 1999; - 2,914,525 shares of common stock reserved for future issuance under our stock incentive plans; 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. 19 21 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 six months ended June 30, 1998 and 1999 and the consolidated balance sheet data at December 31, 1997 and 1998 and June 30, 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. The data presented below do not include pro forma adjustments to reflect the income tax provision as if we were a C corporation in fiscal years 1994, 1995 and 1996.
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, --------------------------------------------------- ----------------- 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 $12,158 $24,901 $ 9,580 $21,365 Services..................................... 851 2,305 3,546 6,157 9,889 4,455 6,924 ------- ------- ------- ------- ------- ------- ------- Total revenues......................... 5,686 9,524 12,862 18,315 34,790 14,035 28,289 ------- ------- ------- ------- ------- ------- ------- Cost of revenues: Licenses..................................... 99 260 950 1,307 3,433 1,504 1,404 Services..................................... 2,126 980 1,467 1,972 2,507 1,044 1,738 ------- ------- ------- ------- ------- ------- ------- Total cost of revenues................. 2,225 1,240 2,417 3,279 5,940 2,548 3,142 ------- ------- ------- ------- ------- ------- ------- Gross profit................................... 3,461 8,284 10,445 15,036 28,850 11,487 25,147 Operating expenses: Sales and marketing.......................... 672 2,179 4,328 5,845 11,836 4,371 12,158 Research and development..................... 502 1,134 2,995 4,293 8,047 3,629 6,034 General and administrative................... 2,250 2,636 3,494 3,450 5,278 2,070 3,989 Compensation and other costs................. -- -- -- -- -- -- 775 ------- ------- ------- ------- ------- ------- ------- Total operating expenses............... 3,424 5,949 10,817 13,588 25,161 10,070 22,956 ------- ------- ------- ------- ------- ------- ------- Income (loss) from operations.................. 37 2,335 (372) 1,448 3,689 1,417 2,191 Other income (expense), net.................... 6 51 389 (137) 336 119 82 ------- ------- ------- ------- ------- ------- ------- Income before income tax provision............. 43 2,386 17 1,311 4,025 1,536 2,273 Income tax provision........................... 26 28 1 1,022 1,679 637 959 ------- ------- ------- ------- ------- ------- ------- Net income..................................... $ 17 $ 2,358 $ 16 $ 289 $ 2,346 $ 899 1,314 ======= ======= ======= ======= ======= ======= Preferred stock dividends...................... 340 ------- Net income applicable to common shareholders... $ 974 ======= Net income per share: Basic........................................ $ -- $ 0.12 $ -- $ 0.01 $ 0.05 $ 0.02 $ 0.03 Diluted...................................... $ -- $ 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 43,990 38,809 Diluted...................................... 19,500 19,500 38,350 40,617 44,459 43,990 43,580
DECEMBER 31, -------------------------------------------------- JUNE 30, 1994 1995 1996 1997 1998 1999 ----------- ------ ------- ------- ------- ----------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents........................... $1,801 $2,709 $ -- $ 2,096 $ 8,981 $11,777 Working capital..................................... 1,158 2,594 553 374 2,771 3,151 Total assets........................................ 4,281 6,171 6,408 9,713 19,645 27,468 Long-term debt...................................... -- -- -- -- -- 10,000 Series A Redeemable Preferred Stock................. -- -- -- -- -- 15,000 Series B Redeemable Preferred Stock................. -- -- -- -- -- 10,340 Total shareholders' equity (deficit)................ 1,681 2,996 2,429 2,836 5,074 (28,751)
20 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations also should be read in conjunction with the consolidated financial statements and notes to those statements included elsewhere in this prospectus. OVERVIEW We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, packaged and custom applications and enable the delivery of information across the 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 $6.2 million in the six months ended June 30, 1999. We intend to expand our international sales activities as part of our business strategy. All of our current international revenues are derived from the operations of our three wholly-owned subsidiaries in Australia, the United Kingdom and Germany. Our international subsidiaries conduct business in the currency of the country in which they operate, exposing us to currency fluctuations and currency transaction losses or gains which are outside of our control. Historically fluctuations in foreign currency exchange rates have not had a material effect on our business. We have not to date conducted any hedging transactions to reduce our risk to currency fluctuations. In the development of new products and enhancements of existing products, the technological feasibility of the software is not established until substantially all product development is complete. Historically, our software development costs eligible for capitalization have been insignificant and all costs related to internal research and development have been expensed as incurred. 21 23 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:
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED JUNE 30, ----------------------- -------------- 1996 1997 1998 1998 1999 ----- ----- ----- ----- ----- Revenues: Licenses......................................... 72.4% 66.4% 71.6% 68.3% 75.5% Services......................................... 27.6 33.6 28.4 31.7 24.5 ----- ----- ----- ----- ----- Total revenues........................... 100.0 100.0 100.0 100.0 100.0 ----- ----- ----- ----- ----- Cost of revenues: Licenses......................................... 7.4 7.1 9.9 10.7 5.0 Services......................................... 11.4 10.8 7.2 7.4 6.1 ----- ----- ----- ----- ----- Total cost of revenues................... 18.8 17.9 17.1 18.2 11.1 ----- ----- ----- ----- ----- Gross profit....................................... 81.2 82.1 82.9 81.8 88.9 Operating expenses: Sales and marketing.............................. 33.6 31.9 34.0 31.1 43.0 Research and development......................... 23.3 23.5 23.1 25.9 21.4 General and administrative....................... 27.2 18.8 15.2 14.7 14.1 Compensation and other costs..................... -- -- -- -- 2.7 ----- ----- ----- ----- ----- Total operating expenses................. 84.1 74.2 72.3 71.7 81.2 ----- ----- ----- ----- ----- Income (loss) from operations...................... (2.9) 7.9 10.6 10.1 7.7 Other income (expense), net........................ 3.0 (0.7) 0.9 0.8 0.3 ----- ----- ----- ----- ----- Income before income tax provision................. 0.1 7.2 11.5 10.9 8.0 Income tax provision............................... -- 5.6 4.8 4.5 3.4 ----- ----- ----- ----- ----- Net income......................................... 0.1% 1.6% 6.7% 6.4% 4.6% ===== ===== ===== ===== =====
SIX MONTHS ENDED JUNE 30, 1998 AND 1999 Revenues Revenues are derived from the sale of software licenses and related services. Total revenues were $14.0 million and $28.3 million for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $14.3 million, or 102.1%. International revenues accounted for 15.3% and 22.0% of total revenues for the six months ended June 30, 1998 and 1999, respectively. Licenses. Licenses were $9.6 million and $21.4 million for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $11.8 million, or 123.0%. This increase resulted from both an increase in the size of both the domestic and international sales organizations as well as the availability of new products. Products available in the first six 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 68.3% and 75.5% of total revenues for the six months ended June 30, 1998 and 1999, respectively. International licenses represented 17.2% and 24.3% of total licenses in the six months ended June 30, 1998 and 1999, respectively. 22 24 Services. Services were $4.5 million and $6.9 million for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $2.4 million, or 53.3%. 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 six months ended June 30, 1999 reflected increases in the installed base of customers that purchased maintenance. Services represented 31.7% and 24.5% of total revenues for the six months ended June 30, 1998 and 1999, respectively. International services accounted for 11.1% and 15.0% of services for the six months ended June 30, 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 $1.5 million and $1.4 million for the six months ended June 30, 1998 and 1999, respectively, representing a decrease of $100,000, or 6.7%. This decrease was principally a result of reduced royalties and amortization of purchased technology and software licenses, offset in part by increased product media, printing and duplication costs. Cost of licenses represented 15.7% and 6.6% of license revenue for the six months ended June 30, 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 $1.0 million and $1.7 million for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $700,000, or 70.0%. 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 23.4% and 25.1% of service revenues for the six months ended June 30, 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, commissions earned by sales personnel, recruiting costs, trade show, travel and entertainment and other marketing communications costs such as advertising and promotion. Sales and marketing expenses were $4.4 million and $12.1 million for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $7.7 million, or 175%. This increase reflects a $3.2 million increase in salaries and related expenses due to the rapid expansion of our sales and marketing organization which we commenced in early 1998. Sales commissions also increased $2.1 million. Sales and marketing expenses represented 31.1% and 43.0% of total revenues for the six months ended June 30, 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 $3.6 million and $6.0 million for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $2.4 million, or 66.7%. This increase was primarily related to an increase in the number of software developers, both in our domestic and Australian development operations. Research and development costs represented 25.9% and 21.3% of total revenues for the six months ended June 30, 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. 23 25 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 $2.1 million and $4.0 million for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $1.9 million, or 90.5%. This increase was due to a number of factors including increases in salaries and related expenses due to an increase in the number of general and administrative personnel necessary to support our expanding operations and increases in professional fees and depreciation. General and administrative costs represented 14.7% and 14.1% of total revenues for the six months ended June 30, 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. Compensation and Other Costs. Compensation and other costs include $715,000 related to the severance package provided to Doran Machin, one of our founders and a director, which will be paid out over a three year period, and $60,000 in compensation costs related to the grant of stock options. Other Income (Expense), net. Other income (expense), net is comprised of interest income, interest expense and foreign currency transaction gains and losses. Other income (expense), net was $119,000 and $82,000 for the six months ended June 30, 1998 and 1999, respectively, representing a decrease of $37,000. Provision for Income Taxes. Provision for income taxes was $637,000 and $959,000 for the six months ended June 30, 1998 and 1999, respectively, representing an increase of $322,000 due to higher income. Our effective income tax rate was 41.5% and 42.2% for the six months ended June 30, 1998 and 1999, respectively. Net Income Applicable to Common Shareholders. Net income applicable to common shareholders represents net income less $340,000 of cumulative dividends payable on the Series B Redeemable Preferred Stock. 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 10.2%, 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%, 66.4% 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%, 33.6% 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 5.7%, 5.7% and 11.9% of total services in 1996, 1997 and 1998, respectively. 24 26 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 161.5%, from 1997 to 1998. Cost of licenses as a percentage of license revenue was 10.2%, 10.8% and 13.8% 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 a $1.8 million increase in royalties and higher amortization of purchased technology and software licenses. 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 41.4%, 32.0% and 25.4% 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 $11.8 million in 1996, 1997 and 1998, respectively, representing increases of $1.5 million, or 34.9%, from 1996 to 1997 and $6.0 million, or 103.4%, from 1997 to 1998. The increase from 1996 to 1997 was primarily due to additional commissions. The increase from 1997 to 1998 reflects our increasing investment in our sales and marketing organization, which included a $3.6 million increase in salaries and related expenses, $1.1 million in additional commissions and additional marketing communications expenses such as trade shows and advertising. Travel and entertainment expenses, and related costs of hiring sales and marketing management also increased. Research and Development. Research and development expenses were $3.0 million, $4.3 million and $8.0 million in 1996, 1997 and 1998, respectively, representing increases of $1.3 million, or 43.3%, from 1996 to 1997 and $3.7 million, or 86.0%, 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 $5.3 million in 1996, 1997 and 1998, respectively, representing a decrease of $44,000, or 1.3%, from 1996 to 1997 and an increase of $1.8 million, or 51.4%, from 1997 to 1998. The most significant expense increases from 1997 to 1998 were for salaries and related expenses and rent. 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 5 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. 25 27 QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited consolidated statement of operations data for the ten quarters in the period ended June 30, 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, 1997 1997 1997 1997 1998 1998 1998 1998 -------- -------- --------- -------- -------- -------- --------- -------- (IN THOUSANDS) Revenues: Licenses................................ $2,505 $2,700 $3,066 $3,887 $4,840 $4,740 $6,190 $9,131 Services................................ 1,487 1,600 1,405 1,665 2,203 2,252 2,544 2,890 ------ ------ ------ ------ ------ ------ ------ ------ Total revenues.................... 3,992 4,300 4,471 5,552 7,043 6,992 8,734 12,021 ------ ------ ------ ------ ------ ------ ------ ------ Cost of revenues: Licenses................................ 215 183 179 730 557 947 1,081 848 Services................................ 420 474 500 578 521 523 609 854 ------ ------ ------ ------ ------ ------ ------ ------ Total cost of revenues............ 635 657 679 1,308 1,078 1,470 1,690 1,702 ------ ------ ------ ------ ------ ------ ------ ------ Gross profit.............................. 3,357 3,643 3,792 4,244 5,965 5,522 7,044 10,319 Operating expenses: Sales and marketing..................... 1,245 1,265 1,461 1,874 1,923 2,448 3,169 4,296 Research and development................ 856 1,230 1,087 1,120 1,766 1,863 1,928 2,490 General and administrative.............. 723 849 900 978 841 1,229 980 2,228 Compensation and other costs............ -- -- -- -- -- -- -- -- ------ ------ ------ ------ ------ ------ ------ ------ Total operating expenses.......... 2,824 3,344 3,448 3,972 4,530 5,540 6,077 9,014 ------ ------ ------ ------ ------ ------ ------ ------ Income (loss) from operations............. 533 299 344 272 1,435 (18) 967 1,305 Other income (expense), net............... (84) (62) (9) 18 48 71 106 111 ------ ------ ------ ------ ------ ------ ------ ------ Income before provision for income taxes................................... 449 237 335 290 1,483 53 1,073 1,416 Provision for income taxes................ 350 183 262 227 615 22 446 596 ------ ------ ------ ------ ------ ------ ------ ------ Net income................................ $ 99 $ 54 $ 73 $ 63 $ 868 $ 31 $ 627 $ 820 ====== ====== ====== ====== ====== ====== ====== ====== AS A PERCENTAGE OF TOTAL REVENUES Revenues: Licenses................................ 62.8% 62.8% 68.6% 70.0% 68.7% 67.8% 70.9% 76.0% Services................................ 37.2 37.2 31.4 30.0 31.3 32.2 29.1 24.0 ------ ------ ------ ------ ------ ------ ------ ------ Total revenues.................... 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 Services................................ 10.5 11.0 11.2 10.4 7.4 7.5 7.0 7.1 ------ ------ ------ ------ ------ ------ ------ ------ Total cost of revenues............ 15.9 15.3 15.2 23.6 15.3 21.0 19.3 14.2 ------ ------ ------ ------ ------ ------ ------ ------ Gross profit.............................. 84.1 84.7 84.8 76.4 84.7 79.0 80.7 85.8 Operating expenses: Sales and marketing..................... 31.2 29.4 32.7 33.8 27.3 35.0 36.3 35.7 Research and development................ 21.4 28.6 24.3 20.2 25.1 26.6 22.1 20.7 General and administrative.............. 18.1 19.8 20.1 17.5 11.9 17.6 11.2 18.5 Compensation and other costs............ -- -- -- -- -- -- -- -- ------ ------ ------ ------ ------ ------ ------ ------ Total operating expenses.......... 70.7 77.8 77.1 71.5 64.3 79.3 69.6 75.0 ------ ------ ------ ------ ------ ------ ------ ------ Income (loss) from operations............. 13.4 6.9 7.7 4.9 20.4 (0.3) 11.1 10.8 Other income (expense), net............... (2.1) (1.4) (0.2) 0.3 0.6 1.0 1.2 0.9 ------ ------ ------ ------ ------ ------ ------ ------ Income before provision for income taxes................................... 11.3 5.5 7.5 5.2 21.0 0.7 12.3 11.7 Provision for income taxes................ 8.8 4.3 5.9 4.1 8.7 0.3 5.1 5.0 ------ ------ ------ ------ ------ ------ ------ ------ Net income................................ 2.5% 1.2% 1.6% 1.1% 12.3% 0.4% 7.2% 6.7% ====== ====== ====== ====== ====== ====== ====== ====== THREE MONTHS ENDED ------------------- MAR. 31, JUNE 30, 1999 1999 -------- -------- (IN THOUSANDS) Revenues: Licenses................................ $9,540 $11,825 Services................................ 3,299 3,625 ------ ------- Total revenues.................... 12,839 15,450 ------ ------- Cost of revenues: Licenses................................ 684 720 Services................................ 904 834 ------ ------- Total cost of revenues............ 1,588 1,554 ------ ------- Gross profit.............................. 11,251 13,896 Operating expenses: Sales and marketing..................... 5,036 7,122 Research and development................ 2,758 3,276 General and administrative.............. 1,938 2,051 Compensation and other costs............ -- 775 ------ ------- Total operating expenses.......... 9,732 13,224 ------ ------- Income (loss) from operations............. 1,519 672 Other income (expense), net............... 113 (31) ------ ------- Income before provision for income taxes................................... 1,632 641 Provision for income taxes................ 689 270 ------ ------- Net income................................ $ 943 $ 371 ====== ======= AS A PERCENTAGE OF TOTAL REVENUES Revenues: Licenses................................ 74.3% 76.5% Services................................ 25.7 23.5 ------ ------- Total revenues.................... 100.0 100.0 ------ ------- Cost of revenues: Licenses................................ 5.3 4.7 Services................................ 7.0 5.4 ------ ------- Total cost of revenues............ 12.3 10.1 ------ ------- Gross profit.............................. 87.6 89.9 Operating expenses: Sales and marketing..................... 39.2 46.1 Research and development................ 21.5 21.2 General and administrative.............. 15.1 13.3 Compensation and other costs............ -- 5.0 ------ ------- Total operating expenses.......... 75.8 85.6 ------ ------- Income (loss) from operations............. 11.8 4.3 Other income (expense), net............... 0.9 (0.2) ------ ------- Income before provision for income taxes................................... 12.7 4.1 Provision for income taxes................ 5.4 1.2 ------ ------- Net income................................ 7.3% 2.4% ====== =======
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. 26 28 While we have not experienced a significant amount of seasonality in the past, we expect that we will begin to experience seasonal customer buying patterns in the foreseeable future. Specifically, we would expect to experience relatively stronger demand for our products during the quarters ending December 31 and June 30, and relatively weaker demand in the quarters ending March 31 and September 30. In addition, to the extent international operations constitute a greater percentage of our revenues in future periods, we anticipate that demand for our products in Europe will decline during the summer vacation season. LIQUIDITY AND CAPITAL RESOURCES We have funded our business to date primarily from cash generated by our operations. Our sources of liquidity as of June 30, 1999 consisted principally of cash and cash equivalents of $11.8 million. Net cash provided by operating activities was $16,000, $3.6 million and $8.2 million in 1996, 1997 and 1998, respectively, and $4.3 million for the six months ended June 30, 1999. The increases in 1997, 1998 and 1999 were primarily due to increases in net income, depreciation and amortization, deferred revenue resulting from additional service contracts and accrued expenses, offset by increases in accounts receivable resulting from increased sales. 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 $1.5 million in the six months ended June 30, 1999. Purchases of technology and software licenses were $769,000, $831,000 and $57,000 in 1996, 1997 and 1998, respectively, and $234,000 for the six months ended June 30, 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 $237,000 for the six months ended June 30, 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 6 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. 27 29 State of Readiness of our Operations. 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; and - non-information technology systems and services, such as utilities, telephone systems and building systems. We are currently in the process of assessing the potential overall impact of the Year 2000 on our operations and we expect to continue this process throughout 1999. The phases of our Year 2000 assessment 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 potentially subject to the Year 2000 problem; - communication as necessary with significant suppliers and service providers to determine the readiness of their products and systems and their ability to remediate their own Year 2000 issues; - comprehensive analysis, including impact analysis and cost analysis of our Year 2000 readiness; and - testing and remediation. We have not to date used nor do we expect in the future to use any independent third parties to validate our risk assessment and cost estimates of our efforts related to Year 2000. Readiness of Our Products. Based on our review to date 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. 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 customers support and warranty costs; and - litigation costs. 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. Although we have not been a party to any litigation or arbitration proceeding to date involving our products or services related to Year 2000 compliance issues, we may 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 28 30 such disputes, and any liability for Year 2000-related damages, including consequential damages, could have a material adverse effect on our business, results of operations and financial condition. Success of our Year 2000 compliance efforts may 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. Contingency Plan. To date, we have not encountered any material Year 2000 problems with the hardware and software systems we use in our operations. However, 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. 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 continue developing such a plan, to the extent possible, throughout 1999. 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." 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. Moreover, to date, other projects, including our new product development efforts, have not been delayed due to our Year 2000 efforts. We do not expect the total cost of Year 2000 problems to be material to our business, financial condition and operating results. Purchasing Patterns of our Customers. 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. 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 . 29 31 In December 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions. SOP 98-9 amends SOP 97-2 and SOP 98-4 extending the deferral of the application of certain provisions of SOP 97-2 amended by SOP 98-4 through fiscal years beginning on or before March 15, 1999. All other provisions of SOP 98-9 are effective for transactions entered into in fiscal years beginning after March 15, 1999. We do not expect the adoption of SOP 98-9 to have a material effect on our results of operations or financial condition. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DERIVATIVES AND FINANCIAL INSTRUMENTS FOREIGN CURRENCY HEDGING INSTRUMENTS We transact business in various foreign currencies. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to revenues and operating expenses in Australia, the United Kingdom and Germany denominated in the respective local currency. To date, we have not used hedging contracts to hedge our foreign-currency fluctuation risks. We will assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis. We also do not use derivative financial instruments for speculative trading purposes. 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. 30 32 BUSINESS This prospectus contains certain forward looking statements within the meaning of the federal securities laws. Actual results and the timing of certain events could differ materially from those projected in the forward looking statements due to a number of factors, including those set forth under "Risk Factors" and elsewhere in this prospectus. OVERVIEW We provide application and information availability software solutions that enhance the performance and reliability of an organization's e-business, enterprise and custom applications and enable the delivery of information across the extended enterprise. Our application availability products are designed to help ensure uninterrupted and high performance access to software systems by utilizing a number of integrated products that tune and monitor applications and the underlying database which stores an enterprise's critical information. Other primary components of our application availability solution include our database replication products that maintain a real-time copy of a database for load balancing and high availability, as well as our products that manage the complex and error-prone process of development and deployment of rapidly changing applications. Our information availability products deliver an enterprise, report-based information management solution that captures, manages and distributes report data or electronic documents from virtually any application for instant distribution over intranets or the Internet. INDUSTRY BACKGROUND Organizations are constantly seeking ways to use information 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. 31 33 Application Availability The challenge of today's competitive environment is to provide users with the ability to immediately execute transactions and access information, without regard to the underlying complexities inherent in the disparate systems that run business applications. Since the emergence of e-business has allowed consumers to directly communicate with an organization's systems, it is more important than ever before to maximize application performance and minimize downtime. Furthermore, as e-business, enterprise resource planning and other applications are deployed to a wider audience, rapid and unpredictable spikes in the number of users can dramatically increase the likelihood of performance degradation and system failure. Not only must organizations have adequate back-up systems in place, but they also need solutions that will enable them to proactively monitor, identify and resolve issues that can adversely affect application performance. Finally, to ensure true application availability, organizations need solutions that will enable them to quickly and accurately develop and deploy new applications and modifications to existing applications. Information Availability In addition to assuring the availability of applications, the imperatives of e-business require organizations to make the strategic information within these applications readily available to the users who need it. The Internet has created a platform for distributing critical, dynamic business information, such as inventory levels, requisitions, billing statements, manufacturing data and sales reports to a broad range of employees, partners and suppliers, many of whom may be located in geographically remote locations and connected through multiple, non-integrated systems. Organizations must be able to leverage this platform to reach customers and provide 24x7x365 access to valuable information, including customer support and current account information. The challenge, however, is effectively extracting, publishing and disseminating large volumes of information to thousands of employees, customers, partners and suppliers over the Internet without massive amounts of application reengineering. Need for a Comprehensive Solution The effectiveness of an organization's information delivery system is dependent on its application availability environment. A user's ability to access information is linked to the performance and reliability of the underlying application. Historically, organizations have relied on a combination of manual processes and a heterogeneous assortment of software tools to manage the performance and reliability of their application infrastructure and to enable the distribution of information throughout the enterprise. However, the requirements of today's e-business initiatives have stretched the capabilities of these traditional solutions. This dynamic environment has created the need for a comprehensive solution that will address the breadth of these application and information availability requirements: - Deliver data from multiple, heterogeneous sources, scale to thousands of users and deliver information across all environments, quickly and cost-effectively; - Provide high performance and reliability for 24x7x365 access, and minimize the strain on existing systems and personnel; - Be easy to use and deploy without requiring in-depth technical expertise; - Adapt to accommodate rapidly changing business needs; - Provide an architecture to realize immediate value for Web-based applications; and - Address these requirements across the entire Web, application and database environments. 32 34 THE QUEST SOLUTION Quest offers application and information availability software solutions that enhance the performance and reliability of e-business, enterprise and custom applications and enable the delivery of information across the 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 Internet-enabled 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 enterprise and custom applications to reach throughout and beyond the enterprise without requiring re-engineering. Additionally, we enable our customers to improve the reliability and performance of existing information technology infrastructure to cost-effectively and predictability support the increasing number of users and large volumes of transactions required by today's e-business applications. Easy to Deploy and Use Our products are easy to deploy and use, thereby minimizing implementation, training and support costs. We designed our products to be installed quickly by the customer, typically without the need for on-site assistance. Our products contain specific integration modules for SAP R/3, PeopleSoft and Oracle Financials, enabling rapid deployment in these environments, minimizing the need for customization and reducing ongoing maintenance requirements. 33 35 Architected to Scale Our products are well-suited for large, enterprise-wide deployments. We designed our products to effectively scale when implemented in large and rapidly expanding environments without compromising system performance. Our products support heterogeneous networks, manage large quantities of information and support thousands of users while at the same time minimizing the consumption of network and computing resources. Our Java user interfaces significantly reduce the need for client-side software management, effectively leveraging today's wide deployment of Internet browser technology. STRATEGY Our objective is to become the leading provider of application and information availability solutions to enable organizations to deliver relevant information and provide sophisticated services to employees, customers, suppliers and partners both inside and outside of the traditional enterprise. Key elements of our strategy include: Extend Product Leadership We offer a family of products that work together to provide application and information availability solutions capable of meeting today's performance requirements. We believe our family of application availability products provides the most thorough and efficient approach to optimizing the performance and availability of e-business, enterprise and custom applications. We also believe that we offer the leading Web-based information availability software solutions. 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 enterprise resource planning (ERP) applications. Our flexible and open architecture allows for the integration of new modules that enhance our current solutions and add new e-business functionality, such as electronic bill presentment. We plan to augment our existing application availability solutions with capabilities to monitor and maintain the underlying infrastructure of e-business applications. For example, we plan to introduce a product that manages and optimizes the performance of Web application servers. Focus on e-Business Applications Market We believe that both recent and expected growth in e-business applications have created strong demand for our application and information availability products. We intend to capitalize on this opportunity by actively marketing our products to companies with strong e-business initiatives. In addition to developing new e-business applications, organizations are attempting to improve the e-business functionality of their existing enterprise applications by extending them over the Internet. As a result, we believe a significant market opportunity exists to help organizations leverage these investments by incorporating new e-business functionality into these systems. We believe that our products will be used as a key component of the infrastructure for emerging e-business applications. Leverage our Significant Installed Base of Customers We have an installed base of thousands of customers that we believe provides us with a significant opportunity for additional sales of current and future products, as well as ongoing maintenance revenues. A majority of our customers have purchased only one or a few of our products or use our products in specific business-units or locations. We believe that we can sell more deeply into our installed customer base by expanding these departmental deployments into enterprise-wide implementations as well as by cross-selling additional products and services. Expand our Sales Force and Distribution Channels We market and sell our products worldwide primarily though a direct sales and telesales force. We believe that our direct sales approach allows us to achieve better control of the sales process and respond more quickly to customer needs while maintaining an efficient sales model. We are continuing to expand 34 36 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 software solutions that support e-business and enterprise application software. We believe that these relationships will both facilitate the successful enterprise deployment of our products and generate additional product sales opportunities. 35 37 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 version control, auditing and rollback capabilities. - ------------------------------------------------------------------------------------------------------------ DATA MANAGER Builds test databases, deploys reference data to production during software rollouts, extracts data for data warehouses or reporting databases, and purges or archives production data that is not needed on-line. - ------------------------------------------------------------------------------------------------------------ SQL IMPACT Manages interdependencies between database objects and application source code, providing detailed impact analysis, documentation and auditing. - ------------------------------------------------------------------------------------------------------------ SQL NAVIGATOR AND TOAD Server-side database development and management solutions with optional add-on modules available for debugging, SQL tuning with expert advice and integrated code libraries for rapid development. - ------------------------------------------------------------------------------------------------------------
36 38 INFORMATION AVAILABILITY Vista Plus. Our Vista Plus products deliver the benefits of enabling Web-based access to existing information and applications without a complex development or deployment effort. Vista Plus is an enterprise, report-based information management solution that captures, stores, indexes, prints and archives report data or electronic documents from virtually any application. Vista Plus maintains a repository of this output for instant distribution over a heterogeneous, widely distributed network, including the Internet, with our sophisticated Java or Windows clients. By storing output from applications in its repository, Vista Plus also eliminates the processing needed to rerun reports, and its report mining capabilities provide users access to information without burdening the primary systems. Vista Plus enables real-time access to business-critical information at any time, even if the source application is not accessible. Vista Plus provides the ability to quickly navigate from summary to detailed information, data extraction, hyperlinks to navigate between related information and numerous print and electronic distribution functions with no application changes, delivering immediate benefits throughout the enterprise. The robust security model built into Vista ensures that only authorized users gain access to data. Vista Plus further extends information availability by transforming production reports into a series of personalized emails, PDF files or HTML pages for Internet distribution of statements such as invoices, purchase orders and financial statements. As a result, the data that is delivered to end users contains relevant information in a familiar and highly usable format. APPLICATION AVAILABILITY We provide a broad range of products that together provide a comprehensive application availability solution. Our products provide a wide range of services that work together to maintain the high level of performance and continuous access required by today's demanding e-business environment. Integration between these components significantly enhances the value of each solution by increasing user productivity and delivering otherwise unavailable functionality. Database Replication SharePlex. SharePlex replicates high volumes of data from an Oracle database to one or more other databases. Replication is accomplished in real-time with very little overhead to critical application servers. Secondary systems can then be used for offloading non-critical processing, thus preserving desired user response times and Web server performance, as well as providing a back-up system for reporting and fail-over. SharePlex also supports wide-area networks without the need for expensive high bandwidth data links. Enterprise Monitoring 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 the ability to quickly navigate from summary to detailed information for diagnosing and resolving issues. I/Watch allows for the mining of previously monitored time periods to help pinpoint the root cause of problems. 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 37 39 displays a comprehensive diagram of a database's internal workings and the flow of information within the database. Instance Monitor tracks database performance in real-time, identifies potential bottlenecks and provides detailed expert advice to help resolve problems as they occur. SQLab Xpert. SQLab Xpert automatically locates and highlights poorly written database application code. It provides expert advice to help both novice and seasoned developers and administrators quickly find solutions to difficult performance problems. Space Manager. Space Manager addresses the complex issues of physical data management to help keep application performance at peak levels. As database structures are modified to accommodate application changes and growth, performance begins to degrade due to poor physical organization of information within the database. Space Manager is designed to perform this necessary maintenance as well as assist in planning for future growth in storage requirements. Application Change Management SQL Impact. SQL Impact scans application code and stores it in its repository. If a change is needed to any object in a database, SQL Impact determines which programs and specific lines of code will be affected, reducing the likelihood of overlooking required application changes. Schema Manager. Schema Manager automatically determines the differences between a development and production database and can synchronize the databases automatically. Schema Manager packages all of the changes needed for a new application deployment, checks to make sure the changes will not fail in the production environment, and implements the changes. Its auditing capability documents all database changes, allowing the immediate rollback of a change if required. Data Manager. Data Manager deploys and transforms data when new applications are rolled out, for example, storing or changing reference data such as sales tax tables and control information. Data Manager also creates test databases for developers, eliminating the need to use a full copy of a production database which can be impractical due to its large size. Database Programming SQL Navigator and TOAD enable development of server side code for databases, a key component of Internet-enabled application development. SQL Navigator and TOAD allow developers to rapidly and 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 six months of 1999, no customer accounted for more than 10% of our total revenues. 38 40 A representative 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 Amazon.Com FirstEnergy Corp. American Cyanamid Applied Materials Pennsylvania Power & Light Boeing Computer Sciences Corp. PG&E Texas Management Eaton Corp. Dell Computer Shell Services International General Electric Plastics Diamond Multimedia Sun Chemical Gulf States Steel Earthlink Valero Energy Honeywell Hewlett-Packard FINANCIAL SERVICES Johnson Controls Imation Koch Industries Mail.com ADP Lockheed Martin Merisel AIG Marketing Rockwell Micro Warehouse American United Life Rogers Tool Works Micron Electronics Ceridian Tax Service Sara Lee Hosiery NCR Chase Manhattan Mortgage Smuckers Oracle Credit Suisse/First Boston Weyerhaeuser Smith-Gardner & Associates Fidelity Investments OTHER Sony First National Bank Chicago Sun Microsystems Mercury Insurance Group American Home Shield Tandy Corporation Nations Bank Andersen Consulting HEALTHCARE/PHARMACEUTICAL Wellington Management Aramark Wells Fargo Bausch & Lomb Worldwide 3M Health Information Systems TELECOMMUNICATIONS Carlson Companies Acuson Dun & Bradstreet Info. Systems AVMED Health Plan Air Touch Communications Earth Tech Blue Cross-Blue Shield (FL) AT&T Hertz Cardinal Health British Telecom JC Penney GE Medical Systems Lucent Technologies Pepsi-Cola Harvard Pilgrim Health Care MCI System House Southwest Airlines Hoechst Marion Roussel Rohm Corporation Time Merck Southwestern Bell Mobile United Space Alliance Partners Health Plan Communications University of Michigan Qualmed TCI Communications Yamaha US Surgical Williams Information Services
The following case studies illustrate how a selected group of representative customers are using a variety of Quest products to ensure high application and information availability across their increasingly heterogeneous and distributed networks. The information in these case studies was compiled in consultation with the companies listed below. Applied Materials Applied Materials is a leading semiconductor equipment manufacturer. To improve efficiency in its global operations, Applied Materials needed a Web-based enterprise-wide report management solution that could seamlessly integrate with their existing applications, automate their processes and provide instant access to corporate reports to thousands of employees worldwide. Such a solution would eliminate the need to prepare, compile and distribute thousands of corporate reports manually. Applied Materials selected and implemented Vista Plus as an enterprise-wide report warehouse and distribution solution for automated electronic delivery and archiving of application reports. Applied Materials was able to realize cost savings and productivity benefits immediately. Administrative overhead was reduced through lower paper and printing costs and reduced human resource expenses. Moreover, Applied Materials deployed Vista Plus without having to reconfigure its existing applications. After experiencing the benefits of Vista Plus, Applied Materials purchased I/Watch, for enterprise monitoring and SQLab Xpert for application turning, to improve the availability and performance of their Oracle database environment. 39 41 EarthLink EarthLink is a leading Internet service provider, with a full range of innovative access and hosting solutions used by approximately 1.15 million individuals and businesses every day. Using Oracle databases, EarthLink needed a better way to diagnose and address day-to-day application availability and management issues. Due to the size and the dynamic nature of its business, downtime would be catastrophic. EarthLink selected our products to satisfy its requirements in this area. To manage its applications, EarthLink uses I/Watch and Instance Monitor for database monitoring, diagnostics and resolution. EarthLink particularly liked the user interfaces and integration of the products they purchased. These products, along with SQLab Xpert, enable their database administrators to perform "targeted tuning" with intelligent tuning recommendations that optimize the performance of the databases. Space Manager provides EarthLink with a comprehensive solution for database reorganization and capacity planning for application availability through preventive maintenance, problem detection and resolution across all databases. NCR NCR provides integrated software, consulting services and hardware solutions for businesses. NCR runs Oracle in a multi-platform environment with a combination of applications, including Oracle Financials, PeopleSoft and other internally developed solutions. NCR employs over 300 servers worldwide and executes mission-critical data transfers. This complexity required a controlled application development and deployment environment. Our change management products allow NCR to facilitate the identification, migration and deployment of critical database changes required to ensure that all databases have the same structure across the 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 database structural changes between development and production databases. In addition, they use SQLab Tuner to tune complex queries and SQL Navigator for server-side development and debugging. As a result of implementing our products, NCR was able to realize a reduction in processing time 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 and services worldwide through a combination of direct sales and telesales forces and, to a lesser extent, resellers and distributors. Our domestic sales organization is headquartered in 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 40 42 involve technology presentations and pilot implementations, and many times involve numerous decision makers. As a result, a key feature of our sales efforts is to establish relationships at all appropriate levels in our customers' organizations. While the sales cycle varies substantially from customer to customer, the typical sales cycle for our Vista Plus and SharePlex products has ranged from three to six months. Focusing on our target markets, our marketing efforts are designed to create awareness for our products and generate sales leads. To achieve these goals, we engage in a variety of marketing activities, including seminars, trade shows, direct mailings and print and Web-based advertising. In addition, we have recently expanded our marketing staff and intend to commence an ongoing public relations program that will include establishing and maintaining relationships with key trade press, business press and industry analysts. We also intend to initiate a customer advisory council which will provide a communication channel for regular feedback from key customers to facilitate the design of products to meet the expanding requirements of our target market. CUSTOMER SERVICE AND SUPPORT A high level of customer service and support is critical to the successful marketing and sale of our products and the development of long-term customer relationships. Our customer support group provides technical support to our customers under support agreements entered into at the time of the initial sale. Our base level of e-mail-, Internet-, fax-, and telephone-based support includes assistance with installation, configuration and initial set-up of our products; ongoing support during normal business hours; and software maintenance and upgrade releases. For an additional fee, we provide support on a 24x7x365 basis as well as training and other services. Customer support is provided domestically through our offices in 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. Our services contracts are generally of 12 months' duration and are renewable at the customer's option. Service contracts are generally priced at approximately 20% of the amount of licenses and the customer is invoiced annually in advance. 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 41 43 to understand complex output data streams, enabling search, transformation and extraction from graphics-intensive output. COMPETITION The market for application and information availability solutions is emerging rapidly, and, as a result, is intensely competitive and characterized by rapidly changing technology and evolving standards. We expect competition to continue to increase both from existing competitors and new market entrants. We believe that our ability to effectively compete depends on many factors, including: - the ease of use, performance, features, price and reliability of our products as compared to those of our competitors; - the timing and market acceptance of new products and enhancements to existing products developed by us and our competitors; - the quality of our customer support; and - the effectiveness of our sales and marketing efforts. Companies currently offering competitive products vary in the scope and breadth of the products and services offered and include: - providers of enterprise report management products such as Actuate, Computer Associates, Mobius, and IBM; - providers of hardware and software replication tools such as EMC and Veritas; and - providers of database and database management products such as BMC, Compuware, Oracle, and Computer Associates. Many of our competitors and potential competitors have greater name recognition, a larger installed customer base company-wide and significantly greater financial, technical, marketing, and other resources than we do. Our competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. In addition, because there are relatively low barriers to entry in the software market, we may encounter additional competition as other established and emerging companies enter our field and introduce new products and technologies. 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 42 44 margins and loss of market share, any of which could materially affect our business, operating results or financial condition. PROPRIETARY RIGHTS Our success and ability to compete are dependent on our ability to develop and maintain the proprietary aspects of our technology. We rely on a combination of trademark, trade secret, copyright law and contractual restrictions to protect the proprietary aspects of our technology. We presently have no patents on our products. We currently hold several trademark registrations and have numerous trademark applications in the United States and certain foreign countries. Our trademark applications might not result in the issuance of any valid trademarks. We seek to protect our source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to signed or shrinkwrap license agreements, which impose restrictions on the licensee's ability to utilize the software. Finally, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, we sell our products internationally. The laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, and to determine the validity and scope of the proprietary rights of others. Any such resulting litigation could result in substantial costs and diversion of resources and would materially adversely affect our business, operating results and financial condition. We cannot assure you that our means of protecting our proprietary rights will be adequate or that competition will not independently develop similar or superior technology. We also believe that, because of the rapid rate of technological change in the software industry, trade secret and copyright protection are less significant than factors such as the knowledge, ability and experience of our employees, frequent product enhancements and the timeliness and quality of customer support services. Our success and ability to compete are also dependent on our ability to operate without infringing upon the proprietary rights of others. We are not aware that we are infringing any proprietary rights of third parties. There can be no assurance, however, that third parties will not claim we infringe their intellectual property rights. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention and resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In the event of a successful claim of product infringement against us and our failure or inability to either license the infringed or similar technology or develop alternative technology on a timely basis, our business, operating results and financial condition could be materially adversely affected. We incorporate technology from third parties into our SQL Navigator, TOAD and Vista Plus products. We currently have a material license agreement with Inso for the use of file viewing technology which is incorporated into an add-on module for our Vista Plus products. We currently pay Inso royalty fees based on sales of our Vista Plus product. This license agreement terminates on February 10, 2002. In addition, we currently have a material license agreement with Artifex for the use of technology which is incorporated into an add-on module for our Vista Plus products. We currently pay Artifex royalty fees based on sales of Vista Plus products incorporating the licensed software. The license for the technology from Artifex remains in effect for so long as any proprietary rights in the licensed technology are enforceable under the laws of any jurisdiction, unless earlier terminated by us upon 30 days written notice or by Artifex upon a material breach by us. As we continue to introduce new products, we may be 43 45 required to license additional technology from others. There can be no assurance that these third-party technology licenses will continue to be available to us on commercially reasonable terms, if at all. SharePlex is a registered trademark owned by us. This prospectus also makes reference to the other trademarks that we own, some of which we are seeking registration for, and to trademarks of other companies. EMPLOYEES As of June 30, 1999, we employed 415 full-time employees, including 208 in sales and marketing, 140 in research and development, 34 in customer service and support and 33 in general and administrative. We believe that our future success will depend in large part upon our continuing ability to attract and retain highly skilled managerial, sales, marketing, customer support and research and development personnel. Like other software companies, we face intense competition for such personnel, and we have at times experienced and continue to experience difficulty in recruiting qualified personnel. There can be no assurance that we will be successful in attracting, assimilating and retaining other qualified personnel in the future. We are not subject to any collective bargaining agreement and we believe that our relationships with our employees are good. FACILITIES Our principal administrative, sales, marketing, support and research and development facility is currently located in approximately 33,000 square feet of space in Newport Beach, California. In October 1999 we intend to relocate our headquarters in Newport Beach to a leased facility in nearby Irvine, California, consisting of approximately 67,500 square feet of office space. The new facility will be under a six-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 advertisements that Mobius alleges in its complaint are false and misleading are two e-mails intended for internal use, a comparison chart believed to have been prepared by a former Quest employee in 1997 for internal purposes, and a statement made regarding our Vista Plus Java client which had been posted on the Internet. 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. In response to Mobius' complaint, we have filed a motion to dismiss which is set for hearing on September 13, 1999. 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. 44 46 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 Kimberly A. Kinnison................... 38 Vice President, Technical Support 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. 45 47 Mr. Aronoff received a B.A. degree in computer science and chemistry from Bar-Ilan University Ramat-Gan, Israel. Douglas F. Garn is the Vice President of Worldwide Sales. Mr. Garn has held this position since January 1998. From March 1996 to January 1998, Mr. Garn was Vice President of North American Sales for Peregrine Systems, Inc. From July 1995 until April 1996, Mr. Garn was Vice President of Sales with 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. Kimberly A. Kinnison has been our Vice President of Technical Support since January 1999. As such, Ms. Kinnison oversees our management information systems department and our worldwide technical support staff. From January 1998 to January 1999, Ms. Kinnison was our Director of Technical Support and from June 1995 to December 1997, she was our Support Manager. Ms. Kinnison joined Quest in November 1991 as a technical support engineer. Prior to joining Quest, Ms. Kinnison held positions as a systems programmer at Hughes Aircraft and instructor/consultant at Hewlett Packard. Ms. Kinnison received her B.S. in Computer Information Systems from California State Polytechnic University, Pomona. Terence J. Mullin has been our Vice President of the Output Management Business Unit since April 1998. From November 1997 to April 1998, Mr. Mullin was the Vice President of Marketing and Business Development of Clarion Corporation of America's Advanced Technology Division. From April 1997 to November 1997, Mr. Mullin was the Vice President of Marketing and Business Development for NetSoft/NetManage. From April 1995 to April 1997, Mr. Mullin held the position of Strategic Planner of Internet Strategy and Marketing at FileNet Corporation. Mr. Mullin studied Computer Science at California State University, Fullerton and completed the Advanced Management Development in Business Administration program offered by the University of Southern California. Charles C. Ramsey has been our Vice President of International Sales since January 1999. In this position, Mr. Ramsey heads up the expansion of our international direct-sales and support teams and will complete the development of a worldwide channel organization. From April 1998 to January 1999, Mr. Ramsey was a Regional Field Sales Manager. From May 1989 to April 1998, Mr. Ramsey was employed with Ziff Davis Market Intelligence, where he was most recently the Vice President of Sales. Prior to working at Ziff Davis, Mr. Ramsey worked for IBM Corporation for five years. Mr. Ramsey received a B.S. in Communications from University of California, San Diego and an M.I.M. from American Graduate School of International Management. 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. 46 48 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. 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." 47 49 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. Mr. Machin resigned from his position as Secretary in April 1999. The compensation table excludes other compensation in the form of perquisites and other personal benefits that constitutes the lesser of $50,000 or 10% of the total annual salary and bonus earned by each of the Named Executive Officers in 1998. The amount set forth in the "All Other Compensation" column includes matching contributions under our 401(k) Plan and expenses paid by us for Mr. Machin's car and the automobile insurance thereon.
LONG-TERM ANNUAL COMPENSATION COMPENSATION --------------------- ------------------ SECURITIES ALL OTHER NAME AND PRINCIPAL POSITION SALARY($) 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 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
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($) OPTIONS EMPLOYEES IN PER-SHARE EXPIRATION ------------------------- NAME GRANTED(#) 1998(%) ($) DATE 5% 10% ---- ---------- ------------ --------- ---------- ---------- ----------- Vincent C. Smith..... -- -- -- -- -- -- David M. Doyle....... -- -- -- -- -- -- Doran G. Machin...... -- -- -- -- -- -- Eyal M. Aronoff...... 24,000 * 1.00 6/23/08 196,215 497,248 15,000 * 1.17 10/1/08 122,634 310,780 Douglas F. Garn...... 450,000 13.3 1.00 6/23/08 3,679,034 9,323,393 126,000 3.7 1.00 7/1/08 1,030,129 2,610,550
- ------------------------- * Less than one percent. 48 50 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 for 300,000 of Mr. Garn's 450,000 options, the options shown in this table are all nonqualified stock options. These options vest as follows: - 20% upon the completion of one year of employment, - 13% upon the completion of each of the next five six-month periods of employment, and - 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. During 1998 we granted options to purchase up to an aggregate of 3,332,700 shares of common stock. All options were granted at an exercise price equal to the fair market value of our common stock on the date of grant, as determined by our board of directors. The potential realizable value is calculated based on the ten year term of the option at its time of grant. It is calculated based on the assumption that the assumed initial public offering price of $13.00 per share appreciates at the indicated annual rate compounded annually for the entire term of the option and that the option is exercised and sold on the last day of its term for the appreciated stock price. Actual gains, if any, on stock option exercises are dependent on the future performance of the common stock and overall stock market conditions. The amounts reflected in the table may not necessarily be achieved. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES The following table sets forth the number and value of shares of common stock underlying the unexercised options held by the Named Executive Officers. No options were exercised during 1998.
NUMBER OF VALUE OF UNEXERCISED SECURITIES UNDERLYING IN-THE-MONEY UNEXERCISED OPTIONS AT OPTIONS AT DECEMBER 31, 1998 DECEMBER 31, 1998 ---------------------------- ---------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- Vincent C. Smith........................... -- -- -- -- David M. Doyle............................. -- -- -- -- Doran G. Machin............................ -- -- -- -- Eyal M. Aronoff............................ -- 39,000 -- $ 465,450 Douglas F. Garn............................ -- 576,000 -- 6,912,000
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 $13.00 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 became effective upon its adoption by the board. On the date of this offering, all outstanding options under our predecessor plan will be incorporated into the 1999 Stock Incentive Plan, and no further option grants will thereafter 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 49 51 substantially the same terms as will be in effect for grants made under the Discretionary Option Grant Program of the 1999 Stock Incentive Plan. Share Reserve. 7,493,400 shares of common stock have been authorized for issuance under the 1999 Stock Incentive Plan. This share reserve 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 determined by the plan administrator; - the stock issuance program under which such individuals may be issued shares of common stock directly, through the purchase of such shares at a price determined by the plan administrator or as a bonus tied to the performance of services; - the salary investment option grant program which may, at the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow executive officers and other highly compensated employees the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants; - the automatic option grant program under which option grants will automatically be made at periodic intervals to eligible non-employee board members to purchase shares of common stock at an exercise price equal to 100% of the fair market value of those shares on the grant date; and - the director fee option grant program which may, in the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow non-employee board members the opportunity to apply a portion of the annual retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants. Administration. The discretionary option grant program and the stock issuance program will be administered by the compensation committee of the board of directors. This committee will determine which eligible individuals are to receive option grants or stock issuances under those programs, the time or times when such option grants or stock issuances are to be made, the number of shares subject to each such grant or issuance, the status of any granted option as either an incentive stock option or a non-statutory stock option under the Federal tax laws, the vesting schedule to be in effect for the option grant or stock issuance and the maximum term for which any granted option is to remain outstanding. The compensation committee will also have the authority to select the executive officers and other highly compensated employees who may participate in the salary investment option grant program in the event that program is activated for one or more calendar years. Plan Features. Our 1999 Stock Incentive Plan 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 50 52 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 1999 Stock Incentive Plan may be accelerated upon similar terms and conditions. - The plan administrator may also grant options which will immediately vest upon our acquisition by another entity, whether or not those options are assumed by the successor corporation. - The plan administrator may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful tender offer for more than fifty percent (50%) of the outstanding voting stock or a change in the majority of our board of directors through one or more contested elections. Such accelerated vesting may occur either at the time of such transaction or upon the subsequent termination of the individual's service. Salary Investment Option Grant Program. In the event the compensation committee decides to put this program into effect for one or more calendar years, each of our executive officers and other highly compensated employees selected for participation may elect to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10,000 nor more than $75,000. Each selected individual who makes such an election will automatically be granted, on the first trading day in January of the calendar year for which that salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of common stock on the grant date. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. A compensation expense will be recorded for the amount of the salary reduction. As a result, the total spread on the option shares at the time of grant will be equal to the amount of salary invested in that option. The option will vest and become exercisable in a series of twelve (12) equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting upon certain changes in the ownership or control of Quest. Automatic Option Grant Program. Each individual who first becomes a non-employee board member at any time after the completion of this offering will automatically receive an option grant for 25,000 shares on the date such individual joins the board, provided such individual has not been in the prior employ of Quest. In addition, on the date of each annual shareholders meeting beginning with the 2001 annual shareholders meeting, each non-employee board member who has served as a non-employee board member since the date of the last annual shareholders meeting will automatically be granted an option to purchase 7,500 shares of common stock. Each automatic grant will have a term of ten years, subject to earlier termination following the optionee's cessation of board service. The initial 25,000 share option will be immediately exercisable for all of the option shares; however, any unvested shares purchased under the option will be subject to repurchase by us, at the exercise price paid per share, should the optionee cease board service prior to vesting in those shares. The shares subject to each 25,000 share automatic option grant will vest over a 51 53 four (4) year period in successive equal annual installments upon the individual's completion of each year of board service over the four (4) year period measured from the option grant date. However, the shares subject to each such automatic grant will immediately vest in full upon certain changes in control or ownership of Quest or upon the optionee's death or disability while a board member. Each 7,500 share automatic option grant will be immediately exercisable and fully vested on the option grant date. Director Fee Option Grant Program. If this program is put into effect in the future, then each non-employee board member may elect to apply all or a portion of any annual retainer fee otherwise payable in cash to the acquisition of a below-market option grant. The option grant will automatically be made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the retainer fee applied to the program by two-thirds of the fair market value per share of common stock on the grant date. As a result, the option will be structured so that the fair market value of the option shares on the grant date less the aggregate exercise price payable for those shares will be equal to the portion of the retainer fee invested in that option. The option will become exercisable in a series of twelve (12) equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares upon certain changes in the ownership or control of Quest or the death or disability of the optionee while serving as a board member. Limited Stock Appreciation Rights. Limited stock appreciation rights will automatically be included as part of each grant made under the automatic option grant, salary investment option grant and director fee option grant programs and may be granted to one or more of our officers as part of their option grants under the discretionary option grant program. Options with such a limited stock appreciation right may be surrendered to Quest upon the successful completion of a hostile tender offer for more than 50% of the Quest outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from us in an amount per surrendered option share based on the highest price per share of common stock paid in connection with the tender offer. Amendment. The board may amend or modify the 1999 Stock Incentive Plan at any time, subject to any required shareholder approval. The 1999 Stock Incentive Plan will terminate no later than June 8, 2009. 1999 EMPLOYEE STOCK PURCHASE PLAN Introduction. The 1999 Employee Stock Purchase Plan was adopted by the board and approved by the shareholders in June 1999 and 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. 52 54 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; - 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 53 55 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. 54 56 CERTAIN TRANSACTIONS SALES OF PREFERRED STOCK In April 1999, we sold an aggregate of 1,688,889 shares of our Series A Preferred Stock at a price of $5.625 per share to investors affiliated with InSight Capital Partners. Mr. Murdock, a director of Quest, is a General Partner of InSight Capital Partners. In April 1999 we also sold 977,778 shares of Series A Preferred Stock and 1,777,778 shares of our Series B Redeemable Preferred Stock to UBS Capital LLC at a price of $5.625 per share. The proceeds from the issuance of the Series A and Series B Preferred Stock was used to repurchase shares of our common stock held by Mr. Machin, one of our co-founders and directors. See "-- Repurchase of Shares from and Severance Arrangement with Director." Both the Series A Preferred Stock and the Series B Preferred Stock have cumulative dividends, liquidation preferences, redemption rights and conversion features. So long as the Series A shares have not been converted into Common Stock, the Series B shares may be converted into Series A shares by Quest at any time prior to April 21, 2000 and by the holders of the Series B shares at any time after April 21, 2000. 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." We intend to use approximately $10.6 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. The entities affiliated with InSight Capital Partners consist of InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P. and WI Software Investors LLC.
SERIES B SERIES A REDEEMABLE TOTAL SHARES ON AN PREFERRED PREFERRED AS-CONVERTED AGGREGATE INVESTOR STOCK STOCK BASIS CONSIDERATION - -------- --------- ---------- ------------------ ------------- Entities affiliated with InSight Capital Partners.................... 1,688,889 -- 2,533,333 $ 9,500,000 UBS Capital LLC....................... 977,778 1,777,778 1,466,667 15,500,000
REPURCHASE OF SHARES FROM AND SEVERANCE ARRANGEMENT WITH DIRECTOR In April 1999 we purchased an aggregate of 14,820,000 shares of our common stock for a total purchase price of $35.0 million from trusts established by Mr. Machin, one of the founders and a director of Quest. During late 1998, Mr. Machin sought to sell his stock and liquidate his position in Quest. Mr. Machin and the Company negotiated at arms-length to determine the pricing of the repurchase and Mr. Machin ultimately agreed upon a price based on the fact that he could obtain cash immediately. In addition, we entered into a severance agreement with Mr. Machin to pay him an annual fee of $200,000 per year from 1999 to 2001 and to provide for his use of a company car, related car expenses and medical benefits. There was no prior agreement that obligated us to consummate the repurchase transaction with Mr. Machin. Currently, Mr. Machin does not own any shares of our capital stock. ACQUISITION OF R*TECH SYSTEMS, INC. AND SALE OF STOCK TO OFFICER In March 1996, we acquired R*Tech Systems, Inc., the sole shareholder of which was Mr. Aronoff, our current Vice President, Engineering and Technology, through a merger of R*Tech with and into Quest. In the merger Quest issued 1,950,000 shares of common stock to Mr. Aronoff. Mr. Aronoff also entered into an employment agreement with us for a term of 24 months, under which he received an annual salary of $85,000, the right to receive commissions on the sale of certain products, the right to 55 57 receive bonus payments of up to $400,000 upon the achievement of specified performance milestones, and an option to purchase up to 2.5% of our outstanding capital stock. In April 1998, Mr. Aronoff purchased 975,000 shares of common stock under the option for a per share purchase price of $.769 and a total purchase price of $750,000, for which Mr. Aronoff executed a promissory note. The note has a term of four years, bears interest at the rate of 5.7% per annum, and up to 25% of the original principal amount of the note may be prepaid in each year of the four-year term. The entire amount due under the note may be prepaid upon a sale or merger of Quest or at any time Mr. Smith no longer serves as our chief executive officer. As of June 30, 1999, $573,008 of principal and interest on this note was outstanding. 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%. As of the date of this prospectus, the entire principal amount of this note is outstanding. This note is also secured in part by the 3,900,000 shares of common stock. TRANSACTIONS WITH DIRECTORS AND OFFICERS In June 1998, we granted options to two of our officers, Eyal Aronoff and Douglas Garn, to purchase 24,000 and 450,000 shares of our common stock, respectively, at an exercise price of $1.00 per share. In July 1998, we granted options to Mr. Garn and Terence Mullin and Charles Ramsey, officers, to purchase 126,000, 75,000 and 150,000 shares of our common stock, respectively, at an exercise price of $1.00. In September 1998, we granted options to Mr. Aronoff and to John Laskey, an officer, to purchase 15,000 and 180,000 shares of our common stock, respectively, at an exercise price of $1.17 per share. In January 1999, we granted options to purchase 120,000 shares of our common stock at an exercise price of $2.37 per share to Carla Fitzgerald, an officer. In January 1999, we granted options to purchase 30,000 and 15,000 shares of our common stock at an exercise price of $2.37 per share to Mr. Mullin and Mr. Ramsey, respectively. In June 1999, we granted options to purchase 35,000 shares of our common stock at an exercise price of $6.75 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. 56 58 PRINCIPAL SHAREHOLDERS The table below sets forth information regarding the beneficial ownership of our common stock as of June 30, 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 30, 1999, as adjusted to reflect - a three-for-two stock split that was effected in June 1999; - the conversion of all outstanding shares of our Series A Preferred Stock into 4,000,000 shares of common stock; and - the redemption for cash of all outstanding shares of our Series B Redeemable Preferred Stock. In addition, information presented in the table below assumes no exercise of the underwriters' over-allotment option. Beneficial ownership is determined in accordance with the rules of the Commission and generally includes voting or investment power with respect to securities. The number of shares beneficially owned and the percentage of shares beneficially owned are based on 33,724,600 shares of common stock outstanding as of June 30, 1999 and 38,124,600 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 30, 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)........................................ 18,233,499 54.1% 47.8% David M. Doyle............................................. 7,397,100 21.9% 19.4% Eyal M. Aronoff(2)......................................... 2,932,920 8.7% 7.7% Jerry Murdock(3)........................................... 2,785,201 8.3% 7.3% c/o InSight Capital Partners 122 East 42nd Street New York, NY 10168 InSight Capital Partners II, L.P.(4)....................... 2,520,001 7.5% 6.6% InSight Capital Partners 122 East 42nd Street New York, NY 10168 UBS Capital LLC(5)......................................... 1,466,667 4.3% 3.8% 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 (12 82.5% persons)(7).............................................. 31,664,670 93.1%
- ------------------------- * Less than one percent. 57 59 (1) Includes 38,100 shares held in the name of McNair Smith and 38,100 shares held in the name of McKenzie Smith, Mr. Smith's minor children. 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 30, 1999. (3) Includes 265,200 shares of common stock owned directly by Mr. Murdock. Also includes 792,000 shares of Series A Preferred Stock held by InSight Capital Partners II, L.P., 88,001 shares of Series A Preferred Stock held by InSight Capital Partners (Cayman) II, L.P., and 800,000 shares of Series A Preferred Stock held by WI Software Investors LLC., which will be converted into an aggregate of 2,520,001 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 88,001 shares of Series A Preferred Stock held by InSight Capital Partners (Cayman) II, L.P., 792,000 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 2,520,001 shares of common stock immediately prior to the closing of this offering. Each of InSight Capital Partners II, L.P. and InSight Capital Partners (Cayman) II, L.P. is a limited partnership controlled by its general partner, InSight Venture Associates II, LLC, which has voting and dispositive powers over its shares of Series A Preferred Stock. (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. UBS is a limited liability company controlled by a board of managers who have voting and dispositive powers over UBS' shares of Series A and Series B Preferred Stock. (6) Consists of 173,700 shares issuable upon the exercise of stock options that are exercisable within 60 days of June 30, 1999. (7) Includes 273,870 shares issuable upon the exercise of stock options that are exercisable within 60 days of June 30, 1999. See Notes 2 and 6. 58 60 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 30, 1999, there were 33,724,600 shares of common stock outstanding held of record by 24 shareholders, and options to purchase an aggregate of 4,578,875 shares of common stock were also outstanding. There will be 38,124,600 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 30, 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, 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 59 61 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." 60 62 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 38,124,600 shares of common stock outstanding assuming the issuance of 4,400,000 shares of common stock offered, no exercise of the underwriters' over-allotment option and no exercise of outstanding stock options after June 30, 1999. Of the total outstanding shares of common stock, the 4,400,000 shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act, except that any shares purchased by our "affiliates," as that term is defined in Rule 144 under the Securities Act, may generally only be sold pursuant to an effective registration statement under the Securities Act or in compliance with the limitations of Rule 144 as described below. The remaining 33,724,600 shares of common stock are "restricted securities" as that term is defined in Rule 144. All of these restricted securities will be available for sale in the public market under Rule 144 following the expiration of the 180 day lock-up agreement further described below. If the underwriter elects to waive the lock-up period for any reason, these shares will be available for sale under Rule 144 prior to that time. Beginning on the effective date of this offering the holders of 4,000,000 restricted shares are entitled to certain rights with respect to registration of these shares for sale in the public market. Registration of such shares under the Securities Act would result in such shares becoming freely tradeable without restriction under the Securities Act, except for shares purchased by our affiliates. If these holders sell in the public market these sales would have a material adverse effect on the market price of the common stock. 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 61 63 to sell within any three-month period a number of shares of common stock that does not exceed the greater of: - one percent of the then-outstanding shares of common stock (approximately 381,246 shares after giving effect to this offering); and - the average weekly trading volume of the common stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a Form 144 notice with respect to this sale. Sales under Rule 144 of the Securities Act are subject to certain restrictions relating to manner of sale, notice and the availability of current public information about us. Under Rule 144(k), a person who is not an affiliate of ours at any time during the 90 days preceding a sale, and who has beneficially owned shares for at least two years, including the holding period of any prior owner other than a person who may be deemed an affiliate of ours, would be entitled to sell these shares immediately following this offering without regard to the volume limitations, manner of sale provisions or notice or other requirements of Rule 144 of the Securities Act. However, the transfer agent may require an opinion of counsel that a proposed sale of shares comes within the terms of Rule 144 of the Securities Act prior to effecting a transfer of these shares. We are unable to estimate the number of shares that will be sold under Rule 144, as this will depend on the market price for our common stock, the personal circumstances of the sellers and other factors. 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 will file, on or after the date of this prospectus, a 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 will become 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." 62 64 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............................................. 4,400,000 =========
We have been advised by the Representatives that the underwriters propose to offer the shares of common stock to the public at the initial public offering price set forth on the cover page of this prospectus and to certain dealers at such price less a concession of not in excess of $ per share, of which $ may be reallowed to other dealers. After the initial public offering, the 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 660,000 additional shares of common stock at the same price per share as we will receive for the 4,400,000 shares that the underwriters have agreed to purchase. To the extent that the underwriters exercise this option, each of the underwriters will have a firm commitment to purchase approximately the same percentage of such additional shares that the number of shares of common stock to be purchased by it shown in the above table represents as a percentage of the 4,400,000 shares offered hereby. If purchased, such additional shares will be sold by the underwriters on the same terms as those on which the 4,400,000 shares are being sold. We will be obligated, pursuant to the option, to sell shares to the extent the option is exercised. The underwriters may exercise such option only to cover over-allotments made in connection with the sale of the shares of common stock offered hereby. If such option is exercised in full, the total public offering price, underwriting discounts and commissions and proceeds to us will be $65,780,000, $4,604,600 and $59,975,400, 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 65 Lock-Up Agreements Each of our executive officers, directors and shareholders and substantially all of our optionholders have agreed with the Representatives, for a period of 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. Directed Shares We have requested that the underwriters reserve up to 12% of the shares of common stock for sale at the initial public offering price to individuals designated by us. 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 66 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 materially complete, and you should refer to the copy of that contract or other document filed as an exhibit to the registration statement or any other document. You may inspect a copy of the registration statement without charge at the Public Reference Section of the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 or at the Commission's regional offices at 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036. The Commission maintains an Internet site that contains reports, proxy information statements and other information regarding registrants that file electronically with the Commission. The Commission's World Wide Web address is www.sec.gov. We intend to furnish holders of our common stock with annual reports containing, among other information, audited consolidated financial statements certified by an independent public accounting firm and quarterly reports containing unaudited condensed financial information for the first three quarters of each fiscal year. We intend to furnish these other reports as we may determine or as may be required by law. 65 67 QUEST SOFTWARE, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report................................ F-2 Consolidated Balance Sheets as of December 31, 1997, 1998 and June 30, 1999 (Unaudited)............................. F-3 Consolidated Statements of Operations for the Years ended December 31, 1996, 1997 and 1998 and the Six Months ended June 30, 1998 and 1999 (Unaudited)........................ F-4 Consolidated Statements of Shareholders' Equity for the Years ended December 31, 1996, 1997 and 1998 and the Six Months ended June 30, 1999 (Unaudited).................... F-5 Consolidated Statements of Cash Flows for the Years ended December 31, 1996, 1997 and 1998 and the Six Months ended June 30, 1998 and 1999 (Unaudited)........................ F-6 Notes to Consolidated Financial Statements.................. F-7
F-1 68 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 Employee Stock Purchase Plan described in note 7 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 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 7 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 July 21, 1999 F-2 69 QUEST SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, ----------------- JUNE 30, 1997 1998 1999 ------- ------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 2,096 $ 8,981 $ 11,777 Accounts receivable, net of allowance for doubtful accounts and sales returns of $783 (1997), $1,052 (1998) and $1,182 (1999)....................................... 4,815 7,443 10,447 Income taxes receivable................................... 122 -- -- Prepaid expenses and other current assets................. 100 720 1,608 Deferred income taxes..................................... -- 198 198 ------- ------- -------- Total current assets.................................. 7,133 17,342 24,030 Property and equipment: Furniture and fixtures.................................... 397 596 825 Machinery and equipment................................... 140 270 410 Computer equipment........................................ 1,001 1,711 2,709 Computer software......................................... 186 315 426 Leasehold improvements.................................... 56 109 166 ------- ------- -------- 1,780 3,001 4,536 Less accumulated depreciation and amortization.............. (857) (1,613) (2,245) ------- ------- -------- Property and equipment, net................................. 923 1,388 2,291 Purchased technology and software licenses, net............. 1,531 527 376 Deferred income taxes....................................... -- 267 267 Other assets................................................ 126 121 504 ------- ------- -------- $ 9,713 $19,645 $ 27,468 ======= ======= ========
PRO FORMA ----------- (UNAUDITED) LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 527 $ 1,468 $ 1,371 Accrued compensation...................................... 775 1,937 3,256 Other accrued expenses.................................... 1,170 2,243 3,706 Deferred support revenue.................................. 4,005 7,298 9,365 Deferred license revenue.................................. 282 1,625 3,181 ------- ------- -------- Total current liabilities............................. 6,759 14,571 20,879 Deferred income taxes....................................... 118 -- -- Bank loan payable........................................... -- -- 10,000 Series A Redeemable Preferred Stock, no par value, 2,667 shares authorized, issued and outstanding at June 30, 1999...................................................... -- -- 15,000 Series B Redeemable Preferred Stock, no par value, 1,800 shares authorized, 1,778 issued and outstanding at June 30, 1999.................................................. -- -- 10,340 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 29,725 shares issued and outstanding at December 31, 1997 and 1998, and June 30, 1999, respectively, 33,725 shares issued and outstanding, pro forma................................................... 3,425 4,241 4,306 $ 19,306 Retained earnings........................................... 1,645 3,991 31 31 Notes receivable from sale of common stock.................. (2,234) (3,158) (3,024) (3,024) Capital distribution in excess of basis in common stock..... -- -- (30,064) (30,064) ------- ------- -------- -------- Total shareholders' equity (deficit).................. 2,836 5,074 (28,751) $(13,751) ------- ------- -------- ======== $ 9,713 $19,645 $ 27,468 ======= ======= ========
See accompanying notes to consolidated financial statements. F-3 70 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ----------------------------- ------------------ 1996 1997 1998 1998 1999 ------- ------- ------- ------- ------- (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Revenues: Licenses............................... $ 9,316 $12,158 $24,901 $ 9,580 $21,365 Services............................... 3,546 6,157 9,889 4,455 6,924 ------- ------- ------- ------- ------- Total revenues.................... 12,862 18,315 34,790 14,035 28,289 Cost of revenues: Licenses............................... 950 1,307 3,433 1,504 1,404 Services............................... 1,467 1,972 2,507 1,044 1,738 ------- ------- ------- ------- ------- Total cost of revenues............ 2,417 3,279 5,940 2,548 3,142 ------- ------- ------- ------- ------- Gross profit............................. 10,445 15,036 28,850 11,487 25,147 Operating expenses: Sales and marketing.................... 4,328 5,845 11,836 4,371 12,158 Research and development............... 2,995 4,293 8,047 3,629 6,034 General and administrative............. 3,494 3,450 5,278 2,070 3,989 Compensation and other costs........... -- -- -- -- 775 ------- ------- ------- ------- ------- Total operating expenses.......... 10,817 13,588 25,161 10,070 22,956 ------- ------- ------- ------- ------- Income (loss) from operations............ (372) 1,448 3,689 1,417 2,191 Other income (expense), net.............. 389 (137) 336 119 82 ------- ------- ------- ------- ------- Income before income tax provision....... 17 1,311 4,025 1,536 2,273 Income tax provision..................... 1 1,022 1,679 637 959 ------- ------- ------- ------- ------- Net income............................... $ 16 $ 289 $ 2,346 $ 899 1,314 ======= ======= ======= ======= Preferred stock dividends................ 340 ------- Net income applicable to common shareholders........................... $ 974 ======= Net income per share: Basic.................................. $ -- $ 0.01 $ 0.05 $ 0.02 $ 0.03 Diluted................................ $ -- $ 0.01 $ 0.05 $ 0.02 $ 0.02 Weighted average shares: Basic.................................. 38,350 40,373 44,261 43,990 38,809 Diluted................................ 38,350 40,617 44,459 43,990 43,580 Pro forma basic and diluted net income per share.............................. $ 0.05 $ 0.02 Pro forma weighted average basic shares outstanding............................ 48,261 42,809 Pro forma weighted average diluted shares outstanding............................ 48,459 45,016
See accompanying notes to consolidated financial statements. F-4 71 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
CAPITAL DISTRIBUTION NOTES IN EXCESS OF TOTAL COMMON STOCK RECEIVABLE BASIS IN SHAREHOLDERS' ----------------- RETAINED FROM COMMON EQUITY SHARES AMOUNT EARNINGS SHAREHOLDERS STOCK (DEFICIT) -------- ------ -------- ------------ ------------ ------------- 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.................. 7 7 -- -- -- 7 Payment on notes receivable from shareholders for purchase of common stock.................................... -- -- -- 230 -- 230 Accrued interest receivable from shareholders............................. -- -- -- (96) -- (96) Repurchase of common stock................. (14,820) (2) (4,934) -- (30,064) (35,000) Compensation expense associated with stock option grants............................ -- 60 -- -- -- 60 Dividends on Series B Redeemable Preferred Stock.................................... -- -- (340) -- -- (340) Net income................................. -- -- 1,314 -- -- 1,314 -------- ------ ------- ------- -------- -------- BALANCE, June 30, 1999..................... 29,725 $4,306 $ 31 $(3,024) $(30,064) $(28,751) ======== ====== ======= ======= ======== ========
See accompanying notes to consolidated financial statements. F-5 72 QUEST SOFTWARE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ----------------------------- ------------------ 1996 1997 1998 1998 1999 ------- ------- ------- ------ -------- (UNAUDITED) Cash flows from operating activities: Net income............................................. $ 16 $ 289 $ 2,346 $ 898 $ 1,314 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization...................... 743 964 1,893 776 1,002 Compensation expense associated with stock option grants.......................................... -- -- -- -- 60 Loss from disposal of property and equipment....... 25 52 -- -- -- Accrued interest receivable from shareholders...... -- (34) (174) (75) (96) Deferred income taxes.............................. -- 178 (643) (970) -- Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable............................. (1,051) (683) (2,628) (212) (3,004) Income taxes receivable......................... -- (122) 122 122 -- Prepaid expenses and other current assets....... (363) 282 (620) (651) (888) Other assets.................................... (131) 38 5 12 (383) Accounts payable................................ 263 113 941 (263) (97) Bank overdraft.................................. 393 (393) -- -- -- Accrued compensation............................ (703) 108 1,162 868 1,319 Other accrued expenses.......................... 119 881 1,141 963 1,471 Deferred revenue................................ 705 1,960 4,636 572 3,623 ------- ------- ------- ------ -------- Net cash provided by operating activities....... 16 3,633 8,181 2,040 4,321 Cash flows from investing activities: Purchases of property and equipment.................... (589) (536) (1,231) (462) (1,520) Purchases of software licenses......................... -- (831) (57) (31) (234) Cash received (paid) for acquisitions.................. (769) 100 -- -- -- ------- ------- ------- ------ -------- Net cash used in investing activities........... (1,358) (1,267) (1,288) (493) (1,754) Cash flows from financing activities: Distributions to shareholders.......................... (1,360) (261) -- -- -- Proceeds from note payable............................. -- -- -- -- 10,000 Proceeds from issuance of preferred stock.............. -- -- -- -- 25,000 Repurchase of common stock............................. -- -- -- -- (35,000) Proceeds from the exercise of stock options............ -- -- -- -- 7 Repayment of note payable to related party............. (7) (9) (8) (4) (8) Payment on notes receivable from shareholders for purchase of common stock............................. -- -- -- -- 230 ------- ------- ------- ------ -------- Net cash (provided by) used in financing activities.................................... (1,367) (270) (8) (4) 229 ------- ------- ------- ------ -------- Net increase (decrease) in cash and cash equivalents..... $(2,709) $ 2,096 $ 6,885 $1,543 $ 2,796 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 $3,639 $ 11,777 ======= ======= ======= ====== ======== Supplemental disclosures of consolidated cash flow information: Cash paid during the year for: Interest............................................. $ 2 $ 8 $ 5 $ 4 $ 69 ======= ======= ======= ====== ======== Income taxes......................................... $ 28 $ 938 $ 2,054 $ 932 $ 1,787 ======= ======= ======= ====== ======== Supplemental schedule of noncash investing and financing activities: Note receivable from shareholders for purchase of common stock......................................... $ 2,200 $ 750 $ 750 ======= ======= ====== Accrued interest receivable from shareholders.......... $ 34 $ 174 $ 75 $ 96 ======= ======= ====== ======== Dividends payable on Series B Redeemable Preferred Stock................................................ $ 340 ========
See Note 2 for details of assets acquired and liabilities assumed in purchase transactions. See accompanying notes to consolidated financial statements. F-6 73 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 June 30, 1999 and for the six months ended June 30, 1998 and June 30, 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 was effective on , 1999. 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 six months ended June 30, 1998 and 1999. However, due to the increase in international operations, the Company's results of operations could be impacted in the future. Fair Value of Financial Instruments -- The Company's consolidated balance sheets include the following financial instruments: cash, accounts receivable, notes receivable, accounts payable, and accrued liabilities. The Company considers the carrying value of cash, accounts receivable, accounts payable, and accrued liabilities in the consolidated financial statements to approximate fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. Based on borrowing rates currently available, the fair value of the notes receivable from the sale of common stock at December 31, 1998 and June 30, 1999 was approximately $3,290 and $3,222, respectively. Cash and Cash Equivalents -- Cash equivalents include short-term, highly liquid investments with original maturities of three months or less. Interest income, included in other income (expense) in the accompanying consolidated statements of operations, was $17, $72, $372, $35 and $315 for the years ended December 31, 1996, 1997 and 1998, and the six months ended June 30, 1998 and 1999, respectively. F-7 74 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Accounts Receivable -- The Company sells and/or licenses its products and services to various companies across several industries. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and sales returns. 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 June 30, 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 $1,638 at December 31, 1997 and 1998, and June 30, 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 $871 at December 31, 1997 and 1998, and June 30, 1999, respectively. The net carrying amount of purchased technology and software licenses was considered recoverable at December 31, 1998 and June 30, 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 $42 of the settlement receivable is recorded in other current assets in the accompanying consolidated financial statements at December 31, 1998 and June 30, 1999, respectively. Capital Distribution in Excess of Basis in Common Stock -- In connection with the repurchase of common stock in April 1999 from a major stockholder (note 3) the excess of the repurchase price over the original cost of the shares has been recorded as a capital distribution in excess of the basis of the common stock in the accompanying consolidated financial statements. Revenue Recognition -- During October 1997, the Financial Accounting Standards Board (FASB) issued Statement of Position (SOP) 97-2, Software Revenue Recognition, which provides guidance in recognizing revenue on software transactions. SOP 97-2 is effective for transactions entered into in fiscal years beginning after December 15, 1997, and supersedes SOP 91-1. The Company adopted this statement, as amended, for the year ended December 31, 1998 and such adoption did not have any impact on the Company's results of operations.. Software Licenses, Services, and Post-Contract Customer Support -- Revenues from sales of software licenses, which generally do not contain multiple elements, are recognized upon shipment of the related product if the requirements of SOP 97-2, as amended, are met. If the requirements of SOP 97-2 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 F-8 75 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 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 June 30, 1999. Advertising Expenses -- Advertising expenses were $636, $300, $594, $257 and $516 for the years ended December 31, 1996, 1997 and 1998 and the six months ended June 30, 1998 and 1999, respectively. Income Taxes -- The Company accounts for its income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. Deferred taxes on income result from temporary differences between the reporting of income for financial statements and tax reporting purposes. 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 6). 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. For the six months ended June 30, 1999, net income applicable to common shareholders was $974 representing net income for the period of $1,314 less Preferred Stock dividends of $340 associated with the Series B Redeemable Preferred Stock. F-9 76 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The table below sets forth the reconciliation of the denominator of the earnings per share calculation:
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, --------------------------- ----------------- 1996 1997 1998 1998 1999 ------- ------- ------- ------- ------- Shares used in computing basic net income per share.............................. 38,350 40,373 44,261 43,990 38,809 Conversion of Series A Preferred Stock... -- -- -- -- 1,547 Conversion of Series B Redeemable Preferred Stock........................ -- -- -- -- 1,017 Dilutive effect of stock options......... -- 244 198 -- 2,207 ------- ------- ------- ------- ------- Shares used in computing diluted net income per share....................... 38,350 40,617 44,459 43,990 43,580 ======= ======= ======= Conversion of Series A Preferred Stock... 4,000 2,453 ------- ------- Redemption of Series B Redeemable Preferred Stock........................ -- (1,017) Shares used in computing proforma diluted net income per share................... 48,459 45,016 ======= =======
The conversion of the Series A Preferred and Series B Redeemable Preferred Stock into common stock reflects the weighted average of such shares per SFAS No. 128. The pro forma adjustment for the conversion of the Series A Preferred Stock represents the adjustment required to reflect the conversion of the Series A Preferred Stock to common stock as if it occurred on January 1, 1999. The adjustment to the pro forma basic and diluted net income per share reflects the redemption of the Series B Redeemable Preferred Stock from the proceeds of the Company's planned initial public offering. 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 6). The accompanying pro forma information, which is unaudited, gives effect to the conversion of all outstanding shares of Series A Preferred Stock into common stock immediately prior to the closing of the offering. 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 six months ended June 30, 1998 and 1999. F-10 77 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 9 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 subsidiary, and in July 1997 commenced liquidation proceedings. At December 31, 1998 and June 30, 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 was included in other accrued expenses in the accompanying consolidated financial statements representing the remaining outstanding F-11 78 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS note payable balance at December 31, 1998. The remaining note payable balance was repaid during the six months ended June 30, 1999. During 1997 the Company received a note receivable from an officer of the Company for the purchase of 3,900 shares of the Company's common stock at $.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. In April 1999, the Company repurchased and cancelled 14,820 shares of common stock from a shareholder of the Company at a price of $2.36 per share. The Company also entered into a severance agreement with the shareholder whereby the shareholder will receive $200 per year through 2001 and provides for use of a company car and related expenses and medical benefits. The Company recorded approximately $715 of expense related to the agreement in April 1999, which is included in compensation and other costs in the accompanying consolidated financial statements. F-12 79 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS \ 4. TERM NOTE In connection with the repurchase of common stock from a shareholder in April 1999 (Note 3), 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 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. The Company was in compliance with all covenants at June 30, 1999. Interest expense related to the loan was $315 for the six months ended June 30, 1999. 5. 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% ===== ====
F-13 80 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred taxes as of December 31, 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. 6. SHAREHOLDERS' EQUITY In April 1999, the Company issued 2,667 shares of Series A Preferred Stock (Series A) for $15,000 and 1,778 shares of Series B Redeemable Preferred stock (Series B) for $10,000. Series A shares 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 F-14 81 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS on a when and as if declared basis at a rate of 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. For the six months ended June 30, 1999, $340 has been recorded as dividends payable. 7. 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. 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. The 1999 Stock Incentive Plan became effective upon its adoption by the board. On the date of the Company's initial public offering all outstanding options under the 1998 plan will be incorporated into the 1999 Stock Incentive Plan, and no further option grants will thereafter be made under the 1998 plan. The incorporated options will continue to be governed by their existing terms, unless the plan administrator elects to extend one or more features of the 1999 Incentive Plan to those options. Except as otherwise noted below, the incorporated options have F-15 82 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS substantially the same terms as will be in effect for grants made under the Discretionary Option Grant Program of the 1999 Stock Incentive Plan. Share Reserve. 7,493 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 shares of common stock in total per calendar year. Programs. The 1999 Stock Incentive Plan is divided into five separate programs: - the discretionary option grant program under which eligible individuals may be granted options to purchase shares of common stock at an exercise price determined by the plan administrator; - the stock issuance program under which individuals may be issued shares of common stock directly, through the purchase of such shares at a price determined by the plan administrator or as a bonus tied to the performance of services; - the salary investment option grant program which may, at the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow executive officers and other highly compensated employees the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants; - the automatic option grant program under which option grants will automatically be made at periodic intervals to eligible non-employee board members to purchase shares of common stock at an exercise price equal to 100% of the fair market value of those shares on the grant date; and - the director fee option grant program which may, in the plan administrator's discretion, be activated for one or more calendar years and, if so activated, will allow non-employee board members the opportunity to apply a portion of the annual retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants. Administration. The discretionary option grant program and the stock issuance program will be administered by the compensation committee of the board of directors. Plan Features. The 1999 Stock Incentive Plan 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 the Company equal to the fair market value of the vested shares of common stock subject to the surrendered option less the exercise price payable for those shares. Payment can be made in cash or in shares of common stock. F-16 83 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Change in Control. The 1999 Stock Incentive Plan includes the following change in control provisions which may result in the accelerated vesting of outstanding option grants and stock issuances: - In the event that the Company is acquired by merger or asset sale or a board-approved sale of more than fifty percent of the then outstanding stock, each outstanding option under the discretionary option grant program which is not assumed or continued by the successor corporation will immediately become exercisable for all the option shares, and all unvested shares will immediately vest, except to the extent the Company's repurchase rights with respect to those shares are assigned to the successor corporation. - The plan administrator will have complete discretion to grant one or more options which will become exercisable for all the option shares in the event those options are assumed in an acquisition but the optionee's service with the Company or the acquiring entity is subsequently terminated. The vesting of outstanding shares under the 1999 Stock Incentive Plan may be accelerated upon similar terms and conditions. - The plan administrator may also grant options which will immediately vest upon our acquisition by another entity, whether or not those options are assumed by the successor corporation. - The plan administrator may grant options and structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a successful tender offer for more than 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 nor more than $75. Each selected individual who makes such an election will automatically be granted, on the first trading day in January of the calendar year for which that salary reduction is to be in effect, an option to purchase that number of shares of common stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of common stock on the grant date. Compensation expense will be recorded for the amount of the salary reduction. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. As a result, the total spread on the option shares at the time of grant will be equal to the amount of salary invested in that option. The option will vest and become exercisable in a series of twelve equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting upon certain changes in the ownership or control. Automatic Option Grant Program. Each individual who first becomes a non-employee board member at any time after the completion of this offering will automatically receive an option grant for 25 shares on the date such individual joins the board, provided such individual has not been in the prior employ of the Company. In addition, on the date of each annual shareholders meeting beginning with the 2001 annual shareholders meeting, each non-employee board member who has served as a non-employee board member since the date of the last annual shareholders meeting will automatically be granted an option to purchase 8 shares of common stock. Each automatic grant will have a term of ten years, subject to earlier termination following the optionee's cessation of board service. The initial 25 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 F-17 84 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS shares. The shares subject to each 25 share automatic option grant will vest over a four year period in successive equal annual installments upon the individual's completion of each year of board service over the four year period measured from the option grant date. However, the shares subject to each such automatic grant will immediately vest in full upon certain changes in control or ownership of Quest or upon the optionee's death or disability while a board member. Each 8 share automatic option grant will be immediately exercisable and fully vested on the option grant date. Director Fee Option Grant Program. If this program is put into effect, 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 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 8, 2009. 1999 EMPLOYEE STOCK PURCHASE PLAN Introduction. The 1999 Employee Stock Purchase Plan was adopted by the board and approved by the shareholders in June 1999 and will become effective immediately upon the effective date of the Company's initial public offering. The 1999 Employee Stock Purchase Plan is designed to allow eligible employees and the employees of participating subsidiaries to purchase shares of common stock, at semi-annual intervals, through their periodic payroll deductions. Share Reserve. 600 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 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. F-18 85 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Eligible Employees. Individuals who are scheduled to work more than twenty hours per week for more than five calendar months per year on the start date of any purchase period may join the plan on such start date. Payroll Deductions. A participant may contribute up to 15% of their cash earnings, and the accumulated payroll deductions will be applied to the purchase of shares on each semi-annual purchase date. The purchase price per share will be equal to 85% the fair market value of the common stock on the start date of the purchase period or, if lower, the fair market value on the semi-annual purchase date. Semi-annual purchase dates will occur on the last business day of January and July each year. In no event, however, may any participant purchase more than .6 shares on any semi-annual purchase date. Change in Control. In the event 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 available to common shareholders would have been decreased to the pro forma amounts indicated below:
DECEMBER 31, JUNE 30, 1998 1999 ------------ --------- Net income available to common shareholders: As reported............................................... $2,346 $ 974 ====== ====== Pro forma................................................. $2,177 $ 598 ====== ====== Basic net income per share: As reported............................................... $ 0.05 $ 0.03 ====== ====== Pro forma................................................. $ 0.05 $ 0.02 ====== ====== Diluted net income per share: As reported............................................... $ 0.05 $ 0.02 ====== ====== Pro forma................................................. $ 0.05 $ 0.01 ====== ======
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 six months ended June 30, 1998 and 1999: expected volatility of zero; risk-free interest rates of 6%; and expected lives of ten years. F-19 86 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A summary of the status of the Plans is presented below:
DECEMBER 31, JUNE 30, --------------------------------------------------------- ------------------------------------- 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 1,198 $1.00 1,419 $3.56 Exercised................. -- $ -- -- $ -- -- $ -- -- $ -- (7) $1.00 Canceled.................. -- $ -- (556) $0.40 (991) $0.77 -- $ -- (200) $2.18 ----- ----- ----- ----- ----- Balance, end of period.... 1,531 $0.64 975 $0.77 3,367 $1.19 2,173 $0.90 4,579 $1.88 Weighted average fair value of options granted during the year......... $0.00 -- $0.53 $0.24 $3.09 ===== ===== ===== ===== =====
The Company will record compensation expense of approximately $1,905 relating to options granted to purchase 387 shares of common stock in May and June of 1999 equal to the difference between the fair market value of the Company's common stock on the grant date and the exercise price of the stock options. The expense will be recognized ratably over the four-year vesting period of the stock options. The Company recorded $60 of expense associated with such option grants during the six month period ended June 30, 1999 which is included in compensation and other costs in the accompanying consolidated financial statements. The following tables summarize information about stock options outstanding as of December 31, 1998 and June 30, 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 ===== ==
JUNE 30, 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........................... 2,228 9.0 $1.00 246 $1.00 $1.16 -- 2.00........................... 667 9.3 $1.17 -- -- $2.00 -- 4.00........................... 1,512 9.6 $2.74 -- -- $4.00 -- 9.00........................... 172 10.0 $8.48 -- -- ----- --- 4,579 246 ===== ===
F-20 87 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Options to purchase 15 shares of common stock at $1.00 per share were exercised in July 1999. 8. COMMITMENTS AND CONTINGENCIES The Company leases its office facilities and certain equipment under various operating leases. Total rent expense was $456, $732, $1,038, $484, and $732, for the years ended December 31, 1997, 1998, and 1999, and the six months ended June 30, 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 ======
Subsequent to December 31, 1998, the Company entered into a new office facility lease which is scheduled to commence October 1, 1999. The minimum lease commitment under the new lease is $1,944, $2,025, $2,106, $2,187, $2,268, and $2,349 for the first, second, third, fourth, fifth, and sixth years following the commencement date, respectively. 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, $196, and $733 to the amended plan for the years ended December 31, 1997 and 1998 and the six months ended June 30, 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 advertisements that Mobius allege in its complaint are false and misleading are two e-mails intended for internal use, a comparison chart believed to have been prepared by a former Company employee in 1997 for internal purposes, and a statement made regarding the Company's Vista Plus Java client which had been posted on the Internet. The 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. In response to Mobius' complaint, the Company has filed a motion to dismiss which is set for hearing on September 13, 1999. 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 the Company's business, results of operations or financial condition; 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, that the ultimate disposition of these matters will not materially affect the Company's results of operations or financial position. F-21 88 QUEST SOFTWARE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. 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. The Company does not separately allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of sales and gross profit as this information and the geographic information described below are the only information provided to the chief operating decision maker. Operating segment data for the three years in the period ended December 31, 1998 and the six months ended June 30, 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.................................................. $12,158 $6,157 $18,315 Cost of revenues.......................................... 1,307 1,972 3,279 ------- ------ ------- Gross profit........................................... $10,851 $4,145 $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 ======= ====== ======= Six months ended June 30, 1998: Revenues.................................................. $ 9,580 $4,455 $14,035 Cost of revenues.......................................... 1,504 1,044 2,548 ------- ------ ------- Gross profit........................................... $ 8,076 $3,411 $11,487 ======= ====== ======= Six months ended June 30, 1999: Revenues.................................................. $21,365 $6,924 $28,289 Cost of revenues.......................................... 1,404 1,738 3,142 ------- ------ ------- Gross profit........................................... $19,961 $5,186 $25,147 ======= ====== =======
F-22 89 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 long-lived assets concerning principal geographic areas in which the Company operates are as follows:
UNITED STATES 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) Long-lived assets............................ 1,662 68 -- 1,730 Year ended December 31, 1997: Revenues..................................... $17,511 $1,261 $ (457) $18,315 Gross profit................................. 14,413 1,075 (452) 15,036 Income (loss) from operations................ 1,533 (339) 254 1,448 Long-lived assets............................ 2,336 118 -- 2,454 Year ended December 31, 1998: Revenues..................................... $32,189 $4,172 $(1,571) $34,790 Gross profit................................. 26,594 3,840 (1,584) 28,850 Income (loss) from operations................ 3,839 (252) 102 3,689 Long-lived assets............................ 1,600 315 -- 1,915 Six months ended June 30, 1998: Revenues..................................... $13,017 $1,746 $ (728) $14,035 Gross profit................................. 10,624 1,591 (728) 11,487 Income (loss) from operations................ 1,291 203 (77) 1,417 Long-lived assets............................ 2,056 180 -- 2,236 Six months ended June 30, 1999: Revenues..................................... $24,573 $4,799 $(1,083) $28,289 Gross profit................................. 21,662 4,574 (1,089) 25,147 Income from operations....................... 1,281 667 243 2,191 Long-lived assets............................ 2,142 525 -- 2,667
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 six months ended June 30, 1998 and 1999, no single customer accounted for 10% or more of total revenue. No single international location accounted for more than 5% of total revenues for any of the periods indicated. F-23 90 Inside Back Cover [QUEST SOFTWARE LOGO] [Background consists of the names of certain Quest customers] Quest Software products have been sold to thousands of corporations, governmental agencies and other organizations worldwide. The companies listed here are a representative sampling of customers who have purchased at least $100,000 of software licenses since January 1996. 91 [QUEST SOFTWARE LOGO] 92 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........................................ $ 19,694 NASD Filing Fee............................................. 7,584 Nasdaq National Market Listing Fee.......................... 90,000 Printing and Engraving Expenses............................. 160,000 Legal Fees and Expenses..................................... 350,000 Accounting Fees and Expenses................................ 175,000 Blue Sky Fees and Expenses.................................. 5,000 Transfer Agent Fees......................................... 15,000 Directors' & Officers' Liability Insurance.................. 250,000 Miscellaneous............................................... 127,722 ---------- Total............................................. $1,200,000 ==========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Registrant's Amended and Restated Articles of Incorporation limit the personal liability of its directors for monetary damages to the fullest extent permitted by the California General Corporation Law (the "California Law"). Under the California Law, a director's liability to a company or its shareholders may not be limited (1) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (2) for acts or omissions that a director believes to be contrary to the best interest of the Registrant or its shareholders or that involve the absence of good faith on the part of the director, (3) for any transaction from which a director derived an improper personal benefit, (4) for acts or omissions that show a reckless disregard for the director's duty to the Registrant or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of a serious injury to the Registrant or its shareholders, (5) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Registrant or its shareholders, (6) under Section 310 of the California Law concerning contacts or transactions between the Registrant and a director, or (7) under Section 316 of the California Law concerning directors' liability for improper dividends, loans and guarantees. The limitation of liability does not affect the availability of injunctions and other equitable remedies available to the Registrant's shareholders for any violation by a director of the director's fiduciary duty to the Registrant or its shareholders. The Registrant's Articles of Incorporation also include an authorization for the Registrant to indemnify its "agents" (as defined in Section 317 of the California Law), through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, the Registrant's Bylaws provide for indemnification of the Registrant's directors, officers and employees. In addition, the Registrant, at its discretion, may provide indemnification to persons whom the Registrant is not obligated to indemnify. The Bylaws also allow the Registrant to enter into indemnity agreements with individual directors, officers, employees and other agents. These indemnity agreements have been entered into with all directors and executive officers and provide the maximum indemnification permitted by law. These agreements, together with the Registrant's Bylaws and Articles of Incorporation, may require the Registrant, among other things, to indemnify these directors or executive officers (other than for liability resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, II-1 93 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 94 8. Since June, 1998, the Registrant has granted stock options to purchase common stock under individual stock option agreements and the 1998 Stock Option/Stock Issuance Plan to eligible officers, directors, consultants and employees of the Registrant as described in the prospectus. 9. Since June, 1999, the Registrant has granted stock options to purchase common stock under the 1999 Stock Incentive Plan to eligible officers, directors, consultants and employees of the Registrant as described in the prospectus. 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** Amended and Restated Articles of Incorporation, as amended. 3.2** Second Amended and Restated Articles of Incorporation, to be filed with the California Secretary of State upon consummation of this offering. 3.3** Amended and Restated Bylaws. 3.4** Second Amended and Restated Bylaws. 4.1 Form of Registrant's Specimen Common Stock Certificate. 5.1 Form of Opinion of Brobeck, Phleger & Harrison LLP. 10.1** Registrant's 1998 Stock Option/Stock Issuance Plan. 10.2 Registrant's 1999 Stock Incentive Plan. 10.3** Registrant's 1999 Employee Stock Purchase Plan. 10.4** Form of Directors' and Officers' Indemnification Agreement. 10.5** Securities Purchase Agreement, dated as of April 21, 1999, by and among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.6** Investors' Rights Agreement dated as of April 21, 1999 among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.7+** Agreement, dated February 19, 1999, between Quest Software, Inc. and INSO Chicago Corporation, dba INSO Corporation. 10.8+** OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 10.9 Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest Software, Inc. 21.1** Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP.
II-3 95
EXHIBIT NUMBER EXHIBIT TITLE - ------- ------------- 23.2 Form of Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1** Power of Attorney (Included on signature page hereto). 27.1 Financial Data Schedule (In EDGAR format only).
- ------------------------- ** Previously filed. + Confidential treatment is being sought with respect to certain portions of this agreement. Such portions have been omitted from this filing and have been filed separately with the Securities and Exchange Commission. II-4 96 (b) FINANCIAL STATEMENT SCHEDULE SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNT
BALANCE AT CHARGES, BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD ----------- ---------- --------- ---------- ---------- Year ended December 31, 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-5 97 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Amendment No. 2 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Newport Beach, State of California, on this 22nd day of July, 1999. QUEST SOFTWARE, INC. By: /s/ DAVID M. DOYLE ------------------------------------ David M. Doyle President and Secretary Pursuant to the requirements of the Securities Act of 1933, as amended, this Amendment No. 2 to the 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 - --------- ----- ---- * Chief Executive Officer (principal July 22, 1999 - --------------------------------------------------- executive officer) and Chairman Vincent C. Smith of the Board /s/ DAVID M. DOYLE President, Secretary and Director July 22, 1999 - --------------------------------------------------- David M. Doyle * Chief Financial Officer (principal July 22, 1999 - --------------------------------------------------- financial and accounting officer) John J. Laskey and Vice President, Finance * Director July 22, 1999 - --------------------------------------------------- Doran G. Machin * Director July 22, 1999 - --------------------------------------------------- Jerry Murdock, Jr. * Director July 22, 1999 - --------------------------------------------------- Raymond J. Lane *By: /s/ DAVID M. DOYLE July 22, 1999 ---------------------------------------------- David M. Doyle (Attorney-in-fact)
II-6 98 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT TITLE - ------- ------------- 1.1 Form of Underwriting Agreement. 3.1** Amended and Restated Articles of Incorporation, as amended. 3.2** Second Amended and Restated Articles of Incorporation, to be filed with the California Secretary of State upon consummation of this offering. 3.3** Amended and Restated Bylaws. 3.4** Second Amended and Restated Bylaws. 4.1 Form of Registrant's Specimen Common Stock Certificate. 5.1 Form of Opinion of Brobeck, Phleger & Harrison LLP. 10.1** Registrant's 1998 Stock Option/Stock Issuance Plan. 10.2 Registrant's 1999 Stock Incentive Plan. 10.3** Registrant's 1999 Employee Stock Purchase Plan. 10.4** Form of Directors' and Officers' Indemnification Agreement. 10.5** Securities Purchase Agreement, dated as of April 21, 1999, by and among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.6** Investors' Rights Agreement dated as of April 21, 1999 among Quest Software, Inc. and InSight Capital Partners II, L.P., InSight Capital Partners (Cayman) II, L.P., UBS Capital LLC, and WI Software Investors LLC. 10.7+** Agreement, dated February 19, 1999, between Quest Software, Inc. and INSO Chicago Corporation, dba INSO Corporation. 10.8+** OEM Agreement, dated March 3, 1998, by and between Quest Software, Inc. and Artifex Software Inc. 10.9 Office Space Lease dated as of June 17, 1999 between The Irvine Company and Quest Software, Inc. 21.1** Subsidiaries of the Registrant. 23.1 Consent of Deloitte & Touche LLP. 23.2 Form of Consent of Brobeck, Phleger & Harrison LLP (Included in Exhibit 5.1 hereto). 24.1** Power of Attorney (Included on signature page hereto). 27.1 Financial Data Schedule (In EDGAR format only).
- ------------------------- ** Previously filed. + Confidential treatment is being sought with respect to certain portions of this agreement. Such portions have been omitted from this filing and have been filed separately with the Securities and Exchange Commission. EX-1.1 2 FORM OF UNDERWRITING AGREEMENT 1 EXHIBIT 1.1 UNDERWRITING AGREEMENT _______ __, 1999 BancBoston Robertson Stephens Inc. Donaldson, Lufkin & Jenrette Securities Corporation CIBC World Markets Corp. FAC/Equities, a division of First Albany Corporation c/o BancBoston Robertson Stephens Inc. 555 California Street, Suite 2600 San Francisco, CA 94104 As Representative of the several Underwriters Ladies and Gentlemen: INTRODUCTORY. Quest Software, Inc., a California corporation (the "Company), proposes to issue and sell to the several underwriters named in Schedule A (the "Underwriters") an aggregate of 4,400,000 shares (the "Firm Shares") of its Common Stock, no par value per share (the "Common Shares"). In addition, the Company has granted to the Underwriters an option to purchase up to an additional 660,000 Common Shares (the "Option Shares") as provided in Section 2. The Firm Shares and, if and to the extent such option is exercised, the Option Shares are collectively called the "Shares". BancBoston Robertson Stephens Inc., Donaldson, Lufkin & Jenrette Securities Corp., CIBC World Markets Corp. and FAC/Equities, a division of First Albany Corporation, have agreed to act as representatives of the several Underwriters (in such capacity, the "Representatives") in connection with the offering and sale of the Shares. The Company has prepared and filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-1 (File No. 333-80583), which contains a form of prospectus to be used in connection with the public offering and sale of the Shares. Such registration statement, as amended, including the financial statements, exhibits and schedules thereto, in the form in which it was declared effective by the Commission under the Securities Act of 1933 and the rules and regulations promulgated thereunder (collectively, the "Securities Act"), including any information deemed to be a part thereof at the time of effectiveness pursuant to Rule 430A or Rule 434 under the Securities Act, is called the "Registration Statement". Any registration statement filed by the Company pursuant to Rule 462(b) under the Securities Act is called the "Rule 462(b) Registration Statement", and from and after the date and time of filing of the Rule 462(b) Registration Statement the term "Registration Statement" shall include the Rule 462(b) Registration Statement. Such prospectus, in the form first used by the Underwriters to confirm sales 2 of the Shares, is called the "Prospectus"; provided, however, if the Company has, with the consent of BancBoston Robertson Stephens Inc., elected to rely upon Rule 434 under the Securities Act, the term "Prospectus" shall mean the Company's prospectus subject to completion (each, a "preliminary prospectus") dated ________ __, 1999 (such preliminary prospectus is called the "Rule 434 preliminary prospectus"), together with the applicable term sheet (the "Term Sheet") prepared and filed by the Company with the Commission under Rules 434 and 424(b) under the Securities Act and all references in this Agreement to the date of the Prospectus shall mean the date of the Term Sheet. All references in this Agreement to the Registration Statement, the Rule 462(b) Registration Statement, a preliminary prospectus, the Prospectus or the Term Sheet, or any amendments or supplements to any of the foregoing, shall include any copy thereof filed with the Commission pursuant to its Electronic Data Gathering, Analysis and Retrieval System ("EDGAR"). The Company hereby confirms its agreements with the Underwriters as follows: SECTION 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company hereby represents, warrants and covenants to each Underwriter as follows: (a) Compliance with Registration Requirements. The Registration Statement and any Rule 462(b) Registration Statement have been declared effective by the Commission under the Securities Act. The Company has complied to the Commission's satisfaction with all requests of the Commission for additional or supplemental information. No stop order suspending the effectiveness of the Registration Statement or any Rule 462(b) Registration Statement is in effect and no proceedings for such purpose have been instituted or are pending or, to the best knowledge of the Company, are contemplated or threatened by the Commission. Each preliminary prospectus and the Prospectus when filed complied in all material respects with the Securities Act and, if filed by electronic transmission pursuant to EDGAR (except as may be permitted by Regulation S-T under the Securities Act), was identical to the copy thereof delivered to the Underwriters for use in connection with the offer and sale of the Shares. Each of the Registration Statement, any Rule 462(b) Registration Statement and any post-effective amendment thereto, at the time it became effective and at all subsequent times, complied and will comply in all material respects with the Securities Act and did not and will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. The Prospectus, as amended or supplemented, as of its date and at all subsequent times, did not and will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The representations and warranties set forth in the two immediately preceding sentences do not apply to statements in or omissions from the Registration Statement, any Rule 462(b) Registration Statement, or any post-effective amendment thereto, or the Prospectus, or any amendments or supplements thereto, made in reliance upon and in conformity with information relating to any Underwriter furnished to the Company in writing by the Representatives expressly for use therein. There are no contracts or other documents required to be -2- 3 described in the Prospectus or to be filed as exhibits to the Registration Statement which have not been described or filed as required. (b) Offering Materials Furnished to Underwriters. The Company has delivered to the Representatives four complete conformed copies of the Registration Statement and of each consent and certificate of experts filed as a part thereof, and conformed copies of the Registration Statement (without exhibits) and preliminary prospectuses and the Prospectus, as amended or supplemented, in such quantities and at such places as the Representatives have reasonably requested for each of the Underwriters. (c) Distribution of Offering Material By the Company. The Company has not distributed and will not distribute, prior to the later of the Second Closing Date (as defined below) and the completion of the Underwriters' distribution of the Shares, any offering material in connection with the offering and sale of the Shares other than a preliminary prospectus, the Prospectus or the Registration Statement. (d) The Underwriting Agreement. This Agreement has been duly authorized, executed and delivered by, and is a valid and binding agreement of, the Company, enforceable in accordance with its terms, except as rights to indemnification hereunder may be limited by applicable law and except as the enforcement hereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting the rights and remedies of creditors or by general equitable principles. (e) Authorization of the Shares To Be Sold by the Company. The Shares to be purchased by the Underwriters from the Company have been duly authorized for issuance and sale pursuant to this Agreement and, when issued and delivered by the Company pursuant to this Agreement, will be validly issued, fully paid and nonassessable. (f) No Applicable Registration or Other Similar Rights. There are no persons with registration or other similar rights to have any equity or debt securities registered for sale under the Registration Statement or included in the offering contemplated by this Agreement, except for such rights as have been duly waived. (g) No Material Adverse Change. Subsequent to the respective dates as of which information is given in the Prospectus: (i) there has been no material adverse change, or any development that could reasonably be expected to result in a material adverse change, in the condition, financial or otherwise, or in the earnings, business, operations or prospects, whether or not arising from transactions in the ordinary course of business, of the Company and its subsidiaries, considered as one entity (any such change or effect, where the context so requires, is called a "Material Adverse Change" or a "Material Adverse Effect"); (ii) the Company and its subsidiaries, considered as one entity, have not incurred any material liability or obligation, indirect, direct or contingent, not in the ordinary course of business nor entered into any material transaction or agreement not in the ordinary course of business; and (iii) there has been no dividend or distribution of any kind declared, paid or made by the Company or, except for dividends paid to the Company or -3- 4 other subsidiaries, any of its subsidiaries on any class of capital stock or repurchase or redemption by the Company or any of its subsidiaries of any class of capital stock. (h) Independent Accountants. Deloitte & Touche LLP, who have expressed their opinion with respect to the financial statements (which term as used in this Agreement includes the related notes thereto) filed with the Commission as a part of the Registration Statement and included in the Prospectus, are independent public or certified public accountants as required by the Securities Act. (i) Preparation of the Financial Statements. The financial statements filed with the Commission as a part of the Registration Statement and included in the Prospectus present fairly the consolidated financial position of the Company and its subsidiaries as of and at the dates indicated and the results of their operations and cash flows for the periods specified. Such financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis throughout the periods involved, except as may be expressly stated in the related notes thereto. No other financial statements or supporting schedules are required to be included in the Registration Statement. The financial data set forth in the Prospectus under the captions "Prospectus Summary--Summary Selected Financial Data", "Selected Financial Data" and "Capitalization" fairly present the information set forth therein on a basis consistent with that of the audited financial statements contained in the Registration Statement. (j) Company's Accounting System. The Company and each of its subsidiaries maintain a system of accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (k) Subsidiaries of the Company. The Company does not own or control, directly or indirectly, any corporation, association or other entity other than the subsidiaries listed in Exhibit 21.1 to the Registration Statement. (l) Incorporation and Good Standing of the Company and its Subsidiaries. Each of the Company and its subsidiaries has been duly organized and is validly existing as a corporation or limited liability company, as the case may be, in good standing under the laws of the jurisdiction in which it is organized with full corporate power and authority to own its properties and conduct its business as described in the prospectus, and is duly qualified to do business as a foreign corporation and is in good standing under the laws of each jurisdiction which requires such qualification. (m) Capitalization of the Subsidiaries. All the outstanding shares of capital stock of each subsidiary have been duly and validly authorized and issued and are fully paid and nonassessable, and, except as otherwise set forth in the Prospectus, all outstanding shares of capital stock of the subsidiaries are owned by the Company either directly or through wholly owned subsidiaries free and clear of any security interests, claims, liens or encumbrances. -4- 5 (n) No Prohibition on Subsidiaries from Paying Dividends or Making Other Distributions. No subsidiary of the Company is currently prohibited, directly or indirectly, from paying any dividends to the Company, from making any other distribution on such subsidiary's capital stock, from repaying to the Company any loans or advances to such subsidiary from the Company or from transferring any of such subsidiary's property or assets to the Company or any other subsidiary of the Company, except as described in or contemplated by the Prospectus. (o) Capitalization and Other Capital Stock Matters. The authorized, issued and outstanding capital stock of the Company is as set forth in the Prospectus under the caption "Capitalization" (other than for subsequent issuances, if any, pursuant to employee benefit plans described in the Prospectus or upon exercise of outstanding options described in the Prospectus). The Common Shares (including the Shares) conform in all material respects to the description thereof contained in the Prospectus. All of the issued and outstanding Common Shares have been duly authorized and validly issued, are fully paid and nonassessable and have been issued in compliance with federal and state securities laws. None of the outstanding Common Shares were issued in violation of any preemptive rights, rights of first refusal or other similar rights to subscribe for or purchase securities of the Company. There are no authorized or outstanding options, warrants, preemptive rights, rights of first refusal or other rights to purchase, or equity or debt securities convertible into or exchangeable or exercisable for, any capital stock of the Company or any of its subsidiaries other than those accurately described in the Prospectus. The description of the Company's stock option, stock bonus and other stock plans or arrangements, and the options or other rights granted thereunder, set forth in the Prospectus accurately and fairly presents the information required to be shown with respect to such plans, arrangements, options and rights. (p) Stock Exchange Listing. The Shares have been approved for inclusion on the Nasdaq National Market, subject only to official notice of issuance. (q) No Consents, Approvals or Authorizations Required. No consent, approval, authorization, filing with or order of any court or governmental agency or regulatory body is required in connection with the transactions contemplated herein, except such as have been obtained or made under the Securities Act and such as may be required (i) under the blue sky laws of any jurisdiction in connection with the purchase and distribution of the Shares by the Underwriters in the manner contemplated here and in the Prospectus, (ii) by the National Association of Securities Dealers, LLC and (iii) by the federal and provincial laws of Canada. (r) Non-Contravention of Existing Instruments Agreements. Neither the issue and sale of the Shares nor the consummation of any other of the transactions herein contemplated nor the fulfillment of the terms hereof will conflict with, result in a breach or violation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or any of its subsidiaries pursuant to, (i) the charter or by-laws of the Company or any of its subsidiaries, (ii) the terms of any indenture, contract, lease, mortgage, deed of trust, note agreement, loan agreement or other agreement, obligation, condition, covenant or instrument to which the Company or any of its subsidiaries is a party or bound or to which its or their property is subject or (iii) any statute, law, rule, regulation, judgment, order or decree applicable to the Company or any of its subsidiaries of any court, -5- 6 regulatory body, administrative agency, governmental body, arbitrator or other authority having jurisdiction over the Company or any of its subsidiaries or any of its or their properties. (s) No Defaults or Violations. Neither the Company nor any subsidiary is in violation or default of (i) any provision of its charter or by-laws, (ii) the terms of any indenture, contract, lease, mortgage, deed of trust, note agreement, loan agreement or other agreement, obligation, condition, covenant or instrument to which it is a party or bound or to which its property is subject or (iii) any statute, law, rule, regulation, judgment, order or decree of any court, regulatory body, administrative agency, governmental body, arbitrator or other authority having jurisdiction over the Company or such subsidiary or any of its properties, as applicable, except any such violation or default which would not, singly or in the aggregate, result in a Material Adverse Change except as otherwise disclosed in the Prospectus. (t) No Actions, Suits or Proceedings. No action, suit or proceeding by or before any court or governmental agency, authority or body or any arbitrator involving the Company or any of its subsidiaries or its or their property is pending or, to the best knowledge of the Company, threatened that (i) could reasonably be expected to have a Material Adverse Effect on the performance of this Agreement or the consummation of any of the transactions contemplated hereby or (ii) could reasonably be expected to result in a Material Adverse Effect. (u) All Necessary Permits, Etc. The Company and each subsidiary possess such valid and current certificates, authorizations or permits issued by the appropriate state, federal or foreign regulatory agencies or bodies necessary to conduct their respective businesses, and neither the Company nor any subsidiary has received any notice of proceedings relating to the revocation or modification of, or non-compliance with, any such certificate, authorization or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, could result in a Material Adverse Change. (v) Title to Properties. The Company and each of its subsidiaries has good and marketable title to all the properties and assets reflected as owned in the financial statements referred to in Section 1(i) above, in each case free and clear of any security interests, mortgages, liens, encumbrances, equities, claims and other defects, except such as do not materially and adversely affect the value of such property and do not materially interfere with the use made or proposed to be made of such property by the Company or such subsidiary. The real property, improvements, equipment and personal property held under lease by the Company or any subsidiary are held under valid and enforceable leases, with such exceptions as are not material and do not materially interfere with the use made or proposed to be made of such real property, improvements, equipment or personal property by the Company or such subsidiary. (w) Tax Law Compliance. The Company and its consolidated subsidiaries have filed all necessary federal, state and foreign income and franchise tax returns and have paid all taxes required to be paid by any of them and, if due and payable, any related or similar assessment, fine or penalty levied against any of them. The Company has made adequate charges, accruals and reserves in the applicable financial statements referred to in Section 1(i) above in respect of all federal, state and -6- 7 foreign income and franchise taxes for all periods as to which the tax liability of the Company or any of its consolidated subsidiaries has not been finally determined. The Company is not aware of any tax deficiency that has been or might be asserted or threatened against the Company that could result in a Material Adverse Change. (x) Intellectual Property Rights. Each of the Company and its subsidiaries owns or possesses adequate rights to use all patents, patent rights or licenses, inventions, collaborative research agreements, trade secrets, know-how, trademarks, service marks, trade names and copyrights which are necessary to conduct its businesses as described in the Registration Statement and Prospectus; the expiration of any patents, patent rights, trade secrets, trademarks, service marks, trade names or copyrights would not result in a Material Adverse Change that is not otherwise disclosed in the Prospectus; the Company has not received any notice of, and has no knowledge of, any infringement of or conflict with asserted rights of the Company by others with respect to any patent, patent rights, inventions, trade secrets, know-how, trademarks, service marks, trade names or copyrights; and the Company has not received any notice of, and has no knowledge of, any infringement of or conflict with asserted rights of others with respect to any patent, patent rights, inventions, trade secrets, know-how, trademarks, service marks, trade names or copyrights which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, might have a Material Adverse Change. There is no claim being made against the Company regarding patents, patent rights or licenses, inventions, collaborative research, trade secrets, know-how, trademarks, service marks, trade names or copyrights. The Company and its subsidiaries do not in the conduct of their business as now or proposed to be conducted as described in the Prospectus infringe or conflict with any right or patent of any third party, or any discovery, invention, product or process which is the subject of a patent application filed by any third party, known to the Company or any of its subsidiaries, which such infringement or conflict is reasonably likely to result in a Material Adverse Change. (y) Year 2000 Preparedness. There are no issues related to the Company's, or any of its subsidiaries', preparedness for the Year 2000 that (i) are of a character required to be described or referred to in the Registration Statement or Prospectus by the Securities Act which have not been accurately described in the Registration Statement or Prospectus or (ii) might reasonably be expected to result in any Material Adverse Change or that might materially affect their properties, assets or rights. All internal computer systems and each Constituent Component (as defined below) of those systems and all computer-related products and each Constituent Component (as defined below) of those products of the Company and each of its subsidiaries fully comply with Year 2000 Qualification Requirements. "Year 2000 Qualifications Requirements" means that the internal computer systems and each Constituent Component (as defined below) of those systems and all computer-related products and each Constituent Component (as defined below) of those products of the Company and each of its Subsidiaries (i) have been reviewed to confirm that they store, process (including sorting and performing mathematical operations, calculations and computations), input and output data containing date and information correctly regardless of whether the date contains dates and times before, on or after January 1, 2000, (ii) have been designated to ensure date and time entry recognition and calculations, and date data interface values that reflect the century, (iii) accurately manage and manipulate data involving dates and times, including single century formulas -7- 8 and multi-century formulas, and will not cause an abnormal ending scenario within the application or generate incorrect values or invalid results involving such dates, (iv) accurately process any date rollover, and (v) accept and respond to two-digit year date input in a manner that resolves any ambiguities as to the century. "Constituent Component" means all software (including operating systems, programs, packages and utilities), firmware, hardware, networking components, and peripherals provided as part of the configuration. The Company has inquired of material vendors as to their preparedness for the Year 2000 and has disclosed in the Registration Statement or Prospectus any issues that might reasonably be expected to result in any Material Adverse Change. (z) No Transfer Taxes or Other Fees. There are no transfer taxes or other similar fees or charges under Federal law or the laws of any state, or any political subdivision thereof, required to be paid in connection with the execution and delivery of this Agreement or the issuance and sale by the Company of the shares. (aa) Company Not an "Investment Company". The Company has been advised of the rules and requirements under the Investment Company Act of 1940, as amended (the "Investment Company Act"). The Company is not, and after receipt of payment for the Shares will not be, an "investment company" or an entity "controlled" by an "investment company" within the meaning of the Investment Company Act and will conduct its business in a manner so that it will not become subject to the Investment Company Act. (bb) Insurance. Each of the Company and its subsidiaries are insured by recognized, financially sound and reputable institutions with policies in such amounts and with such deductibles and covering such risks as are generally deemed adequate and customary for their businesses including, but not limited to, policies covering real and personal property owned or leased by the Company and its subsidiaries against theft, damage, destruction, acts of vandalism and earthquakes, general liability and Directors and Officers liability. The Company has no reason to believe that it or any subsidiary will not be able (i) to renew its existing insurance coverage as and when such policies expire or (ii) to obtain comparable coverage from similar institutions as may be necessary or appropriate to conduct its business as now conducted and at a cost that would not result in a Material Adverse Change. Neither of the Company nor any subsidiary has been denied any insurance coverage which it has sought or for which it has applied. (cc) Labor Matters. To the best of Company's knowledge, no labor disturbance by the employees of the Company or any of its subsidiaries exists or is imminent; and the Company is not aware of any existing or imminent labor disturbance by the employees of any of its principal suppliers, subassemblers, value added resellers, subcontractors, original equipment manufacturers, authorized dealers or international distributors that might be expected to result in a Material Adverse Change. (dd) No Price Stabilization or Manipulation. The Company has not taken and will not take, directly or indirectly, any action designed to or that might be reasonably expected to cause or result in stabilization or manipulation of the price of the Common Stock to facilitate the sale or resale of the Shares. -8- 9 (ee) Lock-Up Agreements. Each officer and director of the Company and each beneficial owner of capital of the Company has agreed to sign an agreement substantially in the form attached hereto as Exhibit A (the "Lock-up Agreements"). The Company has provided to counsel for the Underwriters a complete and accurate list of all securityholders of the Company and the number and type of securities held by each securityholder. The Company has provided to counsel for the Underwriters true, accurate and complete copies of all of the Lock-up Agreements presently in effect or effected hereby. The Company hereby represents and warrants that it will not release any of its officers, directors or other stockholders from any Lock-up Agreements currently existing or hereafter effected without the prior written consent of BancBoston Robertson Stephens Inc. (ff) Related Party Transactions. There are no business relationships or related-party transactions involving the Company or any subsidiary or any other person required to be described in the Prospectus which have not been described as required. Any certificate signed by an officer of the Company and delivered to the Representatives or to counsel for the Underwriters shall be deemed to be a representation and warranty by the Company to each Underwriter as to the matters set forth therein. SECTION 2. PURCHASE, SALE AND DELIVERY OF THE SHARES. (a) The Firm Shares. The Company agrees to issue and sell to the several Underwriters the Firm Shares upon the terms herein set forth. On the basis of the representations, warranties and agreements herein contained, and upon the terms but subject to the conditions herein set forth, the Underwriters agree, severally and not jointly, to purchase from the Company the respective number of Firm Shares set forth opposite their names on Schedule A. The purchase price per Firm Share to be paid by the several Underwriters to the Company shall be $___ per share. (b) The First Closing Date. Delivery of the Firm Shares to be purchased by the Underwriters and payment therefor shall be made by the Company and the Representatives at 6:00 a.m. San Francisco time, at the offices of Brobeck, Pheleger & Harrison LLP (or at such other place as may be agreed upon among the Representatives and the Company), (i) on the third (3rd) full business day following the first day that Shares are traded, (ii) if this Agreement is executed and delivered after 1:30 P.M., San Francisco time, the fourth (4th) full business day following the day that this Agreement is executed and delivered or (iii) at such other time and date not later that seven (7) full business days following the first day that Shares are traded as the Representatives and the Company may determine (or at such time and date to which payment and delivery shall have been postponed pursuant to Section 8 hereof), such time and date of payment and delivery being herein called the "Closing Date;" provided, however, that if the Company has not made available to the Representatives copies of the Prospectus within the time provided in Section 4(d) hereof, the Representatives may, in their sole discretion, postpone the Closing Date until no later that two (2) full business days following delivery of copies of the Prospectus to the Representatives. (c) The Option Shares; the Second Closing Date. In addition, on the basis of the representations, warranties and agreements herein contained, and upon the terms but subject to the conditions herein set forth, the Company hereby grants an option to the several Underwriters to -9- 10 purchase, severally and not jointly, up to an aggregate of 660,000 Option Shares from the Company at the purchase price per share to be paid by the Underwriters for the Firm Shares. The option granted hereunder is for use by the Underwriters solely in covering any over-allotments in connection with the sale and distribution of the Firm Shares. The option granted hereunder may be exercised at any time upon notice by the Representatives to the Company, which notice may be given at any time within 30 days from the date of this Agreement. The time and date of delivery of the Option Shares, if subsequent to the First Closing Date, is called the "Second Closing Date" and shall be determined by the Representatives and shall not be earlier than three nor later than five full business days after delivery of such notice of exercise. If any Option Shares are to be purchased, (i) each Underwriter agrees, severally and not jointly, to purchase the number of Option Shares (subject to such adjustments to eliminate fractional shares as the Representatives may determine) that bears the same proportion to the total number of Option Shares to be purchased as the number of Firm Shares set forth on Schedule A opposite the name of such Underwriter bears to the total number of Firm Shares. The Representatives may cancel the option at any time prior to its expiration by giving written notice of such cancellation to the Company. (d) Public Offering of the Shares. The Representatives hereby advise the Company that the Underwriters intend to offer for sale to the public, as described in the Prospectus, their respective portions of the Shares as soon after this Agreement has been executed and the Registration Statement has been declared effective as the Representatives, in their sole judgment, has determined is advisable and practicable. (e) Payment for the Shares. Payment for the Shares shall be made at the First Closing Date (and, if applicable, at the Second Closing Date) by wire transfer in immediately available-funds to the order of the Company. It is understood that the Representatives have been authorized, for its own account and the accounts of the several Underwriters, to accept delivery of and receipt for, and make payment of the purchase price for, the Firm Shares and any Option Shares the Underwriters have agreed to purchase. BancBoston Robertson Stephens Inc., individually and not as the Representative of the Underwriters, may (but shall not be obligated to) make payment for any Shares to be purchased by any Underwriter whose funds shall not have been received by the Representatives by the First Closing Date or the Second Closing Date, as the case may be, for the account of such Underwriter, but any such payment shall not relieve such Underwriter from any of its obligations under this Agreement. (f) Delivery of the Shares. The Company shall deliver, or cause to be delivered, a credit representing the Firm Shares to an account or accounts at The Depository Trust Company, as designated by the Representatives for the accounts of the Representatives and the several Underwriters at the First Closing Date, against the irrevocable release of a wire transfer of immediately available funds for the amount of the purchase price therefor. The Company shall also deliver, or cause to be delivered a credit representing the Option Shares the Underwriters have agreed to purchase at the First Closing Date (or the Second Closing Date, as the case may be), to an account or accounts at The Depository Trust Company as designated by the Representatives for the -10- 11 accounts of the Representatives and the several Underwriters, against the irrevocable release of a wire transfer of immediately available funds for the amount of the purchase price therefor. Time shall be of the essence, and delivery at the time and place specified in this Agreement is a further condition to the obligations of the Underwriters. (h) Delivery of Prospectus to the Underwriters. Not later than 12:00 noon on the second business day following the date the Shares are released by the Underwriters for sale to the public, the Company shall deliver or cause to be delivered copies of the Prospectus in such quantities and at such places as the Representatives shall request. SECTION 3. COVENANTS OF THE COMPANY. The Company further covenants and agrees with each Underwriter as follows: (a) Registration Statement Matters. The Company will (i) use its best efforts to cause a registration statement on Form 8-A (the "Form 8-A Registration Statement") as required by the Securities Exchange Act of 1934 (the "Exchange Act") to become effective simultaneously with the Registration Statement, (ii) use its best efforts to cause the Registration Statement to become effective or, if the procedure in Rule 430A of the Securities Act is followed, to prepare and timely file with the Commission under Rule 424(b) under the Securities Act a Prospectus in a form approved by the Representatives containing information previously omitted at the time of effectiveness of the Registration Statement in reliance on Rule 430A of the Securities Act and (iii) not file any amendment to the Registration Statement or supplement to the Prospectus of which the Representatives shall not previously have been advised and furnished with a copy or to which the Representatives shall have reasonably objected in writing or which is not in compliance with the Securities Act. If the Company elects to rely on Rule 462(b) under the Securities Act, the Company shall file a Rule 462(b) Registration Statement with the Commission in compliance with Rule 462(b) under the Securities Act prior to the time confirmations are sent or given, as specified by Rule 462(b)(2) under the Securities Act, and shall pay the applicable fees in accordance with Rule 111 under the Securities Act. (b) Securities Act Compliance. The Company will advise the Representatives promptly (i) when the Registration Statement or any post-effective amendment thereto shall have become effective, (ii) of receipt of any comments from the Commission, (iii) of any request of the Commission for amendment of the Registration Statement or for supplement to the Prospectus or for any additional information and (iv) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or the use of the Prospectus or of the institution of any proceedings for that purpose. The Company will use its best efforts to prevent the issuance of any such stop order preventing or suspending the use of the Prospectus and to obtain as soon as possible the lifting thereof, if issued. (c) Blue Sky Compliance. The Company will cooperate with the Representatives and counsel for the Underwriters in endeavoring to qualify the Shares for sale under the securities laws of such jurisdictions (both national and foreign) as the Representatives may reasonably have designated in writing and will make such applications, file such documents, and furnish such -11- 12 information as may be reasonably required for that purpose, provided the Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any jurisdiction where it is not now so qualified or required to file such a consent. The Company will, from time to time, prepare and file such statements, reports and other documents, as are or may be required to continue such qualifications in effect for so long a period as the Representatives may reasonably request for distribution of the Shares. (d) Amendments and Supplements to the Prospectus and Other Securities Act Matters. The Company will comply with the Securities Act and the Exchange Act, and the rules and regulations of the Commission thereunder, so as to permit the completion of the distribution of the Shares as contemplated in this Agreement and the Prospectus. If during the period in which a prospectus is required by law to be delivered by an Underwriter or dealer, any event shall occur as a result of which, in the judgment of the Company or in the reasonable opinion of the Representatives or counsel for the Underwriters, it becomes necessary to amend or supplement the Prospectus in order to make the statements therein, in the light of the circumstances existing at the time the Prospectus is delivered to a purchaser, not misleading, or, if it is necessary at any time to amend or supplement the Prospectus to comply with any law, the Company promptly will prepare and file with the Commission, and furnish at its own expense to the Underwriters and to dealers, an appropriate amendment to the Registration Statement or supplement to the Prospectus so that the Prospectus as so amended or supplemented will not, in the light of the circumstances when it is so delivered, be misleading, or so that the Prospectus will comply with the law. (e) Copies of any Amendments and Supplements to the Prospectus. The Company agrees to furnish the Representatives, without charge, during the period beginning on the date hereof and ending on the later of the First Closing Date or such date, as in the opinion of counsel for the Underwriters, the Prospectus is no longer required by law to be delivered in connection with sales by an Underwriter or dealer (the "Prospectus Delivery Period"), as many copies of the Prospectus and any amendments and supplements thereto as the Representatives may request. (f) Insurance. The Company shall (i) obtain Directors and Officers liability insurance in the minimum amount of $10 million which shall apply to the offering contemplated hereby and (ii) shall cause BancBoston Robertson Stephens Inc. to be added as an additional insured to such policy in respect of the offering contemplated hereby. (g) Notice of Subsequent Events. If at any time during the ninety (90) day period after the Registration Statement becomes effective, any rumor, publication or event relating to or affecting the Company shall occur as a result of which in your opinion the market price of the Company Shares has been or is likely to be materially affected (regardless of whether such rumor, publication or event necessitates a supplement to or amendment of the Prospectus), the Company will, after written notice from you advising the Company to the effect set forth above, forthwith prepare, consult with you concerning the substance of and disseminate a press release or other public statement, reasonably satisfactory to you, responding to or commenting on such rumor, publication or event. -12- 13 (h) Use of Proceeds. The Company shall apply the net proceeds from the sale of the Shares sold by it in the manner described under the caption "Use of Proceeds" in the Prospectus. (i) Transfer Agent. The Company shall engage and maintain, at its expense, a registrar and transfer agent for the Company Shares. (j) Earnings Statement. As soon as practicable, the Company will make generally available to its security holders and to the Representatives an earnings statement (which need not be audited) covering the twelve-month period ending, September 30, 2000 that satisfies the provisions of Section 11(a) of the Securities Act. (k) Periodic Reporting Obligations. During the Prospectus Delivery Period the Company shall file, on a timely basis, with the Commission and the Nasdaq National Market all reports and documents required to be filed under the Exchange Act. (l) Agreement Not to Offer or Sell Additional Securities. The Company will not, without the prior written consent of BancBoston Robertson Stephens Inc., for a period of 180 days following the date of the Prospectus, offer, sell or contract to sell, or otherwise dispose of or enter into any transaction which is designed to, or could be expected to, result in the disposition (whether by actual disposition or effective economic disposition due to cash settlement or otherwise by the Company or any affiliate of the Company or any person in privity with the Company or any affiliate of the Company) directly or indirectly, or announce the offering of, any other Common Shares or any securities convertible into, or exchangeable for, Common Shares; provided, however, that the Company may (i) issue and sell Common Shares pursuant to any director or employee stock option plan, stock ownership plan or dividend reinvestment plan of the Company in effect at the date of the Prospectus and described in the Prospectus so long as none of those shares may be transferred on during the period of 180 days from the date that the Registration Statement is declared effective (the "Lock-Up Period") and the Company shall enter stop transfer instructions with its transfer agent and registrar against the transfer of any such Common Shares and (ii) the Company may issue Common Shares issuable upon the conversion of securities or the exercise of warrants outstanding at the date of the Prospectus and described in the Prospectus. (m) Future Reports to the Representatives. During the period of five years hereafter the Company will furnish to the Representatives (i) as soon as practicable after the end of each fiscal year, copies of the Annual Report of the Company containing the balance sheet of the Company as of the close of such fiscal year and statements of income, stockholders' equity and cash flows for the year then ended and the opinion thereon of the Company's independent public or certified public accountants; (ii) as soon as practicable after the filing thereof, copies of each proxy statement, Annual Report on Form 10-K, Quarterly Report on Form 10-Q, Current Report on Form 8-K or other report filed by the Company with the Commission, the National Association of Securities Dealers, LLC or any securities exchange; and (iii) as soon as available, copies of any report or communication of the Company mailed generally to holders of its capital stock. SECTION 4. CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITERS. The obligations of the several Underwriters to purchase and pay for the Shares as provided herein on the First Closing Date -13- 14 and, with respect to the Option Shares, the Second Closing Date, shall be subject to the accuracy of the representations and warranties on the part of the Company set forth in Section 1 hereof as of the date hereof and as of the First Closing Date as though then made and, with respect to the Option Shares, as of the Second Closing Date as though then made, to the timely performance by the Company of its covenants and other obligations hereunder, and to each of the following additional conditions: (a) Compliance with Registration Requirements; No Stop Order; No Objection from the National Association of Securities Dealers, LLC The Registration Statement shall have become effective prior to the execution of this Agreement, or at such later date as shall be consented to in writing by you; and no stop order suspending the effectiveness thereof shall have been issued and no proceedings for that purpose shall have been initiated or, to the knowledge of the Company or any Underwriter, threatened by the Commission, and any request of the Commission for additional information (to be included in the Registration Statement or the Prospectus or otherwise) shall have been complied with to the satisfaction of Underwriters' Counsel; and the National Association of Securities Dealers, LLC shall have raised no objection to the fairness and reasonableness of the underwriting terms and arrangements. (b) Corporate Proceedings. All corporate proceedings and other legal matters in connection with this Agreement, the form of Registration Statement and the Prospectus, and the registration, authorization, issue, sale and delivery of the Shares, shall have been reasonably satisfactory to Underwriters' Counsel, and such counsel shall have been furnished with such papers and information as they may reasonably have requested to enable them to pass upon the matters referred to in this Section. (c) No Material Adverse Change. Subsequent to the execution and delivery of this Agreement and prior to the First Closing Date, or the Second Closing Date, as the case may be, there shall not have been any Material Adverse Change in the condition (financial or otherwise), earnings, operations, business or business prospects of the Company and its subsidiaries considered as one enterprise from that set forth in the Registration Statement or Prospectus, which, in your sole judgment, is material and adverse and that makes it, in your sole judgment, impracticable or inadvisable to proceed with the public offering of the Shares as contemplated by the Prospectus. (d) Opinion of Counsel for the Company. You shall have received on the First Closing Date, or the Second Closing Date, as the case may be, an opinion of Brobeck, Phleger & Harrison LLP, counsel for the Company, substantially in the form of Exhibit B attached hereto, dated the First Closing Date, or the Second Closing Date, addressed to the Underwriters and with reproduced copies or signed counterparts thereof for each of the Underwriters. Counsel rendering the opinion contained in Exhibit B may rely as to questions of law not involving the laws of the United States or the State of California upon opinions of local counsel, and as to questions of fact upon representations or certificates of officers of the Company, and of government officials, in which case their opinion is to state that they are so relying and that they have no knowledge of any material misstatement or inaccuracy in any such opinion, representation -14- 15 or certificate. Copies of any opinion, representation or certificate so relied upon shall be delivered to you, as Representatives of the Underwriters, and to Underwriters' Counsel. Opinion of Counsel for the Underwriters. You shall have received on the First Closing Date or the Second Closing Date, as the case may be, an opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation, substantially in the form of Exhibit C hereto. The Company shall have furnished to such counsel such documents as they may have requested for the purpose of enabling them to pass upon such matters. (e) Accountants' Comfort Letter. You shall have received on the First Closing Date and on the Second Closing Date, as the case may be, a letter from Deloitte & Touche LLP addressed to the Underwriters, dated the First Closing Date or the Second Closing Date, as the case may be, confirming that they are independent certified public accountants with respect to the Company within the meaning of the Act and the applicable published Rules and Regulations and based upon the procedures described in such letter delivered to you concurrently with the execution of this Agreement (herein called the "Original Letter"), but carried out to a date not more than four (4) business days prior to the First Closing Date or the Second Closing Date, as the case may be, (i) confirming, to the extent true, that the statements and conclusions set forth in the Original Letter are accurate as of the First Closing Date or the Second Closing Date, as the case may be, and (ii) setting forth any revisions and additions to the statements and conclusions set forth in the Original Letter which are necessary to reflect any changes in the facts described in the Original Letter since the date of such letter, or to reflect the availability of more recent financial statements, data or information. The letter shall not disclose any change in the condition (financial or otherwise), earnings, operations, business or business prospects of the Company and its subsidiaries considered as one enterprise from that set forth in the Registration Statement or Prospectus, which, in your sole judgment, is material and adverse and that makes it, in your sole judgment, impracticable or inadvisable to proceed with the public offering of the Shares as contemplated by the Prospectus. The Original Letter from Deloitte & Touche LLP shall be addressed to or for the use of the Underwriters in form and substance satisfactory to the Underwriters and shall (i) represent, to the extent true, that they are independent certified public accountants with respect to the Company within the meaning of the Act and the applicable published Rules and Regulations, (ii) set forth their opinion with respect to their examination of the consolidated balance sheet of the Company as of December 31, 1998 and related consolidated statements of operations, shareholders' equity, and cash flows for the twelve (12) months ended December 31, 1998, (iii) state that Deloitte & Touche LLP has performed the procedures set out in Statement on Auditing Standards No. 71 ("SAS 71") for a review of interim financial information and providing the report of Deloitte & Touche LLP as described in SAS 71 on the financial statements for each of the quarters in the ten-quarter period ended June 30, 1999 (the "Quarterly Financial Statements"), (iv) state that in the course of such review, nothing came to their attention that leads them to believe that any material modifications need to be made to any of the Quarterly Financial Statements in order for them to be in compliance with generally accepted accounting principles consistently applied across the periods presented, and address other matters agreed upon by Deloitte & Touche LLP and you. In addition, you shall have received from Deloitte & Touche LLP a letter addressed to the Company and made available to you for the use of the Underwriters stating that their review of the Company's system of internal -15- 16 accounting controls, to the extent they deemed necessary in establishing the scope of their examination of the Company's consolidated financial statements as of December 31, 1998 did not disclose any weaknesses in internal controls that they considered to be material weaknesses. (f) Officers' Certificate. You shall have received on the First Closing Date and the Second Closing Date, as the case may be, a certificate of the Company, dated the First Closing Date or the Second Closing Date, as the case may be, signed by the Chief Executive Officer and Chief Financial Officer of the Company, to the effect that, and you shall be satisfied that: (i) The representations and warranties of the Company in this Agreement are true and correct, as if made on and as of the First Closing Date or the Second Closing Date, as the case may be, and the Company has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to the First Closing Date or the Second Closing Date, as the case may be; (ii) No stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or are pending or threatened under the Act; (iii) When the Registration Statement became effective and at all times subsequent thereto up to the delivery of such certificate, the Registration Statement and the Prospectus, and any amendments or supplements thereto, contained all material information required to be included therein by the Securities Act and the applicable rules and regulations of the Commission thereunder and in all material respects conformed to the requirements of the Securities Act or the Exchange Act and the applicable rules and regulations of the Commission thereunder, the Registration Statement and the Prospectus, and any amendments or supplements thereto, did not and does not include any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and, since the effective date of the Registration Statement, there has occurred no event required to be set forth in an amended or supplemented Prospectus which has not been so set forth; and (iv) Subsequent to the respective dates as of which information is given in the Registration Statement and Prospectus, there has not been (a) any material adverse change in the condition (financial or otherwise), earnings, operations, business or business prospects of the Company and its subsidiaries considered as one enterprise, (b) any transaction that is material to the Company and its subsidiaries considered as one enterprise, except transactions entered into in the ordinary course of business, (c) any obligation, direct or contingent, that is material to the Company and its subsidiaries considered as one enterprise, incurred by the Company or its subsidiaries, except obligations incurred in the ordinary course of business, (d) any change in the capital stock or outstanding indebtedness of the Company or any of its subsidiaries that is material to the Company and its subsidiaries considered as one enterprise, (e) any dividend or distribution of any kind declared, paid or made on the capital stock of the Company or any of its subsidiaries, or (f) any loss or damage (whether or not insured) to the -16- 17 property of the Company or any of its subsidiaries which has been sustained or will have been sustained which has a material adverse effect on the condition (financial or otherwise), earnings, operations, business or business prospects of the Company and its subsidiaries considered as one enterprise. (g) Lock-up Agreement from Certain Stockholders of the Company. The Company shall have obtained and delivered to you an agreement substantially in the form of Exhibit A attached hereto from each officer and director of the Company and each beneficial owner of the outstanding issued share capital of the Company. (h) Stock Exchange Listing. The Shares shall have been approved for inclusion on the Nasdaq National Market, subject only to official notice of issuance. (k) Compliance with Prospectus Delivery Requirements. The Company shall have complied with the provisions of Sections 2(g) and 3(e) hereof with respect to the furnishing of Prospectuses. (l) Additional Documents. On or before each of the First Closing Date and the Second Closing Date, as the case may be, the Representatives and counsel for the Underwriters shall have received such information, documents and opinions as they may reasonably require for the purposes of enabling them to pass upon the issuance and sale of the Shares as contemplated herein, or in order to evidence the accuracy of any of the representations and warranties, or the satisfaction of any of the conditions or agreements, herein contained. If any condition specified in this Section 4 is not satisfied when and as required to be satisfied, this Agreement may be terminated by the Representatives by notice to the Company at any time on or prior to the First Closing Date and, with respect to the Option Shares, at any time prior to the Second Closing Date, which termination shall be without liability on the part of any party to any other party, except that Section 5 (Payment of Expenses), Section 6 (Reimbursement of Underwriters' Expenses), Section 7 (Indemnification and Contribution) and Section 10 (Representations and Indemnities to Survive Delivery) shall at all times be effective and shall survive such termination. SECTION 5. PAYMENT OF EXPENSES. The Company agrees to pay all costs, fees and expenses incurred in connection with the performance of its obligations hereunder and in connection with the transactions contemplated hereby, including without limitation (i) all expenses incident to the issuance and delivery of the Common Shares (including all printing and engraving costs), (ii) all fees and expenses of the registrar and transfer agent of the Common Stock, (iii) all necessary issue, transfer and other stamp taxes in connection with the issuance and sale of the Shares to the Underwriters, (iv) all fees and expenses of the Company's counsel, independent public or certified public accountants and other advisors, (v) all costs and expenses incurred in connection with the preparation, printing, filing, shipping and distribution of the Registration Statement (including financial statements, exhibits, schedules, consents and certificates of experts), each preliminary prospectus and the Prospectus, and all amendments and supplements thereto, and this Agreement, (vi) all filing fees, attorneys' fees and expenses incurred by the Company or the Underwriters in -17- 18 connection with qualifying or registering (or obtaining exemptions from the qualification or registration of) all or any part of the Shares for offer and sale under the state securities or blue sky laws or the provincial securities laws of Canada or any other country, and, if requested by the Representatives, preparing and printing a "Blue Sky Survey", an "International Blue Sky Survey" or other memorandum, and any supplements thereto, advising the Underwriters of such qualifications, registrations and exemptions, (vii) the filing fees incident to, and the reasonable fees and expenses of counsel for the Underwriters in connection with, the National Association of Securities Dealers, LLC review and approval of the Underwriters' participation in the offering and distribution of the Common Shares, (viii) the fees and expenses associated with including the Common Shares on the Nasdaq National Market, (ix) all costs and expenses incident to the preparation and undertaking of "road show" preparations to be made to prospective investors, and (x) all other fees, costs and expenses referred to in Item 13 of Part II of the Registration Statement. Except as provided in this Section 5, Section 6, and Section 7 hereof, the Underwriters shall pay their own expenses, including the fees and disbursements of their counsel. SECTION 6. REIMBURSEMENT OF UNDERWRITERS' EXPENSES. If this Agreement is terminated by the Representatives pursuant to Section 4, Section 7, Section 8, Section 9, or if the sale to the Underwriters of the Shares on the First Closing Date is not consummated because of any refusal, inability or failure on the part of the Company to perform any agreement herein or to comply with any provision hereof, the Company agrees to reimburse the Representatives and the other Underwriters (or such Underwriters as have terminated this Agreement with respect to themselves), severally, upon demand for all out-of-pocket expenses that shall have been reasonably incurred by the Representatives and the Underwriters in connection with the proposed purchase and the offering and sale of the Shares, including but not limited to fees and disbursements of counsel, printing expenses, travel expenses, postage, facsimile and telephone charges. SECTION 7. INDEMNIFICATION AND CONTRIBUTION. (a) Indemnification of the Underwriters. The Company agrees to indemnify and hold harmless each Underwriter, its officers and employees, and each person, if any, who controls any Underwriter within the meaning of the Securities Act and the Exchange Act against any loss, claim, damage, liability or expense, as incurred, to which such Underwriter or such controlling person may become subject, under the Securities Act, the Exchange Act or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of the Company, which consent shall not be unreasonably withheld), insofar as such loss, claim, damage, liability or expense (or actions in respect thereof as contemplated below) arises out of or is based (i) upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement, or any amendment thereto, including any information deemed to be a part thereof pursuant to Rule 430A or Rule 434 under the Securities Act, or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading; or (ii) upon any untrue statement or alleged untrue statement of a material fact contained in any preliminary prospectus or the Prospectus (or any -18- 19 amendment or supplement thereto), or the omission or alleged omission therefrom of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; or (iii) in whole or in part upon any inaccuracy in the representations and warranties of the Company contained herein; or (iv) in whole or in part upon any failure of the Company to perform its obligations hereunder or under law; or (v) any act or failure to act or any alleged act or failure to act by any Underwriter in connection with, or relating in any manner to, the Shares or the offering contemplated hereby, and which is included as part of or referred to in any loss, claim, damage, liability or action arising out of or based upon any matter covered by clause (i), (ii), (iii) or (iv) above, provided that the Company shall not be liable under this clause (v) to the extent that a court of competent jurisdiction shall have determined by a final judgment that such loss, claim, damage, liability or action resulted directly from any such acts or failures to act undertaken or omitted to be taken by such Underwriter through its bad faith or willful misconduct; and to reimburse each Underwriter and each such controlling person for any and all expenses (including the fees and disbursements of counsel chosen by BancBoston Robertson Stephens Inc.) as such expenses are reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action; provided, however, that the foregoing indemnity agreement shall not apply to any loss, claim, damage, liability or expense to the extent, but only to the extent, arising out of or based upon any untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with written information furnished to the Company by the Representatives expressly for use in the Registration Statement, any preliminary prospectus or the Prospectus (or any amendment or supplement thereto); and provided, further, that with respect to any preliminary prospectus, the foregoing indemnity agreement shall not inure to the benefit of any Underwriter from whom the person asserting any loss, claim, damage, liability or expense purchased Shares, or any person controlling such Underwriter, if copies of the Prospectus were timely delivered to the Underwriter pursuant to Section 2 and a copy of the Prospectus (as then amended or supplemented if the Company shall have furnished any amendments or supplements thereto) was not sent or given by or on behalf of such Underwriter to such person, if required by law so to have been delivered, at or prior to the written confirmation of the sale of the Shares to such person, and if the Prospectus (as so amended or supplemented) would have cured the defect giving rise to such loss, claim, damage, liability or expense. The indemnity agreement set forth in this Section 7(a) shall be in addition to any liabilities that the Company may otherwise have. (b) Indemnification of the Company, its Directors and Officers. Each Underwriter agrees, severally and not jointly, to indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement and each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act, against any loss, claim, damage, liability or expense, as incurred, to which the Company, or any such director, officer or controlling person may become subject, under the Securities Act, the Exchange Act, or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of such Underwriter), insofar as such loss, claim, damage, liability or expense (or actions in respect thereof as contemplated below) arises out of or is based upon any untrue or alleged untrue statement of a material fact contained in the Registration Statement, any preliminary prospectus or the Prospectus (or any amendment or -19- 20 supplement thereto), or arises out of or is based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in the Registration Statement, any preliminary prospectus, the Prospectus (or any amendment or supplement thereto), in reliance upon and in conformity with written information furnished to the Company by the Representatives expressly for use therein; and to reimburse the Company, or any such director, officer or controlling person for any legal and other expense reasonably incurred by the Company, or any such director, officer or controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action. The indemnity agreement set forth in this Section 7(b) shall be in addition to any liabilities that each Underwriter may otherwise have. (c) Information Provided by the Underwriters. The Company hereby acknowledges that the only information that the Underwriters have furnished to the Company expressly for use in the Registration Statement, any preliminary prospectus or the Prospectus (or any amendment or supplement thereto) are the statements set forth in the table in the first, second and third paragraphs under the caption "Underwriting" in the Prospectus; and the Underwriters confirm that such statements are correct. (d) Notifications and Other Indemnification Procedures. Promptly after receipt by an indemnified party under this Section 7 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party under this Section 7, notify the indemnifying party in writing of the commencement thereof, but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party for contribution or otherwise than under the indemnity agreement contained in this Section 7 or to the extent it is not prejudiced as a proximate result of such failure. In case any such action is brought against any indemnified party and such indemnified party seeks or intends to seek indemnity from an indemnifying party, the indemnifying party will be entitled to participate in, and, to the extent that it shall elect, jointly with all other indemnifying parties similarly notified, by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party; provided, however, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that a conflict may arise between the positions of the indemnifying party and the indemnified party in conducting the defense of any such action or that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnified party or parties shall have the right to select separate counsel to assume such legal defenses and to otherwise participate in the defense of such action on behalf of such indemnified party or parties. Upon receipt of notice from the indemnifying party to such indemnified party of such indemnifying party's election so to assume the defense of such action and approval by the indemnified party of counsel, the indemnifying party will not be liable to such indemnified party under this Section 7 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnified party shall have employed separate counsel in accordance with the proviso to the next preceding -20- 21 sentence (it being understood, however, that the indemnifying party shall not be liable for the expenses of more than one separate counsel (together with local counsel), approved by the indemnifying party (BancBoston Robertson Stephens Inc. in the case of Section 7(b) and Section 8), representing the indemnified parties who are parties to such action), (ii) the indemnifying party shall not have employed counsel satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action, or (iii) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying party. (e) Settlements. The indemnifying party under this Section 7 shall not be liable for any settlement of any proceeding effected without its written consent, which consent shall not be unreasonably withheld, but if settled with such consent or if there be a final judgment for the plaintiff, the indemnifying party agrees to indemnify the indemnified party against any loss, claim, damage, liability or expense by reason of such settlement or judgment. Notwithstanding the foregoing sentence, if at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel as contemplated by Section 7(d) hereof, the indemnifying party agrees that it shall be liable for any settlement of any proceeding effected without its written consent if (i) such settlement is entered into more than 30 days after receipt by such indemnifying party of the aforesaid request and (ii) such indemnifying party shall not have reimbursed the indemnified party in accordance with such request prior to the date of such settlement. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement, compromise or consent to the entry of judgment in any pending or threatened action, suit or proceeding in respect of which any indemnified party is or could have been a party and indemnity was or could have been sought hereunder by such indemnified party, unless such settlement, compromise or consent includes (i) an unconditional release of such indemnified party from all liability on claims that are the subject matter of such action, suit or proceeding and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party. (f) Contribution. If the indemnification provided for in this Section 7 is unavailable to or insufficient to hold harmless an indemnified party under Section 7(a) or (b) above in respect of any losses, claims, damages or liabilities (or actions or proceedings in respect thereof) then each indemnifying party shall contribute to the aggregate amount paid or payable by such indemnified party in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and the Underwriters on the other from the offering of the Shares. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities, (or actions or proceedings in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Underwriter on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received -21- 22 by the Company bears to the total underwriting discounts and commissions received by the Underwriters, in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or the Underwriters on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and Underwriters agree that it would not be just and equitable if contributions pursuant to this Section 7(f) were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 7(f). The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to above in this Section 7(f) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this subsection (f), (i) no Underwriter shall be required to contribute any amount in excess of the underwriting discounts and commissions applicable to the Shares purchased by such Underwriter and (ii) no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this Section 7(f) to contribute are several in proportion to their respective underwriting obligations and not joint. (g) Timing of Any Payments of Indemnification. Any losses, claims, damages, liabilities or expenses for which an indemnified party is entitled to indemnification or contribution under this Section 7 shall be paid by the indemnifying party to the indemnified party as such losses, claims, damages, liabilities or expenses are incurred, but in all cases, no later than thirty (30) days of invoice to the indemnifying party. (h) Survival. The indemnity and contribution agreements contained in this Section 7 and the representation and warranties of the Company set forth in this Agreement shall remain operative and in full force and effect, regardless of (i) any investigation made by or on behalf of any Underwriter or any person controlling any Underwriter, the Company, its directors or officers or any persons controlling the Company, (ii) acceptance of any Shares and payment therefor hereunder, and (iii) any termination of this Agreement. A successor to any Underwriter, or to the Company, its directors or officers, or any person controlling the Company, shall be entitled to the benefits of the indemnity, contribution and reimbursement agreements contained in this Section 7. (i) Acknowledgements of Parties. The parties to this Agreement hereby acknowledge that they are sophisticated business persons who were represented by counsel during the negotiations regarding the provisions hereof including, without limitation, the provisions of this Section 7, and are fully informed regarding said provisions. They further acknowledge that the provisions of this Section 7 fairly allocate the risks in light of the ability of the parties to investigate the Company and -22- 23 its business in order to assure that adequate disclosure is made in the Registration Statement and Prospectus as required by the Securities Act and the Exchange Act. SECTION 8. DEFAULT OF ONE OR MORE OF THE SEVERAL UNDERWRITERS. If, on the First Closing Date or the Second Closing Date, as the case may be, any one or more of the several Underwriters shall fail or refuse to purchase Shares that it or they have agreed to purchase hereunder on such date, and the aggregate number of Common Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase does not exceed 10% of the aggregate number of the Shares to be purchased on such date, the other Underwriters shall be obligated, severally, in the proportions that the number of Firm Common Shares set forth opposite their respective names on Schedule A bears to the aggregate number of Firm Shares set forth opposite the names of all such non-defaulting Underwriters, or in such other proportions as may be specified by the Representatives with the consent of the non-defaulting Underwriters, to purchase the Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date. If, on the First Closing Date or the Second Closing Date, as the case may be, any one or more of the Underwriters shall fail or refuse to purchase Shares and the aggregate number of Shares with respect to which such default occurs exceeds 10% of the aggregate number of Shares to be purchased on such date, and arrangements satisfactory to the Representatives and the Company for the purchase of such Shares are not made within 48 hours after such default, this Agreement shall terminate without liability of any party to any other party except that the provisions of Section 4, and Section 7 shall at all times be effective and shall survive such termination. In any such case either the Representatives or the Company shall have the right to postpone the First Closing Date or the Second Closing Date, as the case may be, but in no event for longer than seven days in order that the required changes, if any, to the Registration Statement and the Prospectus or any other documents or arrangements may be effected. As used in this Agreement, the term "Underwriter" shall be deemed to include any person substituted for a defaulting Underwriter under this Section 8. Any action taken under this Section 8 shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. SECTION 9. TERMINATION OF THIS AGREEMENT. Prior to the First Closing Date, this Agreement may be terminated by the Representatives by notice given to the Company if at any time (i) trading or quotation in any of the Company's securities shall have been suspended or limited by the Commission or by the Nasdaq Stock Market, or trading in securities generally on either the Nasdaq Stock Market or the New York Stock Exchange shall have been suspended or limited, or minimum or maximum prices shall have been generally established on any of such stock exchanges by the Commission or the National Association of Securities Dealers, LLC; (ii) a general banking moratorium shall have been declared by any of federal, New York or California authorities; (iii) there shall have occurred any outbreak or escalation of national or international hostilities or any crisis or calamity, or any change in the United States or international financial markets, or any substantial change or development involving a prospective change in United States' or international political, financial or economic conditions, as in the judgment of the Representatives is material and adverse and makes it impracticable or inadvisable to market the Common Shares in the manner and on the terms described in the Prospectus or to enforce contracts for the sale of securities; (iv) in the -23- 24 judgment of the Representatives there shall have occurred any Material Adverse Change; or (v) the Company shall have sustained a loss by strike, fire, flood, earthquake, accident or other calamity of such character as in the judgment of the Representatives may interfere materially with the conduct of the business and operations of the Company regardless of whether or not such loss shall have been insured. Any termination pursuant to this Section 9 shall be without liability on the part of (a) the Company to any Underwriter, except that the Company shall be obligated to reimburse the expenses of the Representatives and the Underwriters pursuant to Sections 5 and 6 hereof, (b) any Underwriter to the Company, or (c) of any party hereto to any other party except that the provisions of Section 7 shall at all times be effective and shall survive such termination. SECTION 10. REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY. The respective indemnities, agreements, representations, warranties and other statements of the Company, of its officers and of the several Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation made by or on behalf of any Underwriter or the Company or any of its or their partners, officers or directors or any controlling person, as the case may be, and will survive delivery of and payment for the Shares sold hereunder and any termination of this Agreement. SECTION 11. NOTICES. All communications hereunder shall be in writing and shall be mailed, hand delivered or telecopied and confirmed to the parties hereto as follows: If to the Representatives: BANCBOSTON ROBERTSON STEPHENS INC. 555 California Street San Francisco, California 94104 Facsimile: (415) 676-2696 Attention: General Counsel If to the Company: QUEST SOFTWARE, INC. 610 Newport Center Drive Newport Beach, CA 92660 Facsimile: 949-720-0426 Attention: Chief Executive Officer Any party hereto may change the address for receipt of communications by giving written notice to the others. SECTION 12. SUCCESSORS. This Agreement will inure to the benefit of and be binding upon the parties hereto, including any substitute Underwriters pursuant to Section 9 hereof, and to the benefit of the employees, officers and directors and controlling persons referred to in Section 7, and to their respective successors, and personal representatives, and no other person will have any right or -24- 25 obligation hereunder. The term "successors" shall not include any purchaser of the Shares as such from any of the Underwriters merely by reason of such purchase. SECTION 13. PARTIAL UNENFORCEABILITY. The invalidity or unenforceability of any Section, paragraph or provision of this Agreement shall not affect the validity or enforceability of any other Section, paragraph or provision hereof. If any Section, paragraph or provision of this Agreement is for any reason determined to be invalid or unenforceable, there shall be deemed to be made such minor changes (and only such minor changes) as are necessary to make it valid and enforceable. SECTION 14. GOVERNING LAW PROVISIONS. (a) Governing Law. This agreement shall be governed by and construed in accordance with the internal laws of the state of New York applicable to agreements made and to be performed in such state. (b) Consent to Jurisdiction. Any legal suit, action or proceeding arising out of or based upon this Agreement or the transactions contemplated hereby ("Related Proceedings") may be instituted in the federal courts of the United States of America located in the City and County of San Francisco or the courts of the State of California in each case located in the City and County of San Francisco (collectively, the "Specified Courts"), and each party irrevocably submits to the exclusive jurisdiction (except for proceedings instituted in regard to the enforcement of a judgment of any such court (a "Related Judgment"), as to which such jurisdiction is non-exclusive) of such courts in any such suit, action or proceeding. Service of any process, summons, notice or document by mail to such party's address set forth above shall be effective service of process for any suit, action or other proceeding brought in any such court. The parties irrevocably and unconditionally waive any objection to the laying of venue of any suit, action or other proceeding in the Specified Courts and irrevocably and unconditionally waive and agree not to plead or claim in any such court that any such suit, action or other proceeding brought in any such court has been brought in an inconvenient forum. Each party not located in the United States irrevocably appoints CT Corporation System, which currently maintains a San Francisco office at 49 Stevenson Street, San Francisco, California 94105, United States of America, as its agent to receive service of process or other legal summons for purposes of any such suit, action or proceeding that may be instituted in any state or federal court in the City and County of San Francisco. SECTION 15. GENERAL PROVISIONS. This Agreement constitutes the entire agreement of the parties to this Agreement and supersedes all prior written or oral and all contemporaneous oral agreements, understandings and negotiations with respect to the subject matter hereof. This Agreement may be executed in two or more counterparts, each one of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement may not be amended or modified unless in writing by all of the parties hereto, and no condition herein (express or implied) may be waived unless waived in writing by each party whom the condition is meant to benefit. The Section headings herein are for the convenience of the parties only and shall not affect the construction or interpretation of this Agreement. -25- 26 If the foregoing is in accordance with your understanding of our agreement, please sign and return to the Company the enclosed copies hereof, whereupon this instrument, along with all counterparts hereof, shall become a binding agreement in accordance with its terms. Very truly yours, QUEST SOFTWARE, INC. By: --------------------------------- Name: Vincent C. Smith Title: Chief Executive Officer The foregoing Underwriting Agreement is hereby confirmed and accepted by the Representatives as of the date first above written. BANCBOSTON ROBERTSON STEPHENS INC. DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION CIBC WORLD MARKETS CORP. FAC/EQUITIES, A DIVISION OF FIRST ALBANY CORPORATION On their behalf and on behalf of each of the several underwriters named in Schedule A hereto. BY BANCBOSTON ROBERTSON STEPHENS INC. By:_________________________________ Authorized Signatory -26- 27 SCHEDULE A Number of Firm Common Shares Underwriters To be Purchased - ------------ --------------- BANCBOSTON ROBERTSON STEPHENS INC. .......................... DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION.......... CIBC WORLD MARKETS CORP. .................................... FAC/EQUITIES, A DIVISION OF FIRST ALBANY CORPORATION Total............................................... S-A 28 EXHIBIT A LOCK-UP AGREEMENT BancBoston Robertson Stephens Inc. Donaldson, Lufkin & Jenrette Securities Corporation CIBC World Markets Corp. FAC/Equities, a division of First Albany Corporation As Representatives of the Several Underwriters c/o BancBoston Robertson Stephens Inc. 555 California Street, Suite 2600 San Francisco, California 94104 RE: Quest Software, Inc. (the "Company") Ladies & Gentlemen: The undersigned is an owner of record or beneficially of certain shares of Common Stock of the Company ("Common Stock") or securities convertible into or exchangeable or exercisable for Common Stock. The Company proposes to carry out a public offering of Common Stock (the "Offering") for which you will act as the representatives (the "Representatives") of the underwriters. The undersigned recognizes that the Offering will be of benefit to the undersigned and will benefit the Company by, among other things, raising additional capital for its operations. The undersigned acknowledges that you and the other underwriters are relying on the representations and agreements of the undersigned contained in this letter in carrying out the Offering and in entering into underwriting arrangements with the Company with respect to the Offering. In consideration of the foregoing, the undersigned hereby agrees that the undersigned will not offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to (collectively, a "Disposition") 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 (collectively, "Securities") now owned or hereafter acquired directly by such person or with respect to which such person has or hereafter acquires the power of disposition, otherwise than (i) as a bona fide gift or gifts, provided the donee or donees thereof agree in writing to be bound by this restriction, (ii) as a distribution to partners or shareholders of such person, provided that the distributees thereof agree in writing to be bound by the terms of this restriction, (iii) with respect to dispositions of Common Stock acquired on the open market or (iv) with the prior written consent of BancBoston Robertson Stephens Inc., for a period commencing on the date hereof and continuing to a date 180 days after the Registration Statement is declared effective by the Securities and Exchange Commission (the "Lock-up Period"). The foregoing restriction has been expressly agreed to preclude the holder of the Securities from engaging in any hedging or other transaction which is designed to or reasonably expected to lead to or result in a Disposition of Securities during A-1 29 the Lock-up Period, even if such Securities would be disposed of by someone other than such holder. Such prohibited hedging or other transactions would include, without limitation, any short sale (whether or not against the box) or any purchase, sale or grant of any right (including, without limitation, any put or call option) with respect to any Securities or with respect to any security (other than a broad-based market basket or index) that included, relates to or derives any significant part of its value from Securities. The undersigned also agrees and consents to the entry of stop transfer instructions with the Company's transfer agent and registrar against the transfer of shares of Common Stock or Securities held by the undersigned except in compliance with the foregoing restrictions. This agreement is irrevocable and will be binding on the undersigned and the respective successors, heirs, personal representatives, and assigns of the undersigned. Dated: ___________________________________ ----------------------------------------- Printed Name of Holder By: ______________________________________ Signature ----------------------------------------- Printed Name of Person Signing (and indicate capacity of person signing if signing if signing as custodian, trustee or on behalf of an entity) A-2 30 EXHIBIT B MATTERS TO BE COVERED IN THE OPINION OF COMPANY COUNSEL (i) The Company and each Significant Subsidiary (as that term is defined in Regulation S-X of the Act) has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation; (ii) The Company and each Significant Subsidiary has the corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Prospectus; (iii) The Company and each Significant Subsidiary is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction, if any, in which the ownership or leasing of its properties or the conduct of its business requires such qualification, except where the failure to be so qualified or be in good standing would not have a Material Adverse Effect. To such counsel's knowledge, the Company does not own or control, directly or indirectly, any corporation, association or other entity other than [list subsidiaries]; (iv) The authorized, issued and outstanding capital stock of the Company is as set forth in the Prospectus under the caption "Capitalization" as of the dates stated therein, the issued and outstanding shares of capital stock of the Company have been duly and validly issued and are fully paid and nonassessable, and, to such counsel's knowledge, will not have been issued in violation of or subject to any preemptive right, co-sale right, registration right, right of first refusal or other similar right; (v) All issued and outstanding shares of capital stock of each Significant Subsidiary of the Company have been duly authorized and validly issued and are fully paid and nonassessable, and, to such counsel's knowledge, have not been issued in violation of or subject to any preemptive right, co-sale right, registration right, right of first refusal or other similar right and are owned by the Company free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest; (vi) The Firm Shares or the Option Shares, as the case may be, to be issued by the Company pursuant to the terms of this Agreement have been duly authorized and, upon issuance and delivery against payment therefor in accordance with the terms hereof, will be duly and validly issued and fully paid and nonassessable, and will not have been issued in violation of or subject to any preemptive right, co-sale right, registration right, right of first refusal or other similar right. The Company has the corporate power and authority to enter into this Agreement and to issue, sell and deliver to the Underwriters the Shares to be issued and sold by it hereunder; B-1 31 (vii) The Company has the corporate power and authority to enter into this Agreement and to issue, sell and deliver to the Underwriters the Shares to be issued and sold by it hereunder; (viii) This Agreement has been duly authorized by all necessary corporate action on the part of the Company and has been duly executed and delivered by the Company and, assuming due authorization, execution and delivery by you, is a valid and binding agreement of the Company, enforceable in accordance with its terms, except as rights to indemnification hereunder may be limited by applicable law and except as enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting creditors' rights generally or by general equitable principles; (ix) The Registration Statement has become effective under the Act and, to such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or are pending or threatened under the Securities Act; (x) The 8-A Registration Statement complied as to form in all material respects with the requirements of the Exchange Act; the 8-A Registration Statement has become effective under the Exchange Act; and the Firm Shares or the Option Shares have been validly registered under the Securities Act and the Rules and Regulations of the Exchange Act and the applicable rules and regulations of the Commission thereunder; (xi) The Registration Statement and the Prospectus, and each amendment or supplement thereto (other than the financial statements (including supporting schedules) and financial data derived therefrom as to which such counsel need express no opinion), as of the effective date of the Registration Statement, complied as to form in all material respects with the requirements of the Act and the applicable Rules and Regulations; (xii) The information in the Prospectus under the caption "Description of Capital Stock," to the extent that it constitutes matters of law or legal conclusions, has been reviewed by such counsel and is a fair summary of such matters and conclusions; and the forms of certificates evidencing the Common Stock and filed as exhibits to the Registration Statement comply with California law; (xiii) The description in the Registration Statement and the Prospectus of the charter and bylaws of the Company and of statutes are accurate and fairly present the information required to be presented by the Securities Act; (xiv) To such counsel's knowledge, there are no agreements, contracts, leases or documents to which the Company is a party of a character required to be described or referred to in the Registration Statement or Prospectus or to be filed as an exhibit to the Registration Statement which are not described or referred to therein or filed as required; B-2 32 (xv) The performance of this Agreement and the consummation of the transactions herein contemplated (other than performance of the Company's indemnification obligations hereunder, concerning which no opinion need be expressed) will not (a) result in any violation of the Company's charter or bylaws or (b) to such counsel's knowledge, result in a material breach or violation of any of the terms and provisions of, or constitute a default under, any bond, debenture, note or other evidence of indebtedness, or any lease, contract, indenture, mortgage, deed of trust, loan agreement, joint venture or other agreement or instrument known to such counsel to which the Company is a party or by which its properties are bound, or any applicable statute, rule or regulation known to such counsel or, to such counsel's knowledge, any order, writ or decree of any court, government or governmental agency or body having jurisdiction over the Company or any of its subsidiaries, or over any of their properties or operations; (xvi) No consent, approval, authorization or order of or qualification with any court, government or governmental agency or body having jurisdiction over the Company or any of its subsidiaries, or over any of their properties or operations is necessary in connection with the consummation by the Company of the transactions herein contemplated, except (i) such as have been obtained under the Securities Act, (ii) such as may be required under state or other securities or Blue Sky laws in connection with the purchase and the distribution of the Shares by the Underwriters, (iii) such as may be required by the National Association of Securities Dealers, LLC and (iv) such as may be required under the federal or provincial laws of Canada; (xvii) To such counsel's knowledge, there are no legal or governmental proceedings pending or threatened against the Company or any of its subsidiaries of a character required to be disclosed in the Registration Statement or the Prospectus by the Securities Act, other than those described therein; (xviii) To such counsel's knowledge, neither the Company nor any of its subsidiaries is presently (a) in material violation of its respective charter or bylaws, or (b) in material breach of any applicable statute, rule or regulation known to such counsel or, to such counsel's knowledge, any order, writ or decree of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries, or over any of their properties or operations; and (xix) To such counsel's knowledge, except as set forth in the Registration Statement and Prospectus, no holders of Company Shares or other securities of the Company have registration rights with respect to securities of the Company and, except as set forth in the Registration Statement and Prospectus, all holders of securities of the Company having rights known to such counsel to registration of such shares of Company Shares or other securities, because of the filing of the Registration Statement by the Company have, with respect to the offering contemplated thereby, waived such rights or such rights have expired by reason of lapse of time following notification of the Company's intent to file the Registration Statement B-3 33 or have included securities in the Registration Statement pursuant to the exercise of and in full satisfaction of such rights. (xx) The Company is not and, after giving effect to the offering and the sale of the Shares and the application of the proceeds thereof as described in the Prospectus, will not be, an "investment company" as such term is defined in the Investment Company Act of 1940, as amended. (xxi) To such counsel's knowledge, the Company owns or possesses sufficient trademarks, trade names, patent rights, copyrights, licenses, approvals, trade secrets and other similar rights (collectively, "Intellectual Property Rights") reasonably necessary to conduct their business as now conducted; and the expected expiration of any such Intellectual Property Rights would not result in a Material Adverse Effect. The Company has not received any notice of infringement or conflict with asserted Intellectual Property Rights of others, which infringement or conflict, if the subject of an unfavorable decision, would result in a Material Adverse Effect. To such counsel's knowledge, the Company's discoveries, inventions, products, or processes referred to in the Registration Statement or Prospectus do not infringe or conflict with any right or patent which is the subject of a patent application known to the Company. In addition, such counsel shall state that such counsel has participated in conferences with officials and other representatives of the Company, the Representatives, Underwriters' Counsel and the independent certified public accountants of the Company, at which such conferences the contents of the Registration Statement and Prospectus and related matters were discussed, and although they have not verified the accuracy or completeness of the statements contained in the Registration Statement or the Prospectus, nothing has come to the attention of such counsel which leads them to believe that, at the time the Registration Statement became effective and at all times subsequent thereto up to and on the First Closing Date or Second Closing Date, as the case may be, the Registration Statement and any amendment or supplement thereto (other than the financial statements including supporting schedules and other financial and statistical information derived therefrom, as to which such counsel need express no comment) contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or at the First Closing Date or the Second Closing Date, as the case may be, the Registration Statement, the Prospectus and any amendment or supplement thereto (except as aforesaid) contained any untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading B-4 34 EXHIBIT C MATTERS TO BE COVERED IN THE OPINION OF UNDERWRITERS' COUNSEL (i) The Shares to be issued by the Company have been duly authorized and, upon issuance and delivery and payment therefor in accordance with the terms of the Underwriting Agreement, will be validly issued, fully paid and non-assessable. (ii) The Registration Statement complied as to form in all material respects with the requirements of the Act; the Registration Statement has become effective under the Act and, to such counsel's knowledge, no stop order proceedings with respect thereto have been instituted or threatened or are pending under the Act. (iii) The 8-A Registration Statement complied as to form in all material respects with the requirements of the Exchange Act; the 8-A Registration Statement has become effective under the Exchange Act; and the Firm Shares or the Option Shares have been validly registered under the Securities Act and the Rules and Regulations of the Exchange Act and the applicable rules and regulations of the Commission thereunder; (iv) The Underwriting Agreement has been duly authorized, executed and delivered by the Company. Such counsel shall state that such counsel has reviewed the opinion addressed to the Representatives from Brobeck, Phleger & Harrison LLP dated the date hereof, and furnished to you in accordance with the provisions of the Underwriting Agreement. Such opinion appears on its face to be appropriately responsive to the requirements of the Underwriting Agreement. In addition, such counsel shall state that such counsel has participated in conferences with officials and other representatives of the Company, the Representatives, Underwriters' Counsel and the independent certified public accountants of the Company, at which such conferences the contents of the Registration Statement and Prospectus and related matters were discussed, and although they have not verified the accuracy or completeness of the statements contained in the Registration Statement or the Prospectus, nothing has come to the attention of such counsel which leads them to believe that, at the time the Registration Statement became effective and at all times subsequent thereto up to and on the First Closing Date or Second Closing Date, as the case may be, the Registration Statement and any amendment or supplement thereto (other than the financial statements including supporting schedules and other financial and statistical information derived therefrom, as to which such counsel need express no comment) contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, or at the First Closing Date or the Second Closing Date, as the case may be, the Registration Statement, the Prospectus and any amendment or supplement thereto (except as aforesaid) contained any untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. EX-4.1 3 FORM OF SPECIMEN COMMON STOCK CERTIFICATE 1 EXHIBIT 4.1 SPECIMEN STOCK CERTIFICATE FACE COMMON STOCK COMMON STOCK [QUEST LOGO] QUEST SOFTWARE INCORPORATED UNDER THE LAWS OF THE STATE OF CALIFORNIA CUSIP 74834T 10 3 SEE REVERSE FOR CERTAIN DEFINITIONS AND RESTRICTIONS ON TRANSFER THIS CERTIFIES THAT is the owner of ________________________________________________________________ FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, NO PAR VALUE, OF QUEST SOFTWARE, INC. (hereinafter and on the back hereof called the "Corporation"),transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney upon surrender of this Certificate properly endorsed. This Certificate is not valid until countersigned and registered by a Transfer Agent and Registrar. WITNESS the facsimile seal of the Corporation and facsimile signatures of its duly authorized officers. Dated: /s/ David M. Doyle /s/ John J. Laskey - ------------------------------------ ------------------------------------ President Chief Financial Officer COUNTERSIGNED AND REGISTERED: U.S. STOCK TRANSFER CORPORATION TRANSFER AGENT AND REGISTRAR BY ---------------------------------- AUTHORIZED SIGNATURE BACK QUEST SOFTWARE, INC. The Corporation is authorized to issue Common Stock and Preferred Stock. The Board of Directors of the Corporation has the authority to fix the number of shares and the designation of any series of Preferred Stock and to determine or alter the rights, preferences, privileges and restrictions granted to or imposed upon any unissued series of Preferred Stock. 2 A statement of the rights, preferences, privileges and restrictions granted to or imposed upon the respective classes or series of shares and upon the holders thereof as established by the Articles of Incorporation of the Corporation and by any certificate of determination, and the number of shares constituting each class or series and the designations thereof, may be obtained by any shareholder of the Corporation upon written request and without charge from the Secretary of the Corporation at the Corporate headquarters. KEEP THIS CERTIFICATE IN A SAFE PLACE. IF IT IS LOST, STOLEN, OR DESTROYED THE CORPORATION WILL REQUIRE A BOND OF INDEMNITY AS A CONDITION TO THE ISSUANCE OF A REPLACEMENT CERTIFICATE. The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM- as tenants in common TEN ENT- as tenants by the entireties JT TEN- as joint tenants with right of survivorship and not as tenants in common UNIF GIFT MIN ACT-_______________________ Custodian ___________________ (Cust) (Minor) under Uniform Gifts to Minors Act _________________________ (State) Additional abbreviations may also be used though not in the above list. FOR VALUE RECEIVED,___________________________ hereby sell, assign and transfer unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE ________________________________________ ________________________________________________________________________________ (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS OF ASSIGNEE) ________________________________________________________________________________ __________________________________________________________________________Shares of the Common Stock represented by the within Certificate, and do hereby irrevocably constitute and appoint______________________________________Attorney to transfer the said stock on the books of the within-named Corporation with full power of substitution in the premises. Dated X_____________________________________ X_____________________________________ NOTICE: THE SIGNATURE(S) TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER. Signature(s) Guaranteed: _______________________________________________________ THE SIGNATURE(S) MUST BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15. EX-5.1 4 FORM OF OPINION OF BROBECK,PHLEGER & HARRISON LLP 1 EXHIBIT 5.1 FORM OF OPINION _____________, 1999 Quest Software, Inc. 610 Newport Center Drive Newport Beach, CA 92660 Re: Quest Software, Inc. Registration Statement on Form S-1 for 5,060,000 Shares of Common Stock ------------------------------------------------------- Ladies and Gentlemen: We have acted as counsel to Quest Software, Inc., a California corporation (the "Company"), in connection with the proposed issuance and sale by the Company of up to 5,060,000 shares of the Company's Common Stock (the "Shares") pursuant to the Company's Registration Statement on Form S-1 (the "Registration Statement") filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended (the "Act"). This opinion is being furnished in accordance with the requirements of Item 16(a) of Form S-1 and Item 601(b)(5)(i) of Regulation S-K. We have reviewed the Company's charter documents and the corporate proceedings taken by the Company in connection with the issuance and sale of the Shares. Based on such review, we are of the opinion that the Shares have been duly authorized, and if, as and when issued in accordance with the Registration Statement and the related prospectus (as amended and supplemented through the date of issuance) will be legally issued, fully paid and nonassessable. We consent to the filing of this opinion letter as Exhibit 5.1 to the Registration Statement and to the reference to this firm under the caption "Legal Matters" in the prospectus which is part of the Registration Statement. In giving this consent, we do not thereby admit that we are within the category of persons whose consent is required under Section 7 of the Act, the rules and regulations of the Securities and Exchange Commission promulgated thereunder, or Item 509 of Regulation S-K. This opinion letter is rendered as of the date first written above and we disclaim any obligation to advise you of facts, circumstances, events or developments which hereafter may be brought to our attention and which may alter, affect or modify the opinion expressed herein. Our opinion is expressly limited to the matters set forth above and we render no opinion, whether by implication or otherwise, as to any other matters relating to the Company or the Shares. Very truly yours, EX-10.2 5 1999 STOCK INCENTIVE PLAN 1 EXHIBIT 10.2 QUEST SOFTWARE, INC. 1999 STOCK INCENTIVE PLAN ARTICLE ONE GENERAL PROVISIONS I. PURPOSE OF THE PLAN This 1999 Stock Incentive Plan is intended to promote the interests of Quest Software, Inc., a California corporation, by providing eligible persons with the opportunity to acquire a proprietary interest, or otherwise increase their proprietary interest, in the Corporation as an incentive for them to remain in the service of the Corporation. Capitalized terms shall have the meanings assigned to such terms in the attached Appendix. II. STRUCTURE OF THE PLAN A. The Plan shall be divided into five separate equity programs: (i) the Discretionary Option Grant Program under which eligible persons may, at the discretion of the Plan Administrator, be granted options to purchase shares of Common Stock, (ii) the Salary Investment Option Grant Program under which eligible employees may elect to have a portion of their base salary invested each year in special options, (iii) the Stock Issuance Program under which eligible persons may, at the discretion of the Plan Administrator, be issued shares of Common Stock directly, either through the immediate purchase of such shares or as a bonus for services rendered the Corporation (or any Parent or Subsidiary), (iv) the Automatic Option Grant Program under which eligible non-employee Board members shall automatically receive options at periodic intervals to purchase shares of Common Stock; and (v) the Director Fee Option Grant Program under which non-employee Board members may elect to have all or any portion of their annual retainer fee otherwise payable in cash applied to a special option grant. B. The provisions of Articles One and Seven shall apply to all equity programs under the Plan and shall govern the interests of all persons under the Plan. 2 III. ADMINISTRATION OF THE PLAN A. Prior to the Section 12 Registration Date, the Discretionary Option Grant and Stock Issuance Programs shall be administered by the Board unless otherwise determined by the Board. Beginning with the Section 12 Registration Date, the following provisions shall govern the administration of the Plan: (i) The Board shall have the authority to administer the Discretionary Option Grant and Stock Issuance Programs with respect to Section 16 Insiders but may delegate such authority in whole or in part to the Primary Committee. (ii) Administration of the Discretionary Option Grant and Stock Issuance Programs with respect to all other persons eligible to participate in those programs may, at the Board's discretion, be vested in the Primary Committee or a Secondary Committee, or the Board may retain the power to administer those programs with respect to all such persons. (iii) Administration of the Automatic Option Grant Program shall be self-executing in accordance with the terms of that program. B. Each Plan Administrator shall, within the scope of its administrative jurisdiction under the Plan, have full power and authority subject to the provisions of the Plan: (i) to establish such rules as it may deem appropriate for proper administration of the Plan, to make all factual determinations, to construe and interpret the provisions of the Plan and the awards thereunder and to resolve any and all ambiguities thereunder; (ii) to determine, with respect to awards made under the Discretionary Option Grant and Stock Issuance Programs, which eligible persons are to receive such awards, the time or times when such awards are to be made, the number of shares to be covered by each such award, the vesting schedule (if any) applicable to the award, the status of a granted option as either an Incentive Option or a Non-Statutory Option and the maximum term for which the option is to remain outstanding; (iii) to amend, modify or cancel any outstanding award with the consent of the holder or accelerate the vesting of such award; and (iv) to take such other discretionary actions as permitted pursuant to the terms of the applicable program. Decisions of each Plan Administrator within the scope of its administrative functions under the Plan shall be final and binding on all parties. C. Members of the Primary Committee or any Secondary Committee shall serve for such period of time as the Board may determine and may be removed by the Board at any time. The Board may also at any time terminate the functions of any Secondary Committee and reassume all powers and authority previously delegated to such committee. 2 3 D. Service on the Primary Committee or the Secondary Committee shall constitute service as a Board member, and members of each such committee shall accordingly be entitled to full indemnification and reimbursement as Board members for their service on such committee. No member of the Primary Committee or the Secondary Committee shall be liable for any act or omission made in good faith with respect to the Plan or any options or stock issuances under the Plan. IV. ELIGIBILITY A. The persons eligible to participate in the Discretionary Option Grant and Stock Issuance Programs are as follows: (i) Employees, (ii) non-employee members of the Board or the board of directors of any Parent or Subsidiary, and (iii) consultants and other independent advisors who provide services to the Corporation (or any Parent or Subsidiary). B. Only Employees who are Section 16 Insiders or other highly compensated individuals shall be eligible to participate in the Salary Investment Option Grant Program. C. Only non-employee Board members shall be eligible to participate in the Automatic Option Grant and Director Fee Option Grant Programs. V. STOCK SUBJECT TO THE PLAN A. The stock issuable under the Plan shall be shares of authorized but unissued or reacquired Common Stock, including shares repurchased by the Corporation on the open market. The maximum number of shares of Common Stock initially reserved for issuance over the term of the Plan shall not exceed Seven Million, Four Hundred Ninety-Eight Thousand, Five Hundred (7,498,500) shares. Such authorized share reserve consists of (i) the number of shares which remain available for issuance, as of the Section 12 Registration Date, under the Predecessor Plan, including the shares subject to the outstanding options to be incorporated into the Plan and the additional shares which would otherwise be available for future grant, plus (ii) an increase of _____________________ (___________) shares authorized by the Board subject to stockholder approval prior to the Section 12 Registration Date. B. No one person participating in the Plan may receive options, separately exercisable stock appreciation rights and direct stock issuances for more than Five Hundred Thousand (500,000) shares of Common Stock in the aggregate per calendar year, beginning with the 1999 calendar year. C. Shares of Common Stock subject to outstanding options (including options incorporated into this Plan from the Predecessor Plan) shall be available for subsequent issuance under the Plan to the extent those options expire, terminate or are cancelled for any reason prior to exercise in full. Unvested shares issued under the Plan and subsequently 3 4 repurchased by the Corporation, at the original exercise or issue price paid per share, pursuant to the Corporation's repurchase rights under the Plan shall be added back to the number of shares of Common Stock reserved for issuance under the Plan and shall accordingly be available for reissuance through one or more subsequent options or direct stock issuances under the Plan. However, should the exercise price of an option under the Plan be paid with shares of Common Stock or should shares of Common Stock otherwise issuable under the Plan be withheld by the Corporation in satisfaction of the withholding taxes incurred in connection with the exercise of an option or the vesting of a stock issuance under the Plan, then the number of shares of Common Stock available for issuance under the Plan shall be reduced by the gross number of shares for which the option is exercised or which vest under the stock issuance, and not by the net number of shares of Common Stock issued to the holder of such option or stock issuance. Shares of Common Stock underlying one or more stock appreciation rights exercised under the Plan shall NOT be available for subsequent issuance. D. If any change is made to the Common Stock by reason of any stock split, stock dividend, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation's receipt of consideration, appropriate adjustments shall be made to (i) the maximum number and/or class of securities issuable under the Plan, (ii) the number and/or class of securities by which the share reserve is to increase each calendar year pursuant to the automatic share increase provisions of the Plan, (iii) the number and/or class of securities for which any one person may be granted options, separately exercisable stock appreciation rights and direct stock issuances under the Plan per calendar year, (iv) the number and/or class of securities for which grants are subsequently to be made under the Automatic Option Grant Program to new and continuing non-employee Board members, (v) the number and/or class of securities and the exercise price per share in effect under each outstanding option under the Plan and (vi) the number and/or class of securities and price per share in effect under each outstanding option incorporated into this Plan from the Predecessor Plan. Such adjustments to the outstanding options are to be effected in a manner which shall preclude the enlargement or dilution of rights and benefits under such options. The adjustments determined by the Plan Administrator shall be final, binding and conclusive. 4 5 ARTICLE TWO DISCRETIONARY OPTION GRANT PROGRAM I. OPTION TERMS Each option shall be evidenced by one or more documents in the form approved by the Plan Administrator; provided, however, that each such document shall comply with the terms specified below. Each document evidencing an Incentive Option shall, in addition, be subject to the provisions of the Plan applicable to such options. A. EXERCISE PRICE. 1. The exercise price per share shall be fixed by the Plan Administrator at the time of the option grant; provided, however, with respect to options granted prior to the Section 12 Registration Date, the exercise price per share shall not be less than eighty-five percent (85%) of the Fair Market Value per share of Common Stock on the option grant date. 2. The exercise price shall become immediately due upon exercise of the option and shall, subject to the provisions of Section II of Article Seven and the documents evidencing the option, be payable in cash or check made payable to the Corporation. Should the Common Stock be registered under Section 12 of the 1934 Act at the time the option is exercised, then the exercise price may also be paid as follows: (i) shares of Common Stock held for the requisite period necessary to avoid a charge to the Corporation's earnings for financial reporting purposes and valued at Fair Market Value on the Exercise Date, or (ii) to the extent the option is exercised for vested shares, through a special sale and remittance procedure pursuant to which the Optionee shall concurrently provide irrevocable instructions to (a) a Corporation-approved brokerage firm to effect the immediate sale of the purchased shares and remit to the Corporation, out of the sale proceeds available on the settlement date, sufficient funds to cover the aggregate exercise price payable for the purchased shares plus all applicable Federal, state and local income and employment taxes required to be withheld by the Corporation by reason of such exercise and (b) the Corporation to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale. Except to the extent such sale and remittance procedure is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date. B. EXERCISE AND TERM OF OPTIONS. Each option shall be exercisable at such time or times, during such period and for such number of shares as shall be determined by the Plan Administrator and set forth in the documents evidencing the option. However, no option shall have a term in excess of ten (10) years measured from the option grant date. 5 6 C. CESSATION OF SERVICE. 1. The following provisions shall govern the exercise of any options outstanding at the time of the Optionee's cessation of Service or death: (i) Any option outstanding at the time of the Optionee's cessation of Service for any reason shall remain exercisable for such period of time thereafter as shall be determined by the Plan Administrator and set forth in the documents evidencing the option, but no such option shall be exercisable after the expiration of the option term. (ii) Any option exercisable in whole or in part by the Optionee at the time of death may be subsequently exercised by his or her Beneficiary. (iii) During the applicable post-Service exercise period, the option may not be exercised in the aggregate for more than the number of vested shares for which the option is exercisable on the date of the Optionee's cessation of Service. Upon the expiration of the applicable exercise period or (if earlier) upon the expiration of the option term, the option shall terminate and cease to be outstanding for any vested shares for which the option has not been exercised. However, the option shall, immediately upon the Optionee's cessation of Service, terminate and cease to be outstanding to the extent the option is not otherwise at that time exercisable for vested shares. (iv) Should the Optionee's Service be terminated for Misconduct or should the Optionee engage in Misconduct while his or her options are outstanding, then all such options shall terminate immediately and cease to be outstanding. 2. The Plan Administrator shall have complete discretion, exercisable either at the time an option is granted or at any time while the option remains outstanding: (i) to extend the period of time for which the option is to remain exercisable following the Optionee's cessation of Service to such period of time as the Plan Administrator shall deem appropriate, but in no event beyond the expiration of the option term, and/or (ii) to permit the option to be exercised, during the applicable post-Service exercise period, for one or more additional installments in which the Optionee would have vested had the Optionee continued in Service. D. STOCKHOLDER RIGHTS. The holder of an option shall have no stockholder rights with respect to the shares subject to the option until such person shall have exercised the option, paid the exercise price and become a holder of record of the purchased shares. E. REPURCHASE RIGHTS. The Plan Administrator shall have the discretion to grant options which are exercisable for unvested shares of Common Stock. Should the Optionee cease Service while holding such unvested shares, the Corporation shall have the right to 6 7 repurchase, at the exercise price paid per share, any or all of those unvested shares. The terms upon which such repurchase right shall be exercisable (including the period and procedure for exercise and the appropriate vesting schedule for the purchased shares) shall be established by the Plan Administrator and set forth in the document evidencing such repurchase right. Prior to the Section 12 Registration Date, the Plan Administrator may not impose a vesting schedule upon any option grant or the shares of Common Stock subject to that option which is more restrictive than twenty percent (20%) per year vesting, with the initial vesting to occur not later than one (1) year after the option grant date. However, such limitation shall not be applicable to any option grants made to individuals who are officers of the Corporation, non-employee Board members or independent consultants. F. FIRST REFUSAL RIGHTS. Until the Section 12 Registration Date, the Corporation shall have the right of first refusal with respect to any proposed disposition by the Participant (or any successor in interest) of any shares of Common Stock issued under the Plan. Such right of first refusal shall be exercisable in accordance with the terms established by the Plan Administrator and set forth in the document evidencing such right. G. LIMITED TRANSFERABILITY OF OPTIONS. During the lifetime of the Optionee, Incentive Options shall be exercisable only by the Optionee and shall not be assignable or transferable other than to a Beneficiary following the Optionee's death. II. INCENTIVE OPTIONS The terms specified below shall be applicable to all Incentive Options. Except as modified by the provisions of this Section II, all the provisions of Articles One, Two and Six shall be applicable to Incentive Options. Options which are specifically designated as Non-Statutory Options when issued under the Plan shall not be subject to the terms of this Section II. A. ELIGIBILITY. Incentive Options may only be granted to Employees. B. EXERCISE PRICE. The exercise price per share shall not be less than one hundred percent (100%) of the Fair Market Value per share of Common Stock on the option grant date. C. DOLLAR LIMITATION. The aggregate Fair Market Value of the shares of Common Stock (determined as of the respective date or dates of grant) for which one or more options granted to any Employee under the Plan (or any other option plan of the Corporation or any Parent or Subsidiary) may for the first time become exercisable as Incentive Options during any one calendar year shall not exceed the sum of One Hundred Thousand Dollars ($100,000). To the extent the Employee holds two (2) or more such options which become exercisable for the first time in the same calendar year, the foregoing limitation on the exercisability of such options as Incentive Options shall be applied on the basis of the order in which such options are granted. D. 10% STOCKHOLDER. If any Employee to whom an Incentive Option is granted is a 10% Stockholder, then the exercise price per share shall not be less than one hundred ten percent (110%) of the Fair Market Value per share of Common Stock on the option grant date, and the option term shall not exceed five (5) years measured from the option grant date. 7 8 III. CHANGE IN CONTROL/HOSTILE TAKE-OVER A. Each option outstanding at the time of a Change in Control but not otherwise fully-vested shall automatically accelerate so that each such option shall, immediately prior to the effective date of the Change in Control, become exercisable for all of the shares of Common Stock at the time subject to that option and may be exercised for any or all of those shares as fully-vested shares of Common Stock. However, an outstanding option shall not so accelerate if and to the extent: (i) such option is, in connection with the Change in Control, assumed or otherwise continued in full force and effect by the successor corporation (or parent thereof) pursuant to the terms of the Change in Control, (ii) such option is replaced with a cash incentive program of the successor corporation which preserves the spread existing at the time of the Change in Control on the shares of Common Stock for which the option is not otherwise at that time exercisable and provides for subsequent payout in accordance with the same vesting schedule applicable to those option shares or (iii) the acceleration of such option is subject to other limitations imposed by the Plan Administrator at the time of the option grant. Each option outstanding at the time of the Change in Control shall terminate as provided in Section III.C. of this Article Two. B. All outstanding repurchase rights shall also terminate automatically, and the shares of Common Stock subject to those terminated rights shall immediately vest in full, in the event of any Change in Control, except to the extent: (i) those repurchase rights are assigned to the successor corporation (or parent thereof) or otherwise continue in full force and effect pursuant to the terms of the Change in Control or (ii) such accelerated vesting is precluded by other limitations imposed by the Plan Administrator at the time the repurchase right is issued. C. Immediately following the consummation of the Change in Control, all outstanding options shall terminate and cease to be outstanding, except to the extent assumed by the successor corporation (or parent thereof) or otherwise expressly continued in full force and effect pursuant to the terms of the Change in Control. D. Each option which is assumed in connection with a Change in Control shall be appropriately adjusted, immediately after such Change in Control, to apply to the number and class of securities which would have been issuable to the Optionee in consummation of such Change in Control had the option been exercised immediately prior to such Change in Control. Appropriate adjustments to reflect such Change in Control shall also be made to (i) the exercise price payable per share under each outstanding option, provided the aggregate exercise price payable for such securities shall remain the same, (ii) the maximum number and/or class of securities available for issuance over the remaining term of the Plan and (iii) the maximum number and/or class of securities for which any one person may be granted options, separately exercisable stock appreciation rights and direct stock issuances under the Plan per calendar year. E. The Plan Administrator may at any time provide that one or more options will automatically accelerate in connection with a Change in Control, whether or not those options are assumed or otherwise continued in full force and effect pursuant to the terms of the Change in Control. Any such option shall accordingly become exercisable, immediately prior to the effective date of such Change in Control, for all of the shares of Common Stock at the time subject to that option and may be exercised for any or all of those shares as fully-vested shares of 8 9 Common Stock. In addition, the Plan Administrator may at any time provide that one or more of the Corporation's repurchase rights shall not be assignable in connection with such Change in Control and shall terminate upon the consummation of such Change in Control. F. The Plan Administrator may at any time provide that one or more options will automatically accelerate upon an Involuntary Termination of the Optionee's Service within a designated period (not to exceed eighteen (18) months) following the effective date of any Change in Control in which those options do not otherwise accelerate. Any options so accelerated shall remain exercisable for fully-vested shares until the earlier of (i) the expiration of the option term or (ii) the expiration of the one (1) year period measured from the effective date of the Involuntary Termination. In addition, the Plan Administrator may at any time provide that one or more of the Corporation's repurchase rights shall immediately terminate upon such Involuntary Termination. G. The Plan Administrator may at any time provide that one or more options will automatically accelerate in connection with a Hostile Take-Over. Any such option shall become exercisable, immediately prior to the effective date of such Hostile Take-Over, for all of the shares of Common Stock at the time subject to that option and may be exercised for any or all of those shares as fully-vested shares of Common Stock. In addition, the Plan Administrator may at any time provide that one or more of the Corporation's repurchase rights shall terminate automatically upon the consummation of such Hostile Take-Over. Alternatively, the Plan Administrator may condition such automatic acceleration and termination upon an Involuntary Termination of the Optionee's Service within a designated period (not to exceed eighteen (18) months) following the effective date of such Hostile Take-Over. Each option so accelerated shall remain exercisable for fully-vested shares until the expiration or sooner termination of the option term. H. The portion of any Incentive Option accelerated in connection with a Change in Control or Hostile Take Over shall remain exercisable as an Incentive Option only to the extent the applicable One Hundred Thousand Dollar ($100,000) limitation is not exceeded. To the extent such dollar limitation is exceeded, the accelerated portion of such option shall be exercisable as a Non-Statutory Option under the Federal tax laws. IV. STOCK APPRECIATION RIGHTS The Plan Administrator may, subject to such conditions as it may determine, grant to selected Optionees stock appreciation rights which will allow the holders of those rights to elect between the exercise of the underlying option for shares of Common Stock and the surrender of that option in exchange for a distribution from the Corporation in an amount equal to the excess of (a) the Option Surrender Value of the number of shares for which the option is surrendered over (b) the aggregate exercise price payable for such shares. The distribution may be made in shares of Common Stock valued at Fair Market Value on the option surrender date, in cash, or partly in shares and partly in cash, as the Plan Administrator shall in its sole discretion deem appropriate. 9 10 ARTICLE THREE SALARY INVESTMENT OPTION GRANT PROGRAM I. OPTION GRANTS The Primary Committee may implement the Salary Investment Option Grant Program for one or more calendar years beginning after the Underwriting Date and select the Section 16 Insiders and other highly compensated Employees eligible to participate in the Salary Investment Option Grant Program for each such calendar year. Each selected individual who elects to participate in the Salary Investment Option Grant Program must, prior to the start of each calendar year of participation, file with the Plan Administrator (or its designate) an irrevocable authorization directing the Corporation to reduce his or her base salary for that calendar year by an amount not less than Ten Thousand Dollars ($10,000.00) nor more than Seventy-Five Thousand Dollars ($75,000.00). The Primary Committee shall have complete discretion to determine whether to approve the filed authorization in whole or in part. To the extent the Primary Committee approves the authorization, the individual who filed that authorization shall be granted an option under the Salary Investment Grant Program on the first trading day in January for the calendar year for which the salary reduction is to be in effect. II. OPTION TERMS Each option shall be a Non-Statutory Option evidenced by one or more documents in the form approved by the Plan Administrator; provided, however, that each such document shall comply with the terms specified below. A. EXERCISE PRICE. 1. The exercise price per share shall be thirty-three and one-third percent (33-1/3%) of the Fair Market Value per share of Common Stock on the option grant date. 2. The exercise price shall become immediately due upon exercise of the option and shall be payable in one or more of the alternative forms authorized under the Discretionary Option Grant Program. Except to the extent the sale and remittance procedure specified thereunder is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date. B. NUMBER OF OPTION SHARES. The number of shares of Common Stock subject to the option shall be determined pursuant to the following formula (rounded down to the nearest whole number): X = A / (B x 66-2/3%), where X is the number of option shares, A is the dollar amount of the approved reduction in the Optionee's base salary for the calendar year, and 10 11 B is the Fair Market Value per share of Common Stock on the option grant date. C. EXERCISE AND TERM OF OPTIONS. The option shall become exercisable in a series of twelve (12) successive equal monthly installments upon the Optionee's completion of each calendar month of Service in the calendar year for which the salary reduction is in effect. Each option shall have a maximum term of ten (10) years measured from the option grant date. D. CESSATION OF SERVICE. Each option outstanding at the time of the Optionee's cessation of Service shall remain exercisable, for any or all of the shares for which the option is exercisable at the time of such cessation of Service, until the earlier of (i) the expiration of the option term or (ii) the expiration of the three (3)-year period following the Optionee's cessation of Service. To the extent the option is held by the Optionee at the time of his or her death, the option may be exercised by his or her Beneficiary. However, the option shall, immediately upon the Optionee's cessation of Service, terminate and cease to remain outstanding with respect to any and all shares of Common Stock for which the option is not otherwise at that time exercisable. III. CHANGE IN CONTROL/HOSTILE TAKE-OVER A. In the event of any Change in Control or Hostile Take-Over while the Optionee remains in Service, each outstanding option shall automatically accelerate so that each such option shall, immediately prior to the effective date of the Change in Control or Hostile Take-Over, become fully exercisable with respect to the total number of shares of Common Stock at the time subject to such option and may be exercised for any or all of those shares as fully-vested shares of Common Stock. Each such option accelerated in connection with a Change in Control shall terminate upon the Change in Control, except to the extent assumed by the successor corporation (or parent thereof) or otherwise continued in full force and effect pursuant to the terms of the Change in Control. Each such option accelerated in connection with a Hostile Take-Over shall remain exercisable until the expiration or sooner termination of the option term. B. Each option which is assumed in connection with a Change in Control shall be appropriately adjusted to apply to the number and class of securities which would have been issuable to the Optionee in consummation of such Change in Control had the option been exercised immediately prior to such Change in Control. Appropriate adjustments shall also be made to the exercise price payable per share under each outstanding option, provided the aggregate exercise price payable for such securities shall remain the same. C. Upon the occurrence of a Hostile Take-Over, the Optionee shall have a thirty (30)-day period in which to surrender to the Corporation each of his or her outstanding options. The Optionee shall in return be entitled to a cash distribution from the Corporation in an amount equal to the excess of (i) the Option Surrender Value of the shares of Common Stock at the time subject to each surrendered option (whether or not the Optionee is otherwise at the time vested in those shares) over (ii) the aggregate exercise price payable for such shares. Such cash distribution shall be paid within five (5) days following the surrender of the option to the Corporation. 11 12 IV. REMAINING TERMS The remaining terms of each option granted under the Salary Investment Option Grant Program shall be the same as the terms in effect for options made under the Discretionary Option Grant Program. 12 13 ARTICLE FOUR STOCK ISSUANCE PROGRAM I. STOCK ISSUANCE TERMS Shares of Common Stock may be issued under the Stock Issuance Program through direct and immediate issuances without any intervening options. Shares of Common Stock may also be issued under the Stock Issuance Program pursuant to share right awards which entitle the recipients to receive those shares upon the attainment of designated performance goals or Service requirements. Each such award shall be evidenced by one or more documents which comply with the terms specified below. A. PURCHASE PRICE. 1. The purchase price per share of Common Stock subject to direct issuance shall be fixed by the Plan Administrator; provided, however, with respect to stock issuances made prior to the Section 12 Registration Date, the purchase price per share shall not be less than eighty-five percent (85%) of the Fair Market Value per share of Common Stock on the issue date and the purchase price per share of Common Stock issued to a 10% Stockholder shall not be less than one hundred and ten percent (110%) of such Fair Market Value. 2. Subject to the provisions of Section II of Article Seven, shares of Common Stock may be issued under the Stock Issuance Program for any of the following items of consideration which the Plan Administrator may deem appropriate in each individual instance: (i) cash or check made payable to the Corporation, or (ii) past services rendered to the Corporation (or any Parent or Subsidiary). B. VESTING/ISSUANCE PROVISIONS. 1. The Plan Administrator may issue shares of Common Stock which are fully and immediately vested upon issuance or which are to vest in one or more installments over the Participant's period of Service or upon attainment of specified performance objectives. Alternatively, the Plan Administrator may issue share right awards which shall entitle the recipient to receive a specified number of vested shares of Common Stock upon the attainment of one or more performance goals or Service requirements established by the Plan Administrator. However, for stock issuances prior to the Section 12 Registration Date, the Plan Administrator may not impose a vesting schedule upon any stock issuance effected under the Stock Issuance Program which is more restrictive than twenty percent (20%) per year vesting, with initial vesting to occur not later than one (1) year after the issuance date. Such limitation shall not apply to any Common Stock issuances made to the officers of the Corporation, non-employee Board members or independent consultants. 13 14 2. Any new, substituted or additional securities or other property (including money paid other than as a regular cash dividend) which the Participant may have the right to receive with respect to his or her unvested shares of Common Stock by reason of any stock dividend, stock split, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation's receipt of consideration shall be issued subject to (i) the same vesting requirements applicable to the Participant's unvested shares of Common Stock and (ii) such escrow arrangements as the Plan Administrator shall deem appropriate. 3. The Participant shall have full stockholder rights with respect to the issued shares of Common Stock, whether or not the Participant's interest in those shares is vested. Accordingly, the Participant shall have the right to vote such shares and to receive any regular cash dividends paid on such shares. 4. Should the Participant cease to remain in Service while holding one or more unvested shares of Common Stock, or should the performance objectives not be attained with respect to one or more such unvested shares of Common Stock, then those shares shall be immediately surrendered to the Corporation for cancellation, and the Participant shall have no further stockholder rights with respect to those shares. To the extent the surrendered shares were previously issued to the Participant for consideration paid in cash or cash equivalent (including the Participant's purchase-money indebtedness), the Corporation shall repay to the Participant the cash consideration paid for the surrendered shares and shall cancel the unpaid principal balance of any outstanding purchase-money note of the Participant attributable to the surrendered shares. 5. The Plan Administrator may waive the surrender and cancellation of one or more unvested shares of Common Stock (or other assets attributable thereto) which would otherwise occur upon the cessation of the Participant's Service or the non-attainment of the performance objectives applicable to those shares. Such waiver shall result in the immediate vesting of the Participant's interest in the shares of Common Stock as to which the waiver applies. Such waiver may be effected at any time, whether before or after the Participant's cessation of Service or the attainment or non-attainment of the applicable performance objectives. 6. Outstanding share right awards shall automatically terminate, and no shares of Common Stock shall actually be issued in satisfaction of those awards, if the performance goals or Service requirements established for such awards are not attained. The Plan Administrator, however, shall have the authority to issue shares of Common Stock in satisfaction of one or more outstanding share right awards as to which the designated performance goals or Service requirements are not attained. II. CHANGE IN CONTROL/HOSTILE TAKE-OVER A. All of the Corporation's outstanding repurchase rights shall terminate automatically, and all the shares of Common Stock subject to those terminated rights shall immediately vest in full, in the event of any Change in Control, except to the extent (i) those repurchase rights are assigned to the successor corporation (or parent thereof) or otherwise 14 15 continue in full force and effect pursuant to the terms of the Change in Control or (ii) such accelerated vesting is precluded by other limitations imposed by the Plan Administrator at the time the repurchase right is issued. B. The Plan Administrator may at any time provide for the automatic termination of one or more of those outstanding repurchase rights and the immediate vesting of the shares of Common Stock subject to those terminated rights upon (i) a Change in Control or Hostile Take-Over or (ii) an Involuntary Termination of the Participant's Service within a designated period (not to exceed eighteen (18) months) following the effective date of any Change in Control or Hostile Take-Over in which those repurchase rights are assigned to the successor corporation (or parent thereof) or otherwise continue in full force and effect. III. SHARE ESCROW/LEGENDS Unvested shares may, in the Plan Administrator's discretion, be held in escrow by the Corporation until the Participant's interest in such shares vests or may be issued directly to the Participant with restrictive legends on the certificates evidencing those unvested shares. 15 16 ARTICLE FIVE AUTOMATIC OPTION GRANT PROGRAM I. OPTION TERMS A. GRANT DATES. Options shall be made on the dates specified below: 1. Each individual who is first elected or appointed as a non-employee Board member at any time after the Underwriting Date shall automatically be granted, on the date of such initial election or appointment, a Non-Statutory Option to purchase Twenty-Five Thousand (25,000) shares of Common Stock, provided that individual has not previously been in the employ of the Corporation (or any Parent or Subsidiary). 2. On the date of each Annual Stockholders Meeting beginning with the 2001 Annual Stockholder Meeting, each individual who has served as a non-employee Board member since the date of the Annual Stockholders Meeting in the immediately preceding year shall automatically be granted a Non-Statutory Option to purchase Seven Thousand Five Hundred (7,500) shares of Common Stock. B. EXERCISE PRICE. 1. The exercise price per share shall be equal to one hundred percent (100%) of the Fair Market Value per share of Common Stock on the option grant date. 2. The exercise price shall be payable in one or more of the alternative forms authorized under the Discretionary Option Grant Program. Except to the extent the sale and remittance procedure specified thereunder is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date. C. OPTION TERM. Each option shall have a term of ten (10) years measured from the option grant date. D. EXERCISE AND VESTING OF OPTIONS. Each option shall be immediately exercisable for any or all of the option shares. However, any shares purchased under the initial 25,000 share option shall be subject to repurchase by the Corporation, at the exercise price paid per share, upon the Optionee's cessation of Board service prior to vesting in those shares. Each initial 25,000-share option shall vest, and the Corporation's repurchase right shall lapse, in a series of four (4) successive equal annual installments over the Optionee's period of continued service as a Board member, with the first such installment to vest upon the Optionee's completion of one (1) year of Board service measured from the option grant date. Each annual 7,500-share option shall be fully vested at the time of grant. E. CESSATION OF BOARD SERVICE. The following provisions shall govern the exercise of any options outstanding at the time of the Optionee's cessation of Board service: 16 17 (i) Any option outstanding at the time of the Optionee's cessation of Board service for any reason shall remain exercisable for a twelve (12)-month period following the date of such cessation of Board service, but in no event shall such option be exercisable after the expiration of the option term. (ii) Any option exercisable in whole or in part by the Optionee at the time of death may be subsequently exercised by his or her Beneficiary. (iii) Following the Optionee's cessation of Board service, the option may not be exercised in the aggregate for more than the number of shares for which the option was exercisable on the date of such cessation of Board service. Upon the expiration of the applicable exercise period or (if earlier) upon the expiration of the option term, the option shall terminate and cease to be outstanding for any vested shares for which the option has not been exercised. However, the option shall, immediately upon the Optionee's cessation of Board service, terminate and cease to be outstanding for any and all shares for which the option is not otherwise at that time exercisable. (iv) However, should the Optionee cease to serve as a Board member by reason of death or Permanent Disability, then all shares at the time subject to the option shall immediately vest so that such option may, during the twelve (12)-month exercise period following such cessation of Board service, be exercised for all or any portion of those shares as fully-vested shares of Common Stock. II. CHANGE IN CONTROL/HOSTILE TAKE-OVER A. In the event of any Change in Control or Hostile Take-Over, the shares of Common Stock at the time subject to each outstanding option but not otherwise vested shall automatically vest in full so that each such option may, immediately prior to the effective date of such Change in Control or Hostile Take-Over, became fully exercisable for all of the shares of Common Stock at the time subject to such option and maybe exercised for all or any of those shares as fully-vested shares of Common Stock. Each such option accelerated in connection with a Change in Control shall terminate upon the Change in Control, except to the extent assumed by the successor corporation (or parent thereof) or otherwise continued in full force and effect pursuant to the terms of the Change in Control. Each such option accelerated in connection with a Hostile Take-Over shall remain exercisable until the expiration or sooner termination of the option term. B. All outstanding repurchase rights shall automatically terminate and the shares of Common Stock subject to those terminated rights shall immediately vest in full, in the event of any Change in Control or Hostile Take-Over. C. Upon the occurrence of a Hostile Take-Over, the Optionee shall have a thirty (30)-day period in which to surrender to the Corporation each of his or her outstanding options. The Optionee shall in return be entitled to a cash distribution from the Corporation in an amount equal to the excess of (i) the Option Surrender Value of the shares of Common Stock at the time subject to each surrendered option (whether or not the option is otherwise at the time exercisable for those shares) over (ii) the aggregate exercise price payable for such shares. Such 17 18 cash distribution shall be paid within five (5) days following the surrender of the option to the Corporation. D. Each option which is assumed in connection with a Change in Control shall be appropriately adjusted to apply to the number and class of securities which would have been issuable to the Optionee in consummation of such Change in Control had the option been exercised immediately prior to such Change in Control. Appropriate adjustments shall also be made to the exercise price payable per share under each outstanding option, provided the aggregate exercise price payable for such securities shall remain the same. III. REMAINING TERMS The remaining terms of each option granted under the Automatic Option Grant Program shall be the same as the terms in effect for options made under the Discretionary Option Grant Program. 18 19 ARTICLE SIX DIRECTOR FEE OPTION GRANT PROGRAM I. OPTION GRANTS The Board may implement the Director Fee Option Grant Program as of the first day of any calendar year beginning after the Underwriting Date. Upon such implementation of the Program, each non-employee Board member may elect to apply all or any portion of the annual retainer fee otherwise payable in cash for his or her service on the Board to the acquisition of a special option grant under this Director Fee Option Grant Program. Such election must be filed with the Corporation's Chief Financial Officer prior to the first day of the calendar year for which the election is to be in effect. Each non-employee Board member who files such a timely election with respect to the annul retainer fee shall automatically be granted an option under this Director Fee Option Grant Program on the first trading day in January in the calendar year for which that fee would otherwise be payable. II. OPTION TERMS Each option shall be a Non-Statutory Option governed by the terms and conditions specified below. A. EXERCISE PRICE. 1. The exercise price per share shall be thirty-three and one-third percent (33-1/3%) of the Fair Market Value per share of Common Stock on the option grant date. 2. The exercise price shall become immediately due upon exercise of the option and shall be payable in one or more of the alternative forms authorized under the Discretionary Option Grant Program. Except to the extent the sale and remittance procedure specified thereunder is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date. B. NUMBER OF OPTION SHARES. The number of shares of Common Stock subject to the option shall be determined pursuant to the following formula (rounded down to the nearest whole number): X = A / (B x 66-2/3%), where X is the number of option shares, A is the portion of the annual retainer fee subject to the non-employee Board member's election, and B is the Fair Market Value per share of Common Stock on the option grant date. C. EXERCISE AND TERM OF OPTIONS. The option shall become exercisable in a series of twelve (12) successive equal monthly installments upon the Optionee's completion of 19 20 each month of Board service during the calendar year in which the option is granted. Each option shall have a maximum term of ten (10) years measured from the option grant date. D. CESSATION OF BOARD SERVICE. Should the Optionee cease Board service for any reason (other than death or Permanent Disability) while holding one or more options, then each such option shall remain exercisable, for any or all of the shares for which the option is exercisable at the time of such cessation of Board service, until the earlier of (i) the expiration of the ten (10)-year option term or (ii) the expiration of the three (3)-year period measured from the date of such cessation of Board service. However, each option held by the Optionee at the time of such cessation of Board service shall immediately terminate and cease to remain outstanding with respect to any and all shares of Common Stock for which the option is not otherwise at that time exercisable. E. DEATH OR PERMANENT DISABILITY. Should the Optionee's service as a Board member cease by reason of death or Permanent Disability, then each option held by such Optionee shall immediately become exercisable for all the shares of Common Stock at the time subject to that option, and the option may be exercised for any or all of those shares as fully-vested shares until the earlier of (i) the expiration of the ten (10)-year option term or (ii) the expiration of the three (3)-year period measured from the date of such cessation of Board service. Should the Optionee die after cessation of Board service but while holding one or more options, then each such option may be exercised, for any or all of the shares for which the option is exercisable at the time of the Optionee's cessation of Board service (less any shares subsequently purchased by Optionee prior to death), by the Optionee's Beneficiary. Such right of exercise shall lapse, and the option shall terminate, upon the earlier of (i) the expiration of the ten (10)-year option term or (ii) the three (3)-year period measured from the date of the Optionee's cessation of Board service. III. CHANGE IN CONTROL/HOSTILE TAKE-OVER A. In the event of any Change in Control or Hostile Take-Over while the Optionee remains in Board service, each outstanding option held by such Optionee shall automatically accelerate so that each such option shall, immediately prior to the effective date of the Change in Control or Hostile Take-Over, become fully exercisable with respect to the total number of shares of Common Stock at the time subject to such option and may be exercised for any or all of those shares as fully-vested shares of Common Stock. Each such option accelerated in connection with a Change in Control shall terminate upon the Change in Control, except to the extent assumed by the successor corporation (or parent thereof) or otherwise expressly continued in full force and effect pursuant to the terms of the Change in Control. Each such option accelerated in connection with a Hostile Take-Over shall remain exercisable until the expiration or sooner termination of the option term. B. Upon the occurrence of a Hostile Take-Over, the Optionee shall have a thirty (30)-day period in which to surrender to the Corporation each of his or her outstanding options. The Optionee shall in return be entitled to a cash distribution from the Corporation in an amount equal to the excess of (i) the Option Surrender Value of the shares of Common Stock at the time subject to each surrendered option (whether or not the Optionee is otherwise at the time 20 21 vested in those shares) over (ii) the aggregate exercise price payable for such shares. Such cash distribution shall be paid within five (5) days following the surrender of the option to the Corporation. IV. REMAINING TERMS The remaining terms of each option granted under this Director Fee Option Grant Program shall be the same as the terms in effect for options made under the Discretionary Option Grant Program. 21 22 ARTICLE SEVEN MISCELLANEOUS I. NO IMPAIRMENT OF AUTHORITY Outstanding awards shall in no way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets. II. FINANCING The Plan Administrator may permit any Optionee or Participant to pay the option exercise price under the Discretionary Option Grant Program or the purchase price of shares issued under the Stock Issuance Program by delivering a full-recourse, interest bearing promissory note payable in one or more installments. The terms of any such promissory note (including the interest rate and the terms of repayment) shall be established by the Plan Administrator in its sole discretion. In no event may the maximum credit available to the Optionee or Participant exceed the sum of (i) the aggregate option exercise price or purchase price payable for the purchased shares plus (ii) any Federal, state and local income and employment tax liability incurred by the Optionee or the Participant in connection with the option exercise or share purchase. III. TAX WITHHOLDING A. The Corporation's obligation to deliver shares of Common Stock upon the exercise of options or the issuance or vesting of such shares under the Plan shall be subject to the satisfaction of all applicable Federal, state and local income and employment tax withholding requirements. B. The Plan Administrator may, in its discretion, provide any or all holders of Non-Statutory Options or unvested shares of Common Stock under the Plan with the right to use shares of Common Stock in satisfaction of all or part of the Withholding Taxes incurred by such holders in connection with the exercise of their options or the vesting of their shares. Such right may be provided to any such holder in either or both of the following formats: Stock Withholding: The election to have the Corporation withhold, from the shares of Common Stock otherwise issuable upon the exercise of such Non-Statutory Option or the vesting of such shares, a portion of those shares with an aggregate Fair Market Value equal to the percentage of the Withholding Taxes (not to exceed one hundred percent (100%)) designated by the holder. Stock Delivery: The election to deliver to the Corporation, at the time the Non-Statutory Option is exercised or the shares vest, one or more shares of Common Stock previously acquired by such holder (other than in connection with the option exercise or share vesting triggering the Withholding Taxes) with an aggregate Fair Market Value equal to the percentage of the Taxes (not to exceed one hundred percent (100%)) designated by the holder. 22 23 IV. FINANCIAL REPORTS The Corporation shall deliver a balance sheet and an income statement at least annually to each individual holding an outstanding option under the Plan, unless such individual is a key Employee whose duties in connection with the Corporation (or any Parent or Subsidiary) assure such individual access to equivalent information. V. EFFECTIVE DATE AND TERM OF THE PLAN A. The Plan shall become effective immediately upon the Plan Effective Date. However, the Salary Investment Option Grant and Director Fee Option Grant Programs shall not be implemented until such time as the Primary Committee or the Board may deem appropriate. Options may be granted under the Discretionary Option Grant Program at any time on or after the Plan Effective Date. However, no options granted under the Plan may be exercised, and no shares shall be issued under the Plan, until the Plan is approved by the Corporation's stockholders. If such stockholder approval is not obtained within twelve (12) months after the Plan Effective Date, then all options previously granted under this Plan shall terminate and cease to be outstanding, and no further options shall be granted and no shares shall be issued under the Plan. B. The Plan shall serve as the successor to the Predecessor Plan, and no further options or direct stock issuances shall be made under the Predecessor Plan after the Section 12 Registration Date. All options outstanding under the Predecessor Plan on the Section 12 Registration Date shall be incorporated into the Plan at that time and shall be treated as outstanding options under the Plan. However, each outstanding option so incorporated shall continue to be governed solely by the terms of the documents evidencing such option, and no provision of the Plan shall be deemed to affect or otherwise modify the rights or obligations of the holders of such incorporated options with respect to their acquisition of shares of Common Stock. C. One or more provisions of the Plan, including (without limitation) the option/vesting acceleration provisions of Article Two relating to Changes in Control, may, in the Plan Administrator's discretion, be extended to one or more options incorporated from the Predecessor Plan which do not otherwise contain such provisions. D. The Plan shall terminate upon the earliest of (i) June 8, 2009, (ii) the date on which all shares available for issuance under the Plan shall have been issued as fully-vested shares or (iii) the termination of all outstanding options in connection with a Change in Control. Upon such plan termination, all outstanding options and unvested stock issuances shall thereafter continue to have force and effect in accordance with the provisions of the documents evidencing such grants or issuances. VI. AMENDMENT OF THE PLAN A. The Board shall have complete and exclusive power and authority to amend or modify the Plan in any or all respects. However, no such amendment or modification shall adversely affect the rights and obligations with respect to stock options or unvested stock issuances at the time outstanding under the Plan unless the Optionee or the Participant consents 23 24 to such amendment or modification. In addition, certain amendments may require stockholder approval pursuant to applicable laws or regulations. B. Options to purchase shares of Common Stock may be granted under the Discretionary Option Grant and Salary Investment Option Grant Programs and shares of Common Stock may be issued under the Stock Issuance Program that are in each instance in excess of the number of shares then available for issuance under the Plan, provided any excess shares actually issued under those programs shall be held in escrow until there is obtained stockholder approval of an amendment sufficiently increasing the number of shares of Common Stock available for issuance under the Plan. If such stockholder approval is not obtained within twelve (12) months after the date the first such excess issuances are made, then (i) any unexercised options granted on the basis of such excess shares shall terminate and cease to be outstanding and (ii) the Corporation shall promptly refund to the Optionees and the Participants the exercise or purchase price paid for any excess shares issued under the Plan and held in escrow, together with interest (at the applicable Short Term Federal Rate) for the period the shares were held in escrow, and such shares shall thereupon be automatically cancelled and cease to be outstanding. VII. USE OF PROCEEDS Any cash proceeds received by the Corporation from the sale of shares of Common Stock under the Plan shall be used for general corporate purposes. VIII. REGULATORY APPROVALS A. The implementation of the Plan, the granting of any stock option under the Plan and the issuance of any shares of Common Stock (i) upon the exercise of any granted option or (ii) under the Stock Issuance Program shall be subject to the Corporation's procurement of all approvals and permits required by regulatory authorities having jurisdiction over the Plan, the stock options granted under it and the shares of Common Stock issued pursuant to it. B. No shares of Common Stock or other assets shall be issued or delivered under the Plan unless and until there shall have been compliance with all applicable requirements of Federal and state securities laws, including the filing and effectiveness of the Form S-8 registration statement for the shares of Common Stock issuable under the Plan, and all applicable listing requirements of any stock exchange (or the Nasdaq National Market, if applicable) on which Common Stock is then listed for trading. IX. NO EMPLOYMENT/SERVICE RIGHTS Nothing in the Plan shall confer upon the Optionee or the Participant any right to continue in Service for any period of specific duration or interfere with or otherwise restrict in any way the rights of the Corporation (or any Parent or Subsidiary employing or retaining such person) or of the Optionee or the Participant, which rights are hereby expressly reserved by each, to terminate such person's Service at any time for any reason, with or without cause. 24 25 APPENDIX The following definitions shall be in effect under the Plan: A. AUTOMATIC OPTION GRANT PROGRAM shall mean the automatic option grant program in effect under the Plan. B. BENEFICIARY shall mean, in the event the Plan Administrator implements a beneficiary designation procedure, the person designated by an Optionee or Participant, pursuant to such procedure, to succeed to such person's rights under any outstanding awards held by him or her at the time of death. In the absence of such designation or procedure, the Beneficiary shall be the personal representative of the estate of the Optionee or Participant or the person or persons to whom the award is transferred by will or the laws of descent and distribution. C. BOARD shall mean the Corporation's Board of Directors. D. CHANGE IN CONTROL shall mean a change in ownership or control of the Corporation effected through any of the following transactions: (i) a merger, consolidation or reorganization approved by the Corporation's stockholders, unless securities representing more than fifty percent (50%) of the total combined voting power of the voting securities of the successor corporation are immediately thereafter beneficially owned, directly or indirectly and in substantially the same proportion, by the persons who beneficially owned the Corporation's outstanding voting securities immediately prior to such transaction, (ii) any stockholder-approved transfer or other disposition of all or substantially all of the Corporation's assets, or (iii) the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities pursuant to a tender or exchange offer made directly to the Corporation's stockholders which the Board recommends such stockholders accept. E. CODE shall mean the Internal Revenue Code of 1986, as amended. F. COMMON STOCK shall mean the Corporation's common stock. G. CORPORATION shall mean Quest Software, Inc., a California corporation, and any corporate successor to all or substantially all of the assets or voting stock of Quest Software, Inc. which shall by appropriate action adopt the Plan. H. DIRECTOR FEE OPTION GRANT PROGRAM shall mean the director fee option grant program in effect under the Plan. A-1 26 I. DISCRETIONARY OPTION GRANT PROGRAM shall mean the discretionary option grant program in effect under the Plan. J. EMPLOYEE shall mean an individual who is in the employ of the Corporation (or any Parent or Subsidiary), subject to the control and direction of the employer entity as to both the work to be performed and the manner and method of performance. K. EXERCISE DATE shall mean the date on which the Corporation shall have received written notice of the option exercise. L. FAIR MARKET VALUE per share of Common Stock on any relevant date shall be determined in accordance with the following provisions: (i) If the Common Stock is at the time traded on the Nasdaq National Market, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question, as such price is reported on the Nasdaq National Market or any successor system. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists. (ii) If the Common Stock is at the time listed on any Stock Exchange, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question on the Stock Exchange determined by the Plan Administrator to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists. (iii) For purposes of any option grants made on the Underwriting Date, the Fair Market Value shall be deemed to be equal to the price per share at which the Common Stock is to be sold in the initial public offering pursuant to the Underwriting Agreement. (iv) For purposes of any options made prior to the Underwriting Date, the Fair Market Value shall be determined by the Plan Administrator, after taking into account such factors as it deems appropriate. M. HOSTILE TAKE-OVER shall mean: (i) the acquisition, directly or indirectly, by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation) of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation's outstanding securities pursuant to a tender or exchange offer made directly to the Corporation's stockholders which the Board does not recommend such stockholders to accept, or A-2 27 (ii) a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination. N. INCENTIVE OPTION shall mean an option which satisfies the requirements of Code Section 422. O. INVOLUNTARY TERMINATION shall mean the termination of the Service of any individual which occurs by reason of: (i) such individual's involuntary dismissal or discharge by the Corporation for reasons other than Misconduct, or (ii) such individual's voluntary resignation following (A) a change in his or her position with the Corporation or Parent or Subsidiary employing the individual which materially reduces his or her duties and responsibilities or the level of management to which he or she reports, (B) a reduction in his or her level of compensation (including base salary, fringe benefits and target bonus under any performance based bonus or incentive programs) by more than fifteen percent (15%) or (C) a relocation of such individual's place of employment by more than fifty (50) miles, provided and only if such change, reduction or relocation is effected by the Corporation without the individual's consent. P. MISCONDUCT shall mean the commission of any act of fraud, embezzlement or dishonesty by the Optionee or Participant, any unauthorized use or disclosure by such person of confidential information or trade secrets of the Corporation (or any Parent or Subsidiary), or any intentional wrongdoing by such person, whether by omission or commission, which adversely affects the business or affairs of the Corporation (or any Parent or Subsidiary) in a material manner. This shall not limit the grounds for the dismissal or discharge of any person in the Service of the Corporation (or any Parent or Subsidiary). Q. 1934 ACT shall mean the Securities Exchange Act of 1934, as amended. R. NON-STATUTORY OPTION shall mean an option not intended to satisfy the requirements of Code Section 422. S. OPTION SURRENDER VALUE shall mean the Fair Market Value per share of Common Stock on the date the option is surrendered to the Corporation or, in the event of a Hostile Take-Over, effected through a tender offer, the highest reported price per share of Common Stock paid by the tender offeror in effecting such Hostile Take-Over, if greater. However, if the surrendered option is an Incentive Option, the Option Surrender Value shall not exceed the Fair Market Value per share. A-3 28 T. OPTIONEE shall mean any person to whom an option is granted under the Discretionary Option Grant, Salary Investment Option Grant, Automatic Option Grant or Director Fee Option Grant Program. U. PARENT shall mean any corporation (other than the Corporation) in an unbroken chain of corporations ending with the Corporation, provided each corporation in the unbroken chain (other than the Corporation) owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. V. PARTICIPANT shall mean any person who is issued shares of Common Stock under the Stock Issuance Program. W. PERMANENT DISABILITY OR PERMANENTLY DISABLED shall mean the inability of the Optionee or the Participant to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of twelve (12) months or more. However, solely for purposes of the Automatic Option Grant and Director Fee Option Grant Programs, Permanent Disability or Permanently Disabled shall mean the inability of the non-employee Board member to perform his or her usual duties as a Board member by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of twelve (12) months or more. X. PLAN shall mean the Corporation's 1999 Stock Incentive Plan, as set forth in this document. Y. PLAN ADMINISTRATOR shall mean the particular entity, whether the Primary Committee, the Board or the Secondary Committee, which is authorized to administer the Discretionary Option Grant, Salary Investment Option Grant and Stock Issuance Programs with respect to one or more classes of eligible persons, to the extent such entity is carrying out its administrative functions under those programs with respect to the persons under its jurisdiction. However, the Primary Committee shall have the plenary authority to make all factual determinations and to construe and interpret any and all ambiguities under the Plan to the extent such authority is not otherwise expressly delegated to any other Plan Administrator. Z. PLAN EFFECTIVE DATE shall mean June 9, 1999, the date on which the Plan was adopted by the Board. AA. PREDECESSOR PLAN shall mean the Corporation's pre-existing 1998 Stock Option/Stock Issuance Plan in effect immediately prior to the Plan Effective Date hereunder. BB. PRIMARY COMMITTEE shall mean the committee of two (2) or more non-employee Board members appointed by the Board to administer the Discretionary Option Grant and Stock Issuance Programs with respect to Section 16 Insiders and to administer the Salary Investment Option Grant Program with respect to all eligible individuals. CC. SALARY INVESTMENT OPTION GRANT PROGRAM shall mean the salary investment grant program in effect under the Plan. A-4 29 DD. SECONDARY COMMITTEE shall mean a committee of one (1) or more Board members appointed by the Board to administer the Discretionary Option Grant and Stock Issuance Programs with respect to eligible persons other than Section 16 Insiders. EE. SECTION 12 REGISTRATION DATE shall mean the date on which the Common Stock is first registered under Section 12(g) of the 1934 Act. FF. SECTION 16 INSIDER shall mean an officer or director of the Corporation subject to the short-swing profit liabilities of Section 16 of the 1934 Act. GG. SERVICE shall mean the performance of services for the Corporation (or any Parent or Subsidiary) by a person in the capacity of an Employee, a non-employee member of the board of directors or a consultant or independent advisor, except to the extent otherwise specifically provided in the documents evidencing the option grant or stock issuance. HH. STOCK EXCHANGE shall mean either the American Stock Exchange or the New York Stock Exchange. II. STOCK ISSUANCE PROGRAM shall mean the stock issuance program in effect under the Plan. JJ. SUBSIDIARY shall mean any corporation (other than the Corporation) in an unbroken chain of corporations beginning with the Corporation, provided each corporation (other than the last corporation) in the unbroken chain owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. KK. 10% STOCKHOLDER shall mean the owner of stock (as determined under Code Section 424(d)) possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Corporation (or any Parent or Subsidiary). LL. UNDERWRITING AGREEMENT shall mean the agreement between the Corporation and the underwriter or underwriters managing the initial public offering of the Common Stock. MM. UNDERWRITING DATE shall mean the date on which the Underwriting Agreement is executed and priced in connection with an initial public offering of the Common Stock. NN. WITHHOLDING TAXES shall mean the Federal, state and local income and employment withholding tax liabilities to which the holder of Non-Statutory Options or unvested shares of Common Stock may become subject in connection with the exercise of those options or the vesting of those shares. A-5 EX-10.9 6 LEASE DATED JUNE 17, 1999 - IRVINE COMPANY 1 EXHIBIT 10.9 OFFICE SPACE LEASE BETWEEN THE IRVINE COMPANY AND QUEST SOFTWARE, INC. 2 OFFICE SPACE LEASE THIS LEASE is made as of the 17th day of June, 1999, by and between THE IRVINE COMPANY, hereafter called "Landlord," and QUEST SOFTWARE, INC., a California corporation, hereinafter called "Tenant." ARTICLE I. BASIC LEASE PROVISIONS Each reference in this Lease to the "Basic Lease Provisions" shall mean and refer to the following collective terms, the application of which shall be governed by the provisions in the remaining Articles of this Lease. 1. TENANT'S TRADE NAME: N/A 2. PREMISES: Suite Nos. 200, 500 & 600 (the Premises are more particularly described in Section 2.1). ADDRESS OF BUILDING: 8001 Irvine Center Drive, Irvine, CA 92618 PROJECT DESCRIPTION (IF APPLICABLE): 8001 Tower and attendant Common Area 3. USE OF PREMISES: General Office and for no other use. 4. ESTIMATED COMMENCEMENT DATE: October 1, 1999 5. LEASE TERM: Seventy-Four (74) months, plus such additional days as may be required to cause this Lease to terminate on the final day of the calendar month. 6. BASIC RENT: One Hundred Fifty-Five Thousand Two Hundred Fifty-Two Dollars ($155,252.00) per month. RENTAL ADJUSTMENTS: Commencing twelve (12) months following the Commencement Date, the Basic Rent shall be One Hundred Sixty-Two Thousand Two Dollars ($162,002.00) per month. Commencing twenty-four (24) months following the Commencement Date, the Basic Rent shall be One Hundred Sixty-Eight Thousand Seven Hundred Fifty-Three Dollars ($168,753.00) per month. Commencing thirty-six (36) months following the Commencement Date, the Basic Rent shall be One Hundred Seventy-Five Thousand Five Hundred Three Dollars ($175,503.00) per month. Commencing forty-eight (48) months following the Commencement Date, the Basic Rent shall be One Hundred Eighty-Two Thousand Two Hundred Fifty-Three Dollars ($182,253.00) per month. Commencing sixty (60) months following the Commencement Date, the Basic Rent shall be One Hundred Eighty-Nine Thousand Three Dollars ($189,003.00) per month. Commencing seventy-two (72) months following the Commencement Date, the Basic Rent shall be One Hundred Ninety-Five Thousand Seven Hundred Fifty-Three Dollars ($195,753.00) per month. 7. PROPERTY TAX BASE: The Property Taxes (as defined in Section 4.2(f) below) per rentable square foot for the twelve month period ending June 30, 2000. BUILDING COST BASE: The Building Costs (as defined in Section 4.2(f) below) per rentable square foot for the twelve month period ending June 30, 2000. EXPENSE RECOVERY PERIOD: Every twelve month period during the Term (or portion thereof during the first and last Lease years) ending June 30. 8. FLOOR AREA OF PREMISES: approximately 67,501 rentable square feet 9. SECURITY DEPOSIT: $172,820.00 (see Section 4.3) 10. BROKER(S): None 11. PLAN APPROVAL DATE: N/A 12. PARKING: Fifteen (15) reserved and Three Hundred (300) unreserved vehicle parking spaces. 1 3 13. ADDRESS FOR PAYMENTS AND NOTICES:
LANDLORD TENANT The Irvine Company Quest Software, Inc. c/o Insignia Commercial Group 8001 Irvine Center Drive 8001 Irvine Center Drive, Suite 1160 Suite 200 Irvine, CA 92618 Irvine, CA 92618 Attn: Property Manager with a copy of notices to: THE IRVINE COMPANY P.O. Box 6370 Newport Beach, CA 92658-6370 Attn: Vice President, Operations - Office Properties
2 4 ARTICLE II. PREMISES SECTION 2.1. LEASED PREMISES. Landlord leases to Tenant and Tenant rents from Landlord the premises shown in Exhibit A (the "Premises"), containing approximately the floor area set forth in Item 8 of the Basic Lease Provisions and known by the suite number identified in Item 2 of the Basic Lease Provisions. The Premises are located in the building identified in Item 2 of the Basic Lease Provisions (which together with the underlying real property, is called the "Building"), and is a portion of the project described in Item 2 (the "Project"). If, upon completion of the space plans for the Premises, Landlord's architect or space planner determines that the rentable square footage of the Premises differs from that set forth in the Basic Lease Provisions, then Landlord shall so notify Tenant and the Basic Rent (as shown in Item 6 of the Basic Lease Provisions) shall be promptly adjusted in proportion to the change in square footage. Within five (5) days following Landlord's request, the parties shall memorialize the adjustments by executing an amendment to this Lease prepared by Landlord. SECTION 2.2. ACCEPTANCE OF PREMISES. Tenant acknowledges that neither Landlord nor any representative of Landlord has made any representation or warranty with respect to the Premises or the Building or the suitability or fitness of either for any purpose, except as set forth in this Lease. The taking of possession or use of the Premises by Tenant for any purpose other than construction shall conclusively establish that the Premises were in satisfactory condition and in conformity with the provisions of this Lease in all respects, except for latent defects and those matters which Tenant shall have brought to Landlord's attention on a written punch list. The list shall be delivered to Landlord within thirty (30) days after the term ("Term") of this Lease commences as provided in Article III below, except that with respect to HVAC performance Tenant shall deliver such list within one hundred twenty (120) days. Nothing contained in this Section shall affect the commencement of the Term or the obligation of Tenant to pay rent. Landlord shall diligently complete all punch list items of which it is notified as provided above. SECTION 2.3. BUILDING NAME AND ADDRESS. Tenant shall not utilize any name selected by Landlord from time to time for the Building and/or the Project as any part of Tenant's corporate or trade name. Landlord shall have the right to change the name, number or designation of the Building or Project without liability to Tenant. SECTION 2.4. RIGHT OF FIRST OFFER. Provided Tenant is not then in default hereunder and is not then subleasing any portion of the Premises (except for subleases to "Related Entities" as defined in Section 9.1(d) below), and provided further that any third party tenants holding rights to lease the First Right Space (as hereinafter defined) elect not to exercise their rights, Landlord hereby grants Tenant the continuing right ("First Right") to lease any space which may become available for lease in the Building ("First Right Space") in accordance with and subject to the provisions of this Section 2.4; provided that the First Right shall not be in effect (i) prior to the date Tenant commences the payment of Basic Rent for the "Second Floor Storage Area" (as defined below) and (ii) during the final twelve (12) months of the initial Lease Term unless Tenant has timely delivered the "Exercise Notice" pursuant to Section 3.3. It is understood, however, that Tenant's First Right is expressly further conditioned upon the prior delivery by Tenant of written notice to Landlord in good faith of Tenant's need for additional space in the Building (the "Space Requirement Notice"). At any time during the Term of this Lease, and provided that all of the foregoing conditions have been satisfied, prior to leasing the First Right Space, or any portion thereof, to any other party, Landlord shall give Tenant written notice of its intention to lease same, which notice (the "First Right Notice") shall describe the particular space to be leased (the "Designated Space"). At Tenant's election, the parties shall thereupon negotiate in good faith the economic terms (including without limitation mutually approved tenant improvements and parking allotments) pursuant to which Tenant would lease the Designated Space for a term coextensive with the Term of this Lease. If, despite such good faith negotiations, the parties are unable mutually to agree on terms within ten (10) business days following delivery of the First Right Notice, then Landlord shall have the right to lease the Designated Space to a third party; provided that should the Designated Space again become available for lease during the Term hereof, the provisions of this Section shall apply ab initio. Conversely, should the parties timely agree on economic terms for Tenant's lease of the Designated Space, then Landlord shall promptly prepare and deliver to Tenant an amendment to this Lease consistent with such agreement, and Tenant shall execute and return same to Landlord within ten (10) days. Tenant's failure to timely return the amendment shall, if not rectified within two (2) days after notice of nonperformance from Landlord, entitle Landlord to lease such space to a third party. Notwithstanding the foregoing, it is understood that Tenant's First Right shall be subject to any extension or expansion rights granted by Landlord to any third party tenant now or hereafter occupying the First Right Space or any portion thereof, and in no event shall any such First Right Space be deemed available for leasing until the existing tenant thereof shall have vacated the First Right Space. Tenant's rights under this Section 2.4 shall belong solely to Quest Software, Inc., a California corporation, and may not otherwise be assigned or transferred by it except in connection with an 3 5 assignment of this Lease to a "Tenant Affiliate" (as defined in Section 9.1(e) below). Any other attempted assignment or transfer shall be void and of no force or effect. SECTION 2.5. OPTION TO EXPAND. Provided that Tenant is not then in default under any provision of this Lease, Tenant shall have the right to lease all of the space which is not then leased by Tenant on the ninth floor (comprising approximately 23,840 rentable square feet) of the Building (the "Option Space") in accordance with and subject to the provisions of this Section 2.5. Tenant shall deliver written notice to Landlord of its irrevocable commitment to lease the Expansion Space at any time prior to June 1, 2000 (the "Expansion Commitment"). If Tenant fails to timely deliver the Expansion Commitment, Landlord shall be free thereafter to lease the Option Space to one or more third parties, subject to Section 2.4 above. The Option Space shall be subject to all of the terms of this Lease, except that (i) subject to Landlord's rights in the event of "Tenant Delays" as described in Exhibit X hereto, the term shall be coterminous with this Lease commencing on the date Landlord has substantially completed the tenant improvements for the Option Space, which date shall be on the earliest possible date agreed to by Landlord and Tenant, but in no event later than August 31, 2001; (ii) the Basic Rent for the Option Space shall be at the prevailing market rental rate (including periodic adjustments) for comparable and similarly improved space within the Building and the adjacent building at 8105 Irvine Center Drive (the "8105 Building") as of the commencement of the Term of the Option Space, based on a reasonable extrapolation of leasing rates actually achieved in recent transactions in the Building and the 8105 Building and, if Tenant is not then being represented by a broker, giving greater weight to transactions in which no third party brokerage commission was paid; (iii) Landlord shall provide Tenant with five (5) employee parking spaces for every one thousand (1,000) usable square feet of the Option Space, which allotment shall include a limited number of reserved spaces equal to one (1) reserved stall for every four thousand (4,000) usable square feet of the Option Space; and (iv) Landlord shall cause to be constructed tenant improvements for the Expansion Space consistent with those provided for the initial Premises pursuant to Exhibit X hereto, which improvements shall be completed in accordance with a space plan approved by the parties. Landlord agrees that in the event the tenant improvement work requested by Tenant for the Expansion Space exceeds the amount of the Landlord's tenant improvement contribution therefor, then Landlord shall, at Tenant's request, submit the tenant improvement work for the Expansion Space to a competitive bidding process involving Landlord-approved contractors. Landlord further agrees that should the Expansion Space comprise the entire rentable area of the ninth floor, then as part of the approved tenant improvement work, Tenant shall have the right to remove the existing corridor space and to convert such space to usable office space, provided that such reconfiguration is in compliance with all building codes and other legal requirements and provided further that Tenant may be required by Landlord, concurrently with Landlord's approval of Tenant's final construction drawings, to restore the corridor to a Building standard condition at the end of the Term. Should the parties be unable to agree upon the rental rate for the Option Space within thirty (30) days following delivery of the Expansion Commitment, then either party may cause the rate to be determined by arbitration pursuant to Section 14.7(b). Tenant understands and agrees that Landlord's obligation to deliver certain suites on the ninth floor of the Building shall be contingent upon Landlord's ability to relocate the existing tenants thereof at a reasonable cost (which cost shall be funded by Tenant); should Landlord be unable to do so despite its good faith efforts, then Landlord shall so notify Tenant and the Option Space shall be deemed to exclude those applicable suites. Upon Tenant's exercise of its rights under this Section 2.5 and the determination of the final economic terms for Tenant's lease of the Option Space, Landlord shall prepare an appropriate amendment to this Lease respecting same and Tenant shall execute and deliver the amendment to Landlord within ten (10) days after receipt. Tenant's rights under this Section 2.5 shall belong solely to Quest Software, Inc., a California corporation, and may not otherwise be assigned or transferred except in connection with an assignment of this Lease to a Tenant Affiliate. Any other attempted assignment or transfer shall be void and of no force or effect. SECTION 2.6. SECOND FLOOR STORAGE AREA. Landlord hereby agrees that Tenant shall be permitted to utilize a portion of space on the second floor of the Building comprising approximately 8,599 rentable square feet and shown on Exhibit A-1 hereto for storage purposes only (the "Second Floor Storage Area"). Notwithstanding any contrary provision in this Lease, Landlord agrees that provided Tenant is not in default under the Lease, and provided further that Tenant is not using the Second Floor Storage Area for its business operations, Tenant shall not be obligated to pay Basic Rent for the Second Floor Storage Area during the initial six (6) months of the Lease Term, which rental credit shall equal Nineteen Thousand Seven Hundred Seventy-Eight Dollars ($19,778.00) per month. Tenant understands and agrees that at Landlord's election and expense, the Second Floor Storage Area shall be demised from the remainder of space on the second floor and shall be kept locked at all times by Landlord. Tenant further understands and agrees that should it require temporary access to the Second Floor Storage Area, Tenant shall so notify Landlord, and Landlord's management agent for the Building shall then permit such access to the Second Floor Storage Area as soon as reasonably possible following the request by Tenant. If, at any time during the first six (6) months of the Term, Tenant desires to commence using the Second Floor Storage Area for its business operations, Tenant shall so notify Landlord in writing and the Second 4 6 Floor Storage Area shall thereupon be made continuously available to Tenant; concurrently therewith, the foregoing rental credit shall be reduced to Nine Thousand Eight Hundred Eighty-Nine Dollars ($9,889.00) per month for the remainder of the initial six month period, with any mid-month reduction appropriately prorated based on the number of days in that month. ARTICLE III. TERM SECTION 3.1. GENERAL. The Term shall be for the period shown in Item 5 of the Basic Lease Provisions. The Term shall commence ("Commencement Date") on the earlier of (a) subject to the provisions of Section 3.2, five (5) days following the date that the Premises have been tendered to Tenant, ready for occupancy as described in section 3.2, but in no event earlier than the Estimated Commencement Date as set forth in Item 4 of the Basic Lease Provisions, or (b) the date Tenant commences its business activities within the Premises. Promptly following request by Landlord, the parties shall memorialize on a form provided by Landlord the actual Commencement Date and the expiration date ("Expiration Date") of this Lease. SECTION 3.2. DELAY IN POSSESSION. If Landlord, for any reason whatsoever, cannot deliver possession of the Premises to Tenant on or before the Estimated Commencement Date, this Lease shall not be void or voidable nor shall Landlord be liable to Tenant for any resulting loss or damage. However, Tenant shall not be liable for any rent and the Commencement Date shall not occur until Landlord delivers possession of the Premises and the Premises are in fact ready for occupancy as defined below, except that if Landlord's failure to so deliver possession on the Estimated Commencement Date is attributable to any action or inaction by Tenant (including without limitation any Tenant Delay described in the Work Letter, if any, attached to this Lease), then the Commencement Date shall not be advanced to the date on which possession of the Premises is tendered to Tenant, and Landlord shall be entitled to full performance by Tenant (including the payment of rent) from the date Landlord would have been able to deliver the Premises to Tenant but for Tenant's Delay(s). The Premises shall be deemed ready for occupancy upon the tendered date, but only if and when Landlord, to the extent applicable, (a) has put into operation all building services essential for the use of the Premises by Tenant, (b) has provided reasonable access to the Premises for Tenant so that they may be used without unnecessary interference, (c) has substantially completed all the work required to be done by Landlord in this Lease, and (d) has obtained requisite governmental approvals to Tenant's occupancy. SECTION 3.3. RIGHT TO EXTEND. Provided that Tenant is not then in default under any provision of this Lease, Tenant may extend the Term of this Lease for one period of sixty (60) months. Tenant shall exercise such right to extend the Term by and only by delivering to Landlord, not less than twelve (12) months prior to the scheduled expiration date of the Term, Tenant's written notice of its irrevocable election to extend (the "Exercise Notice"). Tenant's failure timely to deliver the Exercise Notice shall cause this extension right to lapse and be of no further force or effect. The Basic Rent payable under the Lease during the extension of the Term shall be at ninety-five percent (95%) of the prevailing rental rate and other economic terms for office space being leased by Landlord in the Building and the 8105 Building with a term commencing at or about the commencement of the applicable extension period, as determined based on a reasonable extrapolation of then-current leasing rates actually achieved in such buildings (the "Prevailing Rate"). In determining the Prevailing Rate, recent new and renewal leases with non-equity tenants of the Project shall be considered. The Prevailing Rate shall reflect the rental rate and terms payable in those third party transactions, taking into account pertinent economic concessions then generally being granted by Landlord such as "free rent," Operating Expense base years, parking charge limitations, and the like. It is understood, however, that no consideration shall be given to brokerage commissions, lease "takeover" payments, moving allowances, or tenant improvement allowances (other than retrofit allowances granted to renewal tenants). The rental rates payable in any third party transactions executed more than six (6) months prior to the commencement of the extension period shall be reasonably extrapolated, if applicable, to reflect anticipated changes in the Prevailing Rate based on current rental trends. Following Tenant's delivery of the Exercise Notice, but not later than six (6) months prior to the expiration date of the Term, Landlord shall notify Tenant in writing ("Landlord's Notice") of Landlord's calculation of the Prevailing Rate for the extension period based on the foregoing criteria. Should Tenant dispute Landlord's calculation, then Tenant may, by written notice to Landlord within thirty (30) days following Landlord's Notice, submit the reasonableness of Landlord's calculation of the Prevailing Rate to arbitration in accordance with Section 14.7(b) of the Lease (the "Arbitration Election"). Should Tenant fail timely to make the Arbitration Election, then Landlord's determination of the Prevailing Rate shall be conclusive. 5 7 Within twenty (20) days after the determination of the Prevailing Rate, Landlord shall prepare a reasonably appropriate amendment to this Lease for the extension period and Tenant shall execute and return same to Landlord within fifteen (15) days. Should the Prevailing Rate not be established by the commencement of the extension period, then Tenant shall continue paying rent at the rate in effect during the month preceding such commencement, and a lump sum adjustment shall be made promptly upon the determination of such new rental. The right to extend granted in this Section shall be personal to Quest Software, Inc., a California corporation, and any Tenant Affiliate thereof to which this Lease may be assigned. Any other attempt to assign or transfer such right shall be void from its inception. Time is specifically made of the essence in this Section. ARTICLE IV. RENT AND OPERATING EXPENSES SECTION 4.1. BASIC RENT. From and after the Commencement Date, Tenant shall pay to Landlord without deduction or offset (except as expressly provided in this Lease) a Basic Rent for the Premises in the total amount shown (including subsequent adjustments, if any) in Item 6 of the Basic Lease Provisions. Any rental adjustment shown in Item 6 shall be deemed to occur on the specified monthly anniversary of the Commencement Date, whether or not that date occurs at the end of a calendar month. The rent shall be due and payable in advance commencing on the Commencement Date (as prorated for any partial month) and continuing thereafter on the first day of each successive calendar month of the Term. No demand, notice or invoice shall be required. An installment of rent in the amount of one (1) full month's Basic Rent at the initial rate specified in Item 6 of the Basic Lease Provisions shall be delivered to Landlord concurrently with Tenant's execution of this Lease and shall be applied against the Basic Rent first due hereunder. SECTION 4.2. OPERATING EXPENSE INCREASE. (a) Commencing on the first day of the thirteenth month of the Lease Term, Tenant shall compensate Landlord, as additional rent, for Tenant's proportionate shares of "Building Costs" and "Property Taxes," as those terms are defined below, incurred by Landlord in the operation of the Building and Project. Property Taxes and Building Costs are mutually exclusive and may be billed separately or in combination as determined by Landlord. Tenant's proportionate share of Property Taxes shall equal the product of the rentable floor area of the Premises multiplied by the difference of (i) Property Taxes per rentable square foot less (ii) the Property Tax Base set forth in Item 7 of the Basic Lease Provisions. Tenant's proportionate share of Building Costs shall equal the product of the rentable floor area of the Premises multiplied by the difference of (i) Building Costs per rentable square foot less (ii) the Building Cost Base set forth in Item 7 of the Basic Lease Provisions. Tenant acknowledges Landlord's rights to make changes or additions to the Building and/or Project from time to time pursuant to Section 6.5 below, in which event the total rentable square footage within the Building and/or Project may be adjusted. For convenience of reference, Property Taxes and Building Costs may sometimes be collectively referred to as "Operating Expenses." (b) Commencing prior to the start of the first full "Expense Recovery Period" of the Lease (as defined in Item 7 of the Basic Lease Provisions), and prior to the start of each full or partial Expense Recovery Period thereafter, Landlord shall give Tenant a written estimate of the amount of Tenant's proportionate shares of Building Costs and Property Taxes for the Expense Recovery Period or portion thereof. Commencing on the first day of the thirteenth month of the Lease Term, Tenant shall pay the estimated amounts to Landlord in equal monthly installments, in advance, with Basic Rent. If Landlord has not furnished its written estimate for any Expense Recovery Period by the time set forth above, Tenant shall continue to pay cost reimbursements at the rates established for the prior Expense Recovery Period, if any; provided that when the new estimate is delivered to Tenant, Tenant shall, at the next monthly payment date, pay any accrued cost reimbursements based upon the new estimate. Landlord may from time to time change the Expense Recovery Period to reflect a calendar year or a new fiscal year of Landlord, as applicable, in which event Tenant's share of Operating Expenses shall be equitably prorated for any partial year. (c) Within one hundred twenty (120) days after the end of each Expense Recovery Period, Landlord shall furnish to Tenant a statement showing in reasonable detail the actual or prorated Property Taxes and Building Costs incurred by Landlord during the period, and the parties shall within thirty (30) days thereafter make any payment or allowance necessary to adjust Tenant's estimated payments, if any, to Tenant's actual proportionate shares as shown by the annual statement. If Tenant has not made estimated payments during the Expense Recovery Period, any amount owing by Tenant pursuant to subsection (a) above shall be paid to Landlord in accordance with Article XVI. If actual 6 8 Property Taxes or Building Costs allocable to Tenant during any Expense Recovery Period are less than the Property Tax Base or the Building Cost Base, respectively, Landlord shall not be required to pay the differential to Tenant. Should Tenant fail to object in writing to Landlord's determination of actual Operating Expenses within one (1) year following delivery of Landlord's expense statement, Landlord's determination of actual Operating Expenses for the applicable Expense Recovery Period shall be conclusive and binding on Tenant. (d) Even though the Lease has terminated and the Tenant has vacated the Premises, when the final determination is made of Tenant's share of Property Taxes and Building Costs for the Expense Recovery Period in which the Lease terminates, Tenant shall upon notice pay the entire increase due over the estimated expenses paid. Conversely, any overpayment made in the event expenses decrease shall be rebated by Landlord to Tenant. (e) If Tenant is notified by December 1 of any Expense Recovery Period that any one or more of the Operating Expenses are increased to a rate(s) or amount(s) in excess of the rate(s) or amount(s) used in calculating the estimated expenses for the year, then Tenant's estimated share of Property Taxes or Building Costs, as applicable, shall be increased, effective as of the following January 1, by an amount equal to Tenant's proportionate share of the increase; provided that any increase attributable to the period prior to January 1 shall be amortized and spread over the remainder of the Expense Recovery Period from and after January 1. Landlord shall give Tenant written notice of the amount or estimated amount of the increase, the month in which the increase will become effective, Tenant's monthly share thereof and the months for which the payments are due. Tenant shall pay the increase to Landlord as a part of Tenant's monthly payments of estimated expenses as provided in paragraph (b) above. (f) The term "Building Costs" shall include all expenses of operation and maintenance of the Building and the Project, together with all appurtenant Common Areas (as defined in Section 6.2), and shall include the following charges by way of illustration but not limitation: water and sewer charges; insurance premiums or reasonable premium equivalents should Landlord elect to self-insure any risk that Landlord is authorized to insure hereunder; license, permit, and inspection fees; heat; light; power; janitorial services; repairs; air conditioning; supplies; materials; equipment; tools; tenant services; programs instituted to comply with transportation management requirements; amortization of capital investments reasonably intended to produce a reduction in operating charges or energy conservation; amortization of capital investments necessary to bring the Building into compliance with applicable laws and building codes enacted subsequent to the completion of construction of the Building; labor; reasonably allocated wages and salaries, fringe benefits, and payroll taxes for administrative and other personnel directly applicable to the Building and/or Project, including both Landlord's personnel and outside personnel; any expense incurred pursuant to Sections 6.1, 6.2, 6.4, 7.2, and 10.2 and Exhibits B and C below; and a reasonable overhead/management fee. It is understood that Building Costs shall include competitive charges for direct services provided by any subsidiary or division of Landlord. The term "Property Taxes" as used herein shall include the following: (i) all real estate taxes or personal property taxes, as such property taxes may be reassessed from time to time; and (ii) other taxes, charges and assessments which are levied with respect to this Lease or to the Building and/or the Project, and any improvements, fixtures and equipment and other property of Landlord located in the Building and/or the Project, except that documentary transfer fees, general net income and franchise taxes imposed against Landlord shall be excluded; and (iii) any tax, surcharge or assessment which shall be levied in addition to or in lieu of real estate or personal property taxes, other than taxes covered by Article VIII; and (iv) costs and expenses incurred in contesting the amount or validity of any Property Tax by appropriate proceedings. Property Taxes shall specifically exclude penalties and/or interest charges for failure to timely and fully pay Property Taxes and the amount of any taxes, fees, charges or assessments levied upon or with respect to other tenants of the Building or the Project. Notwithstanding anything to the contrary contained herein, if there is an increase in Property Taxes as a result of any change in ownership of the Building during the initial seventy-four (74) months of the Term, then for the remainder of the initial Term only, Tenant's proportionate share of Property Taxes shall in no event exceed the maximum that might otherwise have been allocated to Tenant pursuant to the provisions of Proposition 13 based on the assumptions that (A) the change of ownership had not occurred and (B) the maximum assessment permissible had been imposed by the taxing authority. A copy of Landlord's unaudited statement of expenses shall be made available to Tenant upon request. The Building Costs may be extrapolated by Landlord to reflect at least ninety-five percent (95%) occupancy of the rentable area of the Building. (g) Notwithstanding the foregoing, Building Costs shall not include the following: (i) rent and other payments made by Landlord under any ground lease or other lease underlying this Lease, and interest, principal, points or fees on debt or amortization of any debt encumbering the Building or Project; (ii) costs incurred to correct any latent defects, or for repair or replacement to the extent of proceeds of insurance received by Landlord, any reimbursement which Landlord receives under any warranties from third parties, and reimbursements from any other responsible parties; (iii) depreciation on the Project or any portion thereof; (iv) costs, expense and penalties (including without limitation attorneys' 7 9 fees) incurred due to Landlord's violation of any lease in the Project, Landlord's violation of any deed of trust, mortgage or ground lease, and Landlord's violation of any law, covenant, condition or restriction applicable to the Project; (v) any and all costs incurred with respect to the installation of tenant improvements or other refurbishment of space for other tenants or occupants of the Project, for furnishing items or services exclusively to a third party tenant of the Project, or for significant aesthetic, decorative or other similar upgrades to the Project; (vi) advertising, marketing, media and promotional expenditures regarding the Project, leasing commissions, attorneys' fees and other costs and expenses incurred in connection with the negotiation, execution, enforcement or termination of leases of premises within the Project, and any other costs or expenses relating to leasing of the Project in general; (vii) compensation, benefits or other amounts payable to employees or affiliates of Landlord other than as expressly set forth herein, or any actual or imputed rental of space within the Project (other than the management and conference offices in the Building not exceeding 4,000 rentable square feet collectively); (viii) costs of any capital improvements made by Landlord not otherwise expressly permitted herein, and with respect to the cost of permitted capital improvements, only to the extent that the annual amount thereof does not exceed the total costs amortized at a market cost of funds over the useful life of such improvements or, if greater, the amount of any other cost savings resulting from the applicable improvement; (ix) all utilities submetered to other tenants of the Project or charged to other tenants of the Project for usage in excess of customary utility usage during normal business hours; (x) expenses in connection with services or other benefits of a type which are not standard for the Building or the Project, and which are not available to Tenant without specific charge therefor, but which are provided to another tenant or occupant of the Project whether or not such other tenant or occupant is specifically charge therefor by Landlord; (xi) the costs of any services (other than normal parking) directly contracted and paid for by other tenants in the Project; (xii) any costs incurred to test, survey, cleanup, contain, abate, remove or otherwise remedy hazardous or toxic materials from the Project; (xiii) management fees, overhead and profit increments paid to subsidiaries or affiliates of Landlord for management or other services on or to the Project or for supplies or other materials, to the extent that the costs thereof exceed the costs that would have been paid had the same been provided by unaffiliated parties on a competitive basis; (xiv) property insurance on the Building or the Project exceeding the full replacement value thereof, or rental abatement insurance exceeding one (1) year; (xv) any other expense that under generally accepted accounting principles consistently applied and practiced would not be considered a normal maintenance or operating expense; (xvi) any cost or expense previously charged by Landlord, and in no event shall there be any duplication of charges; and (xvii) should Landlord elect to self-insure earthquake property damage, imputed self-insurance premiums for such coverage that exceed the earthquake insurance premium component of the Building Cost Base. (h) Provided Tenant is not then in default hereunder, Tenant shall have the right to cause a qualified auditor working on a fixed fee (and not continency basis) to audit Operating Expenses by inspecting Landlord's general ledger of expenses and supporting documents reasonably requested by Tenant not more than once during any Expense Recovery Period. Tenant shall give notice to Landlord of Tenant's intent to audit within ten (10) months after Tenant's receipt of Landlord's expense statement which sets forth Landlord's actual Operating Expenses. Such audit shall be conducted at a mutually agreeable time during normal business hours at the office of Landlord or its management agent where such accounts are maintained and shall be completed within sixty (60) days. If Tenant's audit determines that actual Operating Expenses have been overstated by more than five percent (5%), then subject to Landlord's right to review and/or contest the audit results, Landlord shall reimburse Tenant for the reasonable out-of-pocket costs of such audit. Tenant's rent shall be appropriately adjusted to reflect any overstatement in Operating Expenses. In addition, if any component of Operating Expenses is determined to be either inappropriate or excessive during an Expense Recovery Period, and if the Building Cost Base or Property Tax Base also included such component, then the appropriate Base shall concurrently be adjusted if and to the extent appropriate. In the event of a dispute between Landlord and Tenant regarding the results of such audit, either party may elect to submit the matter for binding arbitration pursuant to Section 14.7(b) below. All of the information obtained by Tenant and/or its auditor in connection with such audit, as well as any compromise, settlement, or adjustment reached between Landlord and Tenant as a result thereof, shall be held in strict confidence and, except as may be required pursuant to litigation, shall not be disclosed to any third party, directly or indirectly, by Tenant or its auditor or any of their officers, agents or employees. Landlord may require Tenant's auditor to execute a separate confidentiality agreement affirming the foregoing as a condition precedent to any audit. In the event of a violation of this confidentiality covenant in connection with any audit, then in addition to any other legal or equitable remedy available to Landlord, Tenant shall have no further audit rights under this Lease. SECTION 4.3. SECURITY DEPOSIT. Concurrently with Tenant's delivery of this Lease, Tenant shall deposit with Landlord the sum, if any, stated in Item 9 of the Basic Lease Provisions (the "Security Deposit"), in the form of (i) cash equal to the difference between such Security Deposit and the security deposit currently held by Landlord under the Existing Lease described in Section 22.6 below (the "Existing Deposit") and (ii) the transfer of the Existing Deposit by Landlord to this Lease upon the Commencement Date hereof. The Security Deposit shall be held by Landlord as security for the full and faithful 8 10 performance of Tenant's obligations under this Lease to pay any rent as and when due, including without limitation such additional rent as may be owing under any provision hereof, and to maintain the Premises as required by Sections 7.1 and 15.3. Upon any breach of those obligations by Tenant, Landlord may apply all or part of the Security Deposit as full or partial compensation. If any portion of the Security Deposit is so applied, Tenant shall within five (5) days after written demand by Landlord deposit cash with Landlord in an amount sufficient to restore the Security Deposit to its original amount. Notwithstanding the foregoing, however, provided Tenant is not, and has not theretofore been, in default under this Lease, Landlord agrees to reduce the principal balance of the Security Deposit to Fifty Thousand Dollars ($50,000.00) if and only if (i) Tenant's capital stock is then publicly-traded and (ii) Tenant has a net worth (exclusive of good will) of at least Ten Million Dollars ($10,000,000.00) as evidenced by current audited financial statements reasonably acceptable to Landlord. Should the Security Deposit be so reduced and should Tenant fail thereafter to maintain the foregoing minimum net worth, then Tenant shall, upon written demand by Landlord, restore the Security Deposit to its original amount. Landlord shall not be required to keep this Security Deposit separate from its general funds, and Tenant shall not be entitled to interest on the Security Deposit. If Tenant fully performs its obligations under this Lease, the Security Deposit or any balance thereof shall be returned to Tenant or, at Landlord's option, to the last assignee of Tenant's interest in this Lease. ARTICLE V. USES SECTION 5.1. USE. Tenant shall use the Premises only for the purposes stated in Item 3 of the Basic Lease Provisions. The parties agree that any contrary use shall be deemed to cause material and irreparable harm to Landlord and shall entitle Landlord to injunctive relief in addition to any other available remedy. Tenant shall not do or permit anything to be done in or about the Premises which will in any way interfere with the rights or quiet enjoyment of other occupants of the Building or the Project, or use or allow the Premises to be used for any unlawful purpose, nor shall Tenant permit any nuisance or commit any waste in the Premises or the Project. Tenant shall not do or permit to be done anything which will invalidate or increase the cost of any insurance policy(ies) covering the Building, the Project and/or their contents, and shall comply with all applicable insurance underwriters rules and the requirements of the Pacific Fire Rating Bureau or any other organization performing a similar function. Tenant shall comply at its expense with all present and future laws, ordinances and requirements of all governmental authorities that pertain to Tenant or its use of the Premises, including without limitation all federal and state occupational health and safety and handicap access requirements, whether or not Tenant's compliance will necessitate expenditures or interfere with its use and enjoyment of the Premises. Tenant shall not generate, handle, store or dispose of hazardous or toxic materials (as such materials may be identified in any federal, state or local law or regulation) in the Premises or Project without the prior written consent of Landlord; provided that the foregoing shall not be deemed to proscribe the use by Tenant of customary office supplies in normal quantities so long as such use comports with all applicable laws. Tenant agrees that it shall promptly complete and deliver to Landlord any disclosure form regarding hazardous or toxic materials that may be required by any governmental agency. Tenant shall also, from time to time upon request by Landlord, execute such affidavits concerning Tenant's best knowledge and belief regarding the presence of hazardous or toxic materials in the Premises. Landlord shall have the right at any time to perform an assessment of the environmental condition of the Premises and of Tenant's compliance with this Section. As part of any such assessment, Landlord shall have the right, upon reasonable prior notice to Tenant, to enter and inspect the Premises and to perform tests, provided those tests are performed in a manner that minimizes disruption to Tenant. Tenant will cooperate with Landlord in connection with any assessment by, among other things, promptly responding to inquiries and providing relevant documentation and records relating to hazardous or toxic materials at the Premises. The reasonable cost of the assessment/testing shall be reimbursed by Tenant to Landlord if such assessment/testing determines that Tenant failed to comply with the requirements of this Section; otherwise, the same shall be at Landlord's expense and not a Building Cost. In all events Tenant shall indemnify Landlord in the manner elsewhere provided in this Lease from any release of hazardous or toxic materials caused by Tenant, its agents, employees, contractors, subtenants or licensees. The foregoing covenants shall survive the expiration or earlier termination of this Lease. SECTION 5.2. SIGNS. (a) Tenant, upon obtaining the approval of Landlord in writing, which approval shall not be withheld for signage conforming to the sign criteria described below, may affix a sign (restricted solely to Tenant's name as set forth herein or such other name as Landlord may consent to in writing) adjacent to the entry door of the Premises and shall maintain the sign in good condition and repair during the Term; provided that such signage may include Tenant's logo if and for so long as the signage is installed on any floor occupied in its entirety by Tenant. The sign shall conform to the criteria for signs established by Landlord and shall be ordered through Landlord. Tenant shall not place or allow to be placed any other sign, decoration or advertising matter of any kind that is visible from the exterior of the 9 11 Premises. Any violating sign or decoration may be immediately removed by Landlord at Tenant's expense without notice and without the removal constituting a breach of this Lease or entitling Tenant to claim damages. (b) During the twelve (12) month period following the execution of this Lease, Tenant shall have the right to install a building-top sign on two (2) sides of the exterior of the Building. The type, location and design of such signage shall be subject to the prior approval of Landlord and the City of Irvine, and shall be subject to the 8001 Tower Sign Criteria. Notwithstanding the foregoing, Landlord hereby approves of either of the two (2) depictions of signage shown on Exhibit Y attached hereto, and agrees that each of those signs conforms to the 8001 Tower Sign Criteria. Fabrication, installation, insurance, and maintenance of such signage shall be at Tenant's sole cost and expense. Except for the foregoing, no sign, advertisement or notice visible from the exterior of the Premises shall be inscribed, painted or affixed by Tenant on any part of the Premises without the prior consent of Landlord. Tenant's signage right shall belong solely to and shall identify only Quest Software, Inc., or any Tenant Affiliate thereof (unless Landlord in good faith and reasonably determines that the name of such Tenant Affiliate is inappropriate for display on a first class office building), and may not otherwise be transferred or assigned without Landlord's prior written consent, which may be withheld by Landlord in Landlord's sole discretion. In the event Quest Software, Inc. and/or any Tenant Affiliate thereof fails to occupy a substantial portion of the Premises, then Tenant shall, within thirty (30) days following notice from Landlord, remove the exterior signage at Tenant's expense. Tenant shall also remove such signage promptly following the expiration or earlier termination of this Lease. Any such removal shall be at Tenant's sole expense, and Tenant shall bear the cost of any resulting repairs to the Building that are reasonably necessary due to the removal. ARTICLE VI. LANDLORD SERVICES SECTION 6.1. UTILITIES AND SERVICES. Landlord shall furnish to the Premises the utilities and services described in Exhibit B, subject to the conditions and payment obligations and standards set forth in this Lease. Landlord shall not be liable for any failure to furnish any services or utilities when the failure is the result of any accident or other cause beyond Landlord's reasonable control, nor shall Landlord be liable for damages resulting from power surges or any breakdown in telecommunications facilities or services. Landlord's temporary inability to furnish any services or utilities shall not entitle Tenant to any damages, relieve Tenant of the obligation to pay rent or constitute a constructive or other eviction of Tenant, except that Landlord shall diligently attempt to restore the service or utility promptly; provided that if Landlord is unable to do so within five (5) business days and such failure prevents Tenant's reasonable use of the Premises for its intended purposes, rent shall be abated from and after the sixth (6th) business day until the utility or service is restored. Tenant shall comply with all rules and regulations which Landlord may reasonably establish for the provision of services and utilities, and shall cooperate with all reasonable conservation practices established by Landlord. Landlord shall at all reasonable times have free access to all electrical and mechanical installations of Landlord. SECTION 6.2. OPERATION AND MAINTENANCE OF COMMON AREAS. During the Term, Landlord shall operate all Common Areas within the Building and the Project. The term "Common Areas" shall mean all areas within the Building and other buildings in the Project which are not held for exclusive use by persons entitled to occupy space, and all other appurtenant areas and improvements provided by Landlord for the common use of Landlord and tenants and their respective employees and invitees, including without limitation parking areas and structures, driveways, sidewalks, landscaped and planted areas, hallways and interior stairwells not located within the premises of any tenant, common entrances and lobbies, elevators, and restrooms not located within the premises of any tenant. In the event Landlord is required to rectify any currently-existing violations of the Americans with Disabilities Act within the Common Areas, Landlord shall do so at its sole expense and the cost thereof shall not be included in the Building Costs allocated to Tenant (including the Building Cost Base). SECTION 6.3. USE OF COMMON AREAS. The occupancy by Tenant of the Premises shall include the use of the Common Areas in common with Landlord and with all others for whose convenience and use the Common Areas may be provided by Landlord, subject, however, to compliance with all nondiscriminatory rules and regulations as are reasonably prescribed from time to time by Landlord. Landlord shall at all times during the Term have exclusive control of the Common Areas, and may restrain any use or occupancy, except as authorized by Landlord's rules and regulations. Tenant shall keep the Common Areas clear of any obstruction or unauthorized use related to Tenant's operations. Landlord may temporarily close any portion of the Common Areas for repairs, remodeling and/or alterations, to prevent a public dedication or the accrual of prescriptive rights, or for any other reasonable purpose, so long as Tenant's access to and use of the Premises is not impaired. 10 12 SECTION 6.4. PARKING. Landlord hereby leases to Tenant, and Tenant hereby agrees to lease from Landlord for the Term of this Lease, the number of vehicle parking spaces set forth in Item 12 of the Basic Lease Provisions. It is understood that twenty percent (20%) of the allotted unreserved parking spaces may, at Landlord's election, be located outside the Parking Area of the Project at a location reasonably designated by Landlord from time to time, which location may include the parking area for the building at 8105 Irvine Center Drive; provided, however, that any such location shall be comparably paved, striped, lighted and maintained and shall be no further from the Building than the farthest boundary of the Parking Area. The costs associated with the operation of any remote parking location shall only be included in Building Costs to the extent such costs are actually incurred by Landlord and are required to be allocated to parking provided to tenants of the Building. The parking spaces shall be provided in accordance with the provisions set forth in Exhibit C to this Lease. SECTION 6.5. CHANGES AND ADDITIONS BY LANDLORD. Landlord reserves the right to make alterations or additions to the Building or the Project, or to the attendant fixtures, equipment and Common Areas. No change shall entitle Tenant to any abatement of rent or other claim against Landlord, provided that the change does not deprive Tenant of reasonable access to or use of the Premises. ARTICLE VII. MAINTAINING THE PREMISES SECTION 7.1. TENANT'S MAINTENANCE AND REPAIR. Tenant at its sole expense shall make all repairs necessary to keep the Premises in the condition as existed on the Commencement Date (or on any later date that the improvements may have been installed), excepting ordinary wear and tear, damage and destruction under Article XI, and Landlord's obligations under this Lease. All repairs shall be at least equal in quality to the original work. Any third party contractor utilized by Tenant shall be subject to Landlord's standard requirements for contractors, as modified from time to time. Landlord may impose reasonable restrictions and requirements with respect to repairs, as provided in Section 7.3, and the provisions of Section 7.4 shall apply to all repairs. Alternatively, Landlord may elect to make any such repair on behalf of Tenant and at Tenant's expense, and Tenant shall promptly reimburse Landlord as additional rent for all costs at market rates reasonably incurred upon submission of an invoice. SECTION 7.2. LANDLORD'S MAINTENANCE AND REPAIR. (a) Subject to Section 7.1 and Article XI, Landlord shall provide service, maintenance and repair with respect to any air conditioning, ventilating or heating equipment which serves the Premises (exclusive of any supplemental HVAC equipment installed by or at the request of Tenant), shall comply with all laws affecting the systems, structure and Common Areas of the Building and Project, shall maintain all services under Exhibit B, and shall maintain in good repair the roof, foundations, footings, the exterior surfaces of the exterior walls of the Building, and the structural, electrical, plumbing (other than plumbing fixtures in the Premises), sewer, telecommunications risers, and mechanical systems (including without limitation elevators) servicing the Premises and the Building, except that Tenant at its expense shall make all repairs which Landlord deems reasonably necessary as a result of the act or negligence of Tenant, its agents, employees, invitees, subtenants or contractors. Landlord shall have the right to employ or designate any reputable person or firm, including any employee or agent of Landlord or any of Landlord's affiliates or divisions, to perform any service, repair or maintenance function. Landlord need not make any other improvements or repairs except as specifically required under this Lease, and nothing contained in this Section shall limit Landlord's right to reimbursement from Tenant for maintenance, repair costs and replacement costs as provided elsewhere in this Lease. Tenant understands that it shall not make repairs at Landlord's expense or by rental offset. (b) Except as provided in Sections 11.1 and 12.1 below, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant's business arising from the making of any repairs, alterations or improvements to any portion of the Building, including repairs to the Premises, nor shall any related activity by Landlord constitute an actual or constructive eviction; provided, however, that in making repairs, alterations or improvements, Landlord shall interfere as little as reasonably practicable with the conduct of Tenant's business in the Premises and shall comply with Tenant's reasonable security procedures and requirements. SECTION 7.3. ALTERATIONS. Tenant shall make no alterations, additions or improvements to the Premises without the prior written consent of Landlord. Landlord's consent shall not be unreasonably withheld as long as the proposed changes do not adversely affect the structural, electrical or mechanical components or systems of the Building and are not visible from the exterior of the Premises. Landlord may impose, as a condition to its consent, any reasonable requirements, including but not limited to (i) a requirement that any work anticipated to cost in excess of $175,000.00 be covered by a lien and completion bond satisfactory to Landlord and (ii) requirements as to the manner, time, and contractor 11 13 for performance of the work. Without limiting the generality of the foregoing, Tenant shall use Landlord's designated mechanical and electrical contractors for all work affecting the mechanical or electrical systems of the Building. Tenant shall obtain all required permits for the work and shall perform the work in compliance with all applicable laws, regulations and ordinances. Landlord shall be entitled to a supervision fee in the amount of five percent (5%) of the cost of the work if Landlord or its management agent for the Project is actively involved in the supervision of the work. Under no circumstances shall Tenant make any improvement which incorporates asbestos-containing construction materials into the Premises. Any request for Landlord's consent shall be made in writing and shall contain architectural plans describing the work in detail reasonably satisfactory to Landlord. Unless Landlord otherwise agrees in writing, all alterations, additions or improvements affixed to the Premises (excluding moveable trade fixtures and furniture) shall become the property of Landlord and shall be surrendered with the Premises at the end of the Term, except that Landlord may, by notice to Tenant given at the time of Landlord's consent to the alteration or improvement, require Tenant to remove by the Expiration Date, or sooner termination date of this Lease, all or any alterations, decorations, fixtures, additions, improvements and the like installed either by Tenant or by Landlord at Tenant's request and to repair any damage to the Premises arising from that removal. However, Tenant shall be required to fund the cost of removing an improvement shown in the "Plan" (as defined in Exhibit X hereto) only to the extent so specifically provided in Exhibit X. Except as otherwise provided in this Lease or in any Exhibit to this Lease, should Landlord make any alteration or improvement to the Premises at the request of Tenant, Landlord shall be entitled to prompt reimbursement from Tenant for all costs reasonably incurred. SECTION 7.4. MECHANIC'S LIENS. Tenant shall keep the Premises free from any liens arising out of any work performed, materials furnished, or obligations incurred by or for Tenant. Upon request by Landlord, Tenant shall promptly cause any such lien to be released by posting a bond in accordance with California Civil Code Section 3143 or any successor statute. In the event that Tenant shall not, within thirty (30) days following the imposition of any lien, cause the lien to be released of record by payment or posting of a proper bond, Landlord shall have, in addition to all other available remedies, the right to cause the lien to be released by any means it deems proper, including payment of or defense against the claim giving rise to the lien. All expenses so incurred by Landlord, including Landlord's attorneys' fees, shall be reimbursed by Tenant promptly following Landlord's demand, together with interest from the date of payment by Landlord at the maximum rate permitted by law until paid. Tenant shall give Landlord no less than twenty (20) days' prior notice in writing before commencing construction of any kind on the Premises so that Landlord may post and maintain notices of nonresponsibility on the Premises. SECTION 7.5. ENTRY AND INSPECTION. Landlord shall at all reasonable times, upon at least 24 hour prior written or oral notice (except in emergencies) and subject to Tenant's reasonable security procedures and requirements, have the right to enter the Premises to inspect them, to supply services in accordance with this Lease, to protect the interests of Landlord in the Premises, to make repairs and renovations as reasonably deemed necessary by Landlord, and to submit the Premises to prospective or actual purchasers or encumbrance holders (or, during the last one hundred and eighty (180) days of the Term or when an uncured Tenant default exists, to prospective tenants), all without being deemed to have caused an eviction of Tenant and without abatement of rent except as provided elsewhere in this Lease. Landlord shall at all times have and retain a key which unlocks all of the doors in the Premises, excluding Tenant's vaults and safes, and Landlord shall have the right to use any and all means which Landlord may deem proper to open the doors in an emergency in order to obtain entry to the Premises, and any entry to the Premises obtained by Landlord shall not under any circumstances be deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or any eviction of Tenant from the Premises. In exercising its rights under this Section, Landlord shall use best efforts to minimize interference with Tenant's use of the Premises. ARTICLE IX. ASSIGNMENT AND SUBLETTING SECTION 9.1. RIGHTS OF PARTIES. (a) Notwithstanding any provision of this Lease to the contrary, Tenant will not, either voluntarily or by operation of law, assign, sublet, encumber, or otherwise transfer all or any part of Tenant's interest in this Lease, or permit the Premises to be occupied by anyone other than Tenant, without Landlord's prior written consent, which consent shall not unreasonably be withheld in accordance with the provisions of Section 9.1.(c). No assignment (whether voluntary, involuntary or by operation of law) and no subletting shall be valid or effective without Landlord's prior written consent and, at Landlord's election, shall constitute a material default of this Lease. Landlord shall not be deemed to have given its consent to any assignment or subletting by any other course of action, including its acceptance of any name for listing in the Building directory. To the extent not prohibited by provisions of the Bankruptcy Code, 11 U.S.C. Section 101 et seq. (the "Bankruptcy Code"), including Section 365(f)(1), Tenant on behalf of itself and its creditors, administrators and assigns waives the applicability of Section 365(e) of the Bankruptcy Code unless the proposed assignee of the Trustee for the estate of the bankrupt meets Landlord's standard for consent as set forth in Section 9.1(c) of this Lease. If this Lease is assigned to any person or entity pursuant to the provisions of the Bankruptcy Code, any and all monies or other considerations to be delivered in connection with the assignment shall be delivered to Landlord, shall be and remain the exclusive property of Landlord and shall not constitute property of Tenant or of the estate of Tenant within the meaning of the Bankruptcy Code. Any person or entity to which this Lease is 12 14 assigned pursuant to the provisions of the Bankruptcy Code shall be deemed to have assumed all of the obligations arising under this Lease on and after the date of the assignment, and shall upon demand execute and deliver to Landlord an instrument confirming that assumption. (b) If Tenant is a corporation, or is an unincorporated association or partnership, the transfer of any stock or interest in the corporation, association or partnership which results in a change in the voting control of Tenant shall be deemed an assignment within the meaning and provisions of this Article; provided, however, that the foregoing shall not apply to any stock transfer to a Tenant Affiliate or to any transfer of capital stock in connection with a public offering of shares or the subsequent trading of those shares by members of the public. (c) If Tenant desires to transfer an interest in this Lease, it shall first notify Landlord of its desire and shall submit in writing to Landlord: (i) the name and address of the proposed transferee; (ii) the nature of any proposed subtenant's or assignee's business to be carried on in the Premises; (iii) the terms and provisions of any proposed sublease or assignment; and (iv) any other information requested by Landlord and reasonably related to the transfer. Except as provided in Subsection (d) of this Section, Landlord shall not unreasonably withhold its consent, provided: (1) the use of the Premises will be consistent with the provisions of this Lease; (2) fifty percent (50%) of any excess rent received by the Tenant from the assignment or subletting, whether during or after the Term of this Lease, shall be paid to Landlord when received; (3) any proposed assignee (but not subtenant) demonstrates that it is financially responsible by submission to Landlord of all reasonable information as Landlord may request concerning the proposed assignee, including, but not limited to, a balance sheet of the proposed assignee as of a date within ninety (90) days of the request for Landlord's consent and statements of income or profit and loss of the proposed assignee for the two-year period preceding the request for Landlord's consent; (4) the proposed assignee or subtenant is neither an existing tenant of the Building or Project nor a prospective tenant with whom Landlord is then actively negotiating; and (5) the proposed transfer will not impose additional burdens or adverse tax effects on Landlord. If Landlord consents to the proposed transfer, Tenant may within ninety (90) days after the date of the consent effect the transfer upon the terms described in the information furnished to Landlord; provided that any material change in the terms shall be subject to Landlord's consent as set forth in this Section. Landlord shall approve or disapprove any requested transfer within thirty (30) days following receipt of Tenant's written request and the information set forth above. Tenant shall pay to Landlord a transfer fee of Five Hundred Dollars ($500.00) if and when any transfer requested by Tenant is approved. (d) Notwithstanding the provisions of Subsection (c) above, in lieu of consenting to a proposed assignment of this Lease or subletting of at least 10,000 rentable square feet of the Premises for substantially all of the remaining Term of this Lease, Landlord may elect to (i) sublease the Premises (or the portion proposed to be subleased), or take an assignment of Tenant's interest in this Lease, upon the same terms as offered to the proposed subtenant or assignee (excluding terms relating to the purchase of personal property, the use of Tenant's name or the continuation of Tenant's business), or (ii) terminate this Lease as to the portion of the Premises proposed to be subleased or assigned with a proportionate abatement in the rent payable under this Lease, effective on the date that the proposed sublease or assignment would have become effective. Landlord may thereafter, at its option, assign or re-let any space so recaptured to any third party, including without limitation the proposed transferee of Tenant. Notwithstanding the foregoing, this Subsection 9.1(d) shall not apply to any proposed assignment or sublease to either a Tenant Affiliate or an entity with which Tenant has a substantial ongoing business relationship (collectively, "Related Entity"). (e) Notwithstanding the foregoing, provided Tenant is not then in default hereunder, Tenant may, without Landlord's consent but with prior written notice to Landlord, assign this Lease or sublet all or any portion of the Premises to (i) any entity resulting from a merger or reorganization of Tenant, (ii) any entity succeeding to the business and assets of Tenant, or (iii) any entity controlling, controlled by, or under common control with, Tenant (collectively, a "Tenant Affiliate"). SECTION 9.2. EFFECT OF TRANSFER. No subletting or assignment, even with the consent of Landlord, shall relieve Tenant, or any successor-in-interest to Tenant hereunder, of its obligation to pay rent and to perform all its other obligations under this Lease. Moreover, Tenant shall indemnify and hold Landlord harmless, as provided in Section 10.3, for any act or omission by an assignee or subtenant. Each assignee shall be deemed to assume all obligations of Tenant under this Lease and shall be liable jointly and severally with Tenant for the payment of all rent, and for the due performance of all of Tenant's obligations, under this Lease. Such joint and several liability shall not be discharged or impaired by any subsequent modification or extension of this Lease. Except for a transfer to a Tenant Affiliate, no transfer shall be binding on Landlord unless any document memorializing the transfer is delivered to Landlord and both the assignee/subtenant and Tenant deliver to Landlord an executed consent to transfer instrument prepared by Landlord and consistent with the requirements of this Article. The acceptance by Landlord of any payment due under this Lease from any other person shall not be deemed to be a waiver by Landlord of any provision of this Lease or to be a consent to any transfer. Consent by Landlord to one or more transfers shall not operate as a waiver or estoppel to the future enforcement by Landlord of its rights under this Lease. In addition to the foregoing, no change in the status of Tenant or any party jointly and severally liable with Tenant as aforesaid (e.g., by conversion to a limited liability company or partnership) shall serve to abrogate the liability of any person or entity for the obligations of Tenant, including any obligations that may be incurred by Tenant after the status change by exercise of a pre-existing right in this Lease. 13 15 SECTION 9.3. SUBLEASE REQUIREMENTS. The following terms and conditions shall apply to any subletting by Tenant of all or any part of the Premises and shall be included in each sublease: (a) Tenant hereby irrevocably assigns to Landlord all of Tenant's interest in all rentals and income arising from any sublease of the Premises, and Landlord may collect such rent and income and apply same toward Tenant's obligations under this Lease; provided, however, that until a default occurs in the performance of Tenant's obligations under this Lease, Tenant shall have the right to receive and collect the sublease rentals. Landlord shall not, by reason of this assignment or the collection of sublease rentals, be deemed liable to the subtenant for the performance of any of Tenant's obligations under the sublease. Tenant hereby irrevocably authorizes and directs any subtenant, upon receipt of a written notice from Landlord stating that an uncured default exists in the performance of Tenant's obligations under this Lease, to pay to Landlord all sums then and thereafter due under the sublease. Tenant agrees that the subtenant may rely on that notice without any duty of further inquiry and notwithstanding any notice or claim by Tenant to the contrary. Tenant shall have no right or claim against the subtenant or Landlord for any rentals so paid to Landlord. In the event Landlord collects amounts from subtenants that exceed the total amount then due from Tenant hereunder, Landlord shall promptly remit the excess to Tenant. (b) In the event of the termination of this Lease, Landlord may, at its sole option, take over Tenant's entire interest in any sublease and, upon notice from Landlord, the subtenant shall attorn to Landlord. In no event, however, shall Landlord be liable for any previous act or omission by Tenant under the sublease or for the return of any advance rental payments or deposits under the sublease that have not been actually delivered to Landlord, nor shall Landlord be bound by any sublease modification executed without Landlord's consent or for any advance rental payment by the subtenant in excess of one month's rent. The general provisions of this Lease, including without limitation those pertaining to insurance and indemnification, shall be deemed incorporated by reference into the sublease despite the termination of this Lease. (c) Tenant agrees that Landlord may, at its sole option, authorize a subtenant of the Premises to cure a default by Tenant under this Lease. ARTICLE X. INSURANCE AND INDEMNITY SECTION 10.1. TENANT'S INSURANCE. Tenant, at its sole cost and expense, shall provide and maintain in effect the insurance described in Exhibit D. Evidence of that insurance must be delivered to Landlord prior to the Commencement Date. SECTION 10.2. LANDLORD'S INSURANCE. Landlord shall provide all of the following types of insurance, with or without deductible and in amounts and coverages as may be determined by Landlord in its discretion: "all risk" property insurance for at least eighty percent (80%) of the replacement cost of the Building, subject to standard exclusions, covering the Building and Project, and such other risks as Landlord or its mortgagees may from time to time deem appropriate, and commercial general liability coverage in limits of not less than $1,000,000.00 per occurrence and $5,000,000.00 in the aggregate. Landlord shall not be required to carry insurance of any kind on Tenant's leasehold improvements, trade fixtures, furnishings, equipment, interior plate glass, signs and all other items of personal property, and shall not be obligated to repair or replace that property should damage occur. All proceeds of insurance maintained by Landlord upon the Building and Project shall be the property of Landlord, whether or not Landlord is obligated to or elects to make any repairs. SECTION 10.3. TENANT'S INDEMNITY. To the fullest extent permitted by law, Tenant shall defend, indemnify and hold harmless Landlord, its agents, lenders, and any and all affiliates of Landlord, from and against any and all claims, liabilities, costs or expenses arising either before or after the Commencement Date from Tenant's use or occupancy of the Premises, the Building or the Common Areas, or from the conduct of its business, or from any activity, work, or thing done, permitted or suffered by Tenant or its agents, employees, subtenants, invitees or licensees in or about the Premises, the Building or the Common Areas (except to the extent contributed to by the gross negligence or willful misconduct of Landlord, its agents or employees), or from any default in the performance of any obligation on Tenant's part to be performed under this Lease, or from any act or negligence of Tenant or its agents, employees, subtenants, invitees or licensees. Landlord may, at its option, require Tenant to assume Landlord's defense in any action covered by this Section through counsel reasonably satisfactory to Landlord. SECTION 10.4. LANDLORD'S NONLIABILITY. Landlord shall not be liable to Tenant, its employees, agents and invitees, and Tenant hereby waives all claims against Landlord, its employees and agents for loss of or damage to any property, or any injury to any person, or loss or interruption of business or income, resulting from any condition including, but not limited to, fire, explosion, falling plaster, steam, gas, electricity, water or rain which may leak or flow from or into any part of the Premises or from the breakage, leakage, obstruction or other defects of the pipes, sprinklers, wires, appliances, plumbing, air conditioning, electrical works or other fixtures in the Building, whether the damage or injury results from conditions arising in the Premises or in other portions of the Building. It is understood that any such condition may require the temporary evacuation or closure of all or a portion of the Building. Should 14 16 Tenant elect to receive any service from a concessionaire, licensee or third party tenant of Landlord, Tenant shall not seek recourse against Landlord for any breach or liability of that service provider. Neither Landlord nor its agents shall be liable for interference with light or other similar intangible interests. Tenant shall promptly following discovery by senior management notify Landlord in case of fire or accident in the Premises, the Building or the Project and of defects in any improvements or equipment. ARTICLE XI. DAMAGE OR DESTRUCTION SECTION 11.1. RESTORATION. (a) If the Building of which the Premises are a part is damaged as the result of an event of casualty, Landlord shall repair that damage as soon as reasonably possible unless: (i) Landlord reasonably determines that the cost of repair would exceed ten percent (10%) of the full replacement cost of the Building ("Replacement Cost") and the damage is not covered by Landlord's fire and extended coverage insurance (or by a normal extended coverage policy for full Replacement Cost should Landlord fail to carry that insurance); or (ii) Landlord reasonably determines that the cost of repair would exceed twenty-five percent (25%) of the Replacement Cost; or (iii) Landlord reasonably determines that the cost of repair would exceed ten percent (10%) of the Replacement Cost and the damage occurs during the final twelve (12) months of the Term, as the Term may have been extended. Should Landlord elect not to repair the damage for one of the preceding reasons, Landlord shall so notify Tenant in the "Casualty Notice" (as defined below), and this Lease shall terminate thereafter on the earlier of (i) sixty (60) days following the date of delivery of the Casualty Notice or (ii) the date Tenant vacates the Premises. (b) As soon as reasonably practicable following the casualty event but not later than sixty (60) days thereafter, Landlord shall notify Tenant in writing ("Casualty Notice") of Landlord's election, if applicable, to terminate this Lease. If this Lease is not so terminated, the Casualty Notice shall set forth the anticipated period for repairing the casualty damage. If the anticipated repair period exceeds one hundred eighty (180) days and if the damage is so extensive as to reasonably prevent Tenant's substantial use and enjoyment of the Premises, then Tenant may elect to terminate this Lease by written notice to Landlord within ten (10) days following delivery of the Casualty Notice. (c) From and after the sixth business day following the casualty event, the rental to be paid under this Lease shall be abated in the same proportion that the floor area of the Premises that is rendered unusable by the damage from time to time bears to the total floor area of the Premises. (d) The provisions of this Section shall not be deemed to require Landlord to repair any improvements or fixtures that Tenant is obligated to repair or insure pursuant to any other provision of this Lease. SECTION 11.2. LEASE GOVERNS. Tenant agrees that the provisions of this Lease, including without limitation Section 11.1, shall govern any damage or destruction and shall accordingly supersede any contrary statute or rule of law. ARTICLE XII. EMINENT DOMAIN SECTION 12.1. TOTAL OR PARTIAL TAKING. If all or a material portion of the Premises is taken by any lawful authority by exercise of the right of eminent domain, or sold to prevent a taking, either Tenant or Landlord may terminate this Lease effective as of the date possession is required to be surrendered to the authority. In the event title to a portion of the Building or Project, other than the Premises, is taken or sold in lieu of taking, and if Landlord elects to restore the Building in such a way as to alter the Premises materially, either party may terminate this Lease, by written notice to the other party, effective on the date of vesting of title. In the event neither party has elected to terminate this Lease as provided above, then Landlord shall promptly, after receipt of a sufficient condemnation award, proceed to restore the Premises to substantially their condition prior to the taking, and a proportionate allowance shall be made to Tenant for the rent corresponding to the time during which, and to the part of the Premises of which, Tenant is deprived on account of the taking and restoration. In the event of a taking, Landlord shall be entitled to the entire amount of the condemnation award without deduction for any estate or interest of Tenant; provided that nothing in this Section shall be deemed to give Landlord any interest in, or prevent Tenant from seeking any award against the taking authority for, the taking of personal property and fixtures belonging to Tenant or for relocation or business interruption expenses or loss of goodwill recoverable from the taking authority. SECTION 12.2. TEMPORARY TAKING. No temporary taking of the Premises shall terminate this Lease or give Tenant any right to abatement of rent, and any award specifically attributable to a temporary taking of the Premises shall belong entirely to Tenant. A temporary taking shall be deemed to be a taking of the use or occupancy of the Premises for a period of not to exceed ninety (90) days. SECTION 12.3. TAKING OF PARKING AREA. In the event there shall be a taking of the parking area such that Landlord can no longer provide sufficient parking to comply with this Lease, Landlord may substitute reasonably equivalent parking in a location reasonably close to the Building; 15 17 provided that if Landlord fails to make that substitution within thirty (30) days following the taking and if the taking materially impairs Tenant's use and enjoyment of the Premises, Tenant may, at its option, terminate this Lease by written notice to Landlord. If this Lease is not so terminated by Tenant, there shall be no abatement of rent and this Lease shall continue in effect. ARTICLE XIII. SUBORDINATION; ESTOPPEL CERTIFICATE SECTION 13.1. SUBORDINATION. At the option of Landlord or any of its mortgagees/deed of trust beneficiaries, this Lease shall be either superior or subordinate to all ground or underlying leases, mortgages and deeds of trust, if any, which may hereafter affect the Building, and to all renewals, modifications, consolidations, replacements and extensions thereof; provided, that so long as Tenant is not in default under this Lease, this Lease shall not be terminated or Tenant's quiet enjoyment of the Premises disturbed in the event of termination of any such ground or underlying lease, or the foreclosure of any such mortgage or deed of trust, to which Tenant has subordinated this Lease pursuant to this Section. In the event of a termination or foreclosure, Tenant shall become a tenant of and attorn to the successor-in-interest to Landlord upon the same terms and conditions as are contained in this Lease, and shall promptly execute any instrument reasonably required by Landlord's successor for that purpose. Tenant shall also, within thirty (30) days following written request of Landlord (or the beneficiary under any deed of trust encumbering the Building), execute and deliver all instruments as may be required from time to time by Landlord or such beneficiary (including without limitation any subordination, nondisturbance and attornment agreement in the form customarily required by such beneficiary, provided such form is consistent with the provisions of this Lease and is reasonably approved by Tenant) to subordinate this Lease and the rights of Tenant under this Lease to any ground or underlying lease or to the lien of any mortgage or deed of trust; provided, however, that any such beneficiary may, by written notice to Tenant given at any time, subordinate the lien of its deed of trust to this Lease. Failure of Tenant to execute any commercially reasonable statements or instruments necessary or desirable to effectuate the provisions of this Article, within thirty (30) days after written request by Landlord, shall constitute a default under this Lease. In that event, Landlord, in addition to any other rights or remedies it might have, shall have the right, by written notice to Tenant, to terminate this Lease as of a date not less than twenty (20) days after the date of Landlord's notice unless Tenant executes and return the document to Landlord prior to such date. Landlord's election to terminate shall not relieve Tenant of any liability for its default. Tenant acknowledges that Landlord's mortgagees and successors-in-interest and all beneficiaries under deeds of trust encumbering the Building are intended third party beneficiaries of this Section. Landlord agrees that it shall use its best efforts to obtain a commercially reasonable nondisturbance agreement in favor of Tenant from any existing mortgagee/deed of trust beneficiary of the Building as of the date hereof. SECTION 13.2. ESTOPPEL CERTIFICATE. (a) Tenant shall, at any time upon not less than thirty (30) days prior written notice from Landlord, execute, acknowledge and deliver to Landlord, in any form that Landlord may reasonably require, a statement in writing in favor of any prospective purchaser or encumbrancer of the Building (i) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of the modification and certifying that this Lease, as modified, is in full force and effect) and the dates to which the rental, additional rent and other charges have been paid in advance, if any, and (ii) acknowledging that, to Tenant's knowledge, there are no uncured defaults on the part of Landlord, or specifying each default if any are claimed, and (iii) setting forth all further information that Landlord may reasonably require. Tenant's statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the Building or Project. Tenant's failure to deliver any estoppel statement within the provided time shall constitute a default under this Lease and shall be conclusive upon Tenant that (i) this Lease is in full force and effect, without modification except as may be represented by Landlord, (ii) there are no uncured defaults in Landlord's performance, and (iii) not more than one month's rental has been paid in advance. (b) Landlord shall, at any time upon not less than thirty (30) days prior written notice from Tenant, execute, acknowledge and deliver to Tenant, in any form that Tenant may reasonably require, a statement in writing in favor of any other party reasonably requested by Tenant for legitimate business reasons (i) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of the modification and certifying that this Lease, as modified, is in full force and effect), the amount of any security deposit then held by Landlord, and the dates to which the rental, additional rent and other charges have been paid in advance, if any, and (ii) acknowledging that, to Landlord's knowledge, there are no uncured defaults on the part of Tenant, or specifying each default if they are claimed, and (iii) setting forth all further information that Tenant may reasonably require. Landlord's statement may be relied upon by the third party beneficiary to which the statement is addressed. Landlord's failure to deliver any estoppel statement within the provided time shall constitute a default by Landlord under this Lease and shall be conclusive upon Landlord that (i) this Lease is in full force and effect, without modification except as may be represented by Tenant, (ii) there are no uncured defaults in Tenant's performance, (iii) the amount of any security deposit as set forth in the Lease is then being held by Landlord, and (iv) not more than one month's rental has been paid in advance. 16 18 ARTICLE XIV. DEFAULTS AND REMEDIES SECTION 14.1. TENANT'S DEFAULTS. In addition to any other event of default set forth in this Lease, the occurrence of any one or more of the following events shall constitute a default by Tenant: (a) The failure by Tenant to make any payment of rent or additional rent required to be made by Tenant, as and when due, where the failure continues for a period of three (3) days after written notice from Landlord to Tenant; provided, however, that any such notice shall be in lieu of, and not in addition to, any notice required under California Code of Civil Procedure Section 1161 and 1161(a) as amended. For purposes of these default and remedies provisions, the term "additional rent" shall be deemed to include all amounts of any type whatsoever other than Basic Rent to be paid by Tenant pursuant to the terms of this Lease. (b) Assignment, sublease, encumbrance or other transfer of the Lease by Tenant, either voluntarily or by operation of law, whether by judgment, execution, transfer by intestacy or testacy, or other means, without the prior written consent of Landlord. (c) The discovery by Landlord that any financial statement provided by Tenant, or by any affiliate, successor or guarantor of Tenant, was materially false. (d) The failure or inability by Tenant to observe or perform any of the covenants or provisions of this Lease to be observed or performed by Tenant, other than as specified in any other subsection of this Section, where the failure continues for a period of thirty (30) days after written notice from Landlord to Tenant; provided, however, that any such notice shall be in lieu of, and not in addition to, any notice required under California Code of Civil Procedure Section 1161 and 1161(a) as amended. However, if the nature of the failure is such that more than thirty (30) days are reasonably required for its cure, then Tenant shall not be deemed to be in default if Tenant commences the cure within thirty (30) days, and thereafter diligently pursues the cure to completion. (e) (i) The making by Tenant of any general assignment for the benefit of creditors; (ii) the filing by or against Tenant of a petition to have Tenant adjudged a Chapter 7 debtor under the Bankruptcy Code or to have debts discharged or a petition for reorganization or arrangement under any law relating to bankruptcy (unless, in the case of a petition filed against Tenant, the same is dismissed within sixty (60) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, if possession is not restored to Tenant within thirty (30) days; (iv) the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where the seizure is not discharged within thirty (30) days; or (v) Tenant's convening of a meeting of its creditors for the purpose of effecting a moratorium upon or composition of its debts. Landlord shall not be deemed to have knowledge of any event described in this subsection unless notification in writing is received by Landlord, nor shall there be any presumption attributable to Landlord of Tenant's insolvency. In the event that any provision of this subsection is contrary to applicable law, the provision shall be of no force or effect. SECTION 14.2. LANDLORD'S REMEDIES. (a) In the event of any default by Tenant, then in addition to any other remedies available to Landlord, Landlord may exercise the following remedies: (i) Landlord may terminate Tenant's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the Premises to Landlord. Such termination shall not affect any accrued obligations of Tenant under this Lease. Upon termination, Landlord shall have the right to reenter the Premises and remove all persons and property. Landlord shall also be entitled to recover from Tenant: (1) The worth at the time of award of the unpaid rent and additional rent which had been earned at the time of termination; (2) The worth at the time of award of the amount by which the unpaid rent and additional rent which would have been earned after termination until the time of award exceeds the amount of such loss that Tenant proves could have been reasonably avoided; (3) The worth at the time of award of the amount by which the unpaid rent and additional rent for the balance of the Term after the time of award exceeds the amount of such loss that Tenant proves could be reasonably avoided; (4) Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result from Tenant's default, including, but not limited to, the cost of recovering possession of the Premises, commissions and other expenses of reletting, including necessary repair, renovation, improvement and alteration of the Premises for a new tenant, reasonable attorneys' fees, and any other reasonable costs; and (5) At Landlord's election, all other amounts in addition to or in lieu of the foregoing as may be permitted by law. The term "rent" as used in this Lease shall be deemed to mean the Basic Rent and all other sums required to be paid by Tenant to Landlord pursuant to the terms 17 19 of this Lease. Any sum, other than Basic Rent, shall be computed on the basis of the average monthly amount accruing during the twenty-four (24) month period immediately prior to default, except that if it becomes necessary to compute such rental before the twenty-four (24) month period has occurred, then the computation shall be on the basis of the average monthly amount during the shorter period. As used in subparagraphs (1) and (2) above, the "worth at the time of award" shall be computed by allowing interest at the rate of ten percent (10%) per annum. As used in subparagraph (3) above, the "worth at the time of award" shall be computed by discounting the amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). (ii) Landlord may elect not to terminate Tenant's right to possession of the Premises, in which event Landlord may continue to enforce all of its rights and remedies under this Lease, including the right to collect all rent as it becomes due. Efforts by the Landlord to maintain, preserve or relet the Premises, or the appointment of a receiver to protect the Landlord's interests under this Lease, shall not constitute a termination of the Tenant's right to possession of the Premises. In the event that Landlord elects to avail itself of the remedy provided by this subsection (ii), Landlord shall not unreasonably withhold its consent to an assignment or subletting of the Premises subject to the reasonable standards for Landlord's consent as are contained in this Lease. (b) The various rights and remedies reserved to Landlord in this Lease or otherwise shall be cumulative and, except as otherwise provided by California law, Landlord may pursue any or all of its rights and remedies at the same time. No delay or omission of Landlord to exercise any right or remedy shall be construed as a waiver of the right or remedy or of any default by Tenant. The acceptance by Landlord of rent shall not be a (i) waiver of any preceding breach or default by Tenant of any provision of this Lease, other than the failure of Tenant to pay the particular rent accepted, regardless of Landlord's knowledge of the preceding breach or default at the time of acceptance of rent, or (ii) a waiver of Landlord's right to exercise any remedy available to Landlord by virtue of the breach or default. The acceptance of any payment from a debtor in possession, a trustee, a receiver or any other person acting on behalf of Tenant or Tenant's estate shall not waive or cure a default under Section 14.1. No payment by Tenant or receipt by Landlord of a lesser amount than the rent required by this Lease shall be deemed to be other than a partial payment on account of the earliest due stipulated rent, nor shall any endorsement or statement on any check or letter be deemed an accord and satisfaction and Landlord shall accept the check or payment without prejudice to Landlord's right to recover the balance of the rent or pursue any other remedy available to it. Tenant hereby waives any right of redemption or relief from forfeiture under California Code of Civil Procedure Section 1174 or 1179, or under any other present or future law, in the event this Lease is terminated by reason of any default by Tenant. No act or thing done by Landlord or Landlord's agents during the Term shall be deemed an acceptance of a surrender of the Premises, and no agreement to accept a surrender shall be valid unless in writing and signed by Landlord. No employee of Landlord or of Landlord's agents shall have any power to accept the keys to the Premises prior to the termination of this Lease, and the delivery of the keys to any employee shall not operate as a termination of the Lease or a surrender of the Premises. SECTION 14.3. LATE PAYMENTS. (a) Any rent due under this Lease that is not paid to Landlord within five (5) days of the date when due shall bear interest at the maximum rate permitted by law from the date due until fully paid. The payment of interest shall not cure any default by Tenant under this Lease. In addition, Tenant acknowledges that the late payment by Tenant to Landlord of rent will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult and impracticable to ascertain. Those costs may include, but are not limited to, administrative, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any ground lease, mortgage or trust deed covering the Premises. Accordingly, if any rent due from Tenant shall not be received by Landlord or Landlord's designee within five (5) days after the date due, then Tenant shall pay to Landlord, in addition to the interest provided above, a late charge in the amount of one hundred dollars ($100.00) for each delinquent payment. Acceptance of a late charge by Landlord shall not constitute a waiver of Tenant's default with respect to the overdue amount, nor shall it prevent Landlord from exercising any of its other rights and remedies. (b) Following each third consecutive installment of rent that is not paid within five (5) days following notice of nonpayment from Landlord, Landlord shall have the option to require that beginning with the first payment of rent next due, rent shall no longer be paid in monthly installments but shall be payable quarterly three (3) months in advance. Should Tenant deliver to Landlord, at any time during the Term, two (2) or more insufficient checks, the Landlord may require that all monies then and thereafter due from Tenant be paid to Landlord by cashier's check. SECTION 14.4. RIGHT OF LANDLORD TO PERFORM. All covenants and agreements to be performed by Tenant under this Lease shall be performed at Tenant's sole cost and expense and without any abatement of rent or right of set-off. If Tenant fails to pay any sum of money, or fails to perform any other act on its part to be performed under this Lease, and the failure continues beyond any applicable grace period set forth in Section 14.1, then in addition to any other available remedies, Landlord may, at its election make the payment or perform the other act on Tenant's part. Landlord's election to make the payment or perform the act on Tenant's part shall not give rise to any responsibility of Landlord to continue making the same or similar payments or performing the same or similar acts. Tenant shall, promptly upon demand by Landlord, reimburse Landlord for all sums paid by Landlord and all necessary incidental costs, 18 20 together with interest at the maximum rate permitted by law from the date of the payment by Landlord. SECTION 14.5. DEFAULT BY LANDLORD. Landlord shall not be deemed to be in default in the performance of any obligation under this Lease unless and until it has failed to perform the obligation within thirty (30) days after written notice by Tenant to Landlord specifying in reasonable detail the nature and extent of the failure; provided, however, that if the nature of Landlord's obligation is such that more than thirty (30) days are required for its performance, then Landlord shall not be deemed to be in default if it commences performance within the thirty (30) day period and thereafter diligently pursues the cure to completion. SECTION 14.6. EXPENSES AND LEGAL FEES. Should either Landlord or Tenant bring any action in connection with this Lease, the prevailing party shall be entitled to recover as a part of the action its reasonable attorneys' fees, and all other costs. The prevailing party for the purpose of this paragraph shall be determined by the trier of the facts. SECTION 14.7. WAIVER OF JURY TRIAL/RIGHT TO ARBITRATE. (A) LANDLORD AND TENANT EACH ACKNOWLEDGES THAT IT IS AWARE OF AND HAS HAD THE ADVICE OF COUNSEL OF ITS CHOICE WITH RESPECT TO ITS RIGHT TO TRIAL BY JURY, AND EACH PARTY DOES HEREBY EXPRESSLY AND KNOWINGLY WAIVE AND RELEASE ALL SUCH RIGHTS TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM BROUGHT BY EITHER PARTY HERETO AGAINST THE OTHER (AND/OR AGAINST ITS OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, OR SUBSIDIARY OR AFFILIATED ENTITIES) ON ANY MATTERS WHATSOEVER ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS LEASE, TENANT'S USE OR OCCUPANCY OF THE PREMISES, AND/OR ANY CLAIM OF INJURY OR DAMAGE. (B) SHOULD A DISPUTE ARISE BETWEEN THE PARTIES REGARDING ANY MATTER DESCRIBED ABOVE, THEN EXCEPT WITH RESPECT TO ACTIONS FOR UNLAWFUL OR FORCIBLE DETAINER EITHER PARTY MAY CAUSE THE DISPUTE TO BE SUBMITTED TO JAMS/ENDISPUTE OR ITS SUCCESSOR ("JAMS") IN THE COUNTY IN WHICH THE BUILDING IS SITUATED FOR BINDING ARBITRATION BEFORE A SINGLE ARBITRATOR. HOWEVER, EACH PARTY RESERVES THE RIGHT TO SEEK A PROVISIONAL REMEDY BY JUDICIAL ACTION. NO ARBITRATION ELECTION BY EITHER PARTY PURSUANT TO THIS SUBSECTION SHALL BE EFFECTIVE IF MADE LATER THAN THIRTY (30) DAYS FOLLOWING SERVICE OF A JUDICIAL SUMMONS AND COMPLAINT BY OR UPON SUCH PARTY CONCERNING THE DISPUTE. THE ARBITRATION SHALL BE CONDUCTED IN ACCORDANCE WITH THE RULES OF PRACTICE AND PROCEDURE OF JAMS AND OTHERWISE PURSUANT TO THE CALIFORNIA ARBITRATION ACT (CODE OF CIVIL PROCEDURE SECTIONS 1280 ET SEQ.). NOTWITHSTANDING THE FOREGOING, THE ARBITRATOR IS SPECIFICALLY DIRECTED TO LIMIT DISCOVERY TO THAT WHICH IS ESSENTIAL TO THE EFFECTIVE PROSECUTION OR DEFENSE OF THE ACTION. THE ARBITRATOR SHALL APPORTION THE COSTS OF THE ARBITRATION, TOGETHER WITH THE ATTORNEYS' FEES OF THE PARTIES, IN THE MANNER DEEMED EQUITABLE BY THE ARBITRATOR, IT BEING THE INTENTION OF THE PARTIES THAT THE PREVAILING PARTY ORDINARILY BE ENTITLED TO RECOVER ITS REASONABLE COSTS AND FEES. JUDGMENT UPON ANY AWARD RENDERED BY THE ARBITRATOR MAY BE ENTERED BY ANY COURT HAVING JURISDICTION. ARTICLE XV. END OF TERM SECTION 15.1. HOLDING OVER. This Lease shall terminate without further notice upon the expiration of the Term, and any holding over by Tenant after the expiration shall not constitute a renewal or extension of this Lease, or give Tenant any rights under this Lease, except when in writing signed by both parties. If Tenant holds over for any period after the expiration (or earlier termination) of the Term, Landlord may, at its option, treat Tenant as a tenant at sufferance only, commencing on the first (1st) day following the termination of this Lease. Any hold-over by Tenant shall be subject to all of the terms of this Lease, except that the monthly rental shall be one hundred fifty percent (150%) of the total monthly rental for the month immediately preceding the date of termination, subject to Landlord's right to modify same upon thirty (30) days notice to Tenant. If Tenant fails to surrender the Premises upon the expiration of this Lease despite demand to do so by Landlord, Tenant shall indemnify and hold Landlord harmless from all loss or liability, including without limitation, any claims made by any succeeding tenant that has a signed lease for all or a portion of the Premises relating to such failure to surrender. Acceptance by Landlord of rent after the termination shall not constitute a consent to a holdover or result in a renewal of this Lease. The foregoing provisions of this Section are in addition to and do not affect Landlord's right of re-entry or any other rights of Landlord under this Lease or at law. 19 21 SECTION 15.2. MERGER ON TERMINATION. The voluntary or other surrender of this Lease by Tenant, or a mutual termination of this Lease, shall terminate any or all existing subleases unless Landlord, at its option, elects in writing to treat the surrender or termination as an assignment to it of any or all subleases affecting the Premises. SECTION 15.3. SURRENDER OF PREMISES; REMOVAL OF PROPERTY. Upon the Expiration Date or upon any earlier termination of this Lease, Tenant shall quit and surrender possession of the Premises to Landlord in as good order, condition and repair as when received or as hereafter may be improved by Landlord or Tenant, reasonable wear and tear and repairs which are Landlord's obligation excepted, and shall, without expense to Landlord, remove or cause to be removed all wallpapering installed by Tenant except in connection with the initial tenant improvement work, together with all personal property and debris, except for any items that Landlord may by written authorization allow to remain. Tenant shall repair all damage to the Premises resulting from the removal, which repair shall include the patching and filling of holes and repair of structural damage, provided that Landlord may instead elect to repair any structural damage at Tenant's expense. If Tenant shall fail to comply with the provisions of this Section, Landlord may effect the removal and/or make any repairs, and the cost to Landlord shall be additional rent payable by Tenant upon demand. If requested by Landlord, Tenant shall execute, acknowledge and deliver to Landlord an instrument in writing releasing and quitclaiming to Landlord all right, title and interest of Tenant in the Premises. ARTICLE XVI. PAYMENTS AND NOTICES All sums payable by Tenant to Landlord shall be paid, without deduction or offset, in lawful money of the United States to Landlord at its address set forth in Item 13 of the Basic Lease Provisions, or at any other place as Landlord may designate in writing. Unless this Lease expressly provides otherwise, as for example in the payment of rent pursuant to Section 4.1, all payments shall be due and payable within five (5) days after demand. All payments requiring proration shall be prorated on the basis of a thirty (30) day month and a three hundred sixty (360) day year. Any notice, election, demand, consent, approval or other communication to be given or other document to be delivered by either party to the other may be delivered to the other party, at the address set forth in Item 13 of the Basic Lease Provisions, by personal service or telegram, telecopier, or electronic facsimile transmission, or by any courier or "overnight" express mailing service, or may be deposited in the United States mail, postage prepaid. Either party may, by written notice to the other, served in the manner provided in this Article, designate a different address. If any notice or other document is sent by mail, it shall be deemed served or delivered three (3) business days after mailing or, if sooner, upon actual receipt. If more than one person or entity is named as Tenant under this Lease, service of any notice upon any one of them shall be deemed as service upon all of them. ARTICLE XVII. RULES AND REGULATIONS Tenant agrees to comply with the Rules and Regulations attached as Exhibit E, and any reasonable and nondiscriminatory amendments, modifications and/or additions as may be adopted and published by written notice to tenants by Landlord for the safety, care, security, good order, or cleanliness of the Premises, Building, Project and/or Common Areas. Landlord shall not be liable to Tenant for any violation of the Rules and Regulations or the breach of any covenant or condition in any lease or any other act or conduct by any other tenant, and the same shall not constitute a constructive eviction hereunder. One or more waivers by Landlord of any breach of the Rules and Regulations by Tenant or by any other tenant(s) shall not be a waiver of any subsequent breach of that rule or any other. Tenant's failure to keep and observe the Rules and Regulations and to cure such failure as provided in Section 14.1(d) above shall constitute a default under this Lease. In the case of any conflict between the Rules and Regulations and this Lease, this Lease shall be controlling. ARTICLE XVIII. BROKER'S COMMISSION The parties recognize as the broker(s) who negotiated this Lease the firm(s), if any, whose name(s) is (are) stated in Item 10 of the Basic Lease Provisions, and agree that Landlord shall be responsible for the payment of brokerage commissions to those broker(s) unless otherwise provided in this Lease. Each party warrants that it has had no dealings with any other real estate broker or agent in connection with the negotiation of this Lease, and agrees to indemnify and hold the other party harmless from any cost, expense or liability (including reasonable attorneys' fees) for any compensation, commissions or charges claimed by any other real estate broker or agent employed or claiming to represent or to have been employed by the indemnifying party in connection with the negotiation of this Lease. The foregoing agreement shall survive the termination of this Lease. 20 22 ARTICLE XIX. TRANSFER OF LANDLORD'S INTEREST In the event of any transfer of Landlord's interest in the Premises, the transferor shall be automatically relieved of all obligations on the part of Landlord accruing under this Lease from and after the date of the transfer, provided that any funds held by the transferor in which Tenant has an interest shall be turned over, subject to that interest, to the transferee and Tenant is notified of the transfer as required by law. No holder of a mortgage and/or deed of trust to which this Lease is or may be subordinate shall be responsible in connection with the Security Deposit, unless the mortgagee or holder of the deed of trust or the landlord actually receives the Security Deposit. It is intended that the covenants and obligations contained in this Lease on the part of Landlord shall, subject to the foregoing, be binding on Landlord, its successors and assigns, only during and in respect to their respective successive periods of ownership. ARTICLE XX. INTERPRETATION SECTION 20.1. GENDER AND NUMBER. Whenever the context of this Lease requires, the words "Landlord" and "Tenant" shall include the plural as well as the singular, and words used in neuter, masculine or feminine genders shall include the others. SECTION 20.2. HEADINGS. The captions and headings of the articles and sections of this Lease are for convenience only, are not a part of this Lease and shall have no effect upon its construction or interpretation. SECTION 20.3. JOINT AND SEVERAL LIABILITY. If more than one person or entity is named as Tenant, the obligations imposed upon each shall be joint and several and the act of or notice from, or notice or refund to, or the signature of, any one or more of them shall be binding on all of them with respect to the tenancy of this Lease, including, but not limited to, any renewal, extension, termination or modification of this Lease. SECTION 20.4. SUCCESSORS. Subject to Articles IX and XIX, all rights and liabilities given to or imposed upon Landlord and Tenant shall extend to and bind their respective heirs, executors, administrators, successors and assigns. Nothing contained in this Section is intended, or shall be construed, to grant to any person other than Landlord and Tenant and their successors and assigns any rights or remedies under this Lease. SECTION 20.5. TIME OF ESSENCE. Time is of the essence with respect to the performance of every provision of this Lease in which time of performance is a factor. SECTION 20.6. CONTROLLING LAW. This Lease shall be governed by and interpreted in accordance with the laws of the State of California. SECTION 20.7. SEVERABILITY. If any term or provision of this Lease, the deletion of which would not adversely affect the receipt of any material benefit by either party or the deletion of which is consented to by the party adversely affected, shall be held invalid or unenforceable to any extent, the remainder of this Lease shall not be affected and each term and provision of this Lease shall be valid and enforceable to the fullest extent permitted by law. SECTION 20.8. WAIVER. One or more waivers by Landlord or Tenant of any breach of any term, covenant or condition contained in this Lease shall not be a waiver of any subsequent breach of the same or any other term, covenant or condition. Consent to any act by one of the parties shall not be deemed to render unnecessary the obtaining of that party's consent to any subsequent act. No breach of this Lease shall be deemed to have been waived unless the waiver is in a writing signed by the waiving party. SECTION 20.9. INABILITY TO PERFORM. In the event that either party shall be delayed or hindered in or prevented from the performance of any work or in performing any act required under this Lease by reason of any cause beyond the reasonable control of that party, then the performance of the work or the doing of the act shall be excused for the period of the delay and the time for performance shall be extended for a period equivalent to the period of the delay. The provisions of this Section shall not operate to excuse Tenant from the prompt payment of rent. SECTION 20.10. ENTIRE AGREEMENT. This Lease and its exhibits and other attachments cover in full each and every agreement of every kind between the parties concerning the Premises, the Building, and the Project, and all preliminary negotiations, oral agreements, understandings and/or practices, except those contained in this Lease, are superseded and of no further effect. Tenant waives its rights to rely on any representations or promises made by Landlord or others which are not contained in this Lease. No verbal agreement or implied covenant shall be held to modify the provisions of this Lease, any statute, law, or custom to the contrary notwithstanding. SECTION 20.11. QUIET ENJOYMENT. Upon the observance and performance of all the covenants, terms and conditions on Tenant's part to be observed and performed, and subject to the other provisions of this Lease, Tenant shall peaceably and quietly hold and enjoy the Premises for the Term without hindrance or interruption by Landlord or any other person claiming by or through Landlord. 21 23 SECTION 20.12. SURVIVAL. All covenants of Landlord or Tenant which reasonably would be intended to survive the expiration or sooner termination of this Lease, including without limitation any warranty or indemnity hereunder, shall so survive and continue to be binding upon and inure to the benefit of the respective parties and their successors and assigns. ARTICLE XXI. EXECUTION AND RECORDING SECTION 21.1. COUNTERPARTS. This Lease may be executed in one or more counterparts, each of which shall constitute an original and all of which shall be one and the same agreement. SECTION 21.2. CORPORATE AND PARTNERSHIP AUTHORITY. If either party is a corporation or partnership, each individual executing this Lease on behalf of the corporation or partnership represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of the corporation or partnership, and that this Lease is binding upon the corporation or partnership in accordance with its terms. SECTION 21.3. EXECUTION OF LEASE; NO OPTION OR OFFER. The submission of this Lease to Tenant shall be for examination purposes only, and shall not constitute an offer to or option for Tenant to lease the Premises. Execution of this Lease by Tenant and its return to Landlord shall not be binding upon Landlord, notwithstanding any time interval, until Landlord has in fact executed and delivered this Lease to Tenant, it being intended that this Lease shall only become effective upon execution by Landlord and delivery of a fully executed counterpart to Tenant. SECTION 21.4. RECORDING. Tenant shall not record this Lease without the prior written consent of Landlord. Tenant, upon the request of Landlord, shall execute and acknowledge a "short form" memorandum of this Lease for recording purposes. SECTION 21.5. AMENDMENTS. No amendment or mutual termination of this Lease shall be effective unless in writing signed by authorized signatories of Tenant and Landlord, or by their respective successors in interest. No actions, policies, oral or informal arrangements, business dealings or other course of conduct by or between the parties shall be deemed to modify this Lease in any respect. ARTICLE XXII. MISCELLANEOUS SECTION 22.1. NONDISCLOSURE OF LEASE TERMS. Tenant acknowledges and agrees that the terms of this Lease are confidential and constitute proprietary information of Landlord. Disclosure of the terms could adversely affect the ability of Landlord to negotiate other leases and impair Landlord's relationship with other tenants. Accordingly, Tenant agrees that it, and its partners, officers, directors, employees and attorneys, shall not intentionally and voluntarily disclose the terms and conditions of this Lease to any other tenant or apparent prospective tenant of the Building or Project, either directly or indirectly, without the prior written consent of Landlord, provided, however, that Tenant may disclose the terms to prospective subtenants or assignees under this Lease, its lenders, accountants and other consultants, and in connection with any securities filing, sale, merger or similar transaction. SECTION 22.2. REPRESENTATIONS BY TENANT. The application, financial statements and tax returns, if any, submitted and certified to by Tenant as an accurate representation of its financial condition have been prepared, certified and submitted to Landlord as an inducement and consideration to Landlord to enter into this Lease. The application and statements are represented and warranted by Tenant to be correct and to accurately and fully reflect Tenant's true financial condition as of the date of execution of this Lease by Tenant. Tenant shall during the Term promptly furnish Landlord with annual financial statements reflecting Tenant's financial condition upon written request from Landlord. SECTION 22.3. CHANGES REQUESTED BY LENDER. If, in connection with obtaining financing for the Building, the lender shall request reasonable modifications in this Lease as a condition to the financing, Tenant will not unreasonably withhold or delay its consent, provided that the modifications do not increase the obligations of Tenant, diminish the rights of Tenant, or adversely affect the leasehold interest created by this Lease. SECTION 22.4. MORTGAGEE PROTECTION. No act or failure to act on the part of Landlord which would otherwise entitle Tenant to be relieved of its obligations hereunder or to terminate this Lease shall result in such a release or termination unless (a) Tenant has given notice by registered or certified mail to any beneficiary of a deed of trust or mortgage covering the Building whose address has been furnished to Tenant and (b) such beneficiary is afforded the opportunity to cure the default by Landlord for a period of thirty (30) days following the later of (i) the expiration of Landlord's cure period under Section 14.5 above or (ii) the delivery to the beneficiary of Tenant's notice. SECTION 22.5. DISCLOSURE STATEMENT. Tenant acknowledges that it has read, understands and, if applicable, shall comply with the provisions of Exhibit F to this Lease, if that Exhibit is attached. 22 24 SECTION 22.6. TERMINATION OF EXISTING LEASE. Landlord and Tenant are currently parties to an office space lease dated January 11, 1991, as subsequently amended, for certain premises situated at 610 Newport Center Drive, Newport Beach, California (as amended, the "Existing Lease"). The parties agree that the Existing Lease shall terminate effective as of the day preceding the Commencement Date of this Lease, provided that such termination shall not relieve Tenant of (a) any accrued obligation or liability under the Existing Lease as of said termination date, or (b) any obligation under the Existing Lease which was reasonably intended to survive the expiration or termination thereof. Any advance rental paid by Tenant under the Existing Lease shall be rebated by Landlord or applied to the rent due hereunder. In the event that the Premises are not ready for occupancy by Tenant as of the Estimated Commencement Date set forth herein, and provided such failure is not attributable to any Tenant Delay, then any Basic Rental increase under the Existing Lease that is scheduled to occur on or after the Estimated Commencement Date hereof shall be suspended. LANDLORD: TENANT: THE IRVINE COMPANY QUEST SOFTWARE, INC. By /s/ WILLIAM R. HALFORD By /s/ VINCENT C. SMITH --------------------------------- ----------------------------------- William R. Halford, President, Printed Name Vincent C. Smith Irvine Office Company, ------------------------- a division of The Irvine Company Title CEO -------------------------------- By /s/ VINCENT P. HAYES By /s/ DAVID DOYLE --------------------------------- ----------------------------------- Vincent P. Hayes Printed Name David Doyle Assistant Secretary ------------------------- Title President -------------------------------- 23 25 EXHIBIT B UTILITIES AND SERVICES The following standards for utilities and services shall be in effect at the Building. Landlord reserves the right to adopt nondiscriminatory modifications and additions to these standards which are reasonable and do not materially adversely affect Tenant's rights under the Lease. In the case of any conflict between these standards and the Lease, the Lease shall be controlling. Subject to all of the provisions of the Lease, including but not limited to the restrictions contained in Section 6.1, the following shall apply: 1. Landlord shall furnish to the Premises during the hours of 8:00 a.m. to 6:00 p.m., Monday through Friday, and 8:00 a.m. to 1:00 p.m. on Saturday, generally recognized national holidays and Sundays excepted, reasonable air conditioning, heating and ventilation services. Subject to the provisions set forth below, Landlord shall also furnish the Building with elevator service (if applicable), reasonable amounts of electric current for normal lighting by Landlord's standard overhead fluorescent and incandescent fixtures and for fractional horsepower office machines, and water for lavatory and drinking purposes. Tenant will not, without the prior written consent of Landlord, consume electricity in the Premises at a level in excess of 3 watts per square foot or otherwise increase the amount of electricity, gas or water usually furnished or supplied for use of the Premises as general office space; nor shall Tenant connect any apparatus, machine or device with water pipes or electric current (except through existing electrical outlets in the Premises) for the purpose of using electric current or water. This paragraph shall at all times be subject to applicable governmental regulations. 2. Upon request from Tenant a reasonable period of time prior to the period for which service is requested, but during normal business hours, Landlord will provide any of the foregoing building services to Tenant at such times when such services are not otherwise available. Landlord may install systems within the Building that permit Tenant to directly access after hour services. Tenant agrees to pay Landlord for those afterhour services at rates that Landlord may establish from time to time. If Tenant requires electric current in excess of that which Landlord is obligated to furnish under this Exhibit B, Tenant shall first obtain the consent of Landlord, and Landlord may cause an electric current meter to be installed in the Premises to measure the amount of electric current consumed. The cost of installation, maintenance and repair of the meter shall be paid for by Tenant, and Tenant shall reimburse Landlord promptly upon demand for all electric current consumed for any special power use as shown by the meter. The reimbursement shall be at the rates charged for electrical power by the local public utility furnishing the current, plus any additional expense incurred in keeping account of the electric current consumed. 3. If any lights, machines or equipment (including without limitation electronic data processing machines) are used by Tenant in the Premises which materially affect the temperature otherwise maintained by the air conditioning system, or generate substantially more heat in the Premises than would be generated by the building standard lights and usual fractional horsepower office equipment, Landlord shall have the right at its election to install or modify any machinery and equipment to the extent Landlord reasonably deems necessary to restore temperature balance. The cost of installation, and any additional cost of operation and maintenance, shall be paid by Tenant to Landlord promptly upon demand. 4. Landlord shall furnish water for drinking, personal hygiene and lavatory purposes only. If Tenant requires or uses water for any purposes in addition to ordinary drinking, cleaning and lavatory purposes, Landlord may, in its discretion, install a water meter to measure Tenant's water consumption. Tenant shall pay Landlord for the cost of the meter and the cost of its installation, and for consumption throughout the duration of Tenant's occupancy. Tenant shall keep the meter and installed equipment in good working order and repair at Tenant's own cost and expense, in default of which Landlord may cause the meter to be replaced or repaired at Tenant's expense. Tenant agrees to pay for water consumed, as shown on the meter and when bills are rendered, and on Tenant's default in making that payment Landlord may pay the charges on behalf of Tenant. Any costs or expenses or payments made by Landlord for any of the reasons or purposes stated above shall be deemed to be additional rent payable by Tenant to Landlord upon demand. 5. In the event that any utility service to the Premises is separately metered or billed to Tenant, Tenant shall pay all charges for that utility service to the Premises and the cost of furnishing the utility to tenant suites shall be excluded from the Operating Expenses as to which reimbursement from Tenant is required in the Lease. If any utility charges are not paid when due Landlord may pay them, and any amounts paid by Landlord shall immediately become due to Landlord from Tenant as additional rent. If Landlord elects to furnish any utility service to the Premises, Tenant shall purchase its requirements of that utility from Landlord as long as the rates charged by Landlord do not exceed those which Tenant would be required to pay if the utility service were furnished it directly by a public utility. 1 26 6. Landlord shall provide janitorial services five days per week, equivalent to that furnished in comparable buildings, and window washing as reasonably required; provided, however, that Tenant shall pay for any additional or unusual janitorial services required by reason of any nonstandard improvements in the Premises, including without limitation wall coverings and floor coverings installed by or for Tenant, or by reason of any use of Premises other than exclusively as offices. The cleaning services provided by Landlord shall also exclude refrigerators, eating utensils (plates, drinking containers and silverware), and interior glass partitions. Tenant shall pay to Landlord the cost of removal of any of Tenant's refuse and rubbish, to the extent that they exceed the refuse and rubbish usually attendant with general office usage. 7. Tenant shall have access to the Building 24 hours per day, 7 days per week, 52 weeks per year; provided that Landlord may install access control systems as it deems advisable for the Building. Such systems may, but need not, include full or part-time lobby supervision, the use of a sign-in sign-out log, a card identification access system, building parking and access pass system, closing hours procedures, access control stations, fire stairwell exit door alarm system, electronic guard system, mobile paging system, elevator control system or any other access controls. In the event that Landlord elects to provide any or all of those services, Landlord may discontinue providing them at any time with or without notice. Landlord may impose a reasonable charge for access control cards and/or keys issued to Tenant; provided that Landlord agrees to furnish, at its expense, the same number of initial access control devices as Tenant is currently utilizing under the Existing Lease, whether by reprogramming those existing devices or supplying new devices. Landlord shall have no liability to Tenant for the provision by Landlord of improper access control services, for any breakdown in service, or for the failure by Landlord to provide access control services. Tenant further acknowledges that Landlord's access systems may be temporarily inoperative during building emergency and system repair periods. Tenant agrees to assume responsibility for compliance by its employees with any regulations established by Landlord with respect to any card key access or any other system of building access as Landlord may establish. Tenant shall be liable to Landlord for any loss or damage resulting from its or its employees use of any access system. 2 27 EXHIBIT C PARKING The following parking regulations shall be in effect at the Building. Landlord reserves the right to adopt reasonable, nondiscriminatory modifications and additions to the regulations by written notice to Tenant. In the case of any conflict between these regulations and the Lease, the Lease shall be controlling. 1. Landlord agrees to maintain, or cause to be maintained, an automobile parking area ("Parking Area") in reasonable proximity to the Building for the benefit and use of the visitors and patrons and, except as otherwise provided, employees of Tenant, and other tenants and occupants of the Building. The Parking Area shall include, whether in a surface parking area or a parking structure, the automobile parking stalls, driveways, entrances, exits, sidewalks and attendant pedestrian passageways and other areas designated for parking. Landlord shall have the right and privilege of determining the nature and extent of the automobile Parking Area, whether it shall be surface, underground or other structure, and of making such changes to the Parking Area from time to time which in its opinion are desirable and for the best interests of all persons using the Parking Area. Landlord shall keep the Parking Area in a neat, clean and orderly condition, and shall repair any damage to its facilities. Landlord shall not be liable for any damage to motor vehicles of visitors or employees, for any loss of property from within those motor vehicles, or for any injury to Tenant, its visitors or employees, unless ultimately determined to be caused by the active negligence or willful misconduct of Landlord. Unless otherwise instructed by Landlord, every parker shall park and lock his or her own motor vehicle. Landlord shall also have the right to establish, and from time to time amend, and to enforce against all users of the Parking Area all reasonable rules and regulations (including the designation of areas for employee parking) as Landlord may deem necessary and advisable for the proper and efficient operation and maintenance of the Parking Area. Garage managers or attendants are not authorized to make or allow any exceptions to these regulations. 2. Landlord may, if it deems advisable in its sole discretion, charge for parking and may establish for the Parking Area a system or systems of permit parking for Tenant, its employees and its visitors, which may include, but not be limited to, a system of charges against nonvalidated parking, verification of users, a set of regulations governing different parking locations, and an allotment of reserved or nonreserved parking spaces based upon the charges paid and the identity of users. In no event shall Tenant or its employees park in reserved stalls leased to other tenants or in stalls within designated visitor parking zones, nor shall Tenant or its employees utilize more than the number of parking stalls allotted in this Lease to Tenant. It is understood that Landlord shall not have any obligation to cite improperly parked vehicles or otherwise attempt to enforce reserved parking rules during hours when parking attendants are not present at the Parking Area. Tenant shall comply with such system in its use (and in the use of its visitors, patrons and employees) of the Parking Area, provided, however, that the system and rules and regulations shall apply to all persons entitled to the use of the Parking Area, and all charges to Tenant for use of the Parking Area shall be no greater than Landlord's then current scheduled charge for parking. The foregoing shall otherwise be subject to Paragraphs 7 and 10 below. 3. Tenant shall, upon request of Landlord from time to time, furnish Landlord with a list of its employees' names and of Tenant's and its employees' vehicle license numbers. Tenant agrees to acquaint its employees with these regulations and assumes responsibility for compliance by its employees with these parking provisions, and shall be liable to Landlord for all unpaid parking charges incurred by its employees. Any amount due from Tenant shall be deemed additional rent. Tenant authorizes Landlord to tow away from the Building any vehicle belonging to Tenant or Tenant's employees parked in violation of these provisions, and/or to attach violation stickers or notices to those vehicles. In the event Landlord elects or is required to limit or control parking by tenants, employees, visitors or invitees of the Building, whether by validation of parking tickets, parking meters or any other method of assessment, Tenant agrees to participate in the validation or assessment program under reasonable rules and regulations as are established by Landlord and/or any applicable governmental agency. 4. Landlord may establish an identification system for vehicles of Tenant and its employees which may consist of stickers, magnetic parking cards or other identification devices supplied by Landlord. All identification devices shall remain the property of Landlord, shall be displayed as required by Landlord or upon request and may not be mutilated or obliterated in any manner. Those devices shall not be transferable and any such device in the possession of an unauthorized holder shall be void and may be confiscated. Landlord may impose a reasonable fee for identification devices and a replacement charge for devices which are lost or stolen; provided that Landlord agrees to furnish, at its expense, the same number of initial identification devices as Tenant is currently utilizing under the Existing Lease, whether by reprogramming those existing devices or supplying new devices. Each identification device shall be returned to Landlord promptly following the Expiration Date or sooner termination of this Lease. Loss or theft of parking identification devices shall be reported to Landlord or its Parking Area operator immediately and a written report of the loss filed if requested by Landlord or its Parking Area operator. 1 28 5. Persons using the Parking Area shall observe all directional signs and arrows and any posted speed limits. Unless otherwise posted, in no event shall the speed limit of 5 miles per hour be exceeded. All vehicles shall be parked entirely within painted stalls, and no vehicles shall be parked in areas which are posted or marked as "no parking" or on or in ramps, driveways and aisles. Only one vehicle may be parked in a parking space. In no event shall Tenant interfere with the use and enjoyment of the Parking Area by other tenants of the Building or their employees or invitees. 6. Parking Areas shall be used only for parking vehicles. Washing, waxing, cleaning or servicing of vehicles, or the parking of any vehicle on an overnight basis (except in connection with occasional business trips), in the Parking Area (other than emergency services) by any parker or his or her agents or employees is prohibited unless otherwise authorized by Landlord. Tenant shall have no right to install any fixtures, equipment or personal property (other than vehicles) in the Parking Area, nor shall Tenant make any alteration to the Parking Area. 7. It is understood that the employees of Tenant and the other tenants of Landlord within the Building and Project shall not be permitted to park their automobiles in the portions of the Parking Area which may from time to time be designated for patrons of the Building and/or Project and that Landlord shall at all times have the right to establish rules and regulations for employee parking. Notwithstanding the foregoing, but subject to Paragraph 10 below, the monthly stall charge for the reserved and unreserved stalls allotted herein to Tenant within the Parking Area or one of the off-site lots described in Section 6.4 of the Lease shall be Seventy-Five Dollars ($75.00) per stall and Fifteen Dollars ($15.00) per reserved and unreserved stall, respectively, during the initial Term of this Lease; thereafter, Tenant shall pay to Landlord or its agents for the use of parking spaces the amounts as Landlord shall from time to time determine. Landlord may authorize persons other than those described above, including occupants of other buildings, to utilize the Parking Area. In the event of the use of the Parking Area by other persons, those persons shall pay for that use in accordance with the terms established above; provided, however, Landlord may allow those persons to use the Parking Area on weekends, holidays, and at other non-office hours without payment. 8. Notwithstanding the foregoing paragraphs 1 through 7, Landlord shall be entitled to pass on to Tenant its proportionate share of any charges or parking surcharge or transportation management costs levied by any governmental agency. The foregoing parking provisions are further subject to any governmental regulations which limit parking or otherwise seek to encourage the use of carpools, public transit or other alternative transportation forms or traffic reduction programs. Tenant agrees that it will use reasonable efforts to cooperate, including registration and attendance, in programs which may be undertaken to reduce traffic. Tenant acknowledges that as a part of those programs, it may be required to distribute employee transportation information, participate in employee transportation surveys, allow employees to participate in commuter activities, designate a liaison for commuter transportation activities, distribute commuter information to all employees, and otherwise participate in other programs or services initiated under a transportation management program. 9. Should any parking spaces be allotted by Landlord to Tenant, either on a reserved or nonreserved basis, Tenant shall not assign or sublet any of those spaces, either voluntarily or by operation of law, without the prior written consent of Landlord, except in connection with an authorized or permitted assignment of this Lease or subletting of the Premises. 10. Tenant acknowledges that it has been advised that Landlord may undertake the construction of a parking structure in the Parking Area of the Building and that such construction shall result in temporarily relocating Tenant's allotted parking spaces to another surface parking area reasonably close to the Building. During the period of such temporary relocation, Landlord shall waive all monthly stall charges under Paragraphs 2 and 7 hereof with respect to the stalls so relocated. Tenant further acknowledges that should Landlord complete construction of the parking structure, Tenant's allotted parking stalls shall be permanently relocated to said structure and the stall charges payable by Tenant pursuant to Paragraph 7 above shall be adjusted to Sixty-Five Dollars ($65.00) per unreserved stall per month and One Hundred Twenty Dollars ($120.00) per reserved stall per month during the initial seventy-four (74) month Lease Term, thereafter, the stall charges shall be Landlord's asking rates for covered parking from time to time. 2 29 EXHIBIT D TENANT'S INSURANCE The following standards for Tenant's insurance shall be in effect at the Building. Landlord reserves the right to adopt reasonable nondiscriminatory modifications and additions to those standards. Tenant agrees to obtain and present evidence to Landlord that it has fully complied with the insurance requirements. 1. Tenant shall, at its sole cost and expense, commencing on the date Tenant is given access to the Premises for any purpose and during the entire Term, procure, pay for and keep in full force and effect: (i) commercial general liability insurance with respect to the Premises and the operations of or on behalf of Tenant in, on or about the Premises, including but not limited to personal injury, nonowned automobile, blanket contractual, independent contractors, broad form property damage, fire legal liability, products liability (if a product is sold from the Premises), liquor law liability (if alcoholic beverages are sold, served or consumed within the Premises), and cross liability and severability of interest clauses, which policy(ies) shall be written on an "occurrence" basis and for not less than $2,000,000 combined single limit (with a $50,000 minimum limit on fire legal liability) per occurrence for bodily injury, death, and property damage liability, or the current limit of liability carried by Tenant, whichever is greater, and subject to such increases in amounts as Landlord may determine from time to time; (ii) workers' compensation insurance coverage as required by law, together with employers' liability insurance coverage; (iii) with respect to improvements, alterations, and the like required or permitted to be made by Tenant under this Lease, builder's all-risk insurance, in amounts satisfactory to Landlord; (iv) insurance against fire, vandalism, malicious mischief and such other additional perils as may be included in a standard "all risk" form, insuring the leasehold improvements, trade fixtures, furnishings, equipment and items of personal property in the Premises, in an amount equal to not less than ninety percent (90%) of their actual replacement cost (with replacement cost endorsement), which policy shall also include loss of income/business interruption/extra expense coverage in an amount not less than nine months loss of income from Tenant's business in the Premises. In no event shall the limits of any policy be considered as limiting the liability of Tenant under this Lease. 2. All policies of insurance required to be carried by Tenant pursuant to this Exhibit shall be written by responsible insurance companies authorized to do business in the State of California and with a general policyholder rating of not less than "A" and financial rating of not less than "X" in the most current Best's Insurance Report. Any insurance required of Tenant may be furnished by Tenant under any blanket policy carried by it or under a separate policy. A certificate of insurance, certifying that the policy has been issued, provides the coverage required by this Exhibit and contains the required provisions, together with endorsements acceptable to Landlord evidencing the waiver of subrogation and additional insured provisions required under Paragraph 3 below, shall be delivered to Landlord prior to the date Tenant is given the right of possession of the Premises. Proper evidence of the renewal of any insurance coverage shall also be delivered to Landlord not less than thirty (30) days prior to the expiration of the coverage. Landlord may at any time, and from time to time, inspect and/or copy any and all insurance policies required by this Lease. 3. Unless otherwise provided below, each policy evidencing insurance required to be carried by Tenant pursuant to this Exhibit shall contain the following provisions and/or clauses satisfactory to Landlord: (i) with respect to Tenant's commercial general liability insurance, a provision that the policy and the coverage provided shall be primary and that any coverage carried by Landlord shall be excess and noncontributory, together with a provision including Landlord and any other parties in interest designated by Landlord as additional insureds; (ii) a waiver by the insurer of any right to subrogation against Landlord, its agents, employees, contractors and representatives which arises or might arise by reason of any payment under the policy or by reason of any act or omission of Landlord, its agents, employees, contractors or representatives; and (iii) a provision that the insurer will not cancel or change the coverage provided by the policy without first giving Landlord thirty (30) days prior written notice. 4. In the event that Tenant fails to procure, maintain and/or pay for, at the times and for the durations specified in this Exhibit, any insurance required by this Exhibit, or fails to carry insurance required by any governmental authority, Landlord may at its election procure that insurance and pay the premiums, in which event Tenant shall repay Landlord all sums paid by Landlord, together with interest at the maximum rate permitted by law and any related costs or expenses incurred by Landlord, within ten (10) days following Landlord's written demand to Tenant. NOTICE TO TENANT: IN ACCORDANCE WITH THE TERMS OF THIS LEASE, TENANT MUST PROVIDE EVIDENCE OF THE REQUIRED INSURANCE TO LANDLORD'S MANAGEMENT AGENT PRIOR TO OCCUPANCY OF THE PREMISES. 1 30 EXHIBIT E RULES AND REGULATIONS The following Rules and Regulations shall be in effect at the Building. Landlord reserves the right to adopt reasonable nondiscriminatory modifications and additions at any time. In the case of any conflict between these regulations and the Lease, the Lease shall be controlling. 1. Except with the prior written consent of Landlord, Tenant shall not sell, or permit the retail sale of, newspapers, magazines, periodicals, or theater tickets, in or from the Premises, nor shall Tenant carry on, or permit or allow any employee or other person to carry on, the business of stenography, typewriting or any similar business in or from the Premises for the service or accommodation of occupants of any other portion of the Building. Tenant shall not allow the Premises to be utilized for any manufacturing of any kind, or the business of a public barber shop, beauty parlor, or a manicuring and chiropodist business, or any business other than that specifically provided for in the Lease. 2. The sidewalks, halls, passages, elevators, stairways, and other common areas shall not be obstructed by Tenant or used by it for storage or for any purpose other than for ingress to and egress from the Premises. The halls, passages, entrances, elevators, stairways, balconies and roof are not for the use of the general public, and Landlord shall in all cases retain the right to control and prevent access to those areas of all persons whose presence, in the judgment of Landlord, shall be prejudicial to the safety, character, reputation and interests of the Building and its tenants. Nothing contained in this Lease shall be construed to prevent access to persons with whom Tenant normally deals only for the purpose of conducting its business on the Premises (such as clients, customers, office suppliers and equipment vendors and the like) unless those persons are engaged in illegal activities. Neither Tenant nor any employee or contractor of Tenant shall go upon the roof of the Building without the prior written consent of Landlord. 3. The sashes, sash doors, windows, glass lights, solar film and/or screen, and any lights or skylights that reflect or admit light into the halls or other places of the Building shall not be covered or obstructed. The toilet rooms, water and wash closets and other water apparatus shall not be used for any purpose other than that for which they were constructed, and no foreign substance of any kind shall be thrown in those facilities, and the expense of any breakage, stoppage or damage resulting from the violation of this rule shall be borne by Tenant. 4. No sign, advertisement or notice visible from the exterior of the Premises shall be inscribed, painted or affixed by Tenant on any part of the Building or the Premises without the prior written consent of Landlord. If Landlord shall have given its consent at any time, whether before or after the execution of this Lease, that consent shall in no way operate as a waiver or release of any of the provisions of this Lease, and shall be deemed to relate only to the particular sign, advertisement or notice so consented to by Landlord and shall not be construed as dispensing with the necessity of obtaining the specific written consent of Landlord with respect to any subsequent sign, advertisement or notice. If Landlord, by a notice in writing to Tenant, shall object to any curtain, blind, tinting, shade or screen attached to, or hung in, or used in connection with, any window or door of the Premises, the use of that curtain, blind, tinting, shade or screen shall be immediately discontinued and removed by Tenant. No awnings shall be permitted on any part of the Premises. 5. Tenant shall not do or permit anything to be done in the Premises, or bring or keep anything in the Premises, which shall in any way increase the rate of fire insurance on the Building, or on the property kept in the Building, or obstruct or interfere with the rights of other tenants, or in any way injure or annoy them, or conflict with the regulations of the Fire Department or the fire laws, or with any insurance policy upon the Building, or any portion of the Building or its contents, or with any rules and ordinances established by the Board of Health or other governmental authority. 6. The installation and location of any unusually heavy equipment in the Premises, including without limitation file storage units, safes and electronic data processing equipment, shall require the prior written approval of Landlord. Landlord may restrict the weight and position of any equipment that may exceed the weight load limits for the structure of the Building, and may further require, at Tenant's expense, the reinforcement of any flooring on which such equipment may be placed and/or an engineering study to be performed to determine whether the equipment may safely be installed in the Building and the necessity of any reinforcement. The moving of large or heavy objects shall occur only between those hours as may be designated by, and only upon previous written notice to, Landlord, and the persons employed to move those objects in or out of the Building must be reasonably acceptable to Landlord. No freight, furniture or bulky matter of any description shall be received into or moved out of the lobby of the Building or carried in any elevator other than the freight elevator designated by Landlord unless approved in writing by Landlord. 7. Landlord shall clean the Premises as provided in the Lease, and except with the written consent of Landlord, no person or persons other than those approved by Landlord will be permitted to enter the Building for that purpose. Tenant shall not cause unnecessary labor by reason of Tenant's carelessness and indifference in the preservation of good order and cleanliness. Landlord shall not be responsible to Tenant or its employees for loss or damage to property in connection with the provision of janitorial services by third party contractors. 1 31 8. Tenant shall not sweep or throw, or permit to be swept or thrown, from the Premises any dirt or other substance into any of the corridors or halls or elevators, or out of the doors or windows or stairways of the Building, and Tenant shall not use, keep or permit to be used or kept any foul or noxious gas or substance in the Premises, or permit or suffer the Premises to be occupied or used in a manner offensive or objectionable to Landlord or other occupants of the Building by reason of noise, odors and/or vibrations, or interfere in any way with other tenants or those having business with other tenants, nor shall any animals or birds be kept by Tenant in or about the Building. Smoking or carrying of lighted cigars, cigarettes, pipes or similar products anywhere within the Premises or Building is strictly prohibited, and Landlord may enforce such prohibition pursuant to Landlord's leasehold remedies. Smoking is permitted outside the Building and within the project only in areas designated by Landlord. 9. No cooking shall be done or permitted by Tenant on the Premises, except pursuant to the normal use of a U.L. approved microwave oven and coffee maker for the benefit of Tenant's employees and invitees, nor shall the Premises be used for lodging. 10. Tenant shall not use or keep in the Building any kerosene, gasoline, or inflammable fluid or any other illuminating material, or use any method of heating other than that supplied by Landlord. 11. If Tenant desires telephone, telegraph, burglar alarm or similar connections, Landlord will direct electricians as to where and how the wires are to be introduced. No boring or cutting for wires or otherwise shall be made without directions from Landlord. 12. Upon the termination of its tenancy, Tenant shall deliver to Landlord all the keys to offices, rooms and toilet rooms and all access cards which shall have been furnished to Tenant or which Tenant shall have had made. 13. Tenant shall not mark, drive nails, screw or drill into the partitions, woodwork or plaster or in any way deface the Premises, except to install normal wall hangings. Tenant shall not affix any floor covering to the floor of the Premises in any manner except by a paste, or other material which may easily be removed with water, the use of cement or other similar adhesive materials being expressly prohibited. The method of affixing any floor covering shall be subject to approval by Landlord. The expense of repairing any damage resulting from a violation of this rule shall be borne by Tenant. 14. On Saturdays, Sundays and legal holidays, and on other days between the hours of 6:00 p.m. and 8:00 a.m., access to the Building, or to the halls, corridors, elevators or stairways in the Building, or to the Premises, may be refused unless the person seeking access complies with any access control system that Landlord may establish. Landlord shall in no case be liable for damages for the admission to or exclusion from the Building of any person whom Landlord has the right to exclude under Rules 2 or 18 of this Exhibit. In case of invasion, mob, riot, public excitement, or other commotion, or in the event of any other situation reasonably requiring the evacuation of the Building, Landlord reserves the right at its election and without liability to Tenant to prevent access to the Building by closing the doors or otherwise, for the safety of the tenants and protection of property in the Building. 15. Tenant shall be responsible for protecting the Premises from theft, which includes keeping doors and other means of entry closed and securely locked. Tenant shall cause all water faucets or water apparatus to be shut off before Tenant or Tenant's employees leave the Building, and that all electricity, gas or air shall likewise be shut off, so as to prevent waste or damage, and for any default or carelessness Tenant shall make good all injuries sustained by other tenants or occupants of the Building or Landlord. 16. Tenant shall not alter any lock or install a new or additional lock or any bolt on any door of the Premises without the prior written consent of Landlord. If Landlord gives its consent, Tenant shall in each case promptly furnish Landlord with a key for any new or altered lock. 17. Tenant shall not install equipment, such as but not limited to electronic tabulating or computer equipment, requiring electrical or air conditioning service in excess of that to be provided by Landlord under the Lease except in accordance with Exhibit B. 18. Landlord shall have full and absolute authority to regulate or prohibit the entrance to the Premises of any vendor, supplier, purveyor, petitioner, proselytizer or other similar person. In the event any such person is a guest or invitee of Tenant, Tenant shall notify Landlord in advance of each desired entry, and Landlord shall authorize the person so designated to enter the Premises, provided that in the sole and absolute discretionary judgment of Landlord, such person will not be involved in general solicitation activities, or the proselytizing, petitioning, or disturbance of other tenants or their customers or invitees, or engaged or likely to engage in conduct which may in Landlord's opinion distract from the use of the Premises for its intended purpose. Notwithstanding the foregoing, Landlord reserves the absolute right and discretion to limit or prevent access to the Buildings by any food or beverage vendor, whether or not invited by Tenant, and Landlord may condition such access upon the vendor's execution of an entry permit agreement which may contain provisions for insurance coverage and/or the payment of a fee to Landlord. 2 32 19. Tenant shall be required to utilize the third party contractor designated by Landlord for the Building to provide any telephone wiring services from the minimum point of entry of the telephone cable in the Building to the Premises. Notwithstanding the foregoing, however, in the event Tenant does not have a telephone switch within the Premises, Tenant may, with Landlord's approval and supervision, use a trained contractor to provide such wiring services, but only from the Premises to the telephone room on the floor on which the Premises are situated. 20. Landlord may from time to time grant tenants individual and temporary variances from these Rules, provided that any variance does not have a material adverse effect on the use and enjoyment of the Premises by Tenant. 3 EX-23.1 7 CONSENT OF DELOITTE & TOUCHE LLP 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE To the Board of Directors and Stockholders of Quest Software, Inc. and subsidiaries We consent to the use in Amendment No. 2 to Registration Statement No. 333-80543 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 July 21, 1999 EX-27.1 8 FINANCIAL DATA SCHEDULE
5 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 11,777,000 0 11,629,000 1,182,000 0 24,030,000 4,536,000 2,245,000 27,468,000 20,879,000 0 25,340,000 0 4,306,000 (28,751,000) 27,468,000 21,365,000 28,289,000 1,404,000 3,142,000 22,956,000 0 0 2,273,000 959,000 1,314,000 0 0 0 1,314,000 .03 .02
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